Reuters Money

Investment policy statements: A roadmap for volatile markets

With the markets still gyrating like a yo-yo, most investment advisers have likely been barraged with questions from their clients. But investors tend to make the worst decisions when confronted with chaos.

To avoid a reactionary and emotional response to market swings, consider an investment policy statement (IPS). An IPS is an honest assessment of your investment goals and objectives and clearly identifies how you plan to achieve them.

Are you saving for a your child’s college education, retirement, a second home? Your IPS lays out your investment constraints, your risk tolerance, and can include your expected rate of return and your portfolio rebalancing schedule, among other details. “It is a roadmap,” says Elle Kaplan, founding partner and CEO of Lexion Capital Management, an investment advisory firm in New York. “It is a flexible, living document that changes with life circumstances.”

IPSs have been around a long time but investors drift away from them during bull markets. Given the current market volatility and the expectation that it will continue, it is no surprise IPSs have made a comeback.

“Investors got re-introduced to risk in the early 2000s and ultra-high net worth individuals started to look at best practices of the institutions,” says Sharath M. Sury, executive director of the Institute for Financial Innovation & Risk Management and an adjust professor of economics at the University of California at Santa Cruz. “As people got educated about risk, they adopted ways to control or discipline their investment managers,” she says. If you have a registered investment adviser, an IPS is considered a best practice.

Unfortunately, “not enough clients do them because it requires a lot of work on their part,” says Margaret Franklin, chair of the Board of Governors of the CFA Institute and CEO of Kinsale Private Wealth in Toronto. In many cases, says Franklin, investment policy statements are either too formulaic or pre-formatted and not customized. “Managers should spend more time with clients, ask more provocative questions and listen more,” she says.

To make the most out of your IPS, consider the following guidelines:

Double-dip recession porridge: 3 bears dish it out

Now that fears of a double-dip recession are on everyone’s mind, the bears are on the prowl and really cranky.

What’s the best way to tame our fears and become confident long-term investors? Let’s listen to what some of my favorite bears have to say and then take a look at the big picture.

The most ominous threats are that of a European bank failure or double-dip recession that would slam both the U.S. and Eurozone. One of the most vocal ursines — Nouriel Roubini, professor of economics at New York University — starts out his jeremiad by asking the question “Is Capitalism Doomed?”

“The massive volatility and sharp equity-price correction hitting global financial markets signal that the most advanced economies are on the brink of a double-dip recession,” Roubini writes.

Bemoaning the Euro debt crisis, America’s fiscal crisis and even the Japanese earthquake and tsunami, Roubini is not sanguine the current system can handle these calamities. Consumers are gloomy and the U.S. housing market is still in the dumps.

“To enable market-oriented economies to operate as they should and can, we need to return to the right balance between markets and provision of public goods. That means moving away from both the Anglo-Saxon laissez-faire and voodoo economics and the continental European model of deficit-driven welfare states.”

Roubini’s route to this radical shift? More infrastructure spending, progressive taxation, reduction of household debt burden and “breaking up too-big-too-fail banks and oligopolistic trusts.” Paging the U.S. Treasury Department, Congress, Federal Reserve and Bank of America.

How much stock should older investors hold?

Jim Dundee’s business is doing well — he’s an optician and owns his own retail optical store near Tampa, Florida. But Dundee started to get nervous about the economy and stock market a couple months ago.

“Even though business has been great here, you could just tell by listening to customers. We serve a pretty savvy clientele, and they were all saying something was brewing and that stocks would take a hit.”

Dundee, who is 57, decided to reduce the exposure to stocks in his retirement portfolio. Working with his broker at Raymond James, he cut equities from 70 percent to 50 percent, with another 35 percent in cash; the remainder is in bonds and gold. He hopes to be “semi-retired” by 62 by scaling back time spent on his business. “I’m asking myself, how little risk can I get away with?”

Dundee is hardly alone. The percentage of U.S. households willing to take “above-average or substantial risk” to meet their financial goals has plunged among all groups according to to survey data from the Investment Company Institute (see chart, below). The decline has been sharp across all age groups, but is especially dramatic among older baby boomers.

And the market’s recent volatility has put new focus on a key question older investors have been asking themselves since the 2008 crash: what is the correct retirement portfolio equity exposure for investors close to retirement, or who already are retired?

Ask the experts, and you’ll get answers that are all over the map. The Putnam Institute recently surveyed target date funds and found that retirement date equity allocations ranged from 65 percent to just 35 percent. And Putnam’s own experts concluded that retirees should have no more than 25 percent of their money in stocks.

Meanwhile, T. Rowe Price advises retirees at age 65 to keep 55 percent of their money in equities, 35 percent in bonds and 10 percent in cash.

Beaten down by market turmoil? The case for hedged mutual funds

The following is a guest post by Juliette Fairley. A frequent contributor to USA Today, Investor’s Business Daily, Bloomberg Wealth Manager and The New York Times, she is also the author of three personal finance and investing books. The opinions expressed are her own.

With the markets so volatile, financial advisers are screaming “diversify” from the rooftops. One small corner of the market that might attract attention in down times: hedged mutual funds.

Before the latest downturn, the hedged equity mutual fund category, which is comprised of only about 100 funds, was up 1.72 percent year-to-date. That’s less than the average equity mutual fund, of which there are about 10,000, which up 4.97 percent.

But in the tumult since the debt deal, the ratio turned to a 5.69 percent loss for hedged funds compared to a 7.83 percent loss for non-hedged funds, according to data from Lipper, a Thomson Reuters company, through Aug. 10, 2011.

That kind of split is why the hedged equity mutual fund remains a small specialty instrument in the toolbox of many financial advisers. Advisers like hedged mutual funds because they keep clients’ portfolios afloat in a down market, despite lower returns over the long-term.

“Hedged mutual funds act as a diversifier and can both reduce losses or make money. They are designed to return a small amount in any market. In balance, they are good by adding choice and selection to the client’s menu,” says John Longo, a registered investment adviser in Morristown, New Jersey.

Another advantage to hedged funds: lower fees. Traditional hedge funds, such as Paulson & Co. or Avenue Capital, charge two percent of the top 20 percent of any profit.

Glassman’s redemption: Find an investment safety net

It’s hard to climb out of an abyss in which you’ve predicted that the Dow Jones Industrial Average would hit 36,000 — only to see it crash twice and get pinned to the mat for years. James Glassman was one of the many bubbly U.S. stock cheerleaders who recommended stocks for the long term at the wrong time.

As most any stock investor will tell you, the last decade for U.S. stocks has been pretty dismal with the dot-com bust, 9/11 and the 2008 meltdown buffeting investors at every turn.

Yet Glassman has made an effort to redeem himself with his latest book Safety Net: The Strategy for De-Risking Your Investments in a Time of Turbulence.

Co-authored with Kevin Hassett of Dow 36,000 at the height of the tech-lemming era, I would have thought that Glassman would have laid low in a bunker with gold, U.S. Treasury Bonds and canned goods for while. It seems that Glassman has seen the light, though, and is preaching some sound advice for a more tumultuous time.

“Yes, stocks bounced up and down,” Glassman writes of his former views on stocks, “but your job as an investor was to hang on and collect your reward for perseverance at the end. I advocated the same strategy of heavy and diversified U.S. equity holdings that most sensible advisors espoused — but with an extra dollop of optimism. And I was wrong.”

So what happened to U.S. stocks for the long run? Not a good idea in the wake of the worst 10-year period of the stock market when accounting for inflation (through 2009), Glassman notes. Now it’s time for a “margin of safety.”

While this strategy would have been great advice more than a decade ago, Glassman’s new religion is asset protection (mine, too, although for me it’s an old faith). Ironically enough, Glassman had to reach back to legendary value investor Ben Graham (and mentor of Warren Buffett) to arrive at his new safety mantra.

Egypt: Mummy’s curse or economic boom?

Did the Egyptian rebellion open up a gold mine for civil reforms or a mummy’s tomb of economic perils?

I choose to think there are some robust opportunities presenting themselves as Egypt and other countries press their demands for freedom from oppression. On the political side, if you subscribe the “big wave” theory that Egypt’s mass protests will trigger similar revolts in other Arab states, then the resulting reforms — should they happen — may fuel prosperity and greater distribution of wealth.

The markets, of course, have a laser focus on Egypt and its ramifications. There’s a huge commodities rally going on; some of it is guided by fear and speculation but most of it is driven by demand.

I’m rooting for the Egyptians to get a better shake from their thuggish government. For a country of 83 million, most of Egypt’s wealth is concentrated at the top and little of its resource wealth is shared.

Compare the most populous country in Africa to the tiny oil-drenched Gulf State Qatar, which reported about $145,000 in GDP per capita and has one of the highest growth rates in the world at 19 percent. My source, by the way, is the U.S. Central Intelligence Agency, which apparently was behind the curve on unfolding events in the land of the Pharaohs. They weren’t watching Twitter closely enough.

As Jack Ablin, chief investment officer of Harris Private Bank, notes in his current market update, Egypt’s per-capita gross domestic product is $6,200, which even lags Tunisia’s $9,500 and most of the Arab world.

The most immediate reaction of the markets as the revolt unfolded was to sell stocks and buy U.S. Treasury Bonds, gold and energy stocks (and other commodities), which is typical. The widespread fear is that the Arab “street” will emulate Egypt and Tunisia and somehow curtail oil production in other oil-producing states. I don’t buy this idea — yet.

3 ways to manage political risk in your portfolio

If it’s not Tunisia, it’s Egypt; if it’s not Egypt, it’s Yemen.

Political turmoil abounds on our TV screens. But hands up: Who adjusted portfolio positions before the unrest in each country began?

Probably very few. You may or may not have been burned as a result, but one thing’s for sure: managing political risk in your portfolio is a must. Here’s a primer.

Use all tools available First: do your research before deciding where to invest. Find out as much as possible about the regions and countries you are interested in. If you’re investing in a mutual fund or exchange-traded fund (ETF), don’t just stop at the headline name.

For example, if you pick the Market Vectors-Africa Index ETF, you may assume the bulk of the assets will be located in more stable countries, such as South Africa. You always have to drill deeper. Among its largest holdings is Egypt’s Orascom, while its top holding is British oil and gas company Tullow Oil, which has major investments in Uganda.

So what’s the best way to assess your political risk? There is, unfortunately, no panacea. If you have invested in a fund, ask for as much information as possible. Often fund managers provide reports that give a good overview, though they are not always up-to-the minute.

Then there’s AON’s comprehensive political risk map, which color codes 211 countries from low to very high risk. The downside is that it, too, can be slow to turn with the times. Its map for 2011 shows Egypt as medium risk. Rating agencies provide ongoing updates and analysis, though not all are accessible for free online.

Wells Fargo: Women don’t save enough for retirement

It’s retirement survey season. Since the Reuters personal finance team began tracking research on personal finance topics at the start of the year, more than 20 studies have hit our inboxes. Some common themes are starting to emerge: investors are risk-adverse; women are too conservative when it comes to retirement savings; and Americans are financially stressed, so much so that they are even lying to their spouses.

Following a study released last December, the latest installment of retirement research from Wells Fargo focuses on middle-class women. The survey, conducted by Harris Interactive last fall and released on Feb. 2, queried middle-class women across five decades, from those in their mid-20s to those who are already retired and in their 60s. Just 54 percent of women say they are confident they will have enough saved to “live the life they want” in retirement. By contrast, 62 percent of men are confident about their retirement goals.

Karen Wimbish, head of retail retirement for Wells Fargo, discussed the findings with Reuters.

What is most surprising about this study? Women are a lot closer to parity in the professional and business world. We represent almost 50 percent of the workforce and have a greater standing in professional jobs. Plus, 35 percent of women in the workforce are college graduates. And three out of five college students are women. But we are definitely two steps back and one step to the left of men when it comes to retirement.

In our study, women estimate they need for $200,000 for retirement, while men say they need $400,000. There’s already a problem because women are going to live longer. This isn’t part of our study, but 75 percent of nursing home residents today are women. Women get a smaller percentage of Social Security benefits than men. They are already behind in terms of guaranteed income. They are underestimating what they need in retirement.

What is shocking about the research? When you look at women aged 40 to 69 –- these are women who should be starting to think about retirement; retirement is knocking at their door; or they are in retirement –- 30 percent said they couldn’t estimate how much they will need to withdrawal from retirement savings annually. They either hadn’t thought about it or didn’t know. That’s head-in-the-sand behavior.

When we looked at women in their 40s and 50s, and asked them how much they need to take out when they retire, 32 percent said they planned to withdrawal 11 percent to more than 30 percent of their retirement savings every year.

Scared investors sitting on the sidelines

Take a look at the stock market these days, and it’s almost like investors are on strike.

For 20 weeks in a row, Americans have pulled money out of domestic mutual funds. They’ve taken their marbles – $70 billion worth during that time period – and essentially gone home. Some have gone into bonds, and some are just sitting in cash, but the idea of equities just seems to make them queasy.

People like Christina Cozzi. The president of Camelot Communications (pictured left), a Manhattan-based marketing firm, had the fear of God put into her by the financial meltdown of 2008, and has been skittish ever since. “I was extremely shocked and scared,” says Cozzi, 27. “I had invested wisely from a young age, and didn’t want to see my portfolio rapidly deplete already.”

So she started selling off some of her higher-risk stocks and mutual funds, and still hasn’t summoned the courage to dive back into the stock market. Especially since she’s starting her own business from the ground up, and every penny is dear. “It’s enough to scare me into knowing that I need to be really smart and safe with my money for the time being.”

Cozzi isn’t alone in wanting to ride out an unpredictable market in safer harbors. “People are just tending to sit still,” says Jeff Tjornehoj, research manager with fund-tracking firm Lipper, a unit of Thomson Reuters. “There’s a lot of anxiety out there, and investors are using bond funds instead of equities to prepare for the future. That’s what’s soaking up all their anxiety right now.”

To a certain extent, that kind of stock strike is perfectly understandable. The economy continues to sputter, the ‘flash crash’ in early May has many investors worried about automated trading, and the financial crisis that brought the banking system to the brink is still fresh in everyone’s minds. As a result almost $11 trillion in cash is now parked throughout the banking system, according to research firm Strategic Insight.

But know that sitting in cash forever isn’t a viable retirement strategy. With yields on money markets and Treasuries so slim these days, you’re probably making close to zero on your money, once you factor in taxes and inflation. That level of returns isn’t going to fuel a worry-free future on a Caribbean beach.

Why younger investors are avoiding stocks

Samantha Shintay won’t be retiring for quite some time. At age 23, she’s been in the workforce for all of one year as a chemist for Nike in Portland, Oregon.

Yet when she discusses retirement investing, Samantha (pictured here) sounds as though the gold watch is right around the corner. Aside from a small amount of Nike stock provided through an employer match, her 401(k) investments lean heavily toward the plan’s most conservative options, including a stable value and bond fund. Only about 40 percent of her holdings are in equities.

“I’m scared — I’ve heard a lot of stories about people completely losing their retirement,” Shintay says. “I’d like my money to be there when I want to use it.”

Are young investors taking the wrong message from the 2008 market meltdown?

Financial experts usually advise young investors to be aggressive, socking away up to three-quarters of their retirement account contributions in stocks. While stocks are riskier and markets fluctuate, they argue, equities help investors keep up with inflation, and leave you with significantly more money to spend in retirement.

But young investors appear to be losing their appetite for risk. Just 34 percent of retirement investors under age 35 said they were willing to take substantial or above average risk in their portfolios last year, down from 48 percent in 2005, according to a survey of mutual fund investors by the Investment Company Institute (ICI).

The shift away from stocks isn’t limited to young investors. The Investment Company Institute reports an overall net outflow of $18.4 billion from domestic equity funds in 2010 through the end of July. That outflow was offset by $27.3 billion that flowed into international equity funds — a pattern that’s been in place since 2006, according to Brian Reid, ICI’s chief economist. But during the same period, a whopping $155.7 billion flowed into the relative safety of bond funds.