Reuters Money

Tax-saving ETF strategies to use before end of 2011

The final quarter marks the traditional time of year when kids dive into leaf piles, heating bills rise and investors with taxable accounts sell underwater stocks to help lower their tax bills.

They shouldn’t have too much trouble finding candidates this year. Despite a recent uptick, most major indexes remain in negative territory for 2011, and with market volatility in high gear more dips could be on the way.

Tax loss harvesting helps ease the pain of a down market by allowing investors to use the losses to offset gains and up to $3,000 of ordinary income on their tax returns. But you have to wait at least 30 days after the sale of a losing stock to buy back the same security. Otherwise, the IRS calls it a “wash sale” and you can’t deduct the loss.

While someone might use a similar stock as a placeholder in case the market bounces back, that option isn’t ideal because performance can vary significantly among stocks in the same industry. Mutual funds covering similar investment turf don’t always move in sync either.

Exchange-traded funds adapt to the strategy more easily. Since there are more than 1,300 of them, it’s fairly easy to find one that has the look, feel and performance of another security but is different enough to use as a substitute, either temporarily or for the long-term, without drawing IRS scrutiny.

“ETFs have made tax loss harvesting a lot simpler than it used to be,” says Charles Zhang of Zhang Financial in Kalamazoo, Michigan. “It’s not that hard to find one that’s a good stand-in.”

Zhang and some other advisers say using two ETFs or mutual funds based on the same index would probably violate the wash sale rule. To be sure, you might not want to sell iShares S&P 500 or a mutual fund based on the index, for example, and immediately replace it with SPDR S&P 500.

5 tips to surviving a bear market

Do you need a special kind of financial adviser to deal with a bear market?

Few will debate that the months ahead will be challenging, and that the extreme market volatility will continue. There are a number of steps you can take with your adviser — or on your own — to weather these changes.

The first thing to consider is that the cards are lining up for the U.S. and European economies to backslide into recession. The Economic Cycle Research Institute is calling for two quarters of negative growth. The European sovereign debt crisis is like a wounded beast. The Federal Reserve doesn’t seem to be able to help, despite lowering short and long-term interest rates.

But a more telling indicator might be the gold-to-copper ratio, which is diligently tracked by Jack Ablin, U.S. portfolio strategist at Harris Private Bank in Chicago.

Copper, which is linked to the construction industry and economic growth in general, tends to underperform gold if a downturn is imminent, Ablin has found. “Over the past six months, copper has underperformed gold by 22 percent, suggesting an economy in reverse,” he says.

“Now that the Fed is out of ammunition, it’s unlikely that the central bank will help spur growth,” Ablin wrote in his Oct. 4 market outlook.

Of course, economists’ tarot cards are not precise. It could happen that the Europeans could figure out a grand solution to their debt woes, recapitalize their banks or buy up the bad debt. Washington may come up with a way to unfreeze the glacial housing and market. Job growth may return. Then again, I could be rabidly optimistic.

Tactical asset allocation might become your new normal

Market volatility is like a headache that hangs on. The cure may lie in shifting your mind from keenly focusing on risk instead of returns.

For many, this is an obvious no brainer, but it involves much more than simply shifting into cash, bonds or gold. What if you don’t want to exit stocks entirely? Then you may need what money managers call tactical asset allocation.

Instead of a long-only, hold-on-for-dear life approach of traditional investing, tactical planning involves shifting in and out of assets as market conditions dictate. In a turbulent market, there are several asset classes that can buffer stock downturns that can be found in several off-the-shelf mutual funds.

The linchpin of tactical investing is flexibility. It’s the opposite of the 60-percent stocks, 40-percent bonds fixed template. As a dynamic model, tactical portfolios are often open to moving into non-financial assets such as gold, real estate and commodities.

What I like best about tactical allocation is that it doesn’t go whole hog on any one asset class. Instead of loading up in the usual suspects in a bearish stock market — such as U.S. Treasuries or gold — it’s open to opportunities around the world. This can avoid big timing blunders and the prospect of being stuck in the wrong asset when markets turn.

It may be a while before the stock market turns bullish again when it’s being pulled in a number of negative directions. European debt woes, a sluggish U.S. economy and the prospect of a global recession are a menacing “lethal trifecta,” as Mohamed El-Erian, Chief Executive of PIMCO, noted recently.

“I worry that, absent a dramatic change in policies in America and Europe,” El-Erian wrote, “things will get worse before they get better. I fear that, given this possibility, it would then take years, if not decades, to repair the underlying damage done to economies, jobs and people’s lives around the globe.”

Has gold been trumped?

When Donald Trump accepts gold bullion as a security deposit for one of his buildings, is it time to bail out of the yellow metal as it heads for its worst month in three years?

However you interpret gold’s recent slide — or the Trump factor –either the pale metal has lost its luster for now or large investors have ratcheted down their fear levels. Either way, there’s going to be more downside volatility in that market.

As I’ve written in the past, I don’t regard gold as a real investment. It doesn’t pay dividends, has no intrinsic value and is no replacement for bread and water if catastrophe strikes.  Gold may be due for a huge correction. The raising of exchange margin requirements for gold traders and the possibility of the Eurozone debt woes being addressed led to a huge sell-off of gold in the past few weeks.

After making a run at $1,900 an ounce, the metal fell to around $1,600. It may be that large investors actually fled gold to be in cash again, thinking that either gold’s run was over or they needed to be in something safer.

Yet if you believed that gold is a proxy for extreme uncertainty — as millions have — when would you begin to shift into less-volatile vehicles such as government or inflation-protected bonds?

Where gold is headed is not something that can be easily predicted. I’m not a big believer in using past results to forecast future market trends or pricing. In fact, I think it’s one of the worst ways to invest. It always gets investors in trouble because they conflate random price movements with actual patterns where none exist. Last year’s winners will often be tomorrow’s losers.

So the bevy of predictions that gold will hit $2,000 an ounce or that any number of technical elements predict its infinite ascent don’t mean too much to me.

Want steady income and safety? Think MBS ETFs

Juliette Fairley is a frequent commentator on Better Home and Garden TV. She has written for the Wall Street Journal, the New York Times and USA Today. The opinions expressed are her own.

Global markets have been slumping since Standard & Poor’s downgraded the U.S. AAA credit rating on Aug. 3, 2011 but niche funds that specialize in mortgage-backed bonds are maintaining gains.

Those funds are mortgage-backed securities exchange-traded funds (MBS ETFs), which invest in highly liquid Fannie Mae and Freddie Mac loans that consist of pools of individual residential mortgages. When homeowners pay their mortgage, the interest is received by the bond holder.  The size of the MBS ETF market is $3.5 billion as of Sept. 21, 2011 with the majority of assets falling under iShares Barclays MBS ETF, according to Morningstar.

“Investors prefer mortgage backed securities due to the fact that the U.S. government stands fully behind them which still give them a high degree of safety considering the recent S&P downgrade,” says Maurice Wilson, a financial adviser with Wilson Wealth Management Group in Charlotte, North Carolina.

When the U.S. had a AAA credit rating, MBS ETFs were a relatively risk-free investment. But even with the S&P downgrade of the United States from AAA to AA, investors are still flocking into Treasury-related debt, driving up the prices on MBS. “Mortgage backed ETF’s act like a Treasury bond so for an investor considering their portfolio’s bond allocation, their purpose is steady income,” says Morningstar ETF analyst Timothy Strauts.

Indeed, the big lure is juicy returns. The average one year annualized return for the category was 5.7 percent as of Sept. 20, 2011, according to Morningstar. “An MBS ETF can be positioned as a piece of a client’s income pie,” says John F. Harrison, a certified financial planner with Aspire Financial Advisors in Newton, Massachusetts.

Another reason Harrison and other advisers like MBS ETFs is because they are perceived to be safer than mutual funds that invest in private-label MBS, such as 40-year mortgages and jumbo loans. The mortgages that make up the securities in these mutual funds do not have the backing of the government and as a result carry a significantly greater risk.

Balancing your portfolio in a bonkers market

Balance is a rare bird these days. Jobs, housing, stocks, European debt: All seem to be in a spasmodic tailspin.

There is some consolation that a balanced portfolio can help smooth out the jagged curves of a bipolar market economy. But balance is rarely what we think it is, and it needs constant monitoring.

When most investment advisers tout a balanced portfolio, it typically means one thing: About 60 percent would be invested in a U.S. all-stock fund and the remainder in bonds.

A good proxy for the stock component would be the index exchange-traded fund SPDR S&P 500 fund. U.S. bonds could be ably represented by the SPDR Barclays Aggregate Bond ETF.  Both funds are low cost, diversified ways of owning the lion’s share of each market. Here’s how the returns break out, according to Craig Israelsen, professor of finance at Brigham Young University, who analyzed the underlying indexes:

A balanced portfolio is roughly half as risky as an all-stock mix. If you looked at August’s returns, you would have only lost 2.75 percent in the 60/40 portfolio, compared to a 5.5 percent loss in the all-stock portfolio or a 1.37 percent gain in the much safer all-bond portfolio. No surprises there because bonds are safe havens when investors flee stocks as they did during last month’s volatility — and may continue to do so in a broad-based pullback.

Let’s look back even deeper into the past decade, which included two recessions, 9/11, the 2008 meltdown and the dot-com blow-out of 2001. Bonds are again the best performers as a buffer against stocks — returning 5.5 percent vs. 2.59 percent for 100 percent stocks. Between those two extremes was the balanced portfolio, with a 4.1 percent return through August 31.

In an even more volatile period — going back only five years to include the 2008 meltdown, recession and recovery — bonds again came out on top with a 6.26 percent return, compared to 0.74 percent return for all stocks and 3.3 percent for the balanced mix.

Hedging can end your retirement panic now

Even with the most recent market agita, there’s no reason for you to worry long-term about your retirement funds.

Is my head in the clouds? As darkly volatile as this moment in personal investing may seem, it’s actually a golden age for portfolio insurance. Retirement worries as we know it can come to an end — if you know how to hedge properly. There are plenty of retail tools available to that end.

Part of my optimism is based on the availability of off-the-shelf portfolio insurance for everyone. If you hedge your holdings the way the big institutions do, big dips will do no harm and you can even make money when the market’s down.

The three most powerful hedging devices come in the form of exchange-traded funds (ETF), which are pooled portfolios based on securities and indexes traded on stock exchanges. You can buy them from any deep-discount broker and leave them in place.

Hedge inflation A rising cost of living generally hurts bond prices. Unlike most bonds, when inflation climbs, Treasury Inflation-Protected Securities gain value. One suggestion is the iShares Barclays TIPS bond fund.

Hedge your stocks Inverse ETFs such as the ProShares Short S&P 500 ETF, move in the opposite direction of the popular stock index.

Hedge your bond position You can short a broad-market bond index through the Direxion Daily Total Bond Market Bear 1X Share or similar ETFs. This is a good hedge if your portfolio is heavy in bonds and interest rates are rising.

4 ways to hedge the market without playing whack-a-mole

Is the recent market upheaval the growling of a new, prolonged bear market or a tempest in a teapot?

It’s too soon to tell and most of us will guess wrong anyway. As Washington and global traders sort out the impact of the U.S. “Tea Party debt downgrade,” you should employ the best hedging strategies possible.

Of course, if you already have a comprehensive financial plan with an investment policy statement in place — and it’s working for you — you’re probably fine. While the ongoing market angst is troubling, you’re still on course.

The only thing that’s guaranteed is that Euro Zone debt woes, the threat of a double-dip recession and ongoing U.S. budget battles will create more short-term volatility than a tropical storm.

Here are some ways of avoiding the market turmoil:

Build a can’t-stomach-stocks portfolio There’s no shame in protecting your principal, particularly if you’re in or near retirement. The last decade was bad enough, and you shouldn’t have to suffer any more losses. If you can’t afford to lose anything, you shouldn’t be in stocks anyway. One way of dynamically measuring risks and avoiding market downturns is through tactical asset allocation.

The site MyPlanIQ provides some ways of customizing your portfolio to the kind of risk you can stomach. One simple, ultra-safe model they suggest combines just two income funds: The PIMCO Total Return fund and the Vanguard Short-Term Bond fund . About 67 percent of the plan is allocated to the PIMCO fund and 33 percent to Vanguard. While this portfolio doesn’t completely offset interest-rate risk, it’s a good place to be if stocks are tanking and there’s negligible inflation.

What U.S. debt downgrade means for ETFs

Is it time to take cover from exchange-traded funds (ETFs) now that Standard and Poor’s has cut the U.S. debt rating?

With the recent U.S. and Euro debt crises introducing new uncertainty, volatility will be the name of the game. As the frenzy of new fund offerings abates, many funds may close because they will be unable to attract sufficient assets. But a handful of safeguards can protect you.

“The number of ETFs that are shut down or liquidated, while previously a rare occurrence, is on the rise,” said Tom Lydon, publisher of the popular ETF Web site www.etftrends.com in an email. “Closings are up 500 percent in each of the last three years over 2007 levels (which equates to one each week).”

When funds close, Lydon noted, “investors are notified and have 30 days to sell on their own or receive the market proceeds at the time of the closure.”

Keep in mind that ETF assets are not insured by any government agency and you’re subject to market and often credit risk. And while many ETFs have eliminated brokerage fees to buy and sell them, they still may not closely track the index they are named after — a frustrating glitch for many investors. The popularity and perils of ETFs recently triggered a warning from a group of state securities regulators.

The North American Securities Administrators Association warned that “some traditional ETFs may be appropriate for long-term holders, but others, including exotic-leveraged and ETFs, may require daily monitoring.”

You can get into a lot of trouble if you don’t understand the more specialized funds. While most are pools of money tied to stock and bond indexes, many use borrowed cash to bet on up or down movements in stocks, bonds, commodities and currencies.

An inside look at a bad stock play

The following is a guest post written by Marianne Paskowski, who was vice president of Reed Business Information’s Television Group. Today she manages her extended family’s portfolios from Cape Cod.The opinions expressed are her own.

So how do you make money in this horrible market? Being semi-retired, I just can’t sit on a pile of cash. But today is the ninth consecutive day that the markets are down. Last Friday was a stinker too, when we saw Gross Domestic Product was only up 1.3 percent. On Tuesday, we heard from the Commerce Department that consumer spending slipped 0.2 percent. Oh, and how can I forget, we have U.S. job data hitting this Friday.

All of those headlines spell code red for me: The country is not as healthy as many had earlier thought.

While my gold and silver trades are playing out well, and so are two Exchange Trade Funds that short the Russell 2000 and the S&P 500, I’m still waiting for that third quarter rally to happen. But today, it sure doesn’t look like the time is at hand. So I’m hoping my next big trade will be to find a way to gradually exit the shorts, when times improve.

My last trade certainly didn’t work out that way. As I tried a move designed to boost my portfolio, I found out the hard way that the market is volatile. So to learn from my mistakes, here’s what I did wrong:

Getting sick of risk-on, risk-off, I strayed out of cash, not that much, but just enough to screw myself up. I bought a financial instrument I didn’t understand, or do any homework on, until after I bought it.