My DIY ROP Life Insurance Policy

As you know, I'm currently in the process of purchasing a $500,000 term life policy for the benefit of my sister, who has recently taken in my parents. I had my medical exam last Friday and Accuquote just confirmed that it received my application. I'm told the underwriting process takes about 4 to 6 weeks, so I should be getting my policy by my next birthday. (Gaaaaaah. I share the same birthday as Michael Vick?? Ugh.)

*Ahem* I digress.

Assuming that my health exam results are "excellent", my annual premium for a basic term life policy should be $595, or about $50/month. I was also quoted $1,250/year, or, $104.17/month for a Return of Premium ("ROP") policy.

ROP policies will allow term life insurance policyholders to recover all or part of their premiums paid over the life of the if they do not die during the stated term. Basically, with an ROP policy, I'll be paying an insurance company $104.17/month now, to get back $104.17/month 30 years later. (By my calculation, the yield on the additional ROP premiums would be about ~3.98% APY over 360 months.)

Any claim that the net cost under an ROP policy is zero, ignores opportunity costs or illiquidity. More importantly, the additional premiums are wasted if the policyholder does die during the term.

This site gives an objective explanation of the pros and cons of ROP policies. But ultimately, I think the most compelling argument against the ROP policy is:

"Why Shouldn't I Get ROP Term Life Insurance?

The main reason people don't get ROP term life insurance is that it costs more. It can cost up to three times as much as term life insurance.

Some financial advisors also suggest that if you can afford ROP life insurance, then you should consider getting regular term life insurance and investing the difference."

Although I'm convinced that the ROP policy is not worth it, I'm intrigued about getting a "refund" of my premiums. I wondered whether I can DIY my own ROP policy?

Confession: Although I have enough money to pay this year's premium, I just realized that I don't have enough room in my monthly budget to pay for subsequent years' premiums. In order to pay for my life insurance policy, I'll need to reduce my monthly student loan payments from $1,478/month to $1,373/month (for the "pretend" ROP policy), or, $1,428/month (for the basic term life policy).

My Plan: I immediately set aside $595 for my basic life insurance premium and an additional $660 for my hypothetical ROP premium for this year. I created a sub-account in my Smartypig account (2.01% APY) specifically to park my "pretend" ROP premium. I also adjusted my budget by reducing my SL payments to $1,373/month. I plan to save and/or invest the additional $55/month "pretend" ROP premiums.

I can already hear the trolls - - "The extra $55/month is better spent paying down your ginormous student loans!! You're such an idiot. No wonder you got yourself in such a horrendous financial hole." And quite frankly, I can't argue with the trolls, since they're right. My private SLs have an APR of 3.547% and are likely to go higher in the upcoming months. But I want to point out that I banked this year's "pretend" ROP premiums from my future spending earmarks, not from my emergency fund or future student loan payments. So I don't want to hear how paying down 3.547% APR is better than banking at 2.01% APY. I get it. I really do.

And I've decided to proceed with my DIY ROP plan because I'll still be able to pay off my private SLs in 2 years with or without the additional $55/month. (Even at the reduced $1,373/month payment, I'll be paying over 3 times the minimum monthly payments owed on my private SLs and over twice the minimum monthly payments on all of my SLs combined.) But the biggest reason why I'm doing this now is because I highly doubt I'll remember to start setting aside my "pretend" ROP premiums several years down the road when I payoff my SLs.

Although I parked this year's "pretend" ROP premiums into a savings account, I intend to dollar cost average my future monthly hypothetical premiums into my Fidelity non-deductible IRA account with commission-free ETFs. In essence, my gamble is whether my "pretend" ROP investments can match or beat 3.98% APR, or even 3.547% APR.

Only time will tell...

Happy With My New Fidelity IRA

On February 3, 2010, Fidelity Investments offered commission-free trades on 25 iShares ETFs. As a small investor and a die-hard, dollar-cost averager, this intrigued me. My biggest obstacle to dollar-cost averaging ETFs was brokerage firms' commission fees. Even at low-commission fee Scottrade, I would need to buy $700+ of any one ETF in order to limit my commissions to 1%.

If I had $700+ to invest monthly, I wouldn't care too much about brokerage commission fees. But alas, since most of my income is going towards paying down student loans and my 401k, I don't have that kind of money to play with invest. (Some day, though, some day.)

Anyhow, I was happy to see that Fidelity was offering TIP commission-free. (I currently have 10 shares of TIP in my Scottrade accounts.) I was even more excited that EEM (MSCI emerging market fund), IVW (S&P500 growth fund), LQD (investment grade corporate bond fund) and EMB (emerging markets bond fund) were also offered commission-free. I was sold.

Traditional v. Roth?
I chose to open a Traditional, non-deductible IRA. Although I expect my 2010 AGI to be below the $105,000 - $120,000 threshold, it may not be if I get laid off at the end of the year and am given my lump-sum severance. In order to avoid the headaches of a potential re-characterization from a Roth to a Traditional IRA and coverting it back to a Roth, I just chose to open a Traditional IRA and convert it a Roth next year.

Open Account With $2,500 or $200/month?
Since I intend to dollar cost average over the year, I chose the SimpleStart IRA process which waives the usual $2,500 minimum investment in lieu of $200 monthly automatic contributions.

I chose to invest $220/month and keep the rest of the money in my numerous "high" interest-bearing savings accounts. Fidelity offers an FDIC-insured, deposit sweep, but it's currently earning 0.10%. That's pretty much close to nothing.

DRIP Feature
I've currently elected to invest solely in income funds in my IRAs to create a source of tax-free, passive income stream in my retirement. I figure that since I'm not presently investing much money in my IRA (in comparison to my 401k), I'm not sacrificing that much potential growth for safety.

For the first two months, I bought couple shares each of LQD and EMB. They both pay out about $.40/share in dividends per month. I was delighted to learn that my Fidelity account also has a DRIP feature which would reinvest my dividends into the ETFs. (I don't think my Scottrade accounts have this feature.)

With the DRIP, I earned an extra 0.005 share of EMB and an extra 0.004 share of LQD and should be getting more at the end of the month. Woo hoo!!

All in all, I'm happy with my new Fidelity account. I'll be the first to admit that the iShares ETFs aren't my first choice, but if I want to dollar-cost average, this is currently my best option. If I can find additional monies to invest, I'd also eventually like to add growth fund ETFs into the mix. My 401k is woefully lacking in growth funds and this may be a great way for me to diversify.

Sold 8 Shares of My Company Stock for a Loss and I’m Okay

I sold some of my company stock at a loss yesterday but I’m okay with it. Here’s (my long-winded explanation) why:

I’m currently reverse-arbitraging a 0% credit card promotional rate that is set to expire on 10/28/09. As of 5/31/09, my credit card balance is $11,574.08, and every month, I pay $122 to my credit card company and stash away $931 into my DollarSavingsDirect savings account that pays 2.0% APY in interest. I’ve so far saved $4,313.08 and at this rate, I’ll be $2,000 short in paying off my credit card balance by October.

I was never worried about the shortfall since knew I was going to make it up by selling some of my company stock that I’ve purchased through my company ESOP plan. The only open issues were: (a) when do I sell my company stock and (b) at what price? I was hoping that I could sell 7 shares for about $285 - $290/share. If so, I can make a small profit AND pay off my credit card debt.

But as they say, the best laid plans of mice and men go oft astray. *Sigh*

Right now, the stock is trading in the $250 - $265/share range but it looks like it’s incrementally trending lower. It also looks like options traders are buying protection between $230 - $280/share range with the October contracts. Great. I potentially have a $20/share downside or a potential $30/share upside if I wait.



I’ve always said I suck at stock trading. (I suck worse at dating, but that’s a topic for whole ‘nother blog.) And to be fair, Peter Lynch allegedly said something to the effect that a good stock picker will only be right six times out of 10. The corollary is that a good stock picker will also be wrong four times out of 10.

Since I can’t predict the future and I need the money, I decided to bite the bullet and sold 8 shares of my company stock for $250.79/share. My total net loss from this transaction is $305.98. I generally don’t like selling stocks (especially good stocks) at a loss, but I’m not too upset about it. Why?

1. Money I need in the next 5 to 10 years, much less money I need in the next 4 months, shouldn’t be in the stock market.
   
2. I can harvest the loss from this sale to reduce my capital gains tax on a $405.91 profit I realized in a prior stock sale earlier this year.
   
3. Since I purchased the stock through an ESOP, my actual contribution was $1,409.72 (and my company matched $896.59). So if you only take my own contributions into account, I’ve actually come out ahead by about $596.60 (minus taxes I paid on the company match.)

I’ve sold my company stocks in the past to pay off debts before and hopefully this will be the last I’ll ever need to do so. I’m pretty confident that all of my future stock purchases from hereon forward will serve its intended purpose –- as my long term nest egg.

Bought 7 Shares of TIP

Update: Oh great. This guy thinks if there's theoretically one type of Treasury bond that the government can default on, it's TIPS.

~~~

I have on ongoing deal with my buddy. (He's co-worker #1 from my prior post.) We joke that we so suck at sports betting and investments, that we'll tell each other about our next bet/investment. For example, if I give my bookie $100 for the Lakers to win the next game, I need to warn him. Based upon my horrendous track record of ALWAYS betting on the wrong horse, he'll just "know" that the Magic will win.

Similarly, if I buy a stock, I need to tell him so he can AVOID that investment since more likely than not, it'll sink like a rock. (Conversely, if I sell, he'll buy since it'll suddenly sky-rocket for no reason.)

I consider today's post as a sort of public service because I bought 7 shares of TIP in my Roth IRA for $101.47/share (ACB $717.29, including $7 trading fee) yesterday. And sure to form, I've already lost money since it's currently worth $708.75.) But I'm not really concerned about the actual value of this ETF. I bought it because it pays out a monthly dividend.... usually.

TIP is the ticker symbol for the iShares ETF "that seeks results that correspond generally to the price and yield performance of the inflation-protected sector of the United States Treasury market as defined by the Barclays Capital U.S. TIPS index. The fund invests at least 90% of the assets in the inflation-protected bonds of its underlying index and at least 95% if the assets in U.S. government bonds. It may also invest up to 10% of assets in U.S. government bonds not included in the underlying index. The fund invests up to 5% of assets in repurchase agreements collateralized by U.S. government obligations and in cash and cash equivalents."

In March 2008, I bought 3 shares of this ETF in my taxable account at $110.31 (ACB $331.23 since no trading fee incurred). Although the ETF value is down 8.2%, it's paid out $18.83 in dividends. This reduced my loss to -2.61%.

Since March 2008, the ETF paid dividends of anywhere between $.33/share to $.93/share. (Note: It didn't pay any dividends during November '08 to March '09, during the whole market crash turmoil, though.) Had I researched this ETF more carefully, I would NOT have purchased it in my taxable account since the monthly dividends make this a tax inefficient investment. So now I've purchased 7 more shares in my Roth.

I don't expect this ETF will be volatile nor do I think it will have much of a downside or an upside. I think it will continue to trade within the narrow price channel of where it is now ($99-$102/share).

So why did I buy it?

1. I'm obsessed with finding an income stream in retirement just in case Social Security goes BK. (I know, I know. Some of you have already commented that some form of Social Security may still be there when I'm over 60. But I'm just hedging my bets. And you know how bad my bets are!) If I accrue TIP and other high-dividend yielding funds in my Roth over the years, I may have some tax-free monthly income that I can supplement my 401k.

2. My spidey senses tell me that inflation is on its way. Maybe not this year and maybe not even next. My private student loan APR has already creeped upwards slightly (3.451% in January to 3.598% in March). The loan rate will be re-setting in July and I'm guessing it'll be higher. Owning TIPS (Treasury Inflation Protected Securities) is one way to hedge against inflation since it pays interest adjusted for inflation, similar to the I-Bond. Unlike purchasing TIPS directly from the Treasury, TIP may not be the perfect way to hedge against inflation, but this is the only way that I know of that I can own TIPS in my Scottrade Roth.

I ask you: Do you think inflation is on its way? What are you doing to protect yourself?

Wanna Bet?

My braniac ex-boyfriend (I'll call him Mr. Spock) and I made a bet yesterday on this question - - Where do you think the S&P 500 will end on the final trading day of 2009?

My guess was $450 (armageddon scenario) to $650 (most likely scenario) to $950 (insanely optimistic scenario). I came up with these figures by looking at the S&P500 20+ year chart and drawing lines at various price points and various time frames.



Mr. Spock's guess was $600 to $800 based upon a much simpler thinking. He figured that most (if not all) of the bad news is baked into the current price of about $700 and a swing of $100 either way is plausible.

Since we are guessing around the same price, we decided to do an over-under bet. He bet that the S&P will end higher than $650 and I bet under. (Keep in mind - - I have a HORRIBLE track record when betting over-under. I hope this is one bet I lose horribly.)

So... what is your bet?

To Harvest Stock Losses or Not...

I purchased Turbo Tax Deluxe from Costco for $49.99 (plus tax) this weekend and I gave it a whirl. I don't have my W-2's or my 1099's yet, but I always try to estimate my potential tax liability in December so that I can start saving up any money that I need to pay by April 15th.



With the exception of last year, I've been fortunate to break even or nearly break even with my taxes (i.e., tax liability less than $100 for both Federal and State taxes). Last year I owed $1,142 in State and Federal taxes due to the fact that I stopped contributing to my 401k to increase revenue and to bring my debt under control. I also sold a bunch of my company stock for a profit, again to pay down my debts.

This year, I contributed to my 401k again which should help reduce my tax liability. But I also sold 14 shares of my company stock for a nice profit.

At this time, Turbo Tax doesn't have my State Forms available yet. (Estimated date of availability 12/30/08.) But based upon my guesstimate of my income and taxes paid, I'll owe about $500 solely on my Federal taxes! If I owe on my Federal, I'll definitely owe on my State taxes. Assuming the $500 estimate is correct, I may owe another $375 in State taxes. I currently have $350 set aside for paying taxes. Like everything else in my life, looks like I'm short yet again. (Story of my life!)

But, if I sell the ETFs (stock ticker: VTI, VEU and TIP) that I purchased in March 2008 for a short-term loss, my Federal tax liability goes down to about $386 and the sales proceed will help gap the estimated tax shortfall. This may be a viable option but I'll need to act before 12/31/08.

To be frankly honest, I wouldn't mind taking the loss to reduce my tax liability. I hate the fact that every time I look at my investments, I'm reminded of the massive losses of the past few months. I can always re-purchase these ETFs at the lower price after 30 days anyways.

But at the same time, I purchased these ETFs with a long-term horizon in mind. I could keep it and dollar-cost average by purchasing additional shares. Maybe I should just suck it up and try to find a way to pay my taxes without selling my ETFs? Dilemmas, dilemmas.

Itching to Gamble, Itching to Invest

My girlfriends and I went on a girls' night out at a local Indian Casino couple Fridays ago. It was a pretty frugal event since my dinner was comp'd by my high-roller friend and I didn't gamble.

Just so you know, it was tough for me not to gamble. I LOVE to gamble. I love the electrifying atmosphere of the casino. I love the electronic sounds of slot machines. I love the sound of poker chips clacking together. I love faking out my poker competition by pretending to be a shy, novice player. (My cover is usually blown when I start trash-talking after winning a pot. Note to Self: Must learn to maintain poker face!) :-P

In addition to the casino, I've been sidelined in the stock market. I haven't invested in the stock market separately from my 401k and my ESOP since my priority right now is to bolster my emergency fund. But I'm DYING to divert some of the my savings into the stock market right now.

Now keep in mind, I've given up on investing in individual stocks. (Exception: I continue to invest in my company stock but only because my employer matches 30% for every dollar I invest.) As a non-professional market trader, I don't have time to valuate stocks by monitoring its fundamentals like P/E ratio, PEG ratio, ROI, ROE, cashflow, etc. I've instead decided a while back that I'm better off investing in a basket of diversified index funds.

If there's anything I've learned in this financial crisis, it's that my 401k alone is an insufficient means to prepare for retirement. One of the reasons is because my 401k doesn't have very good selection of funds. So I'd like to diversify my investments a bit more in my Roth IRA or in my investment account.

For example, I'd really like to diversify my portfolio by investing in:

CATEGORY	SYMBOL	YTD RETURN
Emerging Markets	VWO	-61.23%
REIT	VNQ	-40.85%
Gold	GLD	-14.9%
Utilities	VPU	-33.77%
Health Care	VHT	-27.07%
Natural Resources	IGE	-46.7%

I truly believe that don't know whether these funds are seriously undervalued now and I don't know whether or how soon these funds will rebound. But I am firmly in Warren Buffet's camp. As Warren Buffett wrote: "I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: 'Put your mouth where your money was.' Today my money and my mouth both say equities."

The problem, though, is that as John Maynard Keynes once said: "The market can stay irrational longer than you can stay solvent." With a meager emergency fund, can I afford to take the risk? Unfortunately not. So I'm going to sit this prime buying opportunity out right now. And it's KILLING ME!

I need to keep reminding myself that cost is not a primary reason to buy anything, including stocks and homes. Cost is an element of affordability. If I can't afford it, it really doesn't matter if something is sold at a serious discount, right?

I Opened a Treasury Direct Account!

No, I'm not running for the hills... Yet... (I joke! I joke!) But, the recent stock market crash did give me some food for thought.

Why Buy Bonds?
Investing in bond funds is safer than investing in stocks but this recent stock market crash made me sufficiently concerned that bond funds alone are an insufficient means of providing income as well as capital preservation in retirement.

Suze Orman's book, The Road to Wealth, defines a bond as

[A] debt security, or IOU, issued by a corporation or government agency in exchange for the money you lend it. In most instances, bond issuers agree to repay their loans by a specific date and to make regular interest payments to you until that date. ... With most bonds, the issuer must give you your investment money back, at face value, on the maturity date of the bond.

A bond fund, on the other hand, is

[A] mutual fund that is made up entirely of bonds. Bond funds come in all shapes and sizes, just as bonds do, but the interest rate on a bond fund is not fixed, as it most often is on a single bond. Bond funds pay income every month, however, and investors like knowing they can rely on that check. ... Bond funds do not have a maturity date. ... Because bond funds don't have maturity dates, you can't be sure how much of your original investment you will get back when you sell your shares.

So, in essence, bond funds have the advantage of being more liquid than individual bonds but they don't guarantee the return of your principal.

My bond fund (PTRAX) in my 401k demonstrates this perfectly. PTRAX (PIMCO Total Return/Intermediate-Term Bond Fund) pays dividends regularly, but as of October 18, my cost basis for the fund is $15,848.59 but the current value (including the reinvested dividend) is only $15,107.25 (or, -$741.34, or -4.68%). (Of course, the loss in this bond fund is nothing compared to the losses in my equity funds!)

Why Savings Bonds?
My recent attempt to invest in a short-term California muni-bond was thwarted by the minimum purchase amount. My Scottrade account also has a prohibitive minimum amount of $5,000-$10,000 (and $1,000 increments thereafter) to purchase various bonds.

Sigh... what's a small (and I mean small) investor like me to do?

According to CNN Money's site, U.S. Treasurys are the safest, most liquid investments on the planet next to cash. Per Suze Orman, the U.S. Treasury's Series I Bonds are perfect for non-retirement account money:

1. that you want to keep safe and sound,



2. don't need current income from, and



3. will not need to withdraw for at least 5 years.

Series I bonds have a variable interest rate (4.84% through October 31, 2008) that is tied to the consumer price index (CPI) and thus provide protection against inflation. If inflation goes up, so does the interest rate on these bonds (theoretically).

Many talking heads on CNBC are flappin' their gums about a deflationary economy. But I'm betting that we're headed more towards a '70s-style stagflation. But what do I know? Notwithstanding my bachelor's degree in Economics, I clearly can't read economic tea-leaves (and I still have quite a ways to go to fully fund my emergency fund), so my preference is to only invest a small amount.

The beauty of Series I bonds is that you can purchase the bonds electronically in $25 denominations at TreasuryDirect's website.

Another advantage of the Series I bonds is that the interest on the bonds are tax-deferred until I redeem the bond. Even when I do redeem the bond, I will only have to pay federal tax (all I-bonds are exempt from state income tax, with some exceptions).

For those with little ones, interest earnings on the I-bonds may be excluded from Federal income tax when used to finance education.

The drawback of I-bonds is that I can't redeem the bonds for at least 6 months and I will get penalized with 3 months' interest if I redeem in less than 5 years.

(Please note my disclaimer on the sidebar.)

My Plan
I've been living one pay raise behind this year. Rather than increasing my discretionary spending by the amount of my raise, I've been funneling my raise (approx. $30/paycheck) into my savings. I'll just start investing $25/month in the Series I bond instead.

This will give me some inflation protected income in the future. Perhaps I can use some of the proceeds from the I-bonds as a down payment for my first house. :-D

California's "Craig's List" Sale

Blogger MoneyBeagle previously pointed out that California warned it may need a $7 billion loan from the federal government.

Now, lest you think California is a hobo-state, I'm proud to discover that my magnificent (but broke) home state is offering a $4 billion Revenue Anticipation Note sale between October 16 and October 23. California may not need the $7 billion loan after all! (Okay, so California is doing what we normally do when we're broke -- selling stuff on Craig's List before hitting up mom and dad for a "loan".)

You should really hear Governor Schwarzenegger's radio ad. Who would have thought that when the Terminator said, "Aahll bee baack," it was to hock muni bonds on radio?? This is so awesome!! (Or, is it the sign of the Apocalypse? You be the judge.)

I was intrigued, so I checked out Buy California Bonds' website. The details on the website are very scant so I called a bond broker. There appears to be a couple of insurmountable obstacles (for me) to purchase the California bond:

1. I can only purchase the bond through approved brokerage firms, none with whom I currently have an account.


2. According to a representative I spoke with at Charles Schwab (an approved brokerage firm), he wasn't sure, but believed that I could only purchase the bond in increments of $5,000. This is a bummer since the coupon rate is 5% and the maturity date is June '09. (Please note my disclaimer on the sidebar. I am not warrantying the accuracy of this info!)

As a citizen of California, I wanted to do my good deed to keep my state solvent, but I'm too cash-poor to do so. (Like state, like citizen. Ha ha.)

Oh well. Atleast I tried, right?

It's The End of the World and I Feel Fine

I've been humming REM's song a lot these days. It's no wonder since 60% of those polled think that we're very or somewhat likely to experience another Great Depression.

Whether we're in a recession or depression is really irrelevant when:

1. I'm about to be laid off,
2. my 401k is now down 35% from the end of last year and quickly cascading towards nothing,
3. I only have about 4 months of emergency fund saved up (including my investment account and ESOP), and
4. I'm up to my eyeballs in debt.

When I started writing this post, I was going to question all the relentless cheerleading going on right now by many financial writers who encourage people to stay in stocks despite the cascading market crash, like Liz Pulliam Weston of MSN Money and Brett Arends of WSJ. The advice is rooted in historical data that supports how those who pull out of the stock market during a severe downturn never get back in time to benefit from the rebound.

But as we all know, historical performance doesn't necessarily guarantee future performance. (I even state that in my disclaimer.) What if this market crash is different than before? What if our free market system, our banking system and stock market is irreparably damaged? What if the global community no longer considers the U.S. a safe haven of investments and stop investing in our economy?

I was curled up in a fetal position sucking my thumb until suddenly I just said, "F#(@ it. If I lose it all, I lose it all."

Once I said this to myself, I felt much better. Of course, I have the benefit of knowing I have decades to make up for such a catastrophic loss. But this is a key step to overcoming my fear, particularly my fear of making a mistake. This reminded me of FDR's seminal speech: the only thing I have to fear is fear itself.

A Wall Street Journal article writes:

During the Great Depression, an entire generation became convinced that owning stocks was dangerous.
...
Depression-level stock phobia might be making a comeback. Will you suffer from it or conquer it?
...
First and foremost, Americans are afraid. ... As finance professor Meir Statman of Santa Clara University says, "Fear increases pessimism."
...
[I]t is hard not to be bullish. As an intelligent investor, you must always ask: What is my edge? What information or skill do I possess that the people on the other side of the trade don't? In normal times, that is a high hurdle. Today, however, you need only two things in order to have an automatic edge: cash and courage.

For people who have the courage but not cash (like me, he he), the article recommends rebalancing my investment portfolio by selling a little of anything that's gone up and buying more of whatever's gone down. Since that's already part of my plan, I'll remain on course.

The Wall Street Journal article points out: if you were among the courageous few who bought and held stocks during and after the Depression, you earned spectacular returns.

To be frankly honest, I'm not looking for "spectacular returns". I'll be happy with returns that beat inflation by the time I retire. :-D



Regardless of what the market does today, I wish you all an excellent weekend.

My Feeble (and Meek) Attempt to Short the S&P 500

The Securities and Exchange Commission took the unprecedented step of prohibiting short trading of 799 financial stocks for at least 30 days. It seems short traders are the scapegoats-of-the-moment but this ban expired at 12:01 a.m. this morning.

This reminded me of my feeble attempt to short the S&P 500 (in a very, very, VERY small way) between 2006-2008. It wasn't pretty.

(Note: Before you read on, please note my disclaimer on the sidebar.)

"Short Trader", get it? Never mind....

Why I Attempted to Short the Market
In 2006, I witnessed my SPDR S&P500 ETF (ticker: SPY) that I purchased in October 2001 go up, up and up. I was initially bummed that I didn't buy more between 2001-2003 when it was significantly cheaper.

Eventually, I became worried because I started seeing parallels and similarities (albeit superficial) with existing market conditions and conditions that led to the Great Depression: a President adverse to economic regulations (then Hoover, now Bush), yawning trade gaps, a seemingly endless stock-market boom, cheap money, and over-expansion of credit (then farms, now housing).

The ProFunds family of exchange-traded funds created a bunch of inverse ETFs that target individual economic sectors and broader categories in both the U.S. and abroad. ProShares Ultra Short S&P500 ETF (ticker: SDS) is designed to go up 2% for every 1% the S&P 500 average goes down.

In November 2006, I purchased 3 shares of SDS at $60.50/share (total ACB: $191.49 including $9.99 trading fee). I limited my investment to $200 since I was wary of the concept of “shorting”. I also couldn’t afford more. (He he.)

After I purchased SDS, I watched its value plummet all the way to $48.40/share in October 2007. At the time, I was prepared to lose it all and was relieved I only experimented with $200. But as you are all painfully aware, the market turned in October 2007 and the value of SDS started climbing.

I knew after trading fees were taken into consideration, my break-even price was $67.16/share. For reasons none other than wanting to make a small profit, I placed a limit order of $75/share.

Early 2008, SDS hit a little over $71/share (i.e., above my “break even” selling price) twice, but started going down again. I thought I missed my opportunity to break even and set my target price to $71/ share and later to $70/share.

I guess although I worried about a market crash, I never believed a serious one would materialize. And in my defense, clearly none of the so-called experts on CNBC did either. (Oh... how hindsight is 20-20....)



On 7/7/08, I sold SDS for $70/share.

SDS closed at $97.21/share yesterday. Gaaaaaaaa!!!!

What was my net profit on my $200 investment over a 21-month period?

$8.67 in dividends and a net sale of $8.52 for a net profit of $17.19 (or an equivalent return of 5% APY).

Lessons I’ve Learned

I Suck at Market Timing. Nuff said. :-(

But... I can make money by shorting the market using ETFs even if I can’t time the top and bottom exactly right. The volatility was a killer, though.

Shorting the market was a nerve-wracking and hard way to earn 5% APY. At the time that purchased SDS, ING savings was offering close to 5% APY. With such a small investment amount, I probably would have done just as well putting my money in an online savings account.

I’m "moderately risk averse" to "risk adverse". I set a target for myself at $75/share but lowered it when I thought I missed my opportunity to break even. Had I stuck to my guns, I would have met my target and made a pretty decent profit. But at the same time, I didn’t sell it in a panic when it went down to $48/share.

So based upon this experiment, I’ve given myself a "moderately risk averse" to "risk adverse" grade in risk tolerance. But....

If I am speculating or market timing, invest in smaller increments. I was prepared to lose my entire SDS investment since I only invested $200. But had I invested $2,000, I wonder whether I would have sold the ETF in a panic? (I suspect, “yes”.) All the more reason why if I buy stocks or ETFs based upon market timing, I should keep the investment amounts small.

Limit trading fees up to 2% of investment amount. Since my investment amount was so tiny, TD Ameritrade’s $9.99/trade fees killed most of the profits I realized. But even if I limited the trading fees to 2%, my initial investment would have been 5 times bigger and my return would have been only twice as big. Perhaps when I invest in speculative stocks or ETFs, I am better off investing in smaller increments or, better yet, investing in a $0 fee/market trade account like Zecco.

Short ETFs are not a buy-and-hold investment vehicle, but rather a short-term trading investment. Since I'm more of a passive investor, there's more work and monitoring involved in trading short ETFs than I'd like. Also, if it's a short-term investment, it won’t provide capital gains tax advantages that buy-and-hold stocks have, so that's one less reason to invest in these short ETFs.

Short ETFs Have Inherent Credit Risks. I clearly had no idea what I was investing in other than what it purported to do. This article discusses the risks behind leveraged ETFs that's assets are based upon credit swap agreements.

I think what I'll do now is to take use the proceeds of my SDS sale and plunk it into SPY. Theoretically, when I turn a profit on SPY, I can use the proceeds to purchase SDS in the future. Or am I being too simplistic here? :-D

Mental Health Break - In Search For ANY Good News

I'm scared. I'm scared that I may be laid off during possibly the worst financial crisis in the world. I'm scared that if the current "burn rate" (i.e., selloff) in the stock market continues, my 401k will be worthless in 19 days.

I know I have time on my side so I shouldn't panic. I also know if I dwell on these things, I'm going to drive myself crazy. So, for the sake of my sanity, I've decided to take a break from looking at my 401k/investment account statements for a while.

But why is it that I have this masochistic desire to look at them anyways? I'm just as stupid as the horror movie character who hears a strange noise and goes searching for the source!

Warning: Scene from Return of The Living Dead. This clip has graphic scenes and strong language.

I'm also considering not watching CNBC anymore despite the fact that I'm addicted to it, especially Fast Money. Giving up CNBC is going to be tough, though, since I have a mad crush on Dylan Ratigan. (Blush.)

Finally, as part of my sanity-preservation effort, I've decided to look for some (any) good news. Here's my list:

1. The variable interest rate on my private student loans went down from 5.336% to 4.518%, reducing the monthly minimum payment from $504.91 to $488.85.
   
   Since I'm not strictly following Dave Ramsey's snowball method with respect to my credit card, I'll continue to pay my private student loans $505/month. The fact that I'll be paying more than the minimum on my dreadful student loans makes me happy.




2. This article points out that for the first time since January 1998, consumers paid off more debt than they took on. I certainly fall into that statistic. As the article points out, paying off debts means households will have healthier finances. (Not to be a Negative Nellie here, but is this reduction due to the fact that many people are no longer qualifying for loans?) Regardless, the fact that my savings is going up and my debt is going down makes me happy. Now only if my net worth will go up....




3. My Citibank Ultimate Savings Account's interest rate recently went up from 2.25% to 3.5%. Woo hoo!

If anyone else has some silver lining from this economy to share, I can really use some right now!

It's Official - I'm Losing Money in My 401k

I really hate to start off the week with a downer post but here goes. Since 2001, I've contributed $86,208.64 to my 401k (including my company match). The current value of my 401k is $85,762.41, or -0.52% total return/-0.14% annualized return.

Up until now, I haven't lost any of my contributions. But now that it's fallen below my total contribution amount, I'm feeling a little bit queasy in my stomach.



In my prior post, I discussed the reasoning behind my current 401k target allocations which are:

Investment Fund (Classification)	Target %
DODFX (Int'l Multi-Cap Value)	20%
DODGX (US Large-Cap Value)	20%
BTIIX (S&P500 Index)	20%
NBGEX (Small-Cap Blend)	20%
PTRAX (Intermediate Term Bond)	15%
MLTXX (US Treasury Fund)	5%

Based upon my target allocation, I should have 80% in equity funds, 15% in bond funds and 5% in Treasury funds.

But now, my allocations look like:



I'm going to reiterate that I'm not going to do anything other than to realign my investments to match my target allocations at the end of the year, if necessary.

But here's where I need to do a serious gut check: I am anticipating a long-term (i.e., 10-year to 20-year) stagnation or worse, a downward trend in the market. The current market crisis is caused by over-leveraging and excessive risk-taking by both individuals and businesses. When access to easy money gets cut off, the ability to invest also declines. The recent passage of the $700 billion bailout "rescue" plan will theoretically unclog the liquidity problem in the credit market, but it does not address the deleveraging process that needs to take place in the underlying market.

In this Los Angeles Times article, Harry Holzer, a labor economist at Georgetown University and a fellow at the Urban Institute commented, "[T]here's a good chance this [recession] will be more severe than [in 1990 and 2000, which lasted 8 months], because the last two were not accompanied by the widespread financial crisis that we have now."

This Marketwatch article validates my worries as well. The article argues that the Investment Rate measures the demands for investments over long-term cycles and thus forecasts future market cycles.

The article states:

[I]f demand is increasing over extended periods of time, over the course of many years, we could rationally assume that the market and the economy will fare well. In fact, this has been the case since 1981. Every year, between 1981 and 2007 the demand for investments increased annually. More people had money to invest, and reason to invest it at the same time. During that upward sloping cycle in the Investment Rate market declines and economic downturns were short lived, buy-and-hold strategies worked extremely well for passive investors, and buying the dips made sense religiously. This was true during every major down cycle, including the "crash" of 1987.

However, at the end of 2007 the upward sloping cycle which began in 1981 came to an end. A new era began at the end of 2007, an era representing diminishing demand for investments going forward. The Investment Rate identified this in 2002, when it was first offered to the public.

...

The declines that began at the end of 2007 relate directly to the Great Depression and the Stagflation period of the 1970s because, in all three instances, overall demand for investments on a consumer level was shrinking. The average duration of a major down cycle is 11 years.

The third major down period in history has only just begun.

I am wondering: If this is true, can I really stick to my current plan over the course of 10+ years of diminishing returns? I realize that this is how fortunes are made. In the famous words of Warren Buffet: "Be greedy when people are fearful and be fearful when people are greedy."

During this time, though, I wonder what kind of psychological toll this will take on me?

Would You Sell In This Market?

On 9/11/08, I wrote about how my ESOP account was down 20% for this year. What a difference a week and a half makes - - my ESOP account is now up 25%. Last Friday, the stock closed at $260/share. On Monday, it rocketed to $326/share (an increase of $60/share or 25%!).

As I watched the stock price go up and up and up, I discovered that I absolutely have no exit plan with respect to these stocks. At what price am I willing to sell? Do I hold on to them for the long run? If I do sell, and should I reinvest the proceeds? Or do I pay off debts with this money? Put the money into my emergency fund? If I’m going to reinvest, what should I reinvest in?

There’s no explanation for why the company stock price went from a slow downward spiral to a sudden, upward trajectory. My hypotheses include:

my company is one of the few companies that made tons of money by betting against the subprime mortgage and is thus considered a “safe” stock by investors,

short-traders are covering their bets,

the company has been grossly under valued and the stock price corrected itself, and/or

the increase is just part of the wild market fluctuation right now.

I doubt individual investors caused this stock to pop. What do institutional investors know that I don’t know? Is this a short-term pop or is this a sustained correction?

Anyhow, my cost basis (including my company match) for 14 shares of my company stock is $2,986.03 (or, $213.29/share). Yesterday’s range for this stock was $300-$329.74 and closed at $322.05.

If you were me, would you sell this stock now? If "yes", what do you think I should do with the proceeds?

My Current KISS 401k Allocation

In my Saturday post, I referenced a couple of articles that stressed the importance of asset allocation and asset re-alignment to avoid unnecessary panic-sales during down-markets.

The advice provided by financial advisors to retirees or near-retirees included keeping any money you need in the next 2-3 years in cash (or cash equivalent investments). Money needed in the subsequent decade should be invested in safe, fixed-income investments such as bonds. The rest should be invested in stocks to beat inflation.

But what is the recommended allocation for people with a longer time-horizon like myself?

When I first started contributing to my 401k in 2001, I was clueless about how to invest. (Some would argue I still am. He he.) I started with the "conventional wisdom" that I should subtract my age from 100 (or 110) and invest that amount as a % in stocks. I initially started with 70% in the S&P500 index fund, 15% in the intermediate bond fund and 15% in the US Treasury Fund.

I subsequently readjusted my future contributions to include small-cap and mid-cap funds, but did not re-align my existing investment funds to match my new targets. As a result, my 401k asset allocation last year was: 57% US Large Cap, 2% Mid-Cap, 13% Small-Cap, 16% Intermediate Bond Fund and 12% US Treasury Fund.

Clearly, my 401k was due for a significant re-alignment.

My 401k administrator's (Bank of America fka Merrill Lynch) website provides the following allocation recommendations based upon one's own risk tolerance.




Unfortunately, the above recommendations aren't very helpful since they only give a breakdown between stocks-bonds-cash based upon one's risk tolerance. It doesn't take into consideration of one's investment time horizon. Additionally, it gives no guidance with respect to the sub-allocation within equities and bonds.

CNNMoney's Asset Allocation Calculator provides a better guideline for allocation based upon age and risk tolerance. Based upon my age (mid-30s) and risk-tolearance (aggressive), CNNMoney recommends:


But is this allocation too broad and overly simplistic? Possibly.

For example, this diagram doesn't differentiate between growth vs. value equity funds and between short-term vs. long-term vs. mid-term bond funds. This diagram also completely ignores mid-cap funds and other specialty asset classes such as commodities, REITS and natural resources.

Fortunately (or unfortunately, depending upon your perspective), most of the funds in my 401k plan aren't very attractive. For example, a good chunk of the selection of funds in my 401k either have high expense ratios (i.e., greater than 1%) or are front-loaded. There are also no specialty funds available.

This limitation of options available in my 401k plan is a blessing and a curse. Having too many choices may cause analysis paralysis. And with respect to finances, I believe in KISS ("Keep It Simple, Stupid").

So using the CNNMoney allocation as a basic blueprint (with a small tweak), my current 401k allocation looks like:

Investment Fund (Classification)	Actual % of Portfolio	Target %
DODFX (Int'l Multi-Cap Value)	18.02%	20%
DODGX (US Large-Cap Value)	19.15%	20%
BTIIX (S&P500 Index)	20%	20%
NBGEX (Small-Cap Blend)	21.33%	20%
PTRAX (Intermediate Term Bond)	16.02%	15%
MLTXX (US Treasury Fund)	5.48%	5%

A friend (who is the same age as I and who has 100% of her portfolio in equities) commented that I'm too conservative. Maybe. But I take solace in the fact that since 12/31/07, the S&P 500 index is down 17.79% but my portfolio is "only" down 13.99%. Is it a coincidence that I'm only down 80% of the broad market index? I think not.

Besides, by sticking to my current allocation, I expect to have the recommended amount of my investments in cash or cash equivalent securities by the time I retire, through dollar cost averaging over 3 decades, rather than a panic-sale in my old age. I also try to follow Warren Buffet's advice to measure myself by what he calls the "Inner Scorecard" - judge myself by my own standards, not my friends'.

My current allocations are pretty much in align with my target so I probably won't need to adjust it anytime soon. But I suspect that the international fund will take a hit in the upcoming months and year(s).

Perhaps next year, I will shift some of my large-cap US fund and my bond fund allocation to the international fund. Additionally, in order to diversify further, I'll consider investing in other investments that are unavailable in my 401k in my Roth IRA. I guess that means I should start contributing to my Roth.

Why The Down Market Is Good For Me

So.... the U.S. financial market is in the toilet, our free-market capital system is now looking a little bit Socialist and my tax bill will be huge soon. Last Wednesday, my 401k was down $14,000+. (Although it's back up slightly, I think this recent rally is a short-term, fake-out.)

There's no other way to say it - this really bites.

But since my retirement is 20-30 years away, I'm not (too) worried because there is still plenty of time: (1) to dollar-cost average, (2) for the market to rebound and (3) for my money to compound.

And beyond that, there is one reason why I think this volatile, down market is good for me: I can learn, while my money is less at risk, how to protect my assets proactively in a bear market when I'm closer to retirement.

It's The Allocation, Stupid
Whenever the stock market tanks, there is no shortage of articles telling people what stocks/funds to buy and what defensive moves should be taken. But by the time the market is in a downward trend, it's probably too late to move assets around without falling into the trap of "buy high, sell low."

With respect to retiring in the current bear market, Craig Carnick, who runs Carnick & Co. in Colorado Springs, Colo., recommends raising a buffer of cash ahead of time as the easiest way to keep a portfolio intact during uncertain times. In this article, Carnick says,

"The key to overcoming volatility is that you're not in a position where you're forced to sell at a loss." Carnick recommends keeping up to 20 percent of a portfolio in cash or cash equivalents, or enough for two to three years' worth of income, plus a mix of bonds with varying maturities set to expire over seven to eight years to replenish that money.

In the same article, Dean Barber, a financial planner and founder of Barber Financial Group, says allocating as much as 30 percent of a portfolio to treasury inflation-protected securities, or TIPS, isn't unreasonable, given shaky markets and rising price pressures.

Barber recommends filling out a portfolio with exposure to commodities, cash, and foreign stocks, adding that no more than 30 percent of any retirement portfolio should be in domestic stocks. A few years ago, the allocation would have been 60 percent. That's just too risky now, Barber says. "Retirement is not like golf. There are no mulligans. If you mess it up, you go back to work for 20 years. People can't afford to get it wrong," he says. "The portfolio we have today is more defensive."

Take Profits and Re-Allocate While You're Up
In January 12, 2008, I read this article about various index fund portfolios maintained by real people. One of the highlighted portfolio is managed by Ted Aronson of AJO Partners. In the article, Ted Aronson highlights the importance of taking profits off the table and reinvesting in laggard performing funds/stocks.

"The equity funds in [Aronson] family's taxable portfolio averaged a return of more than 21% the past five years, thanks to his high 40% in foreign funds: But 'I realize a change -- a big change for a lazy investor -- is needed. Time to take some profits off the table,' says Aronson.

'For a U.S.-based investor, 40% international is way too high at this juncture. With the dollar's weakness goosing up foreign returns, and emerging markets having gone almost straight up for five years, time to trim the tree.'

So Aronson is taking 10 whole percentage points "out of emerging markets and putting half into TIPs and half into high-yield bonds." His detailed reasons:

Everything has gone up double digits over the past five years -- except bonds

Emerging markets have gained 36% a year -- nearly a five-fold increase

Dollar is weak retrospectively

Moving money from emerging markets to junk bonds leaves plenty of capital at risk (how you make money)

So, since most portfolios are likely out of balance, Aronson recommends this key asset re-allocation: 'If an investor held anything like 20% in emerging markets five years ago and was 'lazy' in the interim, your holding is more like 40% of the portfolio by now! Moving it down to 10% (from an original 20%) will entail lots of gains. C'est la vie.' My translation: No one goes broke taking profits.).

Now comes this year's big lesson: Aronson warns that most investors will psychologically resist selling the big winners and buying lesser performers. But that's what rebalancing and "Modern Portfolio Theory" (the theory behind Lazy Portfolios) is all about. You stick to your asset allocations as sector performance waxes and wanes over the long-term. Otherwise you're just chasing hot sectors and engaged in high-risk market-timing.

Alternatively: If you're serious about your long-term results, instead of doing an end-of-year rebalancing, rebalance each month. But not by selling high performers, just add new money from your regular monthly savings program to keep your portfolio in line with the original allocations."

At the time I read this article (January 2008), I recall thinking, "But, the emerging market fund is so 'hot'! I wouldn't do this!" Well..... since 12/31/07, the emerging market fund is down over 29% and the bond fund is down less than 5%. I guess this is why Aronson is the pro and I'm the amateur. He he.

I always thought that following market movements and trends were important to establishing your own personal asset allocation. But the more I think about it, Aronson's recommendation is less about market timing and more about having an appropriate, diversified allocation and maintaining the allocation through market ups and downs. In other words, if my current allocations are completely out of alignment with my target allocations, that should be a hint for me to reallocate my assets.

Therefore, as I get closer to retirement, I'll need to remember to take profits off of bloated asset categories while it's up and re-allocate to a more conservative portfolio which consists of higher allocation of cash, bonds and TIPS.

My ESOP Account Down 20.82% for the Year

I contribute approximately $250/month into my company's ESOP. So far this year, I've accumulated 12.92844 shares of my company stock and the actual cost basis (including the company match) is $3,472.79. As of 9/7/08, the current value of the stock is $2,749.62. That's a loss of $723.17, or -20.82%. This is really depressing but I've decided to look at it differently for my own sanity.

My actual out-of-pocket contributions to the ESOP to date is $2,179.05 and the company match (30 cents to $1 contributed) is $1,293.74. (To my sharp-eyed readers: the reason why my company match amount totals more than 30% of my contribution amount is because my employer, for the first time I've ever been employed with this company, paid out a stock bonus due to a very profitable 2007.)

Since the company match is considered taxable income, I've calculated $362.24 of the company match as part of my cost-basis while $931.50 is treated as a windfall. So, if I re-adjust my actual cost basis to $2,541.29, I'm up by about 8% this year, all thanks to the generous company match and bonus.

I've pondered whether I should stop contributing to my ESOP and instead use the extra $250/month to pay off my debt. Afterall, if I use $250/month to pay off debt, I have a guaranteed a return on my money. In contrast, with the market being what it is right now, I have no idea whether I'll break even by continuing to contribute to the ESOP.

After considerable mulling, I've decided to continue to contribute to the ESOP. How many investment vehicles do I have where my investments can go down about 22% (after taxes) and I still come out even? Secondly, as you may know, I expect to be laid off at the end of the year. If anything, at least I could sell my company stocks if I ever need it. Since my EF is currently woefully inadequate, I guess this is another form of an automatic savings that I've implemented for myself for those inevitable rainy days...