In the financial services industry, one of the most coveted careers is that of the financial analyst. Financial analysts can work in both junior and senior capacities within a firm and it is a niche that often leads to other career opportunities. The financial services industry is competitive, and it can be tough to break into the analyst field, but there are some preparations you can make to position yourself for this career. If you’re interested in a career as a financial analyst, read on to find out what you can do to groom yourself for the job.

What is a Financial Analyst?
A financial analyst researches macroeconomic and microeconomic conditions along with company fundamentals to make business, sector and industry recommendations. They also often recommend a course of action, such as to buy or sell a company’s stock based upon its overall current and predicted strength. An analyst must be aware of current developments in the field in which he or she specializes as well as in preparing financial models to predict future economic conditions for any number of variables.

Background of Financial Analysts
If you are still an undergraduate student who is considering a career as a financial analyst, it is best to take courses in business, economics, accounting and math. Other majors that are looked upon favorably include computer sciences, biology, physics and even engineering. Many of the junior analysts hired by firms have these backgrounds, while MBA graduates are often hired as senior analysts right out of business school. (For related reading, see Fitting In At Your Firm.)

If you are not an MBA graduate student or an economics major as an undergraduate, you may want to consider studying for the Series 7 and Series 63 exams or participating in the Chartered Financial Analyst (CFA^®) Program. Keep in mind that participating in these exams will require sponsorship from an NASD member firm or a self-regulatory organization. (To learn how to do this, check out Is it possible to take the Series 7 Exam without being sponsored? and How do I become a CFA chartholder?)

While the CFA exam is highly technical, the Series 7 and 63 exams are other ways to demonstrate a basic familiarity with investment terms and accounting practices. If you look at a sample CFA exam and it seems overwhelming, start with practicing for the Series 7 and 63 exams and then work your way up to the CFA exam or begin to interview for junior analyst positions after passing those Series exams or one of the other exams that are highly regarded by the financial services industry. Many institutions also have training programs for those candidates who show promise in the field. (For more insight, see Succeeding At The Series 63 Exam.)

Types of Analyst Positions
Financial analysts tend to specialize based on the type of institution they work for. Analysts are hired by banks, buy- and sell-side investment firms, insurance companies and investment banks. Of these specialties, three major categories of analysts are those that work for ’sell-side’ investment firms, those that work for ‘buy-side’ investment firms and those that work for investment banks.

Within the investment industry, most analysts tend to work either for buy-side investment firms, where they research stocks for an in-house fund; or sell-side firms that write research reports for buy-side firms. Buy-side firms are investment houses that manage their own funds. In these companies, analysts research companies as they look for stocks to add to an investment fund. They also track the stocks that are in a fund’s portfolio in order to determine when or if the fund’s position in that stock should be sold.

At a sell-side firm, analysts evaluate and compare the quality of securities in a given sector or industry. Based on this analysis, the analysts then make reports with certain recommendations such as: buy, sell, strong buy, strong sell or hold. These recommendations carry a great deal of weight in the investment industry including analysts working within buy-side firms. (For more insight, see Analyst Recommendations: Do Sell Ratings Exist? and Three Kinds Of Analysts And What You Need To Know About Them.)

Even within these specialties, there are subspecialties such as analysts who specialize in equities and those that specialize in analyzing fixed-income instruments. Many analysts also specialize even further within a specific sector or industry. An analyst may specialize in energy or technology, for example.

Analysts in investment banking firms, however, differ from analysts in buy- and sell-side firms as they often play a role in determining whether or not certain deals are feasible based on the fundamentals of the companies involved in a deal. This type of analysis can include IPOs or mergers and acquisitions. Analysts assess current financial conditions as well as rely heavily on modeling and forecasting to make recommendations to senior partners as to whether or not a certain merger is appropriate for that investment bank’s client or whether another client of the investment bank should invest venture capital in a particular company.

What to Expect on the Job
Financial analysts need to remain vigilant about gathering information on the macroeconomy as well as information about specific companies and the fundamental microeconomics of their balance sheets. In order to stay on top of financial news, analysts will need to do a lot of reading on their own time. Analysts tend to read publications such as The Wall Street Journal, The Financial Times and The Economist as well as financial websites.

Being an analyst also often tends to involve a significant amount of travel. Some analysts travel to companies to get a first-hand look at company operations on the ground level. Analysts also frequently attend conferences with colleagues who share the same specialty as they do.

When in the office, analysts learn to be proficient with spreadsheets, relational databases and statistical and graphics packages in order to develop recommendations for senior management and to develop detailed presentations and financial reports that include forecasting, cost benefit analysis, trending and results analysis. Analysts also interpret financial transactions and must verify documents for their compliance with government regulations.

Opportunities for Advancement
As interoffice protocol goes, analysts interact with each other as colleagues while they tend to report to a portfolio manager or other senior in management. A junior analyst may work his or her way up to a senior analyst in a period of three to five years.

For senior analysts who continue to look for career advancement, there is the potential to become a portfolio manager, a partner in an investment bank or senior management in a retail bank or an insurance company. Some analysts go on to become investment advisors or financial consultants.

Tips for Success
The most successful junior analysts are ones that develop proficiency in the use of spreadsheets, databases, PowerPoint presentations and learn other software applications. Most successful senior analysts, however, are those who not only put in long hours, but also develop interpersonal relationships with superiors and mentor other junior analysts. Analysts that are promoted also learn to develop communication and people skills by crafting written and oral presentations that impress senior management.

Conclusion
While a career as a financial analyst requires preparation and hard work, it also has the potential to deliver not just financial rewards but the genuine satisfaction that comes from being an integral part of the business landscape.

by Bryn Harman,CFA

The goal of virtually all investment analysis is to make investment decisions or advise others in making their own investment decisions. Therefore, there is an inextricable link between the art and science of equity analysis and equity portfolio management. College finance programs and the CFA Institute’s Chartered Financial Analyst® program embody this link by teaching the two concepts side by side. As a result, most analysts have a good educational background in both equity analysis and portfolio management subjects like modern portfolio theory (MPT) early in their careers. Analysts frequently turn into portfolio managers over time. (For related reading, see Preparing For A Career As A Portfolio Manager and Modern Portfolio Theory: An Overview.)

Even with a good understanding of equity analysis and MPT, there are certain mechanical elements to portfolio management that must be addressed before actually constructing and running equity portfolios. As is the case with many professions, the real-world application of theoretical investment concepts can involve thinking beyond one’s specialty and training. Running a group of portfolios involves extensive attention to detail, computerization and the need for administrative efficiency. In this article we’ll explain the mechanics of equity portfolio management and how this system can create a group of different portfolios that perform as a homogeneous element.

Investment Philosophy and the Investment Universe
Professional portfolio managers who work for an investment management company generally do not have a choice about the general investment philosophy used to govern the portfolios they manage. An investment firm may have strictly defined parameters for stock selection and investment management. An example would be a firm defining a value investment selection style using certain trading guidelines. Furthermore, portfolio managers are usually also constrained by market capitalization guidelines. For example, small-cap managers may be limited to selecting stocks in the $200 million to $3 billion market cap range. Therefore, the first step in portfolio management is to understand the universe from which investments may be selected. (For related reading, see Determining What Market Cap Suits Your Style.)

Another philosophical consideration is the analytical approach for the portfolio in question. Some firms or portfolios use a bottom-up approach, where investment decisions are made primarily by selecting stocks without consideration to sector selection or economic forecasts. Other styles may be top-down oriented and portfolio managers pay primary attention to analyzing entire sectors or macroeconomic trends as a starting point for analysis and stock selection. Many styles use a combination of these approaches. (For related reading, see A Top-Down Approach To Investing and Where Top Down Meets Bottom Up.)

Tax Sensitivity
A lot of institutional equity portfolios, such as pension funds, are not taxable. This gives portfolio managers more managerial flexibility than taxable portfolios. Non-taxable portfolios may use greater exposure to dividend income and short-term capital gains than their taxable counterparts. Managers of taxable portfolios may need to pay special attention to stock holding periods, tax lots, capital losses, tax selling and dividend income generated by portfolios. Taxable portfolios may be more effective with a lower portfolio turnover rate relative to non-taxable portfolios. Understanding the tax consequences of – or lack thereof – portfolio management activity is of primary importance in building and managing portfolios over time.

Building the Portfolio Model
Whether running one portfolio or a thousand portfolios in one equity investment product or style, building and maintaining a portfolio model is a common aspect of equity portfolio management. A portfolio model is a standard against which individual portfolios are matched. Generally, portfolio managers will assign a percentage weighting to every stock in the portfolio model and then individual portfolios are modified to match up against this weighting mix. Portfolio models are usually computerized using software such as Microsoft Excel or specific portfolio management software tools.

For example, after doing some mix of company analysis, sector analysis and macroeconomic analysis, the portfolio manager may decide that he or she wants to own a relatively large weight of a particular stock. Perhaps in the portfolio manager’s style, a relatively large weighting is 4% of the total portfolio value. By reducing the weighting of other stocks in the portfolio model or by reducing the overall cash weighting, the portfolio manager would buy enough stocks of a particular company in each portfolio to match up against the 4% model weight. All of the portfolios will look like each other (and the portfolio model), at least in terms of the 4% weighting on that particular stock. (For related reading, check out A Guide To Portfolio Construction.)

In this way, the portfolio manager runs all portfolios in a similar or identical fashion given the specific style mandated by that portfolio group. He or she would expect all portfolios in the group to generate returns in a standardized way relative to each other. All of the portfolios will also be very similar to each other in terms of the risk/reward profile. In effect, all of the analytical and security evaluation that the portfolio manager does is run on a model, and not on the individual portfolios.

Achieving Portfolio Efficiency
Running all of his or her portfolios in a similar way allows a portfolio manager to achieve a remarkable analytical efficiency. The portfolio manager needs to only have an understanding of perhaps 30 or 40 stocks owned in similar proportions in all portfolios, rather than 100 or 200 stocks owned in various proportions in 1,000 different portfolio accounts. Analysis on the 30 or 40 stocks can be applied to all portfolios easily by changing model weights in the portfolio model over time. As the outlook on individual stocks changes over time, the portfolio manager only needs to change his or her model weightings to reflect the investment decision in all portfolios simultaneously.

The portfolio model can also be used to handle all day-to-day transactions at the individual portfolio level. New accounts can be set up quickly and efficiently by simply “buying against the model”. Cash deposits and withdrawals can be handled in a similar way. If the portfolio is large enough, the model only really needs to be applied to the change in asset size to build a portfolio that looks just like the portfolio model. Smaller portfolios may be limited by stock board lot constraints, which may affect the portfolio manager’s ability to accurately buy or sell to certain percentage weightings.

Conclusion
Portfolio modeling is a good way to apply analysis and evaluation of a key set of stocks - those that the portfolio manager wants to own - to a set of portfolios in one group or style. Portfolio modeling is an efficient link between equity analysis and portfolio management. As the outlook for individual stocks improves or deteriorates over time, the portfolio manager only needs to change the weightings of those stocks in the portfolio model to optimize the return of all portfolios in the group or style. As long as the individual portfolio accounts are traded efficiently, the group will perform as a homogeneous element.

by Ken Hawkins

Although they would not admit it, most portfolio managers take a core/satellite approach when managing their equity portfolios. The part of the portfolio that might mirror the overall market could be considered the “core” and the part of the portfolio that deviates from the overall market can be considered the “satellite” portion. When you hear portfolio managers say  they are trading around their “core” bank holdings - or they are currently overweight oil stocks and underweight technology stocks, or they have a small cap tilt to their portfolios - they are essentially taking the core/satellite approach.

But what about the average investor? The advent of exchange-traded funds (ETFs) provides an easy way of implementing a core/satellite approach. We provide 10 reasons why this strategy can trump securities-only portfolio management strategies.

What Does the Portfolio Look Like?
ETFs provide a simple way to implement a professional style approach to portfolio management. ETFs form the core of the portfolio and provide diversification. Then, you select individual stocks that are expected to outperform the benchmark to form the satellites around the ETFs. Typically, an investor might put 50% of his equity portfolio in an ETF representing a market index and 50% in individual securities. There is no hard and fast rule about the percentages, but the greater the percentage of the portfolio that is in the core holding, the more the overall portfolio will behave like the overall market.

10 Reasons to Consider a Core/Satellite Investment Strategy using ETFs
For investors who manage their own accounts, a core/satellite strategy combining securities and ETFs is often better than a portfolio of only securities for the following reasons:

1. Better Diversification
Typically, the average investor who buys stock tends to have a poorly diversified portfolio. There is often a concentration in sectors or types of stocks with very similar risk characteristics. Using an ETF to buy a core position provides instant diversification and reduces overall portfolio risk. (For more insight, read The Importance Of Diversification.)

2. Improved Performance
It is widely accepted that a large portion (more than 50%, by most accounts) of professional money managers underperform the stock market. The average individual investor typically fares worse. An investor who sells some stocks and replaces them with a broad-based ETF core holding may be able to improve the overall performance of the portfolio. (For related reading, check out Pump Up Your Portfolio With ETFs.)

3. Easier Rebalancing
A change in an investor’s asset mix is easier to implement when you use an ETF as the core position. If an investor wants to increase his or her equity exposure, the purchase of additional shares of an ETF makes it easy to do without having to buy additional shares for current holdings. (To read more on portfolio rebalancing, see our related article Rebalancing Your Portfolio To Stay On Track.)

4. Easier to Monitor and Understand
The more stocks in a portfolio, the harder it is to monitor and manage; after all, there are more investment decisions that have to be made and more factors to be considered. With an ETF or index fund representing a core position, the number of stocks can be decreased, resulting in a portfolio that is less complex and easier to understand.

5. More Tax Efficient
A portfolio containing all stocks tends to generate more trading activity as the market and investment outlook changes. With more trading activity, more capital gains will be realized and more taxes paid. ETFs are very tax efficient and, with a larger proportion of the portfolio in a single core ETF, fewer capital gains will be triggered. (Investors should consider the impact of taxes on their returns. Be sure to read A Long-Term Mindset Meets Dreaded Capital-Gains Tax for more information.)

6. Lower Transaction Costs
With fewer stocks, there will be fewer trades and fewer commissions. The small annual management fee ETFs carry is easily recovered from the savings on commissions. In an account at a full service broker, the reduction of commissions could be dramatic. This might be why many investment advisors do not like ETFs. (For more on ETF benefits, read Uncovering The ETF Wrap.)

7. A Decrease in Volatility
For the typical investor with an ETF representing a core holding, the overall portfolio will likely be less volatile than one made up entirely of stocks. (Learn to adjust your portfolio when the market fluctuates to increase your potential return in Volatility’s Impact On Market Returns.)

8. Allows For Better Focus
In any well designed and diversified portfolio, an investor will have to invest in sectors or stocks that he or she does not like, but is required to own for diversification purposes. Using an ETF for a core position provides the necessary diversification, allowing the investor to focus on stocks in his or her preferred sectors. (For more on sectors, read Sector Rotation: The Essentials.)

9. Can Implement Sophisticated Investment Strategies
Investment strategies such as enhanced index strategies, risk budgeting, portfolio insurance, style tilts, hedging strategies and tax loss harvesting become easier to implement with a core/satellite approach.

10. Improves The Knowledge of the  Investor
The proper implementation of a core/satellite strategy requires a certain degree of knowledge and understanding about risk, market indexes, benchmarks and portfolio management techniques. As investors gain the knowledge and experience of applying a core/satellite strategy, the process will, in the end, make them better investors

Conclusion
With the introduction of ETFs, the use of a core/satellite strategy becomes a very practical strategy for the average investor to implement. It will not only make investment management easier, but the underlying portfolio will also be better diversified and future performance will likely improve.

Exchange-traded funds (ETFs) were once described as the new kids on the investment block, but today they are giving traditional mutual funds a run for their money. Both ETFs and mutual funds are viable choices for investors. But, with many mutual funds and ETFs available on the market, it’s important for investors to familiarize themselves with the differences between products to ensure they are making appropriate investment decisions. While mutual funds and ETFs share similar traits, there are differences between the two that investors must consider when deciding which to use. Read on to find out.

Legal Structure of Funds
Both mutual funds and ETFs can vary in terms of their legal structure. Mutual funds can typically be broken down into two types.

• Open-Ended Funds – These dominate the mutual fund marketplace in terms of volume and assets under management. With open-ended funds, purchases and sales of fund shares take place directly between investors and the fund company. There’s no limit to the number of shares the fund can issue; as more investors buy into the fund, more shares are issued. Federal regulations require a daily valuation process, called marking to market, which subsequently adjusts the fund’s per-share price to reflect changes in portfolio (asset) value. The value of the individual’s shares is not affected by the number of shares outstanding.
• Closed-End Funds – These funds issue only a specific number of shares and do not issue new shares as investor demand grows. Prices are not determined by the net asset value (NAV) of the fund, but are driven by investor demand. Purchases of shares are often made at a premium or discount to NAV. (For related reading, see Closing Funds: Investment Protection Or Trap? and Open Your Eyes To Closed-End Funds.)

Legal Structure of ETFs
An ETF will have one of three structures:

• Exchange-Traded Open-End Index Mutual Fund – This fund is registered under the SEC’s Investment Company Act of 1940, whereby dividends are reinvested on the day of receipt and paid to shareholders in cash every quarter. Securities lending is allowed and derivatives may be used in the fund.
• Exchange-Traded Unit Investment Trust (UIT) – Exchange-traded UITs are governed by the Act of 1940 also, but must attempt to fully replicate their specific indexes, limit investments in a single issue to 25% or less, and sets additional weighting limits for diversified and non-diversified funds. UITs do not automatically reinvest dividends, but pay cash dividends quarterly. Some examples of this structure include the QQQQ and Dow DIAMONDS (DIA).
• Exchange-Traded Grantor Trust – This type of ETF bears a strong resemblance to a closed-ended fund but, unlike ETFs and closed-end mutual funds, an investor owns the underlying shares in the companies that the ETF is invested in, including the voting rights associated with being a shareholder. The composition of the fund does not change; dividends are not reinvested but instead are paid directly to shareholders. Investors must trade in 100-share lots. An example of this ETF are holding company depository receipts (HOLDRs).

Trading Process
ETFs offer greater flexibility than mutual funds when it comes to trading. Purchases and sales take place directly between investors and the fund. The price of the fund is not determined until end of business day, when net asset value (NAV) is determined. An ETF, by comparison, is created or redeemed in large lots by institutional investors and the shares trade throughout the day between investors like a stock.

Like a stock, ETFs can be sold short. Those provisions are important to traders and speculators, but of little interest to long-term investors. But, because ETFs are priced continuously by the market, there is the potential for trading to take place at a price other than the true NAV, which may introduce the opportunity for arbitrage. (To learn more about arbitrage, read Arbitrage Squeezes Profit From Market Inefficiency.)

Expenses
Due to the passive nature of indexed strategies, the internal expenses of most ETFs are considerably lower than those of many mutual funds. Of the more than 650 available ETFs listed on Morningstar in 2008, those with the lowest expense ratios included the Vanguard Large Cap ETF and Total Market ETF, both tied at .07%, while the highest expense fund was the Goldman Sachs Connect GSCI ETN at 1.25%. By comparison, the lowest fund fees range from .05% to more than 10% per year for other funds. (For more on mutual fund feeds, read Stop Paying High Fees.)

Another expense that should be considered is the product acquisition costs, if any. Mutual funds can often be purchased at NAV, or stripped of any loads, but many (they are often sold by an intermediary) have commissions and loads associated with them, with some loads as high as 8.5%. ETF purchases are free of broker loads. (For related reading, see The Lowdown On No-Load Mutual Funds.)

In both cases, additional transaction fees are usually assessed, but pricing will largely depend on the size of your account, the size of the purchase and the pricing schedule associated with each brokerage firm. Clients of advisors who hold institutional accounts for their clients tend to benefit from lower trading costs, often as low as $9.95 per ETF purchase or $20 for mutual funds. Additional cost considerations should be given if you plan to dollar-cost average into the funds or ETFs, because frequent trading of ETFs could significantly increase commissions, offsetting the benefits resulting from lower fees.

Tax Advantages and Disadvantages
ETFs offer tax advantages to investors. As passively managed portfolios, ETFs (and index funds) tend to realize fewer capital gains than actively managed mutual funds. ETFs are more tax efficient than funds because of the way they are created and redeemed. For example, suppose that an investor redeems $50,000 from a traditional Standard & Poor’s 500 Index (S&P 500) fund. To pay that to the investor, the fund must sell $50,000 worth of stock. If appreciated stocks are sold to free up the cash for the investor, then the fund captures that capital gain, which is distributed to shareholders before year-end. As a result, shareholders pay the taxes for the turnover within the fund. If an ETF shareholder wishes to redeem $50,000, the ETF doesn’t sell any stock in the portfolio. Instead it offers shareholders “in-kind redemptions”, which limit the possibility of paying capital gains. (For more on tax saving, read Money Saving Year-End Tax Tips.)

Liquidity
Liquidity is usually measured by the daily trade volume, which is generally expressed as the number of shares traded per day. Thinly traded securities are illiquid and have higher spreads and volatility. When there is little interest and low trading volumes, the spread increases, causing the buyer to pay a price premium and forcing the seller into a price discount in order to get the security sold. ETFs, for the most part, are immune to this. ETF liquidity is not related to its daily trading volume, but rather to the liquidity of the stocks included in the index. (For related reading, see Diving In To Financial Liquidity.)

Broad-based index ETFs with significant assets and trading volume have liquidity. For narrow ETF categories, or even country-specific products have relatively small amounts of assets and are thinly traded, ETF liquidity could dry up in severe market conditions, so you may wish to steer clear of ETFs that track thinly traded markets or have very few underlying securities or small market caps in the respective index.

ETF Survivability
A consideration before investing in ETFs is the potential that fund companies will go bust. As more product providers enter the marketplace, the financial health and longevity of the sponsor companies will play a greater role. Investors should not invest in ETFs of a company that is likely to disappear, thereby forcing an unplanned liquidation of the funds. The results for investors who hold such funds in their taxable accounts could be an unwelcome taxable event. Unfortunately, it is next to impossible to gauge the financial viability of a startup ETF company, as many are privately held. As such, you should limit your ETF investments to firmly established providers or market dominators to play it safe.

Conclusion
As products are rolled out, investors tend to benefit from increased choices, better variations of product and price competition among providers. It’s important to note the differences between ETFs and mutual funds, and how those differences may impact your bottom line and investment processes.

Dear Investor,

ETFs are booming!

ETF assets rose 44% to $608 billion in 2007 alone, according to the Investment Company Institute. Meanwhile, the number of ETFs available to U.S. investors shot up from 359 in 2006 to 629 at the end of 2007.

It’s no wonder that smart investors are jumping on the ETFs bandwagon.  Just look at all the advantages…

ETFs will help you:

1. 1. Put More Money in Your Pocket: ETF fees and expenses are just a fraction of mutual funds’. There are no 12-b-1 fees, sales loads, or exit charges. And no minimum investment required.  So you can save many thousands of dollars over the long term compared with mutual funds.
   2. Limit Your Risk: You can trade ETFs with stop-loss orders, sharply limiting your downside risk. To make sure you don’t pay more than you want for shares, you can use limit orders, just as you would for a stock.
   3. Leverage Your Investments: You can purchase ETFs on margin. This can help you capture much larger gains than you could with mutual funds which can’t usually be bought on margin.
   4. Reduce Your Taxes: ETFs are a tax-advantaged investment: You are not tagged with capital gains distributions when your fellow investors sell shares, because the underlying stocks in the ETF are traded, not sold. You don’t pay taxes until you sell your shares.
   5. Invest in Many Different Markets and Sectors: There are hundreds of ETFs to choose from, enabling you to trade virtually any index in the world, from the NASDAQ and the Malaysian stock market, to microcaps and Chinese stocks.
   6. Make Money Even in Down Markets: ETFs can be sold short, even during a market rout, to profit from falling stocks. Unlike individual stocks, ETFs are exempt from the uptick rule.
   7. Buy and Sell All Day Long: Unlike mutual funds, which trade at end-of-day prices, ETFs can be bought and sold instantaneously on major stock exchanges all day long, giving you tighter control of your entry and exit prices.

By Martin D. Weiss, PhD.

The stock market is falling swiftly, and you don’t have the luxury of time. So I’ll get straight to the point:

If you haven’t done so already in response to our many earlier warnings, you’d better sell or hedge your vulnerable investments now. If you don’t, be prepared to suffer far deeper losses in the bear market of 2008 and beyond.

But beware: Most brokers will try to talk you out of it. They have a hidden agenda. They want to keep you as a customer; and they know that, once customers sell their stocks, they often close their brokerage accounts.

With this in mind, many brokers have been trained with up to seven sales pitches designed to keep you in the market come hell or high water.

Broker Pitch #1: “Buy more.” Their argument goes something like this: “Your stock is now selling at bargain prices. So if you didn’t already own 100 shares, you’d probably be thinking about buying — not selling. Instead, why not double down and take advantage of dollar-cost averaging?”

The more likely result in a bear market: Every time your stock falls by another $1 per share, instead of losing just $100, you’ll be losing $200.

Broker Pitch #2: “Hold for a recovery!” They argue that the “market will inevitably recover,” that the “recovery is always bigger and better than any near-term decline,” and that you should therefore “always invest for the long term.”

The reality: Bear markets can last for years. It could take still longer for the averages to recover to current levels. During all those years, your money is dead in the water. And don’t forget: If the company goes out of business, your stock will be worthless and will never recover.

Broker Pitch #3: “You can’t afford to take a loss.” If you insist on selling, brokers often come back with this approach: “Your losses are just on paper right now. So if you sell, all you’ll be doing is locking them in. You can’t afford to do that.”

What they don’t tell you is that there’s no fundamental difference between a paper loss and a realized loss. Nor do they reveal that the Securities & Exchange Commission (SEC) requires brokers themselves to value the securities they hold in their own portfolio at the current market price — to recognize the losses as real whether they’ve sold the securities or not.

Broker Pitch #4: “You can’t afford to take a profit and pay the taxes.” If you’ve got a profit in a stock, they say: “All you’ll be doing is writing a fat check to Uncle Sam. You can’t afford to do that.”

The reality: Although it’s not shown on your brokerage statement, the true value of your portfolio is NET of taxes. So whether you or your heirs pay those taxes now or in the future is mostly a difference of timing. And if our next president approves legislation to raise capital gains taxes next year, it could actually cost you more. Besides, which would you prefer — paying some taxes on profits or paying no taxes on losses?

Broker Pitch #5: The “don’t-be-a-fool” argument. “Stocks look very cheap now and we’re very close to rock bottom,” goes the script. “We may even be right at the bottom. If you sell now, three months from now, you’ll be kicking yourself. Don’t be a fool.”

The truth: Brokers don’t have the faintest idea where the bottom is. Nor does anyone at their firm. And they know darn well that stocks do not hit bottom just because they look cheap. Worse, for their own accounts, brokers and their affiliates have been — and are likely to continue — liquidating shares, often targeting precisely the same shares they pitch to their customers.

Broker Pitch #6: “The market is turning.” If the market enjoys an intermediate bounce, which it certainly will at some point soon, this pitch is invoked. “Look at this big rally!” they say. “Your shares are finally starting to come back. After waiting all this time, are you sure you want to run away now — just when things are starting to turn around in your favor?”

The truth: In a bear market, intermediate rallies actually give you the best opportunity to sell.

Broker Pitch #7: The last ace-in-the hole in the broker’s arsenal of pitches is the patriotic approach. “Do you realize,” they’ll say, “what could happen if everyone does what you’re talking about doing? That’s when the market would really nosedive. But if you and millions of other investors would just have a bit more faith in our economy — in our country — then the market will recover and everyone will come out ahead.”

The truth: Locking up precious capital in sinking enterprises is not exactly good for our country. Better to safeguard the funds and reinvest them in better opportunities at a better time.

Surprise, Surprise: The Wall Street Journal
Has Just Made Some of These Same Pitches

Given that the Nasdaq lost more than 75% of its value in the early part of this decade and that bank stocks are now down over 50% since their recent peaks, you’d think Wall Street would have learned to refrain from pitching the same old BS.

But if this weekend’s edition of The Wall Street Journal is any indication, little has changed …

“There’s a decent argument to be made for buy and hold,” says the Journal. “Aside from the absurdity of liquidating an entire equity portfolio — the tax headaches would be epic — investors ultimately end up better off than if they had tried to sell at the top and buy at the bottom. ‘It’s hard to time the market, so stay in and benefit from the inevitable turnaround,’ says David Dreman, chairman of Dreman Value Management.”

In other words, they’re telling you to sit it out and watch the value of vulnerable stocks evaporate.

My view: This advice is driven by the same hidden agenda still prevailing in the brokerage industry — to keep you in bad stocks at all costs.

Were you entrapped by similar pitches during the great tech wreck of 2000-2002? If not, great! If so, don’t let it happen again. And in either case, use it as a learning experience — to pull out some valuable lessons that could save you a lot of money today …

Lesson #1
Many Stocks Have Hidden Risks
That No One Tells You About.

Even during the tech bubble, most investors recognized that there was a chance their stocks could go down, at least for a short while. But they never dreamed their tech stocks could go down so far nor so fast. They had no inkling of the multiple, hidden risks that can drive their portfolios into the gutter:

The risk of earnings lies. Let’s say a stock is selling for $40. And let’s say its earnings are $2 per share. So it’s valued at 20 times earnings, and this is considered fair. Suddenly, the news comes out that the earnings are a bold-faced lie. The true earnings of the company is only half what was stated — $1 per share. “Oh, no!” exclaim the investors. “At 20 times earnings, it’s really only worth $20 per share.” The stock promptly plunges to $20 — an instant 50% loss to shareholders.

In the tech wreck, we saw this kind of outright fraud at big-name companies like Enron, Worldcom, Tyco, and Adelphia. And we saw it repeated hundreds of times with lesser companies. This time around, we see a similar pattern among financial companies that continually understate, cover up or even lie about their true losses.

Case in point: In March 2007, a Bear Stearns hedge fund manager emailed a colleague saying, “The sub-prime market is pretty damn ugly … I think we should close these funds down.” Instead, the company soothed investors with the message that “all was fine.” Three months later, the funds failed and investors were left with less than 30 cents on the dollar.

The risk of inflated Wall Street ratings. In the tech bubble, Wall Street’s enthusiastic “buy” ratings — often bought and paid for by the rated companies — drove thousands of investors into stocks that weren’t worth the paper they were printed on. When it became apparent that the stock ratings were a sham, investor losses were greatly compounded.

Today, little has changed. The SEC and Elliot Spitzer’s attempt to encourage independent research on Wall Street has largely failed.

Worse, the ratings issued by Wall Street’s leading government-sanctioned agencies — Moody’s, S&P and Fitch — are still bought and paid for by the rated companies, often resulting in inflated grades.

Case in point: The rating agencies stalled for months before finally downgrading the nation’s giant bond insurers, Ambac and MBIA. And despite the recent downgrades, the ratings still fail to recognize that the bond insurers’ entire business model — based on unanimous triple-A ratings — has been destroyed.

The evidence: Credit swaps being traded right now on Ambac and MBIA imply that the probability of default over the next five years is an astounding 90%! And still they’re getting “A” or better ratings? It’s a joke.

The risk of failure. The company goes out of business and investors suffer a 100% loss. Unusual? Not quite. In the tech wreck, at least 600 Internet companies went under. And between 1990 and 2002, bankruptcy claimed 390 insurance companies, 932 banks and thrifts, plus tens of thousands of business corporations.

The situation today: Although the Federal Reserve was able to ease the credit crunch by dropping interest rates seven times and rescuing the likes of Bear Stearns, analysts are now concerned that the Fed is running out of options. What happens in the wake of the next big meltdown? I don’t think you want to hang on to your financial stocks while Wall Street tries to guess at the answer.

My rule number one of investing is: Never underestimate the risk.

Lesson #2
So-Called “Free Advice”
Can Cost You a Fortune!

You can get “free advice” from many sources — not just your stockbroker, but also your insurance agent, your financial planner and other professionals. But it isn’t really advice. And it certainly isn’t free.

In the last bear market, “free advice” — embedded in the hyped-up ratings and research reports issued by major Wall Street firms — cost investors a fortune, luring them into Nasdaq stocks that brought losses averaging more than $75 for every $100 invested near the peak. Plus, free advice in other areas — from bonds to insurance — can be equally expensive.

With “free advice,” you can actually get hurt in three different ways:

• You pay significant fees that, despite any assurances to the contrary, inevitably wind up coming out of your pocket.

• You buy investments that are more likely than usual to be underperformers or outright losers.

• You wind up getting locked in to plans or programs that charge various kinds of exit penalties. So when a better, alternative opportunity comes your way, you have to either pass it up or pay through the nose to switch.

In short, taking “free advice” can be like walking into the ring with a professional wrestler. First, he socks it to you with fees. Then, he dumps you into bad investments. And last, he pins you down on the mat and won’t let you go.

So my rule number two of investing is: Never act on so-called “free advice.”

How can you tell? It’s actually quite simple. Everyone you deal with in the financial industry is either a salesperson or an analyst/advisor. It’s virtually impossible for anyone to be both at the same time.

The salesperson will tell you he’s not charging you for the advice. He’ll tell you it “comes with the service” or it’s covered by the transaction fees or commissions. That’s a dead giveaway.

The analyst (or a true advisor) tells you, up front, what he’s going to charge you, he charges the fee, and then he tells you what he charged you. It couldn’t be clearer.

The fee could be something in the neighborhood of $100 per year for a subscription to an investment newsletter. Or it could be, say, $100 per hour for a personal consultation. That’s cheap insurance that can save you — or make you — a tidy sum.

Still not sure how to distinguish between a salesperson and a true analyst or advisor? Here’s what I suggest: No matter whom you encounter in the financial industry — stockbroker, insurance agent, financial planner or banker — ask these questions:

1. Do you (or your company) make more money the more I buy? If the answer is yes, you’ve got a problem right off the bat. Often, the best investment decision is not to buy. And sometimes an even better decision is to sell. If buying nothing or selling is going to be a negative for his earnings, you don’t have an advisor. You’ve got a salesperson posing as an advisor.

2. Who pays your commissions or fees? If he says it’s someone other than you, he’s probably lying. Shake his hand, bid him farewell and walk out the door. No financial institution I’ve ever heard of really pays sales commissions out of its own pocket. If a salesperson is making commissions, it always comes out of your pocket, directly or indirectly.

3. Where are you getting the information or report you’re giving me? If the answer is a source that will benefit from your purchase, you can probably throw most of the info into the trashcan.

In the tech wreck, investors got hooked by salespeople repeatedly. And the same is happening right now. But with these three questions, you can discard the salespeople and find the true advisors. They are those who are …

• Always compensated by you — not by the companies whose financial products you buy.

• Always compensated for their time or their information — not for a sale.

• Always your advocate and defender. Whether it’s just a normal, friendly transaction or a heated legal dispute, it’s always crystal-clear which side they’re on — yours and only yours.

I repeat: “Free advice” is neither free nor advice. Sooner or later, it could cost you a fortune in terms of mediocre performance or, worse, outright losses.

Am I being overly harsh on ethical brokers, sales agents and financial planners? Perhaps. But only in the sense that it’s not really their fault. It’s the system that’s rigged against you.

You see, even the most well-meaning salespeople still have to make a living. But they can’t make a good living if they tell their clients to stay out of the most popular stocks … avoid mutual funds that charge a big fee … or stick with insurance policies that pay the lowest commissions. Nor can they afford to recommend investments that involve very low fees and commissions, which happen to include some of the best choices you can make today.

If they consistently give you this kind of advice, they can’t put food on the table for their families — let alone send their kids to a good college. And they’ll never be eligible for the big bonuses and rich rewards that inevitably flow to the top-performing salespeople.

Many salespeople do try to be as ethical as they can be within the limitations of the system. They’re friendly and helpful. They bend over backwards to do right for their clients. But they’re still salespeople. Work with them to buy the products you want. But get your information and advice elsewhere.

Lesson #3
Wall Street’s “Rules of Thumb”
Are Often Flawed or Deceptive

The bias revealed in the last bear market went beyond just recommending bad investments. It also was the source of many investing “rules” promulgated by Wall Street pros and blindly accepted by most investors — most of which were myths in disguise.

Some examples …

Myth: “Always invest in stocks for the long term.” You saw this in The Wall Street Journal story I just quoted. And you’ve probably heard it in many other permutations as well: “Historically, stocks have always moved higher,” they say. “Bull markets are longer than bear markets,” goes the argument.

The reality: Most of the stats they cite assume you bought stocks after a major decline, when they were at rock bottom. The reality is few people ever buy at those levels. Indeed, most people tend to buy most of their stock after a major rise, when stocks are very pricey. For example:

• If you bought the average Dow Jones Industrial stock before the Crash of ‘29, you would have lost 89 cents for every dollar invested. And even if you had both the cash and the courage to hold on (few did!), you’d still have to wait 24 years — a full generation — before you could recoup your original investment … and another 20 years before you could catch up with an investor who just earned a steady 5% yield during that period.

• If you bought the average Dow stock at its peak in 1973, you would have lost 45.1%. The Dow touched an all-time high of 1051 on January 11, and then dropped for two years, hitting 577 in December 1974. It did not cross above 1000 again until eight years later.

• Losses in many so-called “conservative stocks” were just as bad. If you bought the average utility shares, considered safer than most stocks, your losses would have been 88.2% in 1929-32 and 45.3% in 1973-74.

• All the averages understate the true losses and recovery periods. Reason: Bankrupted — or greatly downsized —companies are routinely removed from the averages and replaced with cream-of-the-crop companies. If your portfolio includes some of those companies, your losses will be worse than the averages and your recovery period will be longer.

Myth: “Don’t sell in panic. It’s probably the bottom.” Why is it that when brokers sell, it’s supposedly based on reason — but when you or I sell, they say it’s based on emotion?

The classic example they like to remind you of is the Crash of ‘87, which took the Dow down 36% in a big hurry, and then was over almost as quickly as it began. “People who sold at the bottom of the ‘87 crash missed out on the biggest bull market in history,” they say.

The reality: There are two problems with that argument. First of all, even if you sold at the very worst time in 1987, there were many, many opportunities to buy back into the market in subsequent months.

Second, their recommendation not to sell didn’t work too well in 2000-2001. The pundits unanimously declared a bottom in April 2000 when the Nasdaq was off 37.1%. Then, they declared another bottom in December 2000, when it was down 55.4%. If you followed their advice, instead of getting hurt just once, you got killed again and again.

Then, ironically, when the Nasdaq did hit a bottom — that’s when the majority of “experts” on Wall Street themselves began to panic! Reflecting the nearly unanimous pessimism of Wall Street experts, Business Week advised its readers to dump their shares even if they had already plunged 80% or 90%. Time’s front cover featured a mean bear and warned of more big trouble ahead. Nearly all the great “bulls” on Wall Street temporarily abandoned their optimistic bent and “warned” you about events that had already happened.

My rule number three of investing: Sell BEFORE the panic stage. In practice, that means selling just as soon as your stocks fall below a predetermined loss level that you’re comfortable with. The actual level will vary, and certain investments, like options, must be treated differently. But generally, a 20% decline in a stock is a key level to consider.

Myth: “Mutual funds have smart managers. They will give you diversification. They will protect you.”

The reality: Mutual funds are neither manna from heaven nor the holy grail of investing. In the great stock market years between 1997 and 1999, only 24% outperformed the S&P 500.

In 2000-2001, the smart, sophisticated mutual fund managers running tech funds got scammed just like everyone else. In fact, every single one of 200 tech stock funds lost money, with 72.5% of the funds losing more than the Nasdaq Composite Index. So much for expertise and diversification!

Four More Rules of
Investing in Today’s Market

My rule number four: Keep a substantial portion of your money in cash or cash-equivalent, including foreign currencies. (For specific instructions, see my two-weeks-ago Money and Markets, Triple Crisis: Your First Defense.)

My rule number five: Hedge with inverse ETFs — special exchange-traded funds designed to go UP in value when the market goes down. (For my step-by-step plan, see last Monday’s Money and Markets, The Triple Crisis Strikes Harder.)

My rule number six: Diversify over a broad spectrum of other investment classes, including natural resources like oil and natural gas. (If you want to get Sean’s oil report coming out tomorrow, today’s your last day to sign up. Click here. And if you invest in oil and gas stocks, be sure to also follow my rule number five for protection.)

My rule number seven: If you work with a money manager, ask him about his programs designed for a bear market. If he doesn’t have one, move your assets to one who does.

Good luck and God bless!

#1. Sign up for a rewards credit card — By no means am I advocating racking up debt on a shiny new card. Rather, I’m suggesting you buy only what you can afford, and pay for it all with one card that actually gives you something back (cash, airline miles, whatever).

As long as you promptly settle up the entire owed balance on every due date, you’re effectively getting something for nothing!

Plus, you receive a nice monthly inventory of all your expenditures, which is great for honing your budget. If your statements come electronically, you might even be able to dump them right into any financial management software you use.

One word of warning, though: Make sure the card you choose doesn’t carry hefty fees. You might consider paying a low annual fee if you’ll be receiving outsized benefits overall. But you should also know that there are rewards cards out there that don’t have annual fees at all.

According to a recent Consumer Reports survey, American Express’ “Blue Cash” card was one of the overall best cash-back rewards cards. So you might consider using that as a benchmark when you do your research.

#2. Consolidate your accounts — While we’re on the subject of credit cards, ask yourself how many you have right now …

Then factor in all your savings accounts, checking accounts, and brokerage accounts …

Now, tally up any retirement plans you have with old employers …

Add in any other miscellaneous accounts …

If you’re starting to count on your toes, it’s time to see which ones you can consolidate!

Reason: The easier it is for you to see all of your assets, the easier it will be for you to manage those assets. In addition, many financial institutions will give you better fee structures and other perks for doing a greater amount of business with them.

If you’re fortunate enough to have savings that exceed FDIC protection (currently $100K per account) you’ll want to spread your assets around enough to get the insurance benefit. But beyond such practical concerns, I think the more consolidation you have, the better.

#3. Pull credit reports to check for errors and fraudulent activity — Because of the Fair Credit Reporting Act, every American is now entitled to a free report from the three nationwide consumer reporting agencies (Equifax, Experian, and Transunion) every 12 months. Yet a lot of people are not taking advantage of this offer.

You can choose to pull all three reports at one time, or space them out throughout the year so you get a frequent look into your records.

Whatever way you choose to do it, look for errors, incorrect addresses, or any suspicious activity. If you have questions or corrections, don’t hesitate to contact the agency. After all, your credit score affects the interest rates you pay on all kinds of loans.

To get your reports, visit www.annualcreditreport.com or call 1-877-322-8228. You can also request them by mail at: Annual Credit Report Service, P.O. Box 105281, Atlanta, GA 30348-5281.

#4. Enroll in whatever retirement plans are available to you — If you’re still working, and your employer offers a 401(k) plan — or any other similar sponsored retirement plan — you should absolutely enroll assuming you qualify. The tax benefit alone makes participating worthwhile.

Moreover, if your employer matches some (or all!) of your contributions, I encourage you to put in enough to get the full match. This is essentially free money … don’t pass it up!

I also encourage you to open up an IRA if you qualify. Again, as I explained a few months ago, there are myriad tax benefits to doing so.

#5. Take advantage of DRIPS — I devoted a lot of space to the benefits of Dividend Reinvestment Plans earlier in June, so I don’t want to be redundant. But I just had to use this opportunity as a gentle reminder to take full advantage of these plans if you don’t need the current income from your stocks. Enrolling is easy and the power of compounding can produce tremendous results!

Bottom line: Together these five small steps would take a few hours to complete. But they’re the kind of moves that could pay you rich rewards for many years to come.

What Does it Mean?
An exchange-traded fund (ETF) that is constructed by using various derivatives for the purpose of profiting from a decline in the value of an underlying benchmark. Investing in these ETFs is similar to holding various short positions, or using a combination of advanced investment strategies to profit from falling prices.

Also known as a “Short ETF,” or ”Bear ETF”.

One advantage is that these ETFs do not require the investor to hold a margin account as would be the case for investors looking to enter into short positions.

There are several inverse ETFs that can be used to profit from declines in broad market indexes, such as the Russell 2000 or the Nasdaq 100. In addition, it is possible to buy inverse ETFs that focus on a specific sector, such as financials, energy or consumer staples. Most investors look to purchase inverse ETFs so that they can hedge their portfolios against falling prices.

Warren Buffett has some advice for young people, like college students, who want to remain financially independent.  It’s not new and its not a surprise, but it is solid counsel on avoiding a very common money pitfall, and worth repeating:

“The biggest suggestion I have is to avoid credit cards. Interest rates are very high on credit cards. Sometimes they are 18 percent. Sometimes they are 20 percent. If I borrowed money at 18 or 20 percent, I’d be broke…. So if I had one piece of advice for young people generally it would be to just avoid credit cards.”

That quote comes from a news release about Buffett’s visit this week to a Dairy Queen in Omaha to promote a July-only special: Girl Scouts Thin Mint Cookie Blizzard Treat.   Dairy Queen is a subsidiary of Berkshire Hathaway.

It was during this event that Buffett told the Associated Press he was amazed that a Chinese fund manager agreed to pay $2.1 million to have lunch with him.  “It kind of blew me away,” said Buffett.  Last year’s winner paid about $650 thousand.  But, says Buffett, the extra dollars won’t necessary translate into a longer lunch, which usually clocks in at three hours in any case.

Every year, a chance to share lunch with Buffett is auctioned off to raise money for San Francisco’s Glide Foundation.

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