Friday, July 13, 2007

Markets at All Time Highs - Should you be worried?

The markets seem a little bubbly these days, hitting all-time highs in several indexes. Most of the experts suddently seem to have become bullish, despite their agreement that the market has been climbing the proverbial "Wall of Worry" recently.

So, should you be worried or euphoric? I've traded thoughts with a few friends recently and the insights might be worth sharing.

First of all, keep in mind that the new highs are over those of about 6 years ago, when euphoria was high but earnings were much lower. Thus, while the market is certainly not cheap today, it does not seem wildly overpriced either. Assuming some of the worries dissipate, it would seem the market has room to run.

On the other hand the bull run is over 4 years old, so the market is a bit nervous. Any sign of new worries or worsening of those now being mentioned are causing traders to keep a finger on the sell button.

As I've said to my friends, I'm neither optimistic nor pessimistic on the market. It does seem a bit bubbly now, but it could well go higher over time. The most likely result is increased volatility. That is great news for me, since my system depends on volatility to outperform the markets (see previous articles for an explanation if you are not a regular reader).

In accord with all this, my system had me buying a few weeks ago but is flashing a sell right now. Of course, this is the short term response to the volatility. In the longer term picture, my system has me holding a significant cash position, meaning I'll be ready to capitalize on any volatility, whether it be short term or a significant bear market. That's the beauty of the don't need to know what the market will do to ourperform the market. Check it out in posts on "Taking Advantage of Volatility" or "Dollar Cost Averaging on Steroids".

Friday, July 6, 2007

Help with Understanding Your Insurance Needs

One thing I've noticed is that insurance decisions are often made on an emotional basis, or on the spur of the moment with minimal analysis, and the decisions sometimes defy logic. As a result, it may be useful to at least work through the basics outside of the pressure of a salesman and in a strategic, rather than adhoc, basis.

Let's start with the fact that there are a huge number of potential types and sources of insurance available, each with a salesman trumpeting its benefits. Obviously, if you are not careful, you could insure yourself into the poorhouse.

So, how should you identify those you must have, versus those it would be nice to have? Start with the premise that you must insure yourself against a financial catastrophe, but not against events that might be painful, but not catastrophic. That is the basis for buying medical insurance and for buying liability insurance. A reasonably likely event such as a major illness or accident could be catastrophic to all but the most financially secure without these insurances. The same applies to flood, fire and casualty insurance on your home. And, for those with minimal financial reserves who have families including young children, term life and disability insurance is mandatory. Death or disability could financially handicap the family for many years.

Beyond these basics, the case for insurance becomes more murky. It would, of course, be painful if you wrecked your car and had to replace it yourself, but would it be catastrophic? Would failure of your washing machine be catastrophic enough to pay for the insurance of an extended warranty? I know it would be nice if these things were insured, but keep in mind there is an offsetting cost. Remember that, under the best of circumstances, the insurance company must base their rates on the likelihood and cost of the insured event, as well as a profit for themselves, commissions for the salesman plus allowances for the less careful and for possible fraud, all on top of their administrative costs. Would the insured event be catastrophic enough to justify these costs? Would your death be financially catastrophic if you are single are newly married? What about if you are near retirement? Note the emphasis on financial-of course it would be catastrophic emotionally, but insurance will do little to help with that. I'd suggest that life insurance should be reduced as the family gains more financial independence and nears retirement.

What about deductibles? Generally, high deductibles considerably reduce insurance cost. Why? Because most events are small and the administrative cost for small claims is high, while the difficulty of preventing fraud or unjustified claims also climbs. At the same time, deductibles which are higher than the usual may fall well below a level that would be catastrophic for you. Because of this, my strategy is to buy deductibles which are just below the catastrophic level for insurances I must have. The cost of the insurance covering the difference between low and high deductibles may be some of the most expensive insurance you can buy. For example, in looking at my medical insurance, I discovered that the cost of medical insurance with a $200/year deductible is about $4000/year. The cost of a similar policy with a deductible of $4000/yr is less than $1000/yr. So, in effect, it cost me $3000/year to insure against the possibility of spending an additional $800/year out of pocket, should I have over $4000 medical cost in a given year.

Let's talk about when and where you should buy your insurance. Buy insurance only after you have created a strategic plan for all your insurances, thinking logically about what events would be catastrohic for you. Then, talk to several companies, comparing rates, coverages and the stability/reliability of the company. Avoid buying coverage adhoc or on the spur of the moment, especially if packaged with another product. These make if difficult to assess the risk or identify what are often outrageous rates or large fees.

As an example, whole life combines insurance with investments. Unfortunately the investment is often subject to large fees and commissions or low returns hidden in the policy. In another personal example, I had an auto salesman try to insert (without even mentioning it) life insurance that would pay off the balance of my auto loan in case of my death. Once I discovered it, he launched into an emotional plea in favor of my wife and kids, who he thought might have trouble paying off the loan if something happened to me. I advised I already had adequate life insurance and, on checking found that the cost of the insurance from my normal insurer would have been less than half what the dealer would charge, and would have been for the full balance of the loan, rather than the declining balance covered by the dealer. Extended warranty insurance is fraught with the same issues, and is even more difficult to evaluate.

I could go on and on, but you can take it from here. Just remember the basics:
  • Develop an insurance strategy in a calm time and logical manner. This allows you to quickly dismiss offers which do not fit your strategy.
  • Insure against only those events that would be catastrophic for yourself or your family. The administative cost, fees and profits involved are too high to justify insuring other events.
  • Get competitive quotes for the insurance you need.
  • Do not combine insurance with other products.

With these simple steps, you can save yourself thousands of dollars in unnecessary cost, and at the same time be comfortable that you have the insurance you need.

Tuesday, July 3, 2007

Financial Cruise Control, a great leap forward

Maybe I'm the only dinosaur left, but I remember when my paycheck was delivered to me in person. I then had to make sure to get it to the bank before it closed, all the while worrying about whether I would forget it, lose it, or get stuck in a meeting. Most other income came in the same form, with the same hassles.

Saving or investing was no better. Your broker called and recommended an investment. You had to research it and make a decision, then try to call him back and execute the order. Then, just to get the money to the brokerage or bank meant a trip or a search for addresses and stamps, and paperwork to fill out.

Spending, same story. Trips to the bank for cash. Gathering the bills and finding addresses, envelopes and stamps. Probably a trip to the post office. I used to spend a few hours a couple of times a month just to make sure the bills got paid, meanwhile enriching the post office and taking my money out of investments early to make sure the money was available.

Thank goodness the good old days are gone. These days, payments are automatically deposited, on time, no hassles, no paperwork. Buying a stock or mutual fund is just a few clicks away on line, any time of day at my convenience. Got a little extra cash? Compare on-line banks for the highest rate and move money to the best place effortlessly. And most the investing is even easier...deducted from my pay and automatically invested or reinvested in accordance with my allocation. No research, no decisions, no real need for any effort once it has been set up.

Spending? Even easier. I haven't been to the bank or post office in months. I put everything on my credit card, from the electric bill to the quick lunch, from the airline flight to the magazine subscription. Then, once a month I download the bill, take a glance and pay all the charges with a few clicks of the mouse, perhaps from my hotel room on my way to the mountains. On the rare occasion that I have to pay cash or send/deliver a check I first get agitated, then take the opportunity to remember how much improved things are today.

For such service, you'd expect to pay a fortune, right? Not so. Payers and collectors alike are glad to avoid the postal expense and paperwork. You can keep your money invested for a month or more, and they'll pay you between 1-5% of your expenses for the privilege, plus often a bonus when you sign up. Unsafe, you say? If you have incorrect charges (which hasn't happened to me in several years), you just dispute the charges and don't need to pay unless the charges turn out to be justified.

I'm led to believe there are still dinosaurs out there who make regular trips to the bank and post office. Who generally pay by cash or check, in person or by mail. You probably refuse to use the cruise control on your car too, right? If that is you, I invite you, step on in to the 21st century, where the living is easy. Put your finances on cruise control. It's cheaper, it's easier, it's more profitable. If you don't believe that last one, check out my post on dollar cost averaging on steroids.