I am taking a course called the United Kingdom Economy and Financial Systems and today my class is heading to the Bank of England Museum for a tour.  I was really excited to see one of the main landmarks surrounding London’s Financial System, however, I was not expecting the surprise that was about to occur.  My class was sitting in a small theater in museum listening to our tour guide discuss the various duties of the Bank of England.  She put on a short video about inflation and how the Bank of England sets the interest rates in order to make sure the economy is running smoothly.  After the video, she addressed the class saying that with a great surprise the Governor of the Bank of England, Mervyn Allister King, was going to talk to our class.  It was also extremely significant to have him talk to us on this date of February 16, 2010 because he recently had to write a letter to the Chancellor discussing why the Bank of England missed the inflation target of 2% (The Bank of England has an error mark of plus or minus 1% which creates a range of 1%-3% inflation).  The inflation for the current period was at 3.5% missing the mark by 0.5%.  Mr. King claimed that the mark was missed by a decrease in the VAT tax (due to the recession in order to stimulate spending), and a recent rise in the VAT tax which ultimately raised prices.  He viewed this as a short-term spike and expects the market to re-balance in the near future.  Mr. King spent 40 minutes with the group answering various questions from my classmates.  Recently, I was discussing with my roommate the significance the Greek Market is having on the Euro as well as the Global Economy, and how that might affect future growth.  I thought that it would be interesting to hear the Governor’s reaction to the ordeal, so I asked the question, ” With the current scare of Greece defaulting on their bonds, how might this impact the Bank of England’s monetary policy as well as the Global economy?”  His response lasted for about five minutes, where he had four main points:  He doesn’t see England or the United States banking systems being effected by Greece’s future bond defaults (if that were to occur), the European Union cannot back Greece’s Bonds because it would allow other countries in the European Union more freedom in their monetary policies due to the security of the backing, the Euro will weaken due to Greece’s instabilities, and no Monetary Union has succeeded unless there is a Political Union holding the countries accountable (i.e. the United States).  I was extremely surprised to hear that he doesn’t feel the banking systems here in the United Kingdom, nor in the United States will be effected.  Although it is comforting to hear this from an investor’s perspective, I am still weary that speculation will play an overpowering role in the near future affecting stock and bond prices even if there is no real effect in the banking system.  All in all, it was a pleasure hearing one of the leaders in the financial community speak regarding the current financial status.

Emerging markets are continuing to be a “hot spot” for investors. Brazil is one of the leading countries attracting capital to its borders. The improving Brazilian Economy is justified by recent data presented by the Banco Central Do Brasil. The Public Sector Net Trend is down from as much as debt being 58% of GDP in 2002 to 37.6% in the first quarter of 2009. It is projected to be at 32.8% by the year 2013. Brazil also is trading at a surplus; exporting $25.6 billion more goods than the country is importing. Brazil exports diversely, with the US only accounting for 13.2% of of Brazil’s total exports. Other percentage of exporting by region include 21% in Asia, 22.9% in Europe, 24.6% in Latin America and the Caribbean, and 18.2% in other regions. Contrary to belief, 40% of Brazil’s exports are primary goods; iron ore, food, oil, tobacco. Nearly 45% of goods exported are finished products including buses, cars, tractors, and planes. Brazil’s credit market has grown significantly, with household credit gaining 18.7% and corporate credit 22.7%.

Some ways to capitalize on Brazil’s growth are to invest in:

• ETF: iShares MSCI Brazil Index (EWZ)

• Banco Bradesco (BBD)

• Itau Unibanco Holding SA (ITUB)

The Shanghai Composite has fallen 12.4% off of its high on August 4^th of this year. Since the beginning of the year, the Shanghai Composite has almost doubled; going from just over 1800 points in January to almost 3500 points in early August. Since the Chinese economy is considered to be the leader in global growth, what does this mean for the US equity market?

For the month of August, the US markets have shown great signs of improvements with the DJIA up 3%. Yet, with the recent sell off today are we beginning to follow suit with the Shanghai composite? Or will the US economy be the first to recover from this devastating recession?

The positive news release from the Federal Government might suggest that the US may be the forerunners in coming out of the recession. The unemployment rate has declined to 9.4%, manufacturing orders are on the rise up 4.1% in July, not to mention that housing sales have risen for the past five months. This boost has led banks to repay TARP loans which will allow the treasury to $109 billion less than what was previously expected during the third quarter.

The BEA also happened to revise the GDP statistics and found two interesting implications regarding the current recession.  First, for the year 2008, the GDP actually contracted 1.9% which more than doubles the previous estimate of a .8% contraction.  This brings the total cumulative decline in 2008 to 2.8%.  This would confirm that the current recession is the worst recession since the 1930s.  Second, the growth rate for the first quarter of 2008, which was previously stated as being a .9% increase in GDP, is now stated to have a -.7% decrease.  Since “a recession is defined as two consecutive negative quarters,” the new information accurately depicts the recession starting at the beginning of the year 2008, right after the business cycle peak, compared to starting 6 months later which was previously thought. 

Information gathered from SeekingAlpha.com, Jeffrey Frankel

On July 10, 2009, AQR Capital Management launched the AQR Momentum indices. The AQR Momentum indices capture the returns of stocks that have positive “momentum.” For a stock to be considered to have positive momentum, it must outperform fellow competitors on a relative basis over the recent past. The three indices included are AQR Momentum Index, AQR Small Cap Momentum Index, and AQR International Momentum Index.

In contrast to the current market hypothesis which states that past performance does not guarantee future results, researchers have noticed that stocks with positive momentum tend to out-perform market averages in the following months. “When the world thinks about diversifying portfolios, the conventional approach has been to think in terms of two style dimensions – value versus growth, and large cap versus small cap. However, there is another dimension which is just as important in explaining returns, and has been largely under-allocated given the current two-style investment paradigm; this is momentum,” said David G. Kabiller, CFA, Founding Principal and Head of Client Strategies at AQR. The advantage of the new AQR Momentum Indices is they provide a transparent way of capturing the momentum effect.

The indices are rebalanced quarterly and include stocks that rank in the top third of their relevant section based on the momentum from the previous year. AQR is also launching three mutual funds to go along with the AQR Momentum Indices which include the AQR Momentum Fund, AQR Small Cap Momentum Fund, and the AQR International Momentum Fund.

Information Provided by AQR Capital Management

• Small Cap Momentum Fund
• International Momentum Fund
• Momentum Index

Solution: 

Inflation, on average, is about 3% per year.  So make sure the return on your investments is beating the inflation rates.  If your investments return a lower percentage than the inflation rate, you are losing money even though you have more money than you started with.  Keeping up with inflation is essential in order to make sure your purchasing power increases.

I would like to talk today about the advantages of putting your money into a retirement plan called a 401k. 401ks are offered through many employers. 401k programs allow you to automatically deduct a certain amount from your paycheck (reducing the amount that is then taxed by the federal and state government) which are then deposited into this savings vehicle. If you work for a company that has a “matching” principal program, this can be extremely beneficial allowing savings to grow rapidly. This type of program allows the employer to add a “match” to your contributions into the retirement plan up to a certain percentage of of your salary. This basically gives you at least a double return on investment due to your employer’s contributions; some companies may even offer more than your contibution. Money placed in a 401k is “tax free” which means that your net paycheck income is reduced (by the amount you contribute to the 401k plan) so you don’t pay taxes on the money going toward the retirement fund until you withdraw the money out of the account later in your life. The money is then taxed at the income tax rate you would normally pay as a senior citizen (typically much less than during your peak earning years). Using the theory of compounding (steadily increasing money saved at interest rates over many years) this system essentially allows accumulation of cash along with significant tax advantages of taking the money out of the account at a time in your life when you will be taxed at lower rates (keeping more money in your pocket).

To illustrate how this works, suppose you decide that you would like to invest an amount of $500 per month. You have a choice to either a) take the money and invest it in individual stocks or b) put the money into your 401k. In option a) the money taken out of the paycheck is already taxed before it is given to you in either a check or direct deposit to your bank account. If we assume that during your peak earning years you will be taxed at a rate close to (33%) , this would leave you an amount of $333 net. However, if you instead chose option b), the money directed into a 401k is not taxed before being placed into these accounts. When added to an employer matching prorgram (we’ll assume 100% match), our investment will now increase in value by 100% (for example you invest 4% and your company matches another 4%). This would result in a $1000 investment instead of a $333 investment (considering an income tax percentage of 33%). The difference would be a loss of $667. So in order for your personal investment to equal that of the 401k, the investment vehicle you choose, whether a stock, bond, etc., must triple in value. This is tough to achieve by even the most well educated/experienced stock managers. Bottom line, this should be a no brainer for anyone with access to these vehicles by their employers.

As we have recently witnessed, even 401k’s can be problematic; but this is unusual. One way that a 401k can lose its entire value, is if you invested it in a “one company” stock 401k program. For instance, Enron coaxed its employees to invest in such a program. This seemed like a really good deal because the past performance seemed to display future gains. However, it created a lot of risk due to the lack of diversity. The best way to make sure that this does not happen would be to invest in a 401k program that involves mutual funds. Mutual funds include a diverse range of stocks, bonds, and other investment vehicles allowing for “downs” in one stock to be offset by “gains” in others; overall, typically creating a steady gain over time Preferably mutual funds with no entrance or exit fees, a low turnover ratio and expense percentage are the most attractive. This reduces the risk of losing money put aside in your 401k, due to the abundance of companies and diversity in a particular mutual fund.

In some cases people mayneed money before their anticipated retirement. The great thing about a 401k is that you may withdraw a set amount without having to pay a penalty (depending on fund rules..which you should ALWAYS read carefully).. If we assume that the average return of the market for the past 80 years is 10% on large cap company stocks in the S&P 500, even if you remove say 5% of your money each year, your money will usually still allowed to grow ( This will allow you to receive some income from your retirement package early while still increasing your 401k’s value (albeit slower than if you do not withdraw the money earlier). One added word of caution here: there may be tax disadvantages to this (depending on your age and tax bracket) which is why most investment professionals discourage this practice unless absolutely necessary. I do believe that investing in your company’s 401k plan has been proven to increase your assets while reducing the risk of losing value on those assets. The key to the 401k technique is to reduce the systematic risk of your portfolio so that you can live a comfortable life in the future.

If you work for a company that does not have a retirement plan, or matching principle, you may be better off trading on the market (doing your own investing). However, this can be extremely time consuming to do. There are tricks to picking probable gainers in the stock market and even the best financial managers lose money. Like the cliché “hindsight is 20/20”, most individual investors pick stocks based on PAST (historical) performance. No financial professional can guarantees a profit on any investment you make. Strategies for investing are everywhere and there is no shortage of slick financial professionals that will “help you manage your money” While most are honest, many are not. Only recently has there been much light shed (and literature) about the greed and dishonesty in the financial industry. Hopefully, this will serve a good lesson for all investors to educate themselves and add transparency to the dealings of financial professionals. As we have learned from the recession today, nothing is predictable. Who would have thought that the largest automobile manufacturer in the world would go bankrupt? Like any good investment, consumer financial education, ongoing supervision of your financial products, consultation with professionals (not paid to sell individual products) and “asking lots of questions” is sound advice to those willing to manage their own money.

Feel free to comment and post your opinion or questions. Thanks for reading!

Written by Mathew Spencer

Edited by Dr. Michelle Nypaver

I was talking to my grandfather the other day, and he asked me why bonds decrease in value when interest rates increase. It didn’t make sense to him because he thought the bond value and interest rate would have the same correlation, meaning when one goes up the other goes up as well. This is a confusing topic that some investors might not fully understand. I am going to explain the inverse correlation to help create a better understanding of this concept.

The first key factor in understanding this issue is that the interest rate on the bond is fixed and will not fluctuate based on the market value. However, the price of the bond that a person is willing to pay can vary. So let’s say you put $1000 into a bond at a fixed interest rate of 5%. This would result in an interest payment of $50. A few months later, the market value of the bond increases 6%. If you were going to sell the bond, a buyer would not accept the deal unless the interest rate matches the market value. Since the interest rate on the bond is fixed at 5%, you must discount the bond to $833 in order to result in the interest payment of $50 ($833 X 6%), thus causing the bond to decrease in value while the interest rate has increased. The same is true for the inverse, if the market interest rate decreases, the value of the bond would increase and you would be able to sell the bond at a premium.

I hope that this would clear up any confusion on the matter. Please feel free to comment and add your financial knowledge.

Paying yourself first, means putting money aside for your financial goals before you spend that money on unneeded items. For instance, you might be looking to save money for a down payment on a dream house, your children’s education, or even retirement, but instead, you purchase Starbucks coffee and Burger King Whoppers. The money you can save by purchasing cheaper alternatives, such as going to the grocery store, could substantially change your investment outlook. In order to achieve your financial goals you should follow three simple steps.

The first step in paying yourself first, is to actually set a financial goal. Whether you are saving for a house or your children’s education, having a goal will help motivate you to stay on track to achieve your financial dreams.

The second step is to create a written budget, so that you can track your expenditures each month. You’ll want to track exactly how you spend your money from each paycheck. The money left over, after you’ve paid for the necessities such as food and utilities, can be divided between “extra” spending money and your savings.

The final step in paying yourself first, is to commit to setting aside a consistent amount from each paycheck, which you’ll put directly into savings. It’s recommended to save a consistent percentage of every paycheck. This practice will help to develop a healthy habit, making it easier to save in future years. The amount you decide to save will be dependent on your family and current financial situation.

Let’s review: In order to be successful at Paying Yourself First, you need to set financial goals, keep a record of all your monthly expenditures, and put a consistent amount of your paycheck into your savings account each month. The importance of paying yourself first is that you start saving. Any amount will help, even if it’s just $2 a day, which can accumulate to $730 a year. Developing a habit of saving will definitely pay off down the road.