Why Diversifying my Investments Hasn’t Worked This January

If you've taken a peak in your portfolio this January most of you probably noticed your entire portfolio glowing bright red. We are constantly preached to diversify our investments but if it fails in the "money time" when markets crash what's the use?

The answer lies in the following two principles of investment and finance which are crucial to understanding the importance and purpose of diversification:

#1 Good diversification lowers a portfolio’s risk level to the market risk level - When it rains everyone gets wet

When we diversify we essentially spread our investments to lower the total risk of our portfolio. How do we lower the portfolio’s risk? By diversifying our investment and investing fractions of our portfolio in different geographies, industries and more.

In so doing we are reducing the specific risks each small investment carries. Specific risks are the risk of bankruptcy of a company, war in a country etc. Due to the fact investments are correlated but not perfectly related we can achieve the same return with smaller risk (for more information read my post on the importance of diversification or Wikipedia on the CAPM model).
Since we do want some return on our investment we have to take a certain risk. The smallest risk possible is the market risk without any additional specific risks. Investing in stocks yields high returns because it is dangerous. Playing it safer yields lower returns.

#2 Portfolio diversification should be examined in the long term

In the short run all markets respond negatively to fears of recession due to the lack of information and fear reciprocal dependencies (such as export, import and consumption) will affect all markets.

In the long term differentiation begins to show. This differentiation depends on market growth, economic factors, conditions and more.

Related Posts:
1. Diversifying your risk in the stock market
2. Diversifying your investments over time

Related posts by neighbour blogs:
1. Diversify fully within asset classes @ The Skilled Investor
2. True diversification @ brip blap

The 80/20 Rule - Let Pareto Do Most of the Work

The 80/20 percent principle has been one of my favorites for a long time. Most of us have derived this rule intuitively through our experience but are not aware of its full potential.

Applying this principle or rule will help you to instantly separate the wheat from the chaff and focus your efforts to gain the maximum desired effect with minimum investment.

In my university years I found out I was doing quite well with out too much effort. I did not excel but also did not wish to sacrifice my spare time studying for those extra 10 points. We are all familiar how 20% of studying yields 80% of the grade. You have to invest 5 times more to get a whopping 100. Is it worth it?

The 80/20 principle also applies in many other cases. As examples consider the following:
1. 20% of clients always seem to generate 80% of revenues
2. 20% of the population usually owns more then 80% of the wealth
3. 20% of taxpayers usually pay more then 80% of total taxes
4. 20% of blog posts usually draw 80% of traffic
5. 20% of products generate over 80% of revenues
6. 20% of code uses up 80% of processing time
7. We wear 20% of our clothes 80% of the time
8. 20% of time generates 80% of the work

In short, 80% of the effects comes from 20% of the causes. This effect or rule is named after Vilfredo Parteo, an Italian economist, who noticed 80% of income in Italy went to 20% of the population.

Being aware of this phenomenon or rule and applying it to analytical situations will often yield very benefiting results. In advertising you will probably notice 80% of the impact comes from 20% of media. These sort of analysis is another tool for your tool box to help you concentrate you efforts where they should be concentrated relatively fast even if it is a bit 'quick and dirty'.

Applying the 80/20 principle to investing dictates 20% of investment yield 80% of the return. The result is actually not intuitive and quite risky. We should avoid diversifying and invest our money and effort in the correct 20% of the portfolio and then "watch it like a hawk". This conclusion is probably right but is very risky and requires more knowledge and resources then most investors have at their disposal.

A good book which elaborates more on the 80/20 principle and its application is "The 80/20 Principle: The Secret to Success by Achieving More With Less" by Richard Koch (Sponsored Amazon link).

Image by Kaufmajn

Portfolio Seems to Shrink Away? Ask Yourself These Questions Before Acting Hastily

When stock markets shed percents we're used to see only in volume discounts investors tend to panic. This phenomenon is as undesirable as it is understandable. A very basic principle of investing is too hold for the long term. However, holding on for the long term is difficult enough with out having to watch your portfolio shrink away.

When markets drop the majority of household investors tend to act quickly and irrationally. Immediate action is sometimes required. But that is not often the case. Household investors, in fear for their savings, are very quick to sell under-valued stocks to the market sharks circling around.

Before taking action I believe we should ask ourselves these following questions which will help us cool our heads and maybe cut the vicious circle of buying high and selling low:

#1 Has there been any fundamental change?
Stock markets tend do let our some air from time to time. Especially after long periods of positive returns. Before taking hastily decisions ask yourself if the market is experiencing fundamental change?What exactly is the nature of the change? Does this change affect your investment portfolio? How?

#2 Have my reasons for investing in a particular stock changed?
Surely you've had good reasons to invest in a certain stock. Re-examine those reasons before acting. Has any of the reasons changed? Has the company's growth been compromised? If the economic slowdown expected to affect sales and revenues? How has the company performed in recent recessions?

#3 Why am I reverting from my original investment strategy?
If you're investing and not gambling surely you have an investment strategy with detailed goals and prospects. Why have you decided to change your investment strategy? When we invest for the long term we know for sure we will see some rainy days. Why are we surprised then? Ask yourself what has caused you to change your investment strategy and what new strategy are you adopting now?

#4 What are the reasons for the action I'm about to take?
If you've decided to change your investment strategy you should be able to answer this question. If you've decided to sell your entire portfolio then you must be expecting a full blown market crash. Are you? Maybe selling half of your stock holding would enable you to minimize your risk, hold on to some of the return you've been able to achieve and maybe help you get back on the horse when thing brighten up? Would you change your strategy if stock prices were on the rise again?

#5 Should I be actively managing my investments?
Actively managing your investments is a tough job. The psychology of investing is not easy to deal with. Especially if it's your own money at stake. Professionals exist for a reason.

Related Posts:
1. What to shop for in the stock market in times of recession
2. Diversifying your investments over time
3. Long term investing isn't always a smart move
4. Buying a stock? Keep in mind someone else is selling...
5. Understanding the difference between investing and gambling

More on investing in a bearish market:

1. Secret to value investing: Ignore market noise @ Seeking Alpha
2. Investors are panicking. Great time to invest @ Wealth Weekly
3. My investment philosophy @ the money gardener
4. How I stomach the market's bumpy ride @ Millionaire Mommy Next Door
5. Five Reasons To Be Optimistic If We Fall Into A Recession @ Money Crashers

Avoiding the Slippery Slope of Debt

Private consumption has been increasing steadily. We're happily consuming away. Sometimes even financing our desires with a small loan here and there.

I've recently bought and refurbished my apartment. I've had to finance this purchase and the refurbishment with a significant mortgage and some personal loans. From my personal experience I find it very easy to get mixed up in debt without notice. Managing a growing amount of loans and re-payments is not an easy task. Having the ability to take more loans creates an illusion of well being and surplus cash which is very dangerous. The question "can we really afford this?" is not always asked. In my apartment I did my best to make the smallest concessions possible. I'm still balancing myself every since (6 months now). Couldn't I've just settled for cheaper tiles?

I don't think life is just about saving and being frugal. I believe we should lead a life worth living without questioning ourselves every other step of the way. However, we should be very aware of our earnings potential and our derived ability to finance our consumption with the bank's money.

Debt is a slippery slope. By definition we repay more then we loan. In times of economic slowdown or temporary difficulties we might find ourselves quickly financing our loan repayments with another, more expansive, loan as we've become more risky lenders. And so on and so forth.

Financing consumption with loans is a big no in my opinion. Consumption can be delayed and gratifications postponed. There is no real happiness in buying another suit or another music player or even taking a vacation on a loan. Consider the following carefully before financing consumption with loans:

#1 How Frustrating it is paying for something you've already forgotten

Hope you enjoyed that trip enough to last you through all the re-payments appearing on your monthly reports. There is a nasty after taste to paying on installments for something you hardly even remember now.

#2 How easy it is to lose control over re-payments

Paying on credit, taking a personal loan, a mortgage and having a bar tab all add up and are terribly difficult to control. It won't be long before you find yourself drowning in re-payments with little ability to afford anything else.

#3 Paying interest is simply wasting money

You could have saved the money payed on interest or consume it otherwise. Sometimes financing is a must (like buying a home) but when it is avoidable just avoid it. Would you have taken that vacation if it cost you 15% more? Take into account the cost if interest.

#4 Constantly repaying debt degrades your ability to build your future

Constantly paying back debt paints your horizon grey instead of blue. We need to look to the future with hope and not with endless debt repayments. Lowing debt slowly and shifting the money to savings will truly empower you in life.

I believe we, as consumers, should have some patience to build a solid financial base which will then allow us to spend with little worries and a care-free mind. Naturally, we won't be able to afford everything but we would enjoy the things we can a whole lot more.

Image by Wallyg

The Fool in the Shower - Is the Fed Turning On the Hot Water Full Blast?

Milton Freedman supposedly made up this analogy describing a bather in cold water who turns on the hot water all the way up and gets scaled.

To be perfectly honest I have no idea how the Fed's cut in interest rates will affect the markets. I do have a strong intuitive feeling this isn't over yet.



This interest cut has been the biggest reduction ever, I believe. Furthermore, this has been the first time the Fed has changed the funds rate between meetings since 2001 (combined effects of terrorism attacks and a recession).

On the one hand this immediate response to stock market plunges world wide is admirable and seems attentive and responsive to market needs. On the other side it's as troubling as the price plunges themselves.

The Fed's cut is most certainly a clear sign we're in trouble. The funds rate is the most available and most immediate tool a central bank has. The quick and resolute cut in interest rates sent a message was meant to show worldwide markets someone is still in control. However, as we've learned countless times before reversing the trend is never an easy task.

There is something troubling about taking popular, some might say populist, measures such as drastic cut in interest rates. Such a move by a central bank makes me uneasy as central banks are expected to behave responsibly and rationally.

Two factors add to my worries. One is the decision by the head of the European central bank, Jean-Claude Trichet, not to cut rates as Europe still battles inflation. Rate cuts could lead to more volatility in already volatile markets, he added. The second is the fact future contracts predicted an additional 0.5 cut in rates in the Fed's meeting that was scheduled for the next week. The shows the capital markets are hungry for available cash. Maybe too hungry to consider the consequences of another deep cut in rates in just two weeks.

If the Fed's decided to cut rates by an additional 0.5% Bernanke has literally used all the artillery he has at his disposal. What would be the next move should the markets insist we're in a recession? I believe the situation would be even graver.

Apparently there is a lot of criticism by senior economists on Bernanke's move. The leadership ability of the Fed is criticised and the decision to cut the funds rate by 0.75% is dubbed a panic reaction. The immediateness of the decisions is wondered upon.

Needless to say the Fed's actions have increased to dollar's weakness and volatility. The last thing the battered dollar needs right now.

Time will tell if the Fed acted in panic or with courage. I believe we'll get a chance to answer this question soon enough.

Image by Jun Acullador

What to Shop for in the Stock Market in Times of Recession?

Yesterday I wrote about collateral damage and overshooting. Obviously some stocks got devalued for no just reason what so ever. Can we hunt down these opportunities? My recommendation was, and still is, no. However, there are sectors which have proven in the past to be more resilient and even suitable for times of recession and economic slowdown.

The primary characteristic for these companies is that their business performance is less sensitive or even encouraged by times of recession and economic slow down. These stocks are called defensive stocks.

The combination of an overshooting effect in stock prices the potential for recession makes buying defensive or cyclical stocks an interesting option.

Sectors which are considered to be defensive are consumer sectors such as tobacco, food, alcohol and retail companies (such as wall mart which has recently been recommended again by analyst Mark Miller after years of standing in place). Other, more riskier sectors, are energy, utilities and the defense industry. High dividend yielding stocks are also considered to be more defensive (intuitively these stocks can be thought of as bonds the more the dividend yield is guaranteed).

NY Time's Paul Lim recently wrote about a rather interesting, and unorthodox, strategy for the current slowdown. Instead of buffing up the portfolio with defensive stocks money managers, he says, are apparently betting on growth stocks which have actually over-performed defensive or value-oriented stocks in 2007 (For the complete article: Going for Growth, Even in a Slowdown).

5 Spontaneous observations on what's going on

I'm an optimist. I believe stock market crashes, certainly scaled, healthy ones as the one we are experiencing are good for us. If we're investing by the book we should be fine and accept what happens in the markets these days as normal and probable. I've written before on my worries about the current stock market pricing, especially the Chinese and Indian markets, and the risk of missing on terrific future growth and potential in these markets for the years to come. These markets are now letting out some long overdue air.
As any investor I consider stock market crashes an opportunity. We must always keep in mind common behavioural patterns and market phenomenology. Here are some of my more spontaneous observations on what's happening:

#1 This could be the turn of the tide
Technical analysis acts on trends and support lines. Trends are analysed for different periods of time and do not change lightly. However, there is always the surprise of the trend begin reversed in a couple of days. Looking back to the past we can see significant return and loss happen in selected days, usually with no specific foretelling reason. That's why markets are so hard to predict.

The stock markets have treated us very favourably these last 5 years. It is only a question of time before the next economic cycle begins. Has it begun? Are we in now officially in a recession. I believe the answer is a big yes and I've written on it these past weeks. The Fed's rate cut proves it beyond a doubt (if you have any).

#2 Controlling the markets is impossible - 2008 Olympics
I've heard a common belief echoing in 2007. According to this belief the Chinese market will not experience any significant crash before the 2008 Olympics. However, if there is a bubble in the Chinese market and we do expect it to explode by the 2008 Olympics it is bound to happen sooner then expected (basic game theory, we all know what is going to happen). There is no real way to control the markets, even in China. As written in previous posts and many other articles the Chinese stock market was bound to experience some sort of sell off. The main question I myself and facing is whether now is a good time to get back on the promising Chinese dragon's back?

It does depend who's buying. For us household investors there is a saying: Never catch a falling knife. However, you could just start reaching for it. Two days ago I wrote about diversifying an investment over time. This could be a potentially good time to mildly increase our investments in more promising markets. Naturally, no one knows what the future brings and there is much at risk (furthermore diversifying over time suits long-term investment periods).

#3 Overshooting and collateral damage - bargains are not as easy to find as promised
I believe most of you will agree it isn't rational to collectively lower most of the companies market cap's by 5%-10%. This is what happened these last two days. Obviously, it is rational to assume there are bargains out there. Furthermore there is a common behavioural pattern of overshooting effect in reaction to bad or good news in stock market prices. If investors reacted irrationally and hysterically then there are even more bargains out there.

The unfortunate fact is that we as household investors have a very hard time identifying these bargains. Unless you enjoy the thrill of the risk I don't think we should even try. There is a false sense of opportunity these days shared and encouraged by the business media to go and hunt for bargains as that is what the professionals do. Do yourself a favor, if you're going bargain hunting why no hunt the professionals? If you're risking already risk it on a good holdings company.

We're reading news these days about investments made by princes and government funds in crumbling banks like Wallid Ben Talal's investment in Citi. Do not forget these are made under very favourable conditions with much more to gain then just good returns.

#4 Some comforting news - the writing was on the wall this time
The crash we are experiencing didn't come out of the blue. Is it possible financial markets are actually reaching maturity? If you're exposed to financial media you are probably not surprised by what is going on. This is a very good sign of a healthy global financial system. I believe this is actually comforting in many ways for the future to come.

#5 Opportunities aplenty
I have written just last week on my dilemma on what to do with money I've managed to save up. I was very troubled by the lack of potentially good investments. Market crashes and especially continuous decline in prices offer more and more investment opportunities.

Image by Wili Hybrid

AP: Casual Blogging Not Just Lunch Money Now

While I have yet to see revenues of over a cup of coffee It seems blogging has become a profitable occupation for those who take it on full time. Unfortunately I've been very busy these last couple of days and in this post I'll mostly refer to interesting articles I've read during the past week.

The first one is by Candice Choi from AP titled: Casual Blogging Not Just Lunch Money Now. Here's what I found interesting, in brief:

1. 39% of American Internet users constantly read blogs.

2. Naturally, there is a very long tail of blogs which earn very little for each successful blog (If you're in it for the money, better reconsider investing your time elsewhere).

3. Approximately a third of blogads 1,500 bloggers make 200$-2,000$ a month. These have over 3,000-50K visitors a day.

As I've detailed above I've not been able to make deadline with my posts the past few days. I've been rather busy with other things. I began writing this blog as a hobby and past time as I enjoy writing and enjoy people's comments and ideas on my writing and tips. Quickly enough writing for "The Personal Financier" has become more then a habit. Not being able to meet deadlines has really upset me since I feel obligated to my more devoted readers.

A very interesting article I've read last week by Dan Post for the New York Times titled: Some Brand-Name Bloggers Say Stress of Posting Is a Hazard to Their Health. Apparently many bloggers feel obligated to readers and to their blogs' success. Obligated enough to risk their health. Stress and anxiety are silent murderers responsible for numerous health problems. The affect of the mind on the body is very significant when it comes to these two. Bloggers beware.

Hopefully I'll be able to return to regular posting shortly.

Diversifying Your Investments Over Time

I've recently written a post on why long term investing isn't always a smart move. As examples I've looked at an investor who chose to invest in either the Nasdaq at 2000 or the Nikkei in the 90's. Both poor choices which have lead to years of loss and a negative return on investment.

Diversification is nearly a must for household investors. Hand picking winning stocks in the style of Warren Buffet or George Soros is very hard. Household investors are often recommended to diversify their investments to include:

1. Industries and economic sectors - For example growth stocks, energy, financial etc.
2. Geographies - USA, emerging markets, Europe etc.
3. Financial Assets - Stocks, bonds etc.

By diversifying we're actually reducing the specific risks in our investments (A company defaulting, a war etc.) and we are left with the market risk. However, time represents another specific risk that should be diversified.

Usually we find ourselves with a significant sum of money available for investment after accumulating it for a time in a deposit or savings account. After reading about the fantastic returns available in the stock market we eagerly rush to invest. We diversify by the books and wait for those legendary returns. Alas, the market suddenly decided to go bearish on us and we're left with 70% of our savings at best for the next couple of years or until the next economic cycle.

No one can time the markets. Not even investment gurus. We shouldn't try either. Instead we should diversify our investment over time. In the long run our buying prices will average out the trends and will enable us to benefit from real long term growth instead of successful speculations.

If you have some money available increase your investment in stocks or stock based assets gradually and slowly in accordance with your investment term.

Related Posts:
1. Long Term Investing Isn’t Always a Smart Move
2. Diversifying your risk in the stock market

Generating Abnormal Returns Using Momentum Stock Investing

The search for an investment strategy that will yield consistently high abnormal returns has long been sought for by academic researches and market professionals. Many analyists promise 2008 would be a more challanging year for investors with less opportunities to generate high returns.

Momentum strategies are not intuitive. Why should a stock price keep on rising just because it has done so far? Apparently they do.

These strategies are among such strategies as the January effect or week end effects that have proved over time to yield high abnormal returns (such that to contradict market efficiency assumptions).

Using momentum strategies is quite simple and requires no use of judgment on the part of the investor. According to this strategy buying stocks which have performed well and selling short stocks which have performed poorly in the past would yield high abnormal returns. The underlying assumption being, of course, that these stocks would continue to perform as they have for a certain period of time in the future.

An example of the use of a momentum strategy would be: Firstly to sort the returns of the 100 top NYSE stocks for the last 12 months in descending order. then to buy the top 10 performers and sell short the bottom 10 performers for a period of 3 months. Selling the stocks short would finance the purchase of the top performing stocks. The period in which to evaluate the stocks or hold them may change (usually 3-12 months) to yield higher abnormal returns.

A more complex version of momentum strategy is demonstrated in Jegadeesh and Titman's "Returns to buying Winners and Selling Losers: Implications for Stock Market Efficiency" (1993). In the article the writers examine a momentum strategy in which the investor updates the portfolio every selected period.

The relative success of this strategy is often attributed to over (or under) reaction to information. New information which would lower or raise the stock's price in a perfect market has an enduring effect thus creating momentum for an extended period of time. Another explanation might be under valuations of stocks by analysts. Analysts tend to over valuate a stock's past performance thus as the under valuation is revealed the stocks tend to perform even better as a result of the previous under valuation.


Image by Waponi

A Case of Too Much Information? Real Estate and Stock Investments Compared

Try to imagine what would happen if there was a market price available for your home at any given moment, which was set by supply and demand. In short, imagine your house was traded in a house exchange. Scary thought, isn't it?

I can picture myself rushing to the computer every other moment hoping prices went up. Even a small fraction of percent would be significant when real estate is at stake.

This kind of behaviour would obviously not constitute smart investing. We always preach to ignore the noise in the short term and invest for the long term. Why is it so difficult to do when it comes to stocks and easily performed when it comes to real estate?



This is all the more baffling as the huge amounts of money we invest in real estate, or our home, make the money we trade in stocks pale in comparison. Why are we so anxious and stressed when it comes to a couple thousand dollar invested in stocks and so relaxed when it's hundred of thousands invested in a home? This is an obvious exaggeration but it does holds some truth.

First and foremost, we are not rational beings. Homo-economicus has yet to make an appearance. But this explanation is too easy.

The more probable explanation is that our real estate is usually also our home and we can make good use of it by living in it or any other similar psychological explanation. Theses uses do not depend on its current market value. But what about real estate investments then? Why are these considered less stressing or safer then investing in stocks?

Actually I find there is all the more reason to be worried when it comes to real estate investments as these investments are usually of very significant volume, they are not diversified and they carry significant specific risks (a risk which can be eliminated in stock investments - for more information see here).

I believe the availability of information when it comes to investing in stocks actually throws us off balance. Warren buffet once said only invest in a company you'd like to own even if the market closed for the next 10 years. This is the basics of long term investments. The noise in the short term is enormous. We are constantly presented with prices, trends, analysis and valuations. Our exposure to the stock market is often and frantic. If we could separate the business behind the stock from the price in which it is traded then we would make some progress.

Another argument might be that when it comes to real estate identifying potential is easier then in the stock market. I highly disagree. Real estate requires no less expertise then stock investments and it is riskier.

Image by Martiniko

What is the Economic Value of Happiness?

Economic models (usually micro-economic) use the concept of 'Utility' when describing balance and equilibrium. As we all know having money doesn't necessarily make you happier (it doesn't hurt either). Money is a very simple, straight forward and usually irrelevant variable when discussing social sciences and behaviour. As a result economists have come up with the concept of utility which quantifies the entire benefit an individual draws from a certain product, service or resource.

Oddly enough, when macro economics are discussed we usually suffice with comparing GDP (gross domestic product) or GNP (gross national product) for varying countries. Obviously GDP and GNP are not measured in utility but in money. This is an unfortunate but unavoidable result of the transition from the world of model to reality.

Measuring utility is very hard (impossible some might say) as utility is subjective. Money, however, is not and as such is most suitable when comparing national economies.

However, a very interesting initiative by French prime minister Nicolas Sarkuzy has been published lately. Mr. Sarkuzy has decided to develop a model which will enable the french to include the happiness of french citizens in the calculation of the GDP of France. In order to accomplish this two Nobel winner have been recruited by the french prime minister.

This step reflects an interesting and common perspective on the financial success of the USA. The USA has with out a doubt been the more successful economy during the last 25 years but has this made its citizens happier? Hasn't the success come at a hefty price?

There are some interesting variables to consider when trying to weigh in the general well fare of the citizens of a nation into its GDP. As an example consider leisure Having more free time with your family or friends or even by yourself most definitely produces higher utility. Including average hours of leisure has much economic sense. There are many more variable which could be introduced to the equation: Quality of the Environment, health care quality, crime levels, social equality, technological advancement, unemployment ratio, average lifespan and many many more.

Introducing these variable into our GDP, for example, might change the way we measure economic success. More importantly it just might enable us a clearer view of the more important things in life.

Image by Sumith Meher

The Problem With Structures - Risks and Hidden Costs

Structured products have grown increasingly common among household investors as they are conceived as a safe investment with nothing but upsides. However, as consumers, we must ask ourselves: Are these structured products better then other forms of investment just because the principal is ensured at the end of the investment period? Isn't this a cheap marketing trick?

Marketing is certainly involved here. Households prefer certainty and security. An investment that can't lose always sounds great. But stop and consider an investment with 0% return – Isn't that the same as losing?

Most structured products can be characterized by the following:
1. They offer protection of principle
2. They require a concession on interest paid
3. They offer enhanced returns which depend on performance
4. They charge management fees

Let's have a look at an example. Say a structured product offers us twice the price increase of euro to dollar in 1 year. A nice return on investment is possible. However, if the euro-dollar exchange rate hasn't changed we've lost 1 year's worth of interest (not to mention management fees).

It is quite easy to synthetically construct structured products which will ensure protection of principal and possible upsides using derivatives or other financial assets. This of course requires more financial know-how and may be costly in terms of transaction costs. It is also easy to expose your portfolio to a certain financial asset or economic indicator by buying derivatives or a smaller portion which will eventually yield the same return. This saves on the expansive management fees charged by banks for these products.

What else should we pay careful attention to when buying structured products?

#1 Alternative loss
As we've seen alternative loss is real. Conceding risk free interest is a loss as any other. Many structured products require a term of investment of over 1 year and up to 3 or 5. Losing alternative interest on 3 years of investment can be quite painful.

#2 Investment Period
Another major drawback of structured products is that money invested can not be liquidated without fines. Investing in bonds, mutual funds, ETF's or stocks guarantees the investor the possibility of selling the investment.

#3 The Terms of the Investment
How is the return calculated? Is the euro-dollar exchanged rates averaged over the month or quarter? Is it the last known exchange rate available? This may be more significant in stocks when price variations can be sharp.

#4 Complexity
Some structured products can be very complicated. Make sure you understand what you're investing in.

After discussing the risks and problems let's have a look at the cases when investing in structured products is more appropriate:

#1 You're financial know-how is limited and you are looking to invest in complicated financial assets
If you want to invest in commodities, derivatives, exchange rates or other risky and complicated financial assets and lack the knowledge investing in structured products is more sound

#2 You just want a taste of risky investment
Investing a certain percent of your portfolio (up to 10% I'd say) for the "excitement", so to speak, can be done by buying structured products.

#3 You want to expose your portfolio to a certain financial asset with little risk You have a hunch the dollar is going to come back big time and you know nothing of derivatives. Buy a structured product.

If you've decided to invest in structured products try and focus on financial assets where high risks and returns are involved. As the principle is protected investing in structured products which are based on very risky financial assets has a better chance of yielding higher returns.

image by redhunt

How to Protect Your Money From Inflation

There is little doubt prices are on the rise. Oil, wheat, corn, metals and more have recently surged in price. The housing slump does balance things out for now but in time we're bound to feel inflation's sting.

Inflation simplified is increase in prices for popular commodities. This price increase devalues each dollar and as a result devalues our earnings and investments. Each dollar can buy less.
How do we protect our money from inflation then? The rule of thumb is to invest in real assets. These assests' value is not dependent, or is adjusted to price levels. Let's have a look at some of the steps we can take to protect our money from inflation:

#1 Change the mix of our deposits to include price adjusted deposits
If we believe inflation is coming it is wise to make use of inflation adjusted deposits. These deposits yield lower returns but guarantee the value of your money. If we look at a deposit with a nominal interest rate of 5% and an inflation of 2.5% in the same year this deposit actually yielded only 2.5%. Saving in inflation adjusted deposits helps lowering your risk and exposure to inflation, even if it is sometimes at the price of lower returns.

#2 Invest in commodities
Commodities are goods traded in a stock exchange. Since real products are behind the exchange price levels are automatically adjusted for inflation. Investing in commodities straight forward can be dangerous. There are a lot of mutual funds and ETF's out there who can help us diversify and lower the risk of our investments. In anyway, however, commodities are a risky investment.

#3 Invest in real-estate
Real estate is just that - Real. Real estate prices adjust to inflation since the real value of the property has no reason to change. Furthermore rent charged should also be adjusted to inflation as the real cost of living should not be devalued because of inflation.

#4 Invest in foreign currency
If we believe inflation will hurt our primary currency we can always invest in another foreign currency or a mix of foreign currencies (for diversification purposes) which we believe are less susceptible to inflation. By investing in other foreign currencies we can enjoy higher returns on investments and deposits with smaller risk of devaluation due to inflation.

#5 Invest in gold
Gold has always been thought of as a haven from inflation. Gold supposedly has a real value and will not be affected by inflation.

#6 Invest in stocks
Investing in stocks in times of inflation is tricky. The value of stocks represent value of firms and as such should be real. However, some firms hold significant liquidated assets and these are naturally susceptible to erosion. In times of inflation investing in value stocks is more recommended.

The Economist: "Sooner or later the world's hottest market will burn up"

I read this very enlightening and interesting article in The Economist which strengths my resolve to avoid the Chinese stock market for the short run. I believe the Chinese market is a great long term opportunity but it seems to lack maturity required for competitive capital markets.

The Economist lists the following as reasons for the foreboding title:

1. The Shanghai stock exchange is virtual and differs greatly from the western concept of stock markets where demand and supply are free.
2. Stocks do not actually grant full ownership rights.
3. Chinese stock prices are believed to move in just one direction: Up. This belief is a result of a series of IPO’s of government companies which were priced in a fashion that would lead to high demands and huge price surges.
4. Lack of alternatives for Chinese savers.
5. Lack of the ability to “Short” on stocks.
6. Lack of transparency.

The complete article can be found here.

More on the Chinese stock market:
1. NYSE urges China for more listing flexibility @ DealBook
2. China: Bubble pop just got louder @ BloggingStocks
3. China and 2008 Beijing Olymptics: Are Chinese Stocks Too Expansive? @ InvestorTrip

Relevant Posts:
1. The Financials of 2008 - What will we talk about?
2. Dollar Reserves Might Change Future Investment Trends

Investment Basics Carnival #5 and Weekly Round Up

Welcome to the fifth edition of the "Investment Basics Carnival". We had 35 posts out of which 17 were chosen and are presented here.

1. Larry Russell presents Fund Authority Scores - Taking the Snake Oil Out of Investment Fund Evaluation posted at THE SKILLED INVESTOR Blog, saying, "Superior mutual fund and ETF performance charts are the sales tools of modern financial snake oil salesmen. They allow investment fund promoters to market selectively their supposedly superior funds and to allege that their excessively high fees are worth it.

2. Michael E Johnson presents Should I Use My Loans To Invest? posted at Student Loan Consolidation

3. Value Seeker presents Stock Investing Vs. Stock Trading - Stock Investment Resource: Stock Market Investing Tips posted at Stock Investing, saying, "Describes the advantages and disadvantages of stock investing compared to stock trading."

4. Slackerwealth presents Investing in Agriculture, ETN, Jim Rogers posted at A Slacker's Quest for His First Million, saying, "Discusses merits of new way of investing in agriculture commodities to hedge against inflation."

5. Leon Gettler presents Fed's rescue plan: too little, too late posted at Sox First, saying, "The Fed’s rescue plan for subprime is a case of shutting the barn door after the horses have bolted. Too little, too late"

6. Steve Faber presents Three Good Rules to Help Find the Best Stock Picks posted at DebtBlog, saying, "Sure, you can pick your stocks the old fashioned way; using a broker. What happens if you want to choose your own? Here are 3 ways you can get started looking."

7. Mr Credit Card presents Cash Back Credit Card Guide posted at Ask Mr Credit Card's Blog

8. aishwish presents YOUR CREDIT SCORES AND CAR INSURANCE RATES: THE DIFFERENCE BETWEEN 760 AND 600 posted at Insurance SchemesInsurance offers

9. Randall presents My Mutual Funds Dropped 23% Yesterday!! posted at Credit Withdrawal.

10. Investing Angel presents Is Trading For You? posted at Stock Tips, saying, "See if stock trading is the right for you!"

11. Lucy Baldwin presents Buying Gold 101 For Beginners posted at Gold To Buy: Investing in Gold, saying, "A beginner's guide to investing in gold."

12. KCLau presents KCLau’s Money Tips in 2007 - Personal Finance Articles Yearly Roundup posted at KCLau's Money Tips, saying, "roundup of finance related article discussed in 2007"

13. Raag Vamdatt presents Goal Based Investing :: RaagVamdatt.com :: Financial Planning demystified posted at RaagVamdatt.com - Financial Planning demystified.

14. Leroy Brown presents Investing takes nerves of steel posted at Llama Money, saying, "Don't jump off a bridge when your investments fall, simply relax and stay the course - things will work out."

15. Investing Angel presents Common Stock Investing Mistakes posted at Stock Tips, saying, "As we go into 2008, let's recap some of the common mistakes we all make and strive to avoid making them in 2008. 1. Trading too often. This largely depends on the size of your asset base."

16. Brian Steeves presents Technical Stock Charts: Average Directional Movement Index posted at FeedBulletin for: financialbullet.

17. Adfecto presents Ignore the Stock Market Pain posted at Adfecto Abundantia - Aspire 2 Wealth, saying, "I follow a few simple rules that let me sleep at night even as the market nose dives. Learn the techniques that keep your portfolio in good shape even in a down market."

My post on Uncertainty and Risk differentiated - Is a Tactical Surprise Preferable to a Strategic Surprise? made it to the Carnival of Capitalists #12 and The Carnival of Personal Finance #134.

My post on doing it yourself doesn’t always pay made it to the Festival of Frugality #107 – The little things edition and the 41st edition of the Carnival of Money Stories.

My post on Understanding Important Hidden Psychological Aspects of Rent vs. Buy Comparisons made it to the Carnival of Debt Management #34.

I’d like to thank both the authors and carnival admins for their time and quality content.

Building Character Through Long Distance Running

I took part in a 10K race today (~6.25 miles). There is something powerful and motivating about running alongside several hundred other runners. I've been running long distances for 6 years now and I believe long distance running (or any endurance sport) are great character builders.

Some argue this is a 'what came first - the hen or the egg?' sort of argument. They argue some people posses the qualities required to practice long distance running or any endurance sport. From my experience it is quite the contrary.

The required stamina and mental strength can be built slowly and gradually through training. Each accomplishment makes you hungry for more and increases your belief in yourself. There is an increasing trend of executives who adopt the practice of endurance sports, especially triathlon, as another from of achievement and as something more to note on their resume.

I believe adopting an endurance sport can lead to changes in mentality and way of thinking, in addition to the clear physical benefits. Here are 5 major benefits gained by running long distances:

#1 Endurance
You'd be surprised what your body can take if you test it. The biggest difficulty in endurance sports is overcoming the mental difficulties. Overcoming this obstacle quickly develops your endurance for both physical and mental stress. Many people have a very low threshold for stress and pressure. Unfortunately these are very common in our modern lives. Running for long distances works-out your brain as well and help build the necessary immunities.

#2 Patience
Running for an hour obviously requires mental and physical endurance but it requires patience as well. When running an hour can last forever. Patience is a virtue when it comes to business. Business and market processes take time. Many great investors such as Warren Buffet and Jim Rogers preach to patience in investments (Buffet was once quoted to pick stocks which he was confident he could hold in case the market closes for 10 years). Believe me, endurance sports provide a great perspective on time.

#3 Competitiveness
I ran by tens of people today and I'm really not that fast. Something about coming in first is very basic in our psychology. Practicing competitive sports helps sharpen your competitive instincts and your hunger for success.

#4 Ambitiousness
I used to have a 1 mile route I used to run. When I completed my first mile jog I was delighted (I wasn't in the best possible shape obviously). Feeling victorious just made me want to complete two laps the next time. It took some more time before I accomplished that but 4 and 6 laps weren't so far behind. I believe being ambitious is required to being successful. Setting a goal and accomplishing it demonstrates this better then anything.

#5 Self Confidence
Physical self confidence is rapidly built when running for long distances (you'll see amazing results in a couple of weeks to a month, especially if you've just started). The bigger benefit is the mental self confidence gained with each goal completion. Since running a 10k used to unachievable in my eyes completed it literally made me realise almost nothing is out of your reach. You'll also notice self confidence radiates strongly to your surroundings and quickly changes their attitudes.

Fitness is becoming a new religion. I don't believe in taking anything to extremes. However, I am certain long distance running is a great pass time both or your physical and mental health and well being.

How much are you willing to spend on lifestyle and image?

I enjoy the occasional meeting in a coffee shop now and then. An interesting thought came to me today after having ordered yet another overpriced cappuccino. How much am I willing to spend on my concepts of lifestyle and on my image?

The more observant of us have probably noticed Coca-Cola, Pepsi, Starbucks or Nike don’t just sell drinks or shoes. They sell lifestyle. Advertising is in part about creating associations between the product and our desires. We buy these products because we’ve been ‘programmed’ to associate Coca-Cola with freshness and coolness for example (there are many other examples).

The issue of spending on lifestyle is complicated and vast in scope. Hopefully I’ll write more on the subject in the near future. In this post I intend to linger on a very specific and annoying aspect of it. If you’ve ever ordered a coke for 5$ you probably know what I’m writing about.

Pricey places allow themselves to charge extra for the most basic products. Ordering a 5$ coke at a fancy restaurant is the best example for paying purely for lifestyle and image.

Advertisers and companies are not dumb. They do charge extra for the “lifestyle factor” but they usually offer greater value in either design, originality, technology, innovation and more. This greater value offered by no means explains the price gap between brands and non-brands but it allows us as consumers to explain to ourselves why we just paid 150$ for shoes (we solve the cognitive dissonance created).

Overcharging for a bottle of coke is purely charging for image. True, the waiter did serve it to you with a twist of lemon but it’s still a coke. One of the reasons pricey restaurants usually serve premium brands (like Evian for ex.) is to justify the huge difference in price between plain water and their water.

Furthermore, I believe expansive restaurants actually adopt higher price levels for basic products in order to relay their message of exclusivity to potential customers. If you see a 10$ bottle of water on the menu please think again if you’re one of us or not.

Consumption is on of the forces of modern living. Paying for lifestyle is a relatively new and evolving phenomenon which I find very intriguing. Hopefully I’ll post more on the subject in the near future. If you find the topic interesting please let me know.

10 Tips and Truths for Successful Option Trading

Household investors tend to lose at option trading. This is an unfortunate but unavoidable fact as these are sophisticated markets which require high proficiency and deep understanding as well as advance algorithms and computing power in trading.

Tips for success in trading option should be in accordance to the aforementioned truth.

#1 Limit your losses
It is very easy to adopt a double or nothing attitude at options trading. This is a mistake as the risks, at times, are highly against you. Only trade money you are willing to lose.

#2 In options high variability yields high return
An option holds a certain potential. When you hold on to an option in times of high variability the chances of that potential becoming real are increased. Think of an option to buy a certain stock at the price of 9$. If the stock price fluctuates significantly (for Ex. 4$-8$) your option will be worth more then if the stock price was very stable (for Ex. around 6$). This is due to the increased chances of the stock price crossing 9$ and the option becoming ‘in the money’.

#3 Control your emotions
Option trading requires cool heads and discipline. Trust and follow your initial analysis. Train yourself to be self-disciplined and avoid the temptation of either buying or selling before the goal you’ve previously set. During the actual trading you don’t have the luxury of carefully analyzing your next move.

#4 Look for trade volume for quick buy in and buy out
You might identify a priceless chance of buying at very low prices but remember you’ll eventually have to sell it at higher prices. Make sure trade volume is sufficient for quick trades.

#5 Trust your judgment and be wary of the judgment of others

#6 Don't be tempted to take unnecessary risks
Some opportunities seem to be too good to be true. Successful traders develop an intuition which sometimes enables them to identify these opportunities. However, identifying one should not lead to an “All In” attitude. Taking measured and calculated risks is a must

#7 Take the time to evaluate the market at various stages
Successful traders carefully examine opening and closure in particular for signs of trends and large transactions.

#8 Don't be quick to sell on profits or hesitant to sell on losses
Two common and well known mistakes made by investors.

#9 Technical analysis tools may be useful in short term trading
Take the time to learn them.

#10 Selling options is not a profitable strategy in the long run due to occasional high market variability which will eventually result in huge losses

Increase Your Motivation to Save by Illustrating Your Progress

If you’re an avid manager of your personal finances you are probably keeping a budget of your incomes and expanses. Most of us are hard working people trying our best to save a decent amount each month. Since our monthly savings add up quite slowly and our loan repayments go even slower we sometimes have a hard time noticing the big picture and the general direction in which we’re headed.

I have found illustrating that direction or trend is very helpful in motivating me to do my best to increase my monthly savings. Since you probably have the figures available on your budgeting excel sheet illustrating the trend shouldn't be hard work.Think of the following graph illustrating the trend of increased savings and reduced debt for a certain household. This household has borrowed 100,000$ for 5 years and has a savings of 20,000$ which grows by 500$ each month.


If we look at the trend for 10 more months we can easily see the lines converging in the near future. This illustration is a great motivator in my opinion as the next question you’ll ask yourself when you see the trend is what will happen if I increase my monthly savings to 750$ instead of 500$? Well, here’s the answer:


Increasing the monthly amount saved has an even stronger effect due to compounding interest. Obviously, there is more to compound on.

Visualising and Illustrating are powerful tools. They help make abstract concepts and trends more tangible for us and enable us to understand the bigger picture. I heartily recommend using illustrations and visualizations when analysing raw data.

There Goes the January Effect – Are We Facing a Recession?

A week ago I wondered whether we will get to see the famous January effect making an appearance in the markets. I’m afraid the answer seems to be a definite no. January Isn’t over and still may surprise us but the January effect in all its glory has regrettably not made a grand entrance.

The Nasdaq has lost 6.5% the past week with the Dow Jones not far behind, again under 13,000 points. Several indicators support the general feeling the US economy is headed for a recession. Although it is still too early to determine we’re heading to a recession for certain more and more telling signs are available to investors:

1. US unemployment rate surprisingly jumped to 5% (from a previous 4.7%).
2. The Institute of Supply Management’s manufacturing PMI reading fell to 47.7% (from a previous 50.8%) which translates to decline in manufacturing activities.
3. The ’Fed’ announced a 50% increase in credit auctioned in January.
4. Investors currently estimate a 0.5% cut in fed funds rate is more probable then not, according to future contract prices. Apparently both Goldman-Zachs and J.P Morgan have updated their forecasts to a 0.5% cut in fed funds rate.

As I’ve quoted in a past post it appears, according to Globes.com, that since 1950's out of the 36 times the first 5 days of January ended positively 31 years have also generated positive results (The remaining 21 times the first 5 days of January ended negatively 11 years ended positively and 10 ended negatively).

What 2008 holds is yet a mystery but it seems chances of recession are growing stronger and stronger everyday.

More on the current economy:
1. Economic Indicators Take a Turn for the Worse @ Econbrowser
2. Do I Think a Recession is coming? @ The Wastrel Show
3. Tech Shares in Massive Selloff; Bracing for Recession @ Tech Trader Daily
4. Recession? Stagflation? @ Herb Greenberg’s MarketBlog

Long Term Investing Isn’t Always a Smart Move

I am truly confused. I’ve been able to save some money recently and I’ve stopped to think on how and where I should invest it. One of the rules of thumb of investments is to invest for the long term. If your investment period is long enough stocks will eventually yield the highest possible return compared to all other options.

While this rule of thumb has proved itself in the past the future is a whole other matter. Furthermore, as an investor I’m constantly asking myself are price levels justified? Are stocks priced correctly?

We only need to take a look at a poor investor who decided to invest some of his savings in the Nasdaq Index somewhere in early 2000 when the Nasdaq hovered over 5,000 points. This investor has yet to see his original capital investment. Not to mention losing 8 years of alternative return on investment. Another, even better, example is having invested in Japan’s Nikkei Index somewhere in the 1990’s in levels of almost 40,000 points only to find that today, after almost 18 years, the Nikkei toys around 15,000 points.

Naturally rules of thumb are not always correct. Acting on induction or action based on past performance is logically wrong but we have little choice in the matter as only the past is known.

As a result the question I’m constantly asking myself is are markets today priced correctly? In my post about The Financials of 2008 I quoted Blumberg on the Chinese market. The Chinese market is a wonderful long term investment opportunity but it seems there is a bubble evolving in it. Chinese stock prices have risen to imaginary worth. PetroChina’s market cap is 39% that of Axon Mobile with 50% of the profits. China Mobile’s market cap is 41% that of T&T with 75% of the profits. Stocks in the CSI 300 index are traded at a P/E multiplier of 44.7!

The US economy is very edgy and markets have performed quite nicely since 2003 (even if returns where amongst the lowest when compared to other markets).

So, Do I have good reasons to be concerned? I believe so.

More on investing for the long term:
1. Controlling the risks @ My 1st Million At 33
2. Discover The Market’s 10 Year Cycle @ Trader’s Narrative
3. What Would I Buy in 2008 @ The Indian Investor’s Blog
4. Wealth Building Strategies @ Dual Income No Kids


Related posts at Personal Financier:
1. The Financials of 2008 – What Will We Talk About?
2. Investing mistakes to avoid
3. Understanding the difference between investing and gambling
4. Tips for young investors

How to Make the Most of an Out of Office Vacation

I’ve recently returned from a 5 day vacation out of office. Many of us are familiar with that stinging and painful sensation when you’re mobile phone rings with your boss calling right in the middle of an afternoon nap on the beach.

The primary purpose of taking vacations is to have fun and unwind. Reducing the built up stress is crucial for a healthy professional life. Many times business and office needs require our attention, even on vacation. It has been shown that mixing business and pleasure while on vacation greatly decreases the vacation’s effectiveness in reducing stress. How do we make the most of such a vacation then?

As many things in life having a great out of office vacation is about planning and setting the ground. Here are my suggestions and tips on how to make the most of such a vacation:

#1 Time your vacations to your office lows
It is much easier to enjoy a vacation when everyone else is also out of office. True, most of the times tourist destinations will be packed full with screaming kids but it is always possible to find a more remote site and truly enjoy the peace and quiet with little or no office disturbances.

While some people naturally object to being told when to take their time off it has been shown stress levels decrease greatly when you’re not thinking of what’s going on in the office when you’re not there.

#2 Prepare by closing open ends and tasks due
If you’ve left unfinished and urgent business behind you should naturally expect a phone call. If you’ve planned a vacation be sure to prepare properly and close loose ends.

#3 Prepare by organizing work related material which your colleagues might need when you’re gone
Ever tried guiding someone to one of your many, overlapping subfolders to locate a certain file over the phone? If you have you know it’s very frustrating. Set up a small folder with relevant information and files and make its existence public knowledge. Assure you’re colleagues everything they need is in there.

#4 If you want to reduce disturbance to a minimum let people know you don’t want to be disturbed
You’ll be amazed how some people don’t mind working while on vacation. I myself find that weird. However, if someone doesn’t mind working, especially your boss, why should he mind calling you on vacation? Let your colleagues know you’d like some quiet time off.

#5 If you have to work on vacation set a fixed and firm schedule and abide by it
Have an hour a day to go over mail and make some calls. Use only that hour and get things done in that hour. This way you’ll be relaxed the remaining 23 hours of your day and be much more efficient on that exact hour. If you’ve set up that time let people know they may disturb you at that time only.

#6 Leave you cell phone behind or silence it
This is a no-brainer but it seems many people find it hard to part with their phone. If you answer your cell while on vacation don’t expect people to stop calling.

#7 Leave an out of office reply and update your voice mail
This is crucial. If you simply don’t answer you’ll be considered plain rude. You can’t blame people for disturbing you if they don’t know you’re on vacation.

#8 Assign your immediate assignments and clients to your colleagues
It is vital you’re clients and colleagues will have a contact when you’re gone. This will greatly decrease your levels of stress and anxiety of whether the office is getting by with out you.

#9 Delegate authorities
This is one of my favourites. You’re not as important as you think. Many decisions can be maid by your subordinates and co-workers. When leaving for vacations have some issues decided upon with out you. This is a tip for life as well.

More on the vacations:
1. Last Minute Vacations – Risks and Rewards @ Blueprint for Financial Prosperity
2. Money Lessons I’ve Learned on the Road (the hard way) @ SavingAdvice.com

The Financials of 2008 – What Will We Talk About?

I am not a big fan of forecasts and trend predictions. The papers are filled with year end summations and forecasts. Through my readings I have noticed some financial concepts are being constantly repeated. I believe these will be the main building blocks of the financial discussion in 2008.

Inflation
It’s everywhere. Prices have been slowly yet surely increasing since 2007 started. The increase in oil prices was the most noticeable but other commodities were not late to follow. Industrial metal prices such as: aluminium and steel and basic food prices such as: wheat, corn, soy and other vegetable oils have all sky rocketed. The price increase of basic and raw materials will surely lead to further price increase in consumption goods and foods such as milk, pasta, bread and meat as feeding animals is much more expansive. An increase in transportation prices and in furnished goods is also probable due to the increase in raw material prices. The real estate market in the United States might serve to cool down inflation as prices and home sales are still declining but the general direction seems to be upwards.

Commodities
So, will investing in commodities be a sound move for 2008? It seems so (though I often discourage investing on trends). The nature of commodities is such that balancing surplus demand is a long process which takes time. You can’t just plant a wheat or corn field in a week. There seems to be a bigger trend of growing and even shifting consumption to evolving countries. This is natural of course as this is exactly what these countries are doing: evolving. As countries like Chine and India continue to grow each Chinese or Indian is able to afford greater consumption. Think of billions of people increasing there weekly meat consumption by 2 pounds. The numbers quickly add up.

China
There is little debate over whether China is growing in the long haul. There is a question of whether the Chinese stock market is reflecting that growth accurately. With high inflation and interest levels and a stock market which yielded almost 160% in 2007 China is a scary investment.

Blumberg has recently reported Chinese stock prices have risen to imaginary worth. PetroChina’s market cap is 39% that of Axon Mobile with 50% of the profits. China Mobile’s market cap is 41% that of T&T with 75% of the profits. Stocks in the CSI 300 index are traded at a P/E multiplier of 44.7!

I myself have decided not to participate in the feast for now and I’m waiting for a violent correction due in the Chinese stock market for a better opportunity.

2008 will with out a doubt be a very interesting year where investors will have a harder time generating the handsome returns of 2005-2007.

The January Effect – Will This January Generate Abnormal Returns As Well?

The January effect is one of a series of known ‘market failures’. We assume the stock market to be efficient with regards to publicly available information. However, in some instances one is able to generate abnormal return using a publicly known phenomenon. The January effect is one such phenomenon.

Some studies have shown stocks generate abnormal returns in January when compared to other months of the year. These studies have also shown that:

1. The first days of January are mostly responsible for this effect.
2. Companies with lower market values generate greater abnormal returns.

This phenomenon can also be phrased as following: The majority of abnormal returns generated by companies with lower market value are happens in January.

The most common explanations are:
1. Tax considerations – After realizing loss for tax purposes in December investor hurry and buy back the stocks sold.
2. This phenomenon is more common is lower market cap companies as each transaction has more effect.

January is also considered a sort of proxy for the entire year. It appears, according to Globes.com, that since 1950's out of the 36 times the first 5 days of January ended positively 31 years have also generated positive results (The remaining 21 times the first 5 days of January ended negatively 11 years ended positively and 10 ended negatively).

So, will we see the January effect in 2008? We’ll know in a few days. Many speculations are available as markets are sensitive and edgy.

More on the January Effect:
1. The January Effect – 2007 @ Trader’s Narrative
2. 15 January Effect Stocks Trading Ideas 2007-08 @ Alpha Trends
3. Two January Effect Stocks @ BloggingStocks
4. January Effect Trading Opportunities in Financials @ Seeking Alpha