Free Money Finance

Five Alternative Investments to Protect Your Portfolio

US News lists five alternative investments to protect your portfolio as follows:

• Real estate -- The bogeyman of this downturn should still—someday—be a viable part of your portfolio. The housing bust makes it easy to shun the sector entirely, but real estate investment trusts, or REITs, historically offer unique risk-management benefits.

• Inflation-protected securities -- A slowing economy and the threat of deflation haunt the market today, but the return-killing specter of inflation will eventually re-emerge, if history is any guide. A small allocation of treasury inflation-protected securities, or TIPS, helps lower the risk of unexpected jumps in prices.

• Commodities -- It may not be happening right now, but commodities generally move in the opposite direction of both stocks and bonds, especially over long periods of time. Plus, commodities tend to perform best when your portfolio needs them most. A dollop of commodities offsets the risk of inflation, allowing you to buy longer-dated bonds with higher yields.

• Fixed annuities -- Annuities aren't for everyone, but for retirees considering how to make shrinking portfolios last, they're worth keeping in mind. Fixed annuities are contracts issued by insurance companies that provide regular payments until the end of the holder's life. They offer some of the best security against ups and downs in investment returns at a time when you'll be spending your hard-won gains in retirement.

• Stable-value funds -- Offered through retirement accounts, including IRAs, stable-value funds are a conservative answer for investors looking for just a bit more return than the usual money market fund provides. Stable-value funds are essentially agreements between an issuer and an insurer who agree to keep the fund's value stable. Volatility and risk are generally low for stable value.

Other than real estate (through owning my home), I don't have any of these. Inflation-protected securities and commodities are options I should likely investigate while fixed annuities and stable-value funds don't hold much interest for me. How about you -- any of these either part of your current portfolio or something you want to check out?

The Four Ways to Invest

Bankrate lists the different ways to invest as follows:

• Passive investing -- Passive investing has its advantages. For one, it's almost a set-it-and-forget-it strategy. A purely passive strategy would be buying an S&P 500 index fund and then never touching it again.

• Fundamental analysis -- Fundamental analysis involves studying the entire picture of the broad economy, industries within the economy and then individual companies within each industry to assess its financial strength.

• Technical analysis -- Technical analysts use charts to study historical stock prices and trading volume data to gauge investor sentiment as a guide to the prospects of a particular security.

• Market timing -- But even professional traders often use either technical or fundamental analysis to time the market. In addition to studying price and volume data on charts or studying financial statements and the economy, they focus on something called the moving average.

Here's my take on these:

1. As most of you know, I'm an index fund investor. One reason is because they keep costs low (which impacts returns dramatically.) In addition, I've purchased my funds in a way to keep costs as low as possible.

2. I used to use fundamental analysis until I realized it took too much time, effort, knowledge, information, and luck to be successful for me (and for most people for that matter -- that's why people spending their careers doing this usually don't beat the market once costs are taken into account.) The most famous/notable exception to this "rule" is Warren Buffett. And, of course, we all know how he advises people to invest. :-)

3. I have a friend who uses technical analysis -- at least he did until he realized it didn't work (and it was eating him up in fees.)

4. Is "market timing" a viable strategy? Has anyone ever been able to predict the rise and fall of the market in advance over the long term? Sure, people have predicted one or two growth spurts or declines (I could do that much), but who has done it over and over again for years?

Employee Stock Purchase Plans: Great Investments

The following is a guest post from Financial Fellow.

I work for a publicly traded company that offers its employees the option of buying its stock at a 15% discount.   I take full advantage of this program.  Why?  It allows me to gross an extra 2-3% a year on top of my salary with extremely minimal risk.   Here’s how it works:

Each paycheck 15% of my income is withheld.  On the last day of the quarter all the money that has been withheld is used to purchase shares of my company’s stock at a 15% discount of the stock’s quarter ending price.  Next, I sell all the stock at the full share price as soon as possible - usually 7 business days after the purchase date.  (It takes about a week for the purchase of shares to be fully processed and reflected on my account.)  In the process I earn a 15% return on my money in, at most, 3 months!  The below provides an example of how it works with a hypothetical annual salary of $75,000 – notice that I’ve profited almost $500 in one quarter.

• $75,000 Annual Salary -- $18,750 Quarterly Salary -- $2,812 (15% of Quarterly Salary)
• $55.00 (Hypothetical Stock Price) -- $46.75 (Hypothetical Stock Price at a 15% Discount)
• $2,812 / $46.75 = 60.14 (# of Shares Bought at Discount)
• $55.00 (Hypothetical Stock Price at Time of Sale)
• 60.14 Shares x $8.25 (Stock Sell Price – Stock Purchase Price) = $496.16 (Proceeds)
• $496.16 (Proceeds) - $25 (Sell Fee) =  $471 Gross Profit for a single quarter

Over the course of a year I would have grossed almost $1,900 through the employee stock purchase program.

What if the stock price goes down?

Am I worried about the stock price dropping between the time I buy and sell the stock?  No.  Under my company’s plan, the stock purchased each quarter will only be subject to market fluctuations for a little more than a week.  During that time, the stock price would have to fall more than 15% for me to lose money.  Could that happen?  Yes.  Will it happen?  Not too often.  Even if it did happen I would still have another 3 quarters in the year to offset the drop.  Don’t forget that the stock price could also go up.  Additionally, the more quarters I participate in the employee stock plan, the more likely my gains and losses will be averaged out and result solely in the 15% gain.

What about an Enron, AIG, or Bear Sterns-like collapse?  What if I’m participating in my company’s employee stock purchase plan and the company stock drops to pennies virtually overnight?  First off, if that did happen it would need to occur while my purchased stock was subject to market fluctuations in order to impact me.   Over the course of a year my purchased stock will only be subject to market fluctuations for about 1 month.  That means that even if the company lost all of its value overnight there is only an 8.3% chance that I would have been holding any stock when it occurred.  But, let’s assume worst case scenario that it happened while I was holding stock.  At most, I would have just lost less than 4% of my gross salary.  Admittedly an unfortunate occurrence, however, it is a very unlikely one.  Also, that 4% loss in my gross salary would have been offset by any gains I made in subsequent quarters.   Notice in the example above that I just made $471 in a quarter.  Keep going for another 5 quarters (6 quarters in total) and I would have earned enough gross profit to offset losing all of my quarterly contributions ($2,812) in an Enron-like collapse.  As I stated above there is a risk.  The risk, however, is extremely minimal and greatly outweighed by the potential gains.

What about taxes?

In the above example I made just under a couple thousand dollars.  You may be wondering how that money will be taxed.  The 15% discount ($1,984 in total) is treated as ordinary income.  Using the above example my gross salary of $75,000 will be reported on my W-2 as $76,984 and I would pay ordinary income taxes on the full amount (see example below).   Any gain or loss due to the fluctuation in the value of the stock price between the time I bought and sold it (which should average out to a 0% fluctuation over time) would be treated as a short term capital gain or loss. 

($55.00   x   60.14 Shares)  -   ($46.75   x   60.14 Shares) = $496.15 Discount for a single quarter
$496.15 Discount   x   4 quarters   =   $1,984 Discount for a year

One other potential tax implication exists:  The Alternative Minimum Tax (AMT).  The selling of stock (whether through an employee stock plan or another means) could increase my chances of triggering the AMT.  Prior to enrolling in your company’s employee stock plan, you may want to perform a hypothetical tax return to determine if you would be at risk of triggering the AMT. 

What to consider relative to your company’s employee stock plan

The example provided above is based off the rules that govern my company’s employee stock purchase plan.  Although they are generally similar, these plans vary from company to company.  Your company’s plan (assuming they have one) could be more or less lucrative than mine or present a different level of risk.  Be sure to evaluate your own company’s stock purchase plan prior to enrolling in it.  With that in mind here are some things to consider when deciding whether or not you want to participate in your company’s plan: 

• The percent of discount your company offers you on its stock
• The amount of time that you are required to hold the stock
• How long it takes to sell the stock from the day it is purchased to the day the sale is finalized
• How much are the sell fees (amount the broker charges to sell your stock)
• The federal government caps the amount of money you can contribute in an Employee Stock Purchase Plan to $25,000 per year.
• Make sure that you have enough money in your savings/checking account to cover the withholdings from your income that will be taken out of your paycheck.  (Note that you may have to build up your cash reserves prior to participating in the plan.)

A return that’s hard to beat

Participating in my company’s employee stock plan allows me to get a 15% return on my money in 3 months or less with a very small, manageable amount of risk.  There are very few other opportunities where you will get that large of a return on your investment in such a short period of time with so low a risk!

Is Buying a Title of Nobility an Investment or a Scam?

So I get this email a couple of weeks ago:

I recently invested in a title of nobility through a private brokerage firm called (name deleted). Their site is (site deleted). Might be of some interest to your readers as I was able to receive a rewards discount being that I am a Centurion Card member and for those looking to diversify. They have a relationship with Centurion rewards at American Express.

I wasn't sure if this was legit, someone trying to promote a site they actually owned, or what in the Sam Brown was going on. But I was curious, so I replied:

How does an "investment" like this work?

He responded:

Considering titles are unique and historical, as time goes on they become more and more valuable (less and less are available on the market).

I bought a Scottish Barony in 1982 for a tiny sum of $8,000. I sold it in 1999 for $275,000. I wasn't planning on really ever selling it since it is a historical addition to my family, but it was too good to pass up.

At this point, both my BS (sounds too good to be true) and curiosity (wow, what a return!) meters were on overload. So I said:

Really? Care to write a post on it for my site? What you did, how you did it, etc. Maybe even a bit on what these go for now.

This was the response I received:

It was 1982 when I came across a growing market for titles of nobility. I purchased a Scottish Feudal Barony for my family for a paltry sum of $8,000. Initially I purchased the title as a historical addition to my family. In the late 90’s, a huge boom in value happened in the noble titles market. Similar Barony titles to the one I had were being sold for 20 to 30 times what I paid. In 1999, I sold my title for the sum of $275,000.

It wasn’t until the Spring of 2008 when I became interested again in titles of nobility due to the changing economy and the safety of my assets. I came to know a private brokerage firm through a friend. I was able to look over a small catalog of available titles of nobility. After over 3 months of thinking, I decided to go ahead with acquiring another title of nobility. With the changing global economy, titles of nobility I knew would always retain their value and most likely soar. I decided to invest $20,000 into a single low ranking title of nobility. Over about a 60 day period, I was kept informed by my agent of the status of the transfer of the title. As of August 2008, I am now the holder of a title of nobility once again.

The differentiating factor of the noble titles market from any other is every title is unique with their different histories. This is what allowed me to invest again. I was able to acquire a less historical title from the one I bought in 1982. I’d probably have to offer a much more significant amount than I sold the Barony for to get it back. There’s very few available in 2008. As time goes on, I hope the title I purchased will gain much in value. During this economic slump, now is a good time to acquire a title. A percentage of the market buys titles for just the historical or vanity value. Those are the people who are not looking for titles right now because of the economic slump. Investors can get into the market in several different budget areas. The title will always be unique and historical. I now await for the vanity and history based buyers to pump the market value of the title I purchased.

At this point, I went a googling and found the following at wikipedia under false titles of nobility:

Fake titles of nobility are supposed titles of nobility which have, in fact, been fabricated, and are not recognized by any government, or have not been so recognized in the past. They have received an increasing amount of press attention as the number of schemes which attempt to sell these titles has increased.

It is impossible to purchase genuine British titles of nobility or peerage titles directly, with one exception: it is possible to acquire a feudal title in the grade of baron in Scotland. Until the Abolition of Feudal Tenure (Scotland) Act of 2000, the transfer of such a barony required some interest in land, specifically the caput baronium (the seat of the barony), since the Act the titles stand on their own and transference by sale without land is legal. Scottish feudal baronies have been transferred by sale for well over half a millennium.

I also found this interesting piece on the nobility amendment to the US Constitution:

The Titles of Nobility Amendment (TONA) is a proposed amendment to the United States Constitution dating from 1810. It was submitted to the state legislatures during the 2nd Session of the 11th Congress via a resolution offered by U.S. Senator Philip Reed of Maryland—and has not taken effect because it has not yet been ratified by the legislatures of enough states.

The text of the proposed amendment:

If any citizen of the United States shall accept, claim, receive or retain, any title of nobility or honour, or shall, without the consent of Congress, accept and retain any present, pension, office or emolument of any kind whatever, from any emperor, king, prince or foreign power, such person shall cease to be a citizen of the United States, and shall be incapable of holding any office of trust or profit under them, or either of them.

Yikes! I'd hate to buy an "investment" and lose my citizenship! Then again, the chance this will pass is virtually zero. After all, it's been almost 200 years since it was proposed.

And finally, to round out some information for those interested, here's a page on nobility in general.

Then I searched some more. If you want to see all the sites out there selling titles of nobility, go to Google and type in "titles of nobility for sale". Look at all the info (pro and con) on titles of nobility both in the search results and the Adwords ads (to the right). Play around with similar search terms and you'll find even more firms selling these (most of which look questionable in nature) as well as pieces saying they are scams.

Personally, I think this sounds a bit shady, but I'm open to learning something new. So I thought I'd post on this and see if anyone knows anything about titles of nobility for purchase and (especially) as an investment. Any thoughts out there?

How I Easily Improved My Investment Returns Using Vanguard Admiral Shares

Not long ago I told you all how I'm reorganizing my investments. This post will give a bit more detail on what I'm doing. Specifically, it will tell how I saved some money while investing and thus will improve my investing return.

As I noted previously, I sold several of my older funds and consolidated the amounts into these three funds:

• Vanguard Total Stock Market Index (VTSMX)
• Vanguard Total Bond Market Index (VBMFX)
• Vanguard Total International Stock Index (VGTSX)

But what I didn't say was that I had enough in my various accounts to convert the first two to Vanguard Admiral shares. What are Admiral shares? They are the same shares as those held in a "regular" Vanguard fund (same value, stocks, etc.) except their expense ratios are lower. The catch? You have to have at least $100,000 invested in a fund per account (not total among various accounts) to get the lower-cost options. Here's the difference in the expense ratios:

• Vanguard Total Stock Market Index (VTSMX) -- 0.15% expense ratio
• Vanguard Total Stock Market Index Admiral (VTSAX) -- 0.07% expense ratio

• Vanguard Total Bond Market Index (VBMFX) -- 0.19% expense ratio
• Vanguard Total Bond Market Index Admiral (VBTLX) -- 0.10% expense ratio

FYI, Vanguard Total International Stock Index (VGTSX) has an expense ratio of 0.27% and does not have an Admiral option.

So, for every $100,000 invested in Vanguard Total Stock Market Index Admiral shares, $80 is saved per year versus investing in "regular" Vanguard Total Stock Market Index shares. And for the bond index fund, $90 per year is saved for every $100k invested. I have a few of these funds in various accounts, so I'm currently saving over $250 each year in investing fees using Admiral shares. While it's not a fortune, $250 for doing nothing different (I still get the funds I want) is nothing to sneeze at either. And it's something that will certainly improve my overall investment results since costs have a BIG impact on total investment returns.

Jane Bryant Quinn Hates Gold Investing

Here's an interesting piece on investing in gold where the author (famed personal finance writer Jane Bryant Quinn) says there's no reason to invest in physical gold (coins, bars, etc.). A summary:

Owning 20 or 30 coins is nice but won't protect your standard of living in a world where dollars are dust. Gold isn't even a reliable hedge against inflation. It reached $850 an ounce in January 1980, a price not seen again until January 2008. During those intervening 28 years, gold plunged and reared but lost more than half of its purchasing power. For a 1980 investor to break even after inflation, gold would have to reach $2,200. It might, but how long did you plan to wait?

Ok, so you can't buy enough of it to protect you in case of a collapse and it doesn't outpace inflation -- so what's the use of buying physical coins? Her point exactly!

Now she does offer some alternatives to buying physical gold including the following:

A cheaper way of buying gold is through an exchange traded fund. The most widely traded fund, SPDR Gold Shares, costs 0.4 percent a year in fees, plus your brokerage commission. You don't own the gold directly. A trust holds large gold bars (warehoused principally in London) and sells shares against them, which are traded on the open market.

It costs even less to buy bullion in a pool account, such as the ones offered by Kitco. Like an ETF, a pool account sells shares in a large bar of warehoused gold. You pay just a hair over the spot gold price, and sell it back to Kitco for just a hair under. There are no annual expenses. For a fee, you can redeem in gold itself. As with ETFs, you depend on the pool's trustee to support its guarantee.

Then again, she doesn't detail why buying these are or aren't a good investment -- she just tells us about them. This leads me to believe she's not a big fan of investing in gold no matter where or how you buy it.

Finally, she lists a couple tax-related issues associated with gold that I found interesting:

• Dealers have to report to the Internal Revenue Service if you sell 25 or more Maples or Krugerrands. They're not required to report your sales of American Eagles and some other coins, although some may do so.

• Gold, by the way, is taxed as a collectible -- whether you buy it in the form of coins, ETF shares or an interest in a pool account. Your tax rate on long-term capital gains would be 28 percent, compared with 15 percent on other assets. Only a significant price gain (or currency collapse) redeems your bet.

Yikes! That last one is a killer!

Anyone out there have any sizeable amounts of gold? How are you holding it (physical, ETF, pool account)? Why?

Deducting Investment Losses Off Your Taxes

This topic seems well-timed. It's on when and how much you can deduct from investment losses on your taxes. The summary:

First, you can use your capital losses to soak up your capital gains, with no dollar limit. For example, suppose you sold a stock earlier this year for a $25,000 gain. Now you sell another stock for a $25,000 loss. Put those two together, and your loss erases your entire gain. Thus, you don't owe any capital-gains tax on that $25,000 gain.

Now suppose your capital losses are bigger than your gains, or that you have no gains at all. In that case, you can deduct as much as $3,000 of net capital losses (or as much as $1,500 if you're married and filing separately from your spouse) each year from your wages and other ordinary income. Additional amounts get carried over into future years.

I think I'll have amounts to carry over for a few years (if you need details on what I'm talking about, see my Wednesday post on selling my mutual funds.)

All About Annuities

Every once in awhile I get a question about annuities -- what do I know about them, what do I think of them, etc. I don't really have a single post that describes what annuities are, how to handle them, etc., so when I saw this piece from the Wall Street Journal that talks about annuities, I knew I had to post on it.

This specific piece describes many of the basics including how annuities work, the difference between fixed and variable annuities, how annuities have been affected by recent market conditions, and whole host of other questions. If you're interested in finding out more about annuities, this article is a good place to start.

If you're interested in the pros and cons of annuities, here's a piece from Bankrate. They start with thoughts on when an annuity should be considered:

Only after you've contributed the maximum to your 401(k), SEP, Keogh, IRA and whatever other tax-deferred opportunities are available to you, should you consider an annuity.

Then they list the benefits of annuities as follows:

• Lifetime income is guaranteed
• Earnings are tax-deferred
• There is no limit on how much you can contribute
• There are no income restrictions
• You can switch investments within your contract without paying taxes
• You get a premium for outliving your life expectancy

And the cons of them:

• Fee and commissions can be high and cut deeply into your return. Look for low-load or no-load contracts with low fees.
• Annuities are generally bought with after-tax dollars.
• At payback time, income is taxed as ordinary income, even if most of it is from capital gains. Not good if you're in a 28 percent or 39.6 percent income-tax bracket and your capital gains tax rate is 20 percent.
• Annuity talk can sound like doublespeak, making it hard to separate the good contracts from the bad ones.
• An annuity is a long-term investment, and bailing out early can kick up penalties, taxes and surrender charges.
• You could be paying for life insurance you don't need.
• You need a long stretch of time and a big chunk of money to make it work.

Personally, I haven't used annuities yet though I may do so in the future. My biggest hang-up with them is that I view them as wily expensive -- as are most "investments" available from insurance companies. Then again, maybe this is a misperception on my end and they aren't as expensive as I think.

Anyone have some words of wisdom on annuities for us all?

Three Reasons to Invest in Gold

Kiplinger's offers three reasons (reasons they say are debatable, risky, and scary) to invest in gold as follows:

• Reason #1. The first reason to own gold -- the debatable one -- is its beneficial effect on your total investment program. Many financial planners and other experts point out that gold can reduce a portfolio's volatility. And it's true that in both inflationary times and times of uncertainty, gold's price tends to rise as prices of most stocks and certain bonds tend to fall-although gold has been sinking, along with just about everything else, in recent weeks. The net effect of gold's historical tendencies is to stabilize a portfolio's value. However, gold can drag down performance over time. For this reason, many advisers do not endorse its use. Russell Wild, a financial planner in Allentown, Pa., puts it this way: "Over the long term, gold has just about kept up with the rate of inflation, but with a lot more volatility." Not very impressive.

• Reason #2. The second reason for buying gold, the risky one, is simply that you think its price will rise substantially. Maybe. But keep in mind that even when gold was trading at about $1,400 an ounce last spring, many analysts were bullish because of all the financial uncertainty. Today the financial situation is much worse, but instead of rising, the price of gold is at less than half its spring peak.

• Reason #3. Then there's the scary reason to own gold: protection from a collapse of the financial system. If this happens, a single gold coin will be worth a wheelbarrow full of currency (think of Germany's Weimar Republic issuing 50-million-Mark bank notes in the 1920s). Unfortunately, we couldn't find any survivalists to interview for this story, but all the experts we contacted had a good laugh when asked about this scenario.

This piece was written October 24. I bet there are far fewer "experts" laughing now than there would have been three months ago.

Anyway, here's their conclusion to the piece:

In the end, none of the three reasons for owning gold carries much weight.

They also offer how to buy gold if you simply MUST have some -- two options:

• The simplest, safest, most efficient way is with an exchange-traded fund, such as iShares Comex Gold Trust (symbol IAU) or Street Tracks Gold Trust (GLD).

• If you want to buy gold for that warm, secure feeling it brings, buy some coins. You can purchase gold American Eagles or Canadian Maple Leafs at close to gold's spot price from a reputable dealer, such as March's Superior Gold Group.

I don't own any gold as of yet and don't really have any intentions of buying any (though I must admit that the current financial crisis has led me to do a bit more investigating of the issue.) How about you? Anyone out there own gold? How do you own it (coins? ETFs?) What percentage of your portfolio does it make up?

Update: more food for thought -- here's a piece saying gold isn't performing as expected.

Why I Sold My Mutual Funds

In my post titled Six Investment Pitfalls I commented:

Yep, I've done all of these in my lifetime. Early on in my investing career, when I knew little about the subject and thought I could pick killer stocks better than anyone on the planet, I did all of these -- several times. Then, when I learned a bit more, I became somewhat smarter, but didn't quite get all the facts right again. Now I have some mutual funds that I should have never been in (and want to get out of) but yet have huge capital gains tax implications if I sell them. Making bad decisions early on can certainly have long-term consequences. Hopefully, someone can learn from my mistakes.

Let me add a bit more detail to this.

After I figured out that I wasn't a stock-picking pro (10 to 15 years ago), I decided that I'd invest in mutual funds instead. But I 1) didn't have a strategy and 2) didn't know how important it was to control investing costs. So I picked a NUMBER of funds here and there in various accounts -- taxable accounts, IRA for my wife, and an IRA for me (rolled over from a 401k). In fact, I never met a mutual fund I didn't like. I ended up with somewhere around 40 different funds in three accounts.

I eventually realized that this was foolhardy (investing without a strategy) and I studied the topic a bit more. That's when I decided index funds were for me and I developed a strategy around investing in them. That was several years ago and since that time index funds have become the mainstay of my portfolio.

But I still had the other 40 funds. When I moved over to index fund investing, I simply started new funds -- I didn't sell the old ones. So I ended up with money in a wide number of funds I didn't really want. So I could have simply sold them, right? Not unless I wanted a big capital gains tax hit. After all those years, the funds had made some decent gains, so if I sold them all at once, I'd have a hefty tax bill.

Of course I could have sold them when I sold loser funds/stocks (then the gains would be offset by other investment losses), but I didn't have any losers because I was never selling. So I ended up with a huge number of funds that were difficult to track and manage.

That's when a reader suggested that I give away my appreciated mutual funds. If I gave them directly to a charitable organization, I could avoid the capital gains tax altogether (for more info on this, see How Shrewd Investors Save on Taxes.) So this is what I did in 2007 and the first half of 2008. I gave mutual fund shares directly to my favorite charities. I then took the amount I would have given in cash during normal times and invested that in index funds. This got rid of several funds in a couple years, but I still had a long road to go (BTW, in case you're interested, I gave a boatload away in early 2008 -- enough to cover my giving for the whole year -- so I got a good amount of value from some of these funds before the market tanked.)

Then the market crashed big-time. In the span of a few weeks, my capital gains were eroded and I had losses. Now I didn't need to wait to sell all the funds I owned, so I sold them all and invested the proceeds into the following index funds:

• Vanguard Total Stock Market Index (VTSMX)
• Vanguard Total Bond Market Index (VBMFX)
• Vanguard Total International Stock Index (VGTSX)

Of course I would have preferred that the market stayed high and I would have gotten myself out of the funds as originally planned, but I'm trying to make lemonade out of lemons here. At least my investments will be much simpler to manage in the future and will reflect the strategy I want them too. Then again, they'll be easier to manage because they're a lot lower in value too. :-(

For additional perspective, check out this piece from the Wall Street Journal on getting a portfolio do-over.

Avoiding Another Lost Decade

The following is a guest post from Marotta Asset Management. Though I don't agree with it all, I did find this piece it to be a very interesting article on investing.

Many investors are panicking. From its peak in March 2000, the major market indexes still show significant losses. Even looking back over the past 10 years provides little comfort. The news media is calling it "the lost decade."

The lament began with a front-page Wall Street Journal article in March of this year that noted the S&P 500 had only gained 1.3% over the past 10 years, factoring in inflation and dividends. Since then, the market has continued to lose ground, leaving investors depressed and discouraged about their investments.

Many proactive investors experienced an even larger drop when in their scramble to beat the markets, they sold what had just gone down to purchase what was just about to go down. Chasing returns often amplifies losses and volatility, so much so that many investors believe they are cursed with the reverse Midas touch: What they bought must go down.

As if to add to the misery, many buy-and-hold investors did not even receive the flat market return. They thought they were purchasing actively traded funds, but they were simply buying closet index funds with overly inflated expense ratios. Excessively loaded fees sapped value from their investments while the underlying strategy went nowhere.

I've said before that we do not recommend S&P 500 index funds. Because the S&P 500 is a capitalization-weighted index, it tends to buy more of a stock when it goes up and hold less of a stock when it becomes more reasonably priced.

If the S&P were a financial advisor it would say, "Let's buy mostly large-cap growth stocks in the industry that did well last year with a high price per earnings ratio." The result of this advice is a very aggressive and volatile portfolio that does better at the end of a bull market than at the beginning. And it performs very poorly at preserving capital during a bear market--exactly what has happened over the last decade.

If you are invested primarily in funds that mimic the S&P 500, a lost decade should be no surprise. If we use market history to run hundreds of Monte Carlo simulations on a portfolio invested in an S&P 500 index fund, projections indicate returns at or below zero about 6% to 7% of the time. This scenario is astonishingly accurate of trends in the past 100 years in which six ten-year periods showed no gains. These periods were the 10 years ending in 1914, 1921, 1932, 1938, 1974 and 1977.

If you were invested in the Vanguard 500 Index, your 10-year average return through the end of last month was 3.06%. Inflation during the past decade officially averaged 3.0%, although actual inflation was probably at least 5%. To make matters worse, your portfolio has dropped again this month. So if you were invested in an S&P 500 fund, your decade-long progress toward your retirement goals is at a standstill.

But if you were smart, you did not lose this past decade. If you were invested in a balanced portfolio, you experienced both higher returns and lower volatility.

Even a balanced portfolio of just six different common funds could have boosted your 10-year average return to 8.18%. And it would have lowered your volatility from a standard deviation of 14.4% to only 12.3%. That is a 5.12% better annual return with 2.1% less volatility.

The balanced portfolio I used as a comparison doesn't cherry-pick investments that have done the best recently. In fact, this portfolio underperformed the S&P 500 by 7.5% over the past quarter. Asset allocation means always having something to complain about.

My comparison portfolio allocates 20% to fixed income in the Vanguard Total Bond Index (VBMFX). Of the remainder, it allocates 31% to U.S. stocks with 21% in the Vanguard 500 Index (VFINX) and 10% in the Vanguard Small Cap Index (NAESX). Another 31% goes to foreign stocks with 21% in Vanguard Total International Stock (VGTSX) and 10% in the Vanguard Emerging Market Index (VEIEX). Finally, an 18% allocation is made to hard asset stocks in the T. Rowe Price New Era Fund (PRNEX).

The funds just described have been popular for over 10 years. They have not made their gains from active trading. And they have low expense ratios. These are not necessarily the best funds; they are simply typical funds in each of the asset classes.

Theory and practice agree that a balanced portfolio is a far superior way to meet your financial goals. In Monte Carlo simulations, balanced portfolios earn money over a decade, even the bottom 5% of random returns. The exact portfolio construction is less critical than including asset categories with a low correlation to the S&P 500. A well-balanced portfolio should result in good returns with lower volatility. Returns will still vary widely because the markets are inherently volatile, but the worst cases should be considerably better.

In conjunction with my recommendation of a diversified portfolio, the markets continue to provide object lessons and practical labs. Recently foreign stocks, emerging markets and hard asset stocks have all corrected more than U.S. stocks and are trading at valuations that make them an attractive way to diversify your portfolio. Holding on to an undiversified portfolio will, on average, keep on providing inferior returns with high volatility. Don't wait for an undiversified portfolio to recover. You can't afford to miss another decade.

How to Get Better Investment Returns

Isn't it funny how it takes something catastrophic like a meltdown of our entire economy before the media goes back to "tried and true" ways to save and earn money? People, people -- they're tried and true for a reason. They work in all economic situations. If you ignore them in good times, you'll be much worse off in bad times. But I'm starting to get off topic, so let's move on.

Here's a piece that talks about how to improve your investment returns by keeping investing expenses low. The summary:

One way to stem some of the bleeding in your retirement account is to pick funds that charge rock-bottom fees. A firm's annual expenses eat away at returns. By keeping those to a minimum, investors can keep some of their money in their pockets.

Yep, this is one reason I like index funds -- because costs matter if you want to maximize your investment returns.

I'm about to make a few moves along this line (lower my investing costs even farther), and I'll be sure to update you when that occurs. Stay tuned.

Paying Down Your Mortgage Makes a Comeback

As an add on to our discussion yesterday on how to pay off a mortgage -- check out these thoughts from the NY Times:

Homeowners with an aversion to debt are sometimes tempted to pay down their mortgages before they come due. That can be a misguided approach, some financial counselors say, if borrowers can instead put that money into relatively safe investments that produce a higher rate of return than the interest rate they are paying on their mortgages.

In the current financial environment, however, prepaying on a mortgage might make sense.

With the securities markets plunging early this month, there have been few well-paying safe harbors for investors, making early mortgage payments more enticing than might otherwise be the case.

As has always been true, paying off a debt is a guaranteed return on your money. With the market the way it's been lately, nothing's guaranteed in the short run (though in the long run odds are it will be a good performer.)

As you all probably know, I paid off my mortgage using a specific formula for buying a house. The move to pay off our mortgage, something that once looked ridiculous to many when evaluated on a financial basis alone, now looks like it was a pretty good move, doesn't it? ;-)

For those of you interested, I've written about the tradeoffs of investing versus prepaying your mortgage (a couple times.)

I'm interested in hearing from you. Anyone out there who used to be in favor of investing over mortgage/debt prepayment now shifted their position (at least in the short term)?

Invest in Waves or in One Chunk? Dollar-Cost Averaging Versus Lump-Sum Investing

Here's an interesting discussion on which is a better investing option -- dollar-cost averaging or lump-sum investing. In other words, if you have an amount of money you want to invest, is it better to trickle it in over time or dump it all into the market at once? Here's what the piece linked above advises:

Over short periods as well as long, investing lump sums is the equal of dollar-cost averaging, except in those rare times when the market is going straight up, when lump-sum investing does better.

"At our firm, we tell clients that there is no difference," says Paul A. LaViola, the vice president of RTD Financial Advisors in Philadelphia. "However, emotionally, it can make someone feel better if they DCA when the market is going down or they are unsure about the market."

Now, of course, this assumes that you have one big lump sum to invest (which most people don't have). So, practically speaking, most people (for example, those with 401ks) invest using dollar-cost averaging. Or I guess this could be called lump sum investing too -- since they invest the entire amount they have available each month at one time. It's kind of circular logic/discussion, and I'm starting to get confused going through what exactly these two options are.

Anyway, here's my take and what I do:

1. Each month, I contribute to my 401k and that money is invested immediately.

2. Also each month I have money go from my checking account to Vanguard where it's invested immediately.

3. At the beginning of each year, I have several lump sum contributions -- to IRAs, Coverdells, and 529s. I invest these immediately.

4. Overall, my plan is to get the money into the market as soon as it's available (to start the compounding process) -- whether that means on a monthly basis or for those bigger portions at the start of each year.

How about you? How do you invest your money?

Investing: Fear Not, in the Face of Disaster

The following is a guest post from Poor MD.

My first night while on call as a medical intern, a "code blue" was announced over the intercom.  This meant that somewhere in the hospital, someone had stopped breathing and/or their heart had stopped.  It was up to us, the hospital house officers, just fresh out of medical school, to spring into action and perform life-saving cardiopulmonary resuscitation (CPR).

The patient's room was a dizzying frenzy of activity with nurses, techs, and aids rushing to and fro shouting for this instrument or that medication.  Before I stepped into the room, I shut my eyes for a brief second and remembered the most important rules for running a potentially life saving code:

1. Check to make sure I'm still breathing
2. Check to make sure I still have a pulse
3. Relax, and let my knowledge and training do its thing.

After I had assured myself I was indeed still breathing and with a pulse, any fears that I had evaporated and I calmly walked into the room to do what my extensive training had prepared me to do.

Our economy is circling the drain and it seems as though everyone is running around with their heads cut off.  No doubt, there are times when I look at my retirement fund and think to myself that my investments are in dire need of life support.  But before doing something with your investments you'll likely regret even more in the long run, take the time to check that you are breathing, that you still have a pulse, and then remember what you've learned from personal finance blogs, books, and financial giants like Warren Buffett.

I was recently asked by a reader of my blog "with my retirement fund going down the drain, what should I do."  Realize that every situation is different, but for someone young with 30 plus years before retirement, time is on your side.  As Buffett once said, "Be fearful when others are greedy.  Be greedy when others are fearful."

Now is not the time to be fearful.  If anything, I would recommend increasing how much is invested to take advantage of the market situation and at the least continue to contribute as you have been.  If you don't have a retirement fund, now is a great time to start one. 

Market values are certainly much better today than they were several years ago during the over inflated, pre-bubble bursting days.  If you find yourself close to retirement, you will need to evaluate your portfolio and make adjustments toward something more conservative.  But whatever you do, don't foolishly do something just to do something like selling off all your assetts.

Of course, the best advice I can give you is to never take financial advice from a medical doctor.

Index Funds Get Even Better

If you've been an FMF reader for more than 15 minutes, you know how much I like index funds. Well, it seems they're getting even better. Consider this quote from an interview with new Vanguard chief executive Bill McNabb:

Almost over any rolling 10-year period, index funds outperform active because of cost. That's the single biggest driver. If you think we're in an environment where single-digit returns might be more prevalent...cost is going to be an even bigger, more distinguishing factor. It's one thing to have a 75 or 100 basis point cost advantage in a market that's up 14 or 15 percent, it's another thing when it's up 7 or 8 percent. It's a huge difference in terms of percentage saved. The other part of it is that we haven't even begun to see power of indexing globally, as trading has becoming a global phenomenon.

We've talked before about the major impact costs can have on your investment returns. And in a world where returns may be even smaller for years to come, keeping your costs low is more important than ever. Hence, index funds are better than ever. ;-)

Four Reasons Not to Overreact

Here are four reasons not to overreact to the recent drops in the stock market:

• Reason 1: Market timing is a losing strategy. You may be thinking you should sell now and get back into stocks later when the market "settles down" and the economy starts to recover. But this approach—called market timing—can lead to disappointing returns. In effect, it puts you at risk of selling low and buying high.

• Reason 2: Investors have been rewarded for taking risk. The steep and sudden stock market drops we've seen recently are certainly unsettling and may have done serious damage to your portfolio. But this very risk is why, over the long term, stocks have outperformed bonds or cash investments.

• Reason 3: Playing it "safe" can lead to a shortfall. Remember, your investments will need to outpace inflation over time, otherwise you'll lose purchasing power. Historically, it's been stocks that have helped investors compensate for inflation by delivering higher average annual returns than cash investments or bonds.

• Reason 4: Emotional decisions often lead to regrets. "Generally speaking, it tends to be a very bad idea to make emotional decisions in times that are already emotionally charged," he said. "If the market had a bad day yesterday and you come in today and sell, that doesn't make up for yesterday's losses. Actually, what you're doing is just capturing your losses."

I have to admit that even for a long-term investor (20 years or so before I need the money I have in the market) the recent stock market ups and downs (mostly downs unfortunately) have been difficult to bear. But I've kept as calm as possible, remain committed to investing (my 401k is still buying every month), and try to remind myself of the long-term goal. If I could, I'd probably turn off the TV and screen the internet to eliminate all the bad financial news, but then again, I'm a money blogger. Just seems like that solution wouldn't work for me. ;-)

A few things I have thought about during this recent downturn:

1. I need to review my asset allocation and put more into bonds/cash. I probably have 10% invested in them now -- a bit too aggressive even for someone with 20 years to go and who’s willing to take a lot of risk.

2. We're all in this together. I have a decent amount in international stocks, but they've been beaten down just like US stocks. When something as big as the mortgage crisis happens, it's going to take down everything.

3. What alternative investments are there to stocks? Maybe starting a business or investing (part ownership) in local businesses?

4. What's safe in a true market meltdown? Let's say the worst had happened and the market totally crashed -- what would be a safe place to keep your money? What would hold its value in these times? Cash? Gold? Something else?

An Investor's Perspective

The following is a guest post from PW at Pursuing Wealth. PW is a full time stock market investor who also holds a regular job.

I admit my blog caters to a different audience and the readers of FMF will most likely not find value in what I write. However, I volunteered to write a post for FMF while he’s on vacation because I’m sickened by what I see happening in the stock market and society in general. Because I’m a stock market investor, I have learned to make money whether the stock market is going up or down, but everyday working Americans don’t know how to do that. I’m watching my co-workers realize that they can’t retire because their 401K has lost so much money. I spoke with an elderly lady this weekend whose $300,000 nest egg left to her by her late husband has now dwindled down to $60,000. People are losing their hard earned dollars, and they feel helpless. So as an investor, I wanted to share my thoughts with you.

I’m a regular reader of Free Money Finance (FMF) and the only way I was able to free up cash to pay off debt and invest in the stock market was by following the principles you’ll find here at FMF. Do you remember the insurance article I wrote? Just by following one money-saving tip, I freed up $107 a month to invest or pay off debt. Please read everything you can on personal finance and don’t buy into the get rich quick hype. Use common sense principles taught by people like FMF and Dave Ramsey. Three years ago I couldn’t even tell you what a mutual fund was, much less how the stock market worked. But a severe financial crisis caused me to reach out for help and become educated about personal finance. I was fortunate in that one of the people I reached out to happen to be a millionaire who taught me not only the basics like buying cars with cash, but also how to invest in the stock market. He taught me how to get rich slowly and how to get rich fast. The lesson that stood out the most was not to learn about money management from the government, if you do you’ll end up broke, in debt, and needing a bailout. I also learned that it pays to stay educated. Education alone can’t recession-proof your life, you have to take action.

I found an article (PDF) written by State Farm that will help to keep things in perspective concerning the stock market such as:

“Despite the current challenges faced by the financial markets, investors should remain mindful that we have seen market cycles like this before. In fact, over the past 100 years, the S&P 500 Index has declined 10% or more, on average, once per year. Declines of 20% or more occur once every three to four years (source: Ned Davis Research). In other words, market declines are normal and as we work through and rebound from these current challenges, odds are there will be others on the horizon…the stock market has never produced a loss during any rolling 15-year period (1926-2006)”

Does that mean we won’t have another Great Depression or that you won’t lose money? No. But that does help you to keep things in perspective so that you will not make short-term impulsive decisions (like cashing out your 401K) for a long-term need (retirement). If you do not have the proper education necessary to make good financial decisions, then please find someone who does.  Just be sure that they are producing results based on what they know.   

In the November issue of Kiplinger magazine, an article titled “Bad Decisions in Bad Economic Times” states that “Investors will endure all kinds of risk, crazy risk, to maintain the status quo”. This doesn’t just apply just to investors. Families also take on all kinds of risk to maintain the status quo. People finance cars for 5 years or more, they buy big houses they can’t afford, buy clothes on credit they don’t need, or might not wear. Whenever you take on an enormous amount of debt, you have also taken on an enormous amount of risk. We are seeing the effect that risk has on the economy when things go awry. I know, I know, people don’t want to buy old cars with cash or live like a pauper because it makes them “feel” poor and generally people don’t like to feel poor and that is why they spend the way they do. I used to feel like I was poor when I first started my personal finance journey and sold all my “toys” and started to get out of debt. I was given a 15 year old Honda Accord, which I still drive. However the feeling quickly faded as my bank account grew. Then I started to feel like the people I read about in The Millionaire Next Door.

Also when things in the economy are at their worst, people emerge to prey on your panic. Be careful about buying into the “get rich quick” mentality. Common sense personal finance, spending less than you learn, will get you there just fine. Here is a vague recount of what a get rich quick guru told me:

“The secret to becoming wealthy is that it’s no secret. The steps are easy and elementary and anyone with a fifth grade education can do it. However, they are so elementary that people often overlook them because they convince themselves that becoming wealthy involves some special skill or knowledge and that it can’t be that simple. It’s also definitely not in the how to, if it was then all the people that read my books would be rich. Your results are in the why (why is it a must that you become wealthy). When your why is big enough you will figure out the how to. You make a choice to become wealthy and then take the necessary steps to get there. That’s it! It’s not oh let me wander aimlessly through life spending my money the way I want, getting in debt, and hope that someday I’ll be rich…People see that I have amassed a fortune investing in XYZ. They want to know how I amassed my fortune. They convince themselves that there has to be an easier and faster way to riches. Yes there is an easier and faster way, but it certainly isn’t found listening to the sales pitch of someone trying to exploit the fact that you are looking for a secret. The intense desire to become wealthy causes one to make irrational decisions. I became wealthy and then become wealthy two times over by selling my knowledge to you in the form of seminars, books, and personal coaching.”

I was blown away. Spilling his knowledge is free, it doesn’t take much effort on his part, the hard work has already been done, and yet people will pay for it. Secrets are for suckers and he suckered me into buying his product.

A fortunate and unfortunate truth about life is that for those who are educated about personal finance and have spent years following the principles of wealth building, the worst of times are also the best of times. Everything is on sale for them. They aren’t strapped down with debt and they can take their cash and get a great deal on a home for their family. Warren Buffet, one of the words greatest investors, is now starting to buy stocks because the prices haven’t been this low in a long time.

Les Brown said that, “once you stop fighting for what you want, what you don't want will automatically take over!” If you stop fighting for a healthy body, you become overweight. If you stop fighting for your marriage, you grow apart, and when you stop fighting to become wealthy, you become poor. Fight to keep your life recession-proof and fight to take care of your family. You deserve to live the life you’ve always dreamed of, now go and make it happen!

The Easiest Way To Launch Into Real Estate Investing

The following is a guest post from Prosperity Junky.

If you have been reading Free Money Finance for some time you are very likely investing in the stock market in some capacity.  But, have you also considered real estate investing?  Maybe you have but not sure how to get started?  Here’s my story detailing the easiest way to start your real estate investment business. 

It all began with simply my desire to move to a different part of the city.  I had wanted to make this move for over two years but I had not found the right opportunity to make that happen.  This was difficult for two reasons.  First, I currently owned a house and I was planning to rent or sell that house before I could move.  Second, I obviously would need to find a new house to buy and it takes time to find the “right” house. 

Luckily, an acquaintance presented me with an offer I could not refuse.  In casual conversation he said he had received a job offer and he was going to leave his company.  When I heard that, I really didn’t think too much about it.  As I asked a little more about the new offer, he revealed that the new position was in a different part of the state and he would need to relocate.  Hmm…now I got a little more interested!  I had a rough idea of where he lived and I knew it was close to where I wanted to be.  Being the opportunist that I like to think I am, I asked, “When are you going to be moving?”  He said, “Well I have to start my new job within 4 weeks so I will be moving soon.”  Ding! Ding! Ding!  The bells of opportunity were ringing. 

I knew right away this guy was going to have a difficult time trying to sell his house.  His job offer came at a time that the housing market was in a slump.  Houses were not selling quickly.  In addition to that, his house was also in a fairly new community.  If you were in the market for a new house, you could buy a brand new house in this area for nearly the same price or less than he was going to list his house.  On top of that, if you bought a comparable new house you could customize it to your liking.  I also new this guy needed to sell his house quickly because he needed to start his job in four weeks.  We already knew it was going to be hard for him to sell his house.  However, it was going to be EXTREMELY difficult to sell his house within four weeks. 

It’s fair to say I had the negotiating advantage I needed.  Thankfully, this didn’t require much negotiating because I had very motivated seller.  We negotiated the deal and he agreed to the following:

1. He would sell me the house for only the amount he owed on his loan. 
2. Closing costs would be covered by me.
3. No real estate agents would be used for this transaction so that we could avoid any agent fees.  Everything was done through a title company.
4. The seller would leave his refrigerator and washer and dryer without cost to me.

This was all done in relatively short order.  Now I only had to figure out what to do with my existing house.  With the depressed housing market this was an optimal time to rent the house.  As it turns out, the seller needed a few extra weeks to get his things moved out of the house.  With this extra time, I decided to move forward with renting. 

I quickly listed my home for rent.  I based the monthly rent off corresponding rentals in the area and my monthly expense obligations.  I immediately had people interested in the property.  I spent about three weeks interviewing prospective tenants.  By the third week, I had selected a tenant and already received their deposit and a signed leased. 

Eight weeks after this whole process started, I closed on the new house and moved into my new home.  Two weeks later, the tenant moved into my previous home.  I was officially a real estate investor!

I did this successfully by making two very smart money moves:

1. I identified and negotiated the purchased a new house at a significant discount plus bonuses
2. I turned a primary residence into an investment with little effort

What were the keys to my success?

1. Money and Credit:  I had been living below my means for some time and my credit score was high so I was in a good position to purchase a new home when the opportunity was right.  Note: It doesn’t matter what investment opportunity comes your way, if you don’t have money or the financing to make it happen.
2. Discounted Property:  I successfully identified a golden opportunity to purchase a new home.  This included finding a home which met my criteria which was owned by a motivated seller.  Because of this, the property was purchases at a nearly 20% discount even after closing costs.  Note: With real estate investing you make your money during the purchase, not the sale.
3. Motivated Seller:  By finding a very motivated seller, it put me in a very strong position to negotiate a very attractive deal that I just couldn’t pass up.  This increases your ability to get the property at a significant discount.
4. Tenant Selection:  Although I found a tenant in short order, I was diligent in my selection process therefore I was able to select a responsible tenant who is taking care of my investment.  Note: Not selecting the right tenant can cost you a ton of money.
5. Attractive Financing:  Finally by renting what was initially a primary residence, I took advantage of a lower fixed interest rate than would typically be available when purchasing an investment property directly.  This helps to ensure that you can cash flow every month.

Real estate investing is not for everyone.  It takes patient and hard work.  However, it does provide some significant advantages over other types of investments.  If you decide it’s for you, turning your primary residence into an investment property can be the easiest way to launch your real estate investing business.

FMF readers - Are you investing in real estate?  How did you get started?

Career Versus Investments

Mighty Bargain Hunter says that earning power trumps investments. I know what he mans -- that investments are not certain, but your income is (or at least more certain than a potential return on investment.) Anyway, I thought I would add my (very random) thoughts to this discussion:

1. Your career is your most important financial asset. It's the one asset you have that allows you to survive (food, clothing, shelter, etc.) as well as provides excess (hopefully) for you to acquire other assets (home, car, investments.)

2. If you spend less than you earn, you'll eventually end up with a savings/investment portfolio that is greater than your earning power/career. That's a good thing -- especially if you're still working. You'll now have an asset bigger than your career (investments) AND still have your career. Let the good times roll!

3. If you find yourself in this situation, your net worth is now at the mercy of the markets. In the past, you may have been able to save enough from your job to make up for any market downturns. But once your portfolio gets sizeable, you can't save enough to offset market downturns. This is where I find myself these days. Unless the market turns around quickly, I'll have my first loss of net worth ever -- simply because my biggest asset (investments) is down this year.

4. But what's the alternative? Nothing really. Yes, it's likely to be a down year, but I'm continuing to max out my 401k, 529 plans (to get the highest tax deduction), Coverdells, and IRAs -- plus saving in a taxable account. I'm buying at very low prices these days, planning for the purchase made now to be worth a mini-fortune 25 years down the road.

5. Eventually, we all reach retirement, our careers end, and we only have the investments to live off of. If all plays out according to plan, the investments generate more than our careers did and we spend our last years doing things we enjoy.

I told you my thoughts were going to be random. Not sure this piece makes sense completely, but let's just say it represents a transition from career-dependence to career and investments to investment-dependence. Sound ok? ;-)

Eastern Europe and Turkey: BRIC Wannabes

The following is a guest post from Marotta Asset Management. Here are their previous pieces on Brazil, Russia, India, and China.

In 2003, the Goldman Sachs Global Economics Department predicted that the economic and geopolitical influence of Brazil, Russia, India and China (the BRIC countries) would become increasingly visible in the developed world and even dominate it by 2050.

BRIC nations have surpassed expectations. The original Goldman Sachs analysis projected the four economies would comprise over 10% of the global output by the end of the decade. A year and a half early, they comprise nearly 13%.

Goldman Sachs published an update on the BRIC nations this year, forecasting that although growth is slowing, they will still contribute almost half of all global growth in 2008 and 2009.

It is easy to be lulled into thinking you can simply buy and hold investments in BRIC countries. But emerging markets have faced serious crises every several years. A better strategy is to buy and rebalance, trimming positions as they appreciate and reinvesting as they correct. With the drop in emerging markets this year, 2008 is now an opportunity to reinvest.

These countries have averaged a total return on investment in their stock markets that is now down to 27.49% over the past five years because they have dropped sharply over the past year, falling 24.48%.

The BRIC acronym made four emerging market countries sound like more attractive investment opportunities than the other two dozen. Nobody likes being excluded from the cool crowd. Other countries have been clamoring to add their initials into the mix ever since.

BRICET is the term used to add Eastern Europe and Turkey to the in-crowd. Since the fall of the Soviet Union, Eastern European countries have been struggling out of the darkness of communist rule into the light of free markets.

Eastern Europe has become a fuzzy term that may include a different set of countries depending on who is using the label.

The S&P/Citigroup BMI European Emerging Markets Capped Index includes companies from the Czech Republic, Hungary, Poland, Russia and Turkey. This index, constituted to include the most developed countries of Eastern Europe, is heavily weighted toward Russian companies as a result. Selecting these countries produces an index that is more developed than the typical Eastern European country.

The least developed countries are sometimes not even classified as emerging. Instead they are labeled "frontier markets," a step below emerging. These countries include Albania, Belarus, Bosnia, Bulgaria, Croatia, Estonia, Herzegovina, Latvia, Lithuania, Montenegro, Republic of Macedonia, Romania, Serbia and Ukraine. Many of them are listed in the MSCI Frontier Markets Index.

Although a few of the countries just named, such as Ukraine and Croatia, have very little freedom, others are entering the global scene on the side of free markets. A dozen countries in Eastern Europe have implemented a flat tax on either personal or corporate income. Most of them have a higher percentage of freedom than even Brazil, the best of the BRIC countries, according to the Heritage Foundation's Freedom Index.

In addition to a flat tax, many Eastern European countries are taking advantage of their proximity to Western Europe. Several Eastern European countries have joined the European Union (EU) and benefited from the single economic market representing 31% of the world's total economic output. The lack of trade barriers and a common stable currency encourages growth. To join the EU, a country must have a stable democracy that respects human rights; the rule of law, including EU law; and a functioning market economy capable of competing within the EU.

These requirements have the effect of pushing countries politically toward free markets, which helps them overcome the socialist or centralized planning legacy of communism. In addition to economic alliances with the West, some have also been invited and joined NATO. Turkey also enjoys significant freedom having been a part of NATO since 1952.

All of these economic freedoms and the accompanying social stability have produced good investment returns for Eastern Europe over the past five years, averaging 20.51%. The MSCI Turkey Index averaged 25.20% over the past five years. The BRIC index has earned 27.49% annualized.

But all emerging market countries have a high correlation. Little benefit is gained by diversifying among BRIC, Eastern Europe and Turkey. Currently the BRIC index is down 38.86% year to date. Eastern Europe is down 39.16%, and Turkey is down 31.30%.

Emerging and frontier markets are suitable for a portion of your portfolio, but only a portion. You must take care to limit the percentage of your assets invested in categories that are highly correlated and therefore all move in sync with one another. Diversification means finding asset classes that are not positively correlated to reduce the chances that everything in your portfolio goes down together.

Determining the correlation between your investments is one of the most important steps you can take toward building a defensive investment strategy. Tools are readily available online.

BRIC Countries: China

The following is a guest post from Marotta Asset Management.

In mid-September, the Chinese observe the Moon Festival. Timed to the moon's fullest and brightest phase, the festival celebrates the abundance of the summer's harvest. In recent years the Chinese economy has been waxing toward ascendance. It passed Japan in November 2007 and began to rival the brightness of America.

One in every five people in the world lives in communist China. Unlike other BRIC countries, the Chinese lack representative government, the rule of law administered by independent judges, basic human rights, freedom of the media, independent universities and the right of workers to move freely. Even the constitution makes clear that the government has no limits or accountability to the Chinese people.

China began its experiment of mixing explosive free-market economics with totalitarian control and repression in 1978 when Deng Xiaoping took power.

After having been purged once by Mao and a second time by the Gang of Four, Deng did not deify Mao. Rather he declared the leader to be "seven parts good, three parts bad." Understanding that Chinese Marxism needed to be reinterpreted to allow market forces, Deng argued that "socialism does not mean shared poverty." His most famous quote clarifies his utilitarian nature: "I don't care if it's a white cat or a black cat. It's a good cat so long as it catches mice."

Deng abandoned centralized planning and protected the unrestricted flow of goods throughout the country. The resulting competition between provinces led to significant growth in China's standard of living. Unlike Gorbachev, who tried to institute his own reforms in the top-down approach of perestroika, Deng simply allowed freedom at the bottom. Then he sanctioned and took credit for whatever reforms worked.

Much of China's innovation has been an investment in infrastructure. The country is spending about 12% of its gross domestic product (GDP) on infrastructure, which accounts for 43% of emerging market investments. Greater investment in infrastructure reduces the cost of moving goods and allows freer trade within the country. Estimates suggest that a 1% increase in a country's infrastructure boosts its GDP by 1%.

So the resulting economic growth in China has been explosive. But containing an explosion is difficult if not impossible.

Free markets thrive when a country guarantees property rights and the rule of law. China possesses neither of these. All land is state owned and can only be leased. The state also owns the banks, either directly or indirectly. A majority of judges are retired military officers and directed by the party. As a result, enforcement of contracts is impossible. Party officials are effectively police, prosecutor, judge and jury for any case of importance.

Currently China is ranked 52.8% free, "mostly unfree," in the Heritage Foundation's Index of Economic Freedom. Although it ranks 126 out of 157 countries, China does place highest among the communist countries, beating Vietnam, Laos, Cuba and North Korea.

Freeing selective market forces produces impressive economic gains until bottlenecks in the existing monuments to centralized power hinder progress. Without a free press and working court system, the resulting internal totalitarian monopoly of economics can't be called capitalism. As a result, most of China's growth stems from its participation in free-trade agreements.

Thanks to China's growth, it will pass the U.S. economy in the near future. But because of its huge population, its average citizens will still be economically poor by American standards. And they will be politically destitute.

The Communist Party in China worries most about religious movements, which pose the greatest threat to the party's supremacy. In 1999, about 10,000 members of the Falun Gong spiritual movement surrounded the Chinese Communist Party headquarters in Beijing. They silently meditated to protest their rejection as an accepted spiritual movement. As a result, China severely repressed Falun Gong's leaders and practitioners.

Religious groups are obligated to register in China. Their leaders must be trained and approved by the government. Sermons and teachings are monitored to ensure they do not confront government decree. Thus spiritual movements such as the Falun Gong and unregistered house church movements provide the biggest challenge to the party's supremacy and power.

Movement toward democracy, freedom and the rule of law is not inevitable. Since the brutal crackdown on pro-democracy demonstrations in Tiananmen Square in 1989, government leaders have used force