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October 2006 - Posts
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In the world of investment risk, the good news is that mutual funds are a relatively safe bet when compared to other investment options. That being said, however, risk varies among different funds, and funds are still subject to market fluctuations. Mutual funds, as a rule, are not as volatile as a single stock because they are made up of a number of stocks. Even in a market crash some of the stocks will stay afloat, although the funds’ per share price will drop. The balance tends to offset losers with winners, particularly since the market has always fared well over time. The more aggressive the fund (the more risky), the more volatile the fund will be. Don’t be fooled by short-term pluses and minuses. Once you have looked at the track record of a mutual fund and have seen that the fund you’ve chosen has performed well over one, three, and five years, you should anticipate investing for at least three to five years. Greater risk means greater volatility. It also means you need more perseverance, as most funds will recover. If, however, your fund is experiencing volatility because of a change in managers or the direction the fund is taking, then you may want to investigate more thoroughly who is at the helm of the ship and what direction the mutual fund is not taking. There are several reasons a fund may be volatile: fluctuations in the stock market; changing interest rates (particularly pertaining to bonds); foreign currency rates; and fund management. Also, a fund that is actively buying and selling more heavily will often be more volatile. Look to see if similar funds, in the same category, are also experiencing similar volatility. Returning to the notion that a rising tide raises all ships, you may simply find that the volatility of your fund is typical for that type of fund at the present time. If, however, your fund is acting differently from similar funds, look more closely at the management. In general, whatever the reason, short-term volatility is not at all uncommon for mutual funds. While you can lose money, the odds are strongly in your favor that the fund will bounce back if you hold onto it over time, particularly if it is a domestic-based equity fund. That's what history has shown in the past.
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It’s crucial that you stay on top of all your mutual fund holdings. Some people become complacent when they buy into mutual funds, thinking that the funds’ professional manager is doing the job, and regular reports will provide sufficient information on the funds’ performance. Not true. You have as much obligation to know what’s happening with your mutual funds as you do with any other investment option. Financial publications, national newspapers, and local newspapers are all places to keep tabs on your mutual funds. Add to that the Financial News Network and online services, and it’s likely that you can find all the important information on your mutual fund on a daily basis. First and foremost, make sure you know exactly what symbol your fund goes by and don’t forget the letter following the fund, being the A, B, C, D issue. The letters primarily refer to the type of load, front load, back load, no load, etc. It’s amazing how many people have realized, after several days or weeks, that they either can’t find their fund or have been following the wrong fund. Once you have found your fund, you need to understand the letters and numbers that make up the mutual fund listings. Among the many symbols and numbers you will see included the name of the fund family, the name of the specific fund, and the fund’s objective (OBJ), which will be listed such as CV (convertible fund), LG (large-cap growth), or GL (government, long-term bond fund). The NAV (Net Asset Value) is the current price per share of the fund, or the price at which the fund is selling shares. By multiplying the number of shares you own by that price per share you can tell the current value of your fund. By comparing this to the total at which you bought the mutual fund, you will know how your fund is doing. If you purchased a fund from Aim, for example, at $9 per share and bought 2000 shares, then your initial investment would have been $18,000. If the fund is now at $11, then your value in the fund is now $22,000 or a $4,000 profit (if it’s a no-load fund, less operating costs and capital gains tax). Next the listing will have changes, or the movement of the fund, by either the day, week, or YTD percent (which is year-to-date total percentage, including reinvested dividends and capital gains). All of this will give you an idea of which direction the fund is going. This is how you can follow your fund, but it is NOT how to choose a fund; to choose a fund you need the one-, three-, five-, and/or even ten-year totals and more information. Chasing daily returns is ill-advised in stocks or mutuals. Some listings will include “Down Market” or “Bear Market,” which will indicate how the fund has performed during the downturns in the market. Again, this is information you’ll want when looking to purchase a fund. A volatility ranking will tell you how much of a roller-coaster ride you can expect. Such a rating is the “beta” of the mutual fund. This is not generally found in daily listings but on comparison listings of funds over time. This can ease your mind on a day-to-day basis—you see sudden drops and then realize that this fund will have its share of peaks and valleys on route to (hopefully) showing solid gains. Tomorrow, a last word on volatility.
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So, now you’re aware of the pros and cons of investing in mutual funds. There are many upsides, and some negatives that you have to mull over depending on your own investment goals. But as with all investment opportunities, one important question is probably eating at you right now: How do you make money in mutual funds? Obviously, selling off shares of your mutual fund at a higher Net Asset Value (NAV) per share than that at which you purchased the fund will net you a profit. The fund acts as a single unit, and the total return is based on all the stocks, bonds, and other securities held. Therefore, if certain stocks do very well within the portfolio while others don’t, you cannot simply sell off the lucrative investments or get rid of the losers. You have no say in the individual investments, but you can sell off your shares of the fund as a whole. There can be profits made, however, in the form of capital gains when the fund manager sells off a security. While funds are constantly reinvesting money, you can actually see money from the fund as you hold onto it. Income funds will dispense income from dividends paid by stocks within the portfolio or interest paid by bonds in a bond or balanced fund. If you are seeking a steady flow of income from a mutual fund, this may be the route to go. Despite operating costs and commissions, there have been some solid results from mutual funds in recent years. How long the trend will continue depends on a number of factors led by the economy, the stock market, and the number of effective fund managers, among other things. Historically, mutual funds, especially stock mutual funds, make make money on an average annual basis. The best thing to do is to keep investing; keep your money away from the local mall or bingo parlor and into the stock market. That's the key to wealth creation.
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While not quite as scintillating as the latest Jonathan Grisham thriller, your mutual fund’s report, whether it’s annual or semi-annual, is your gauge to measure how the fund is performing. It’s probably not a great idea to peruse this report as nighttime reading – unless you’re looking for a new way to combat insomnia. Nonetheless you should find a quiet place to look over this document. Among the most significant information within the report are the holdings of the fund. It’s important to look over this list carefully to determine whether or not the fund manager is “style drifting.” In other words, a fund that is supposed to be buying large-cap stocks may suddenly be investing in several smaller companies. It’s more likely, however, that the fund may have drifted in the other direction because, as noted earlier, small companies tend to grow—and they move from small-caps to mid- or even large-caps while still sitting in the same mutual funds. Naturally, if the fund is doing well you’ll be less concerned. It’s amazing how your perspective changes when looking at the holdings based on the fund’s performance. What looks like a brilliant move by the fund manager in a fund that has seen a 30 percent rise doesn’t look nearly as good in a fund that has seen a 10 percent drop. Some questions may arise: Is the fund satisfying my level of risk or is it becoming too aggressive or too conservative for me? Is the fund lacking in diversification by moving more strongly into similar stocks? The holdings will also tell you which companies the fund believes are strong. Look them over, and see if you agree. You may not know all of the companies held, but investigate a few. Looking at the portfolio holdings, you want to find: 1. Familiar names. “Familiar” means for that type of fund. A household name like Coca-Cola won’t show up in a small-cap fund, but you are looking for smaller companies that belong in that fund. NOTE: Just because you own a fund doesn’t mean you no longer have to follow the activities of companies and their stocks. If you see holdings in your fund that you don’t like, you can look at other funds that have shares of stocks that you feel are more promising. 2. Portfolio concentration. Besides showing what is in the portfolio, the annual (or semi-annual) report will tell you how much, or what percentage, the fund is investing in each area. 3. Performance. Not surprisingly, for the funds that perform well this information sometimes jumps off the page, while it’s harder to decipher in a fund that is not performing well. You should know how the fund has performed in the short and long term. How the fund has performed against a specific index should also be included for purposes of comparison. There should also be an explanation of WHY the fund has performed well or poorly. Which factors have made an impact on the fund? What management has been doing and some indication of what they are planning to do should be included. The bottom line is that after reading the annual report you should feel either confident in holding onto the fund or determined to sell your shares. If you are left feeling unsettled as to what you should do (because you do not feel you have adequate information or the report is not easily discernable), then you should look in Morningstar, Kiplingers, the Wall Street Journal, or other sources to see if they discuss your fund. You should also call the fund or fund family and let them know you have some questions; after all, you are paying an operating fee that includes service charges, so let them serve you by providing some answers. If a fund does not help make you feel comfortable, then it’s not the right investment for you. Remember, it’s your money.
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So far, this whole mutual fund thing sounds pretty good. Lots of options, good return, minimized risk, reasonable fees. Before you have your cake and eat it, recognize that there are some costs that won’t appear on the glossy surface as you explore mutual funds. One other “cost,” which isn’t related to the fund directly but to the government, is an old standard: taxes. On the plus side, if you lose money on the fund you won’t be paying capital gains tax, but that’s hardly a reason to celebrate. If you see a profit, you will pay taxes on dividends or on capital gains distributions paid to you while owning shares of the fund, or on your profits (capital gains) from selling your shares of the fund. You may also be subject to state taxes, depending on the state in which you reside. You may also see capital gains based on the trading done by the fund manager, even though you haven’t sold any of your shares. These can hit you for taxes. Buying funds late in the year is ill-advised because you can be hit for higher taxes as the fund is just about to distribute their capital gains.
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All this glory that is part and parcel to investing in mutual funds does not come for free. While mutual funds certainly decrease the cost of investing to the individual, there are all sorts of fees and expenses attached to becoming a shareholder in a fund. These fees can vary significantly, so it’s important that you understand how to find them and understand them. Generally listed as the “expense ratio” are several costs that shareholders will pay for services and management of the fund. While the Securities and Exchange Commission is closely monitoring funds to make sure that shareholders are aware of all the expenses related to their fund, it’s important that you as an investor understand the basics behind these fees and have a sense of what to look for on your own. After all, there are thousands of funds, and some of them have devised new and inventive ways to “bill you,” so to speak, while the vast majority are fairly straightforward about where the expenses are going. International funds often have higher expense ratios than domestic funds because they are dealing with companies overseas. A mutual fund operates like a smaller business within the structure of the larger fund family. It is an entity unto itself in that the fund does not interact with other funds under the same umbrella company. They share printed materials and costs, such as advertising the financial group, but from the perspective of the fund family, each fund is handled separately. In other words, the expense ratio you’re paying for “Fund A” will not spill over to pay the manager of “Fund B.” Also, the success of one fund does not hinge upon the success of another. Often you will look down the listings of funds in one family and see some winners and losers along the way. Unlike the portfolio within the fund, where the manager can try to dispense of the losers or at lease balance equities that are not doing well with ones that are, the fund family cannot integrate the portfolios of different funds. Fees generally include the following: Service fees. These fees are used for financial compensation of the planners, analysts, and brokers who assist customers with fund-related questions and provide information and advice regarding the fund. Accounting and legal services may also be included. Administrative fees. These are the fees associated with office staff, office space, and other fundamentals to running a business, including equipment. Sometimes these funds are absorbed under management fees. Office expenses incurred by a fund also include online support and information, check processing, auditing, record keeping, shareholders’ reports, and printed matter.
Management fees. This is the percentage that goes to the fund manager. This can be a flat percentage or one set up to coincide with the growth of the fund based on returns. The bigger the fund gets, in terms of assets, the lower the percentage will generally be.
12b-1 fee. This is a fee used primarily for marketing or advertising the fund. Since there are so many mutual funds on the market, it is becoming increasingly important for fund families to advertise. Your fee is not just a contribution to the fund’s advertising budget but will hopefully help the fund to grow—and as the fund grows, there will be more money available. Therefore, the fund will have greater leverage to buy more holdings, which can—with a good fund manager—be to your advantage. In fact, some funds report that because of advertising, their overall expense ratios have gone down as the funds have grown. So for those who do not like the 12b-1 fee, remember that it can work in your favor. I'll have more on fees in my next blog.
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The rock stars of the financial world, successful managers of the hottest funds appear on financial talk shows, write books, and are the talk of the financial community—until, of course, their hot streak ends. In the mutual fund boom of the late 1990s, following the successes and failures of fund managers was not only a phenomena in the financial world, main stream media began to focus their attentions on these wunderkind who made – or lost – investors so much money. It’s surprising that trading cards weren’t issued. Of course, that hasn't been the case so far in the 2000's, where stock funds haven't soared as high as they did 10 years ago. But professional fund managers are another reason for the popularity of mutual funds in the U.S. During the last quarter of the twentieth century, Americans have heavily embraced the notion that if you want something done right, you should get a professional to do it for you. This is not a bad idea, particularly if you do not have the time to delve into the numerous financial papers to do the proper research necessary for finding individual stocks. Fund managers save you the trouble of sifting through thousands of potential stocks in an effort to build up your portfolio through one fund. Of course, as the number of funds grows, you will soon find yourself sifting through more funds than stocks. Nonetheless, it’s the full-time job of the fund manager to select the right investments for the fund. These managers are well-versed in the intricacies of the national and international fund markets. To assess a good fund manager, you need to look at his or her background over several years. You want to look for consistency in management of the fund or previous funds. You also want to see that the fund manager is holding true to his or her fund’s financial goals. If, for example, you are looking at a more conservative growth and income fund, you don’t want to find out that the fund manager is making high-risk investments and taking the fund in a different direction (this is called “style drift”). It is more common than you might think to have fund managers with roving eyes—managers who look at and buy stocks that don’t fit the fund’s stated objective. On the other hand, if a fund is struggling, you may appreciate if the fund manager starts drifting for the sake of keeping your investment afloat. You should also look closely at a mutual fund’s portfolio. While you may not be familiar with each and every purchase, you can ascertain whether they are following the latest trends or bucking the system. If you have heard, for example, that a certain market, such as automobiles, is taking a downturn, and the fund manager is buying heavily in that area, it will mean one of two things: either he or she is buying now for an anticipated turnaround (value investing), or he or she is not keeping up with the market’s news. You should also look at how the fund manager fared during the down markets of, for example, 1997, 2001, and 2002. See how quickly their funds rebounded. Did he or she panic and make drastic moves or hold on tight and ride out the storm? Naturally it will depend on the type of fund and the particular holdings. The manager’s response is worth taking note of, since the market does go through volatile periods. You also need to check out a new fund manager if you own a fund and the manager changes. A new fund manager needs to show that he or she can work within the structure of the particular fund, holding true to the goal of that fund. Fund size and assets can matter as well. A manager who has handled a $2 billion fund successfully may not be as comfortable when handed a $20 billion figure in a larger fund. Some managers are only successful with a finite amount of funds. You might also want to know whether or not this fund manager is working closely with a team of analysts or doing it all on his or her own. If the latter is the case, you could be in trouble when the manager moves to another fund and takes along his or her secrets. Forbes, Kiplingers, Money, Morningstar.com, and other sources will rate the mutual funds and often give you the “lowdown” or profile on the fund manager. It’s important to look for consistency. If the fund manager has bounced from one fund to another, it is not a good sign if you’re looking to hold the fund for a long time period. It is also not to your advantage to have a fund with a different manager at the helm every year.
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Mutual funds today are as easy to purchase as making a phone call or a trip to your computer. Fund families (large investment firms or brokerage houses with many funds), seeing the serge in popularity and wanting to make funds easily accessible to all investors, have toll-free numbers and Web sites that make it easy for you to buy and sell mutual funds. Transactions are also, occasionally, made by the old fashioned method of “snail” mail, although fewer people are doing that. Electronic trading has allowed investors to trade at all hours from the comfort of their own homes. It’s not hard to find the Top 10, Top 20, or Top 50 funds on your browser, as rated by some leading financial source, and then buy them online. It is also not hard to get “addicted to trading” and find yourself overdoing a good thing. The accessibility and ease of trading online and through toll-free numbers has led many overzealous investors into deep trouble. Many new investors need to learn to be patient. For those who need to put their hands on their money in a hurry and convert mutual fund shares to cash, another benefit of mutual funds is liquidity. A phone call allows you to sell your shares in the fund at its current Net Asset Value (NAV, or posted rate per share), and you should have your money in three or four business days. The risk of investing in a mutual fund is less than that of a single stock because the fund is managed professionally and because of diversification. Mutual funds offer you diversification without making you do all of the work. Funds can hold anywhere from a few select stocks to more than one hundred stocks, bonds, and money market instruments. While some funds own as few as twenty or twenty-five stocks, others like the Schwab1000 own one thousand stocks. The diversity minimizes much of your risk. If, for example, you bought one stock on your own it could go either way. However, if you bought six stocks, it would be less likely that all six would go down. If three went down and three went up you would be even. If you saw two dropping, you could sell them and buy something else, while you were still earning money off the others. The mutual funds work on the same “safety in numbers” principle. Although there are funds with higher and lower risks, the comfort of many mutual funds is that they limit risk by balancing higher-risk investments with lower-risk/safer investments. Diversity acts to your advantage as it protects you against greater swings in the market, be it the stock or bond market. Further diversification can also come from buying more than one fund. You can also allocate your assets into different types of funds. If you buy into a few funds in different categories, you’ll have that much more diversification and that much less technical risk. (It’s usually not advisable to have more than six or seven mutual funds at a given time or you can start to counterbalance your efforts to construct a strong portfolio.) Your portfolio might include, for example: -- A more conservative bond fund -- A “tech” fund to cash in on a hot industry -- A more high-risk international fund -- A low-risk, blue-chip fund -- A growth fund The idea is to balance your portfolio between more- and less-conservative—or higher- and lower-risk investments. Depending on your needs, you will diversify. One investor will have 10 percent in bond funds, 20 percent in growth, 30 percent in tech, and so on, while another will have 5 percent in tech and 40 percent in blue-chip. That’s why there is no boilerplate investment strategy. It seems odd to need to diversify your mutual funds since the job of the fund is to diversify the stocks, but it’s all part of building a solid investment portfolio. Your mutual fund is the sum of many parts. Therefore, you may want another fund in your portfolio. Another significant reason for diversifying your mutual fund investments is to spread your assets out across sectors, industries, and asset classes. A fund manager, no matter how skilled, is limited by the goals and the direction set forth by the fund.
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On our blog, we've spent the past month or so focusing on stocks and the stock market. For good reason, stocks represent the best way to accumulate wealth in all the financial markets. But there is another way to trade in stocks. And in bonds, too, for that matter -- mutual funds. These are pooled funds of money that invest in groups of stocks and bonds, offering cheaper access to both. While Americans broadly get the credit for founding the idea of a mutual fund, the truth is that the idea of pooling money together for investing purposes started in Europe in the mid-1800s. The concept of mutual funds came to the U.S. via that conduit of many cutting-edge ideas - Harvard University. The faculty and staff of Harvard created the first pooled fund in the U.S. in 1893. About thirty years later, on March 21st, 1924, three Bostonian securities executives got together, threw their money in a pot, and the first official mutual fund was born. Called the Massachusetts Investors Trust, it was widely heckled by the investment community at the time. Little did they know how popular mutual funds would become as the century wore on. What Is a Mutual Fund? One of most effective investment tools ever created, mutual funds are cost efficient and provide easy access to a wide variety of stocks and bonds with little effort on the part of the investor. A mutual fund provides an opportunity for a group of investors to work toward a common investment objective more effectively by combining their monies to leverage better results. Mutual funds are managed by financial professionals responsible for investing the money pooled by the fund’s investors into specific securities (usually stocks or bonds). By investing in a mutual fund, you are becoming a shareholder of the fund – you’re buying a piece of a pie that you hope will grow over time. Just as carpooling saves money for each member of the pool by decreasing travel costs for everyone, mutual funds decrease transaction costs for individual investors. As part of a group of investors, individuals are able to make investment purchases with much lower trading costs than if they tried to do it on their own. The biggest single advantage to mutual funds, however, is diversification. Funds can provide a steady flow of income or can be engineered for growth in the short or long term. The success of the fund depends on the sum of its parts, which are the individual stocks or bonds within the fund’s portfolio. Currently, the number of mutual funds exceeds 10,000 thousand. Consider that as recently as 1991 the number was just over three thousand and at the end of 1996 it was listed at around six thousand. As noted earlier, mutual funds have become extremely popular. Stock funds are growing as a way to play the market without having to make all the choices of when to buy and sell. However, bond funds are also growing, partly because of the complexities associated with understanding individual bonds, and as a way to hold more bonds than the average investor could afford if buying them on an individual basis. Money market funds offer a safe alternative to bank accounts, providing higher interest rates. As late as the early 1950s, less than 1 percent of Americans owned mutual funds. The popularity of funds grew marginally in the 1960s, but possibly the largest factor in the growth of the mutual fund was Individual Retirement Account (IRA) provisions made in 1981, which allowed individuals (including those already in corporate pension plans) to contribute up to $2,000 a year tax-free. Mutual funds are now mainstays in 401ks, IRAs and Roth IRAs. In the next few weeks, we'll delve into mutual funds, explain how they work, and how to use them to maximum benefit. It's a trip worth taking, as far as your financial future is concerned.
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If you ever eaves drop on a day trader yakking into his cell phone (not that you’d want to) you’re liable to hear a litany of letters strung together around high-octane Wall Street words like “P/E ratio”, “Yield” and “Dividends” No problem. Chances are the letters stand for the stock symbols the trader is buying and selling and the Wall Street verbiage simply points to how well the stock in question is doing that day in the financial markets. It’s lingo, however, every investor should come to know. So for a brief tour of stock symbols and trading tables, look no further. You’ve come to the right place. Stock Symbols Stock ticker symbols have a pedigree that any Vanderbilt would be proud of. Ticker symbols appeared in 1844, shortly after the introduction of the telegraph machine. Wall Street fell in love with the symbols immediately, as stock prices could be transmitted by brokers in seconds instead of days. Full names of companies were used at first, but that proved unwieldy. Frustrated wire operators began transmitting stock prices with the company name in shorthand, and a revolution was born. About 25 years later, just after the Civil War ended, the first stock ticker machine began clacking away in New York City. At the turn of the century, newspapers began tracking stock prices via ticker symbols on their business pages. A millennium later, you can still find stock tickers in newspapers. But it's also generated electronically online on business web sites like The Motley Fool, CBSMarketwatch.com, and a host of others. Here's how stock symbols work. Each stock traded on global exchanges is identified by a short symbol. For example, the symbol for Citigroup is "C". Similar abbreviations are used for stock options, mutual funds and many other securities.
Ticker symbols get reused on different exchanges, so you'll sometimes see a qualification ahead of the ticker symbol. For example, the symbol "C:A" refers to a company traded on one of the Canadian exchanges (Toronto, to be exact) with the symbol A. The stock quote services on the web usually understand this notation.
Stock symbols are designated by one, two, or three or more letters for a reason. A ticker with three letters or fewer indicates the company trades on the New York or American exchanges. Tickers with four or five letters trade on the Nasdaq, Nasdaq Small Cap or OTC Bulletin Board markets. When you run into a stock ticker symbol with five letters, there's usually a story behind the company. If, for example, a stock ticker symbol has an "E" at the end of its name is considered by the Securities and Exchange Commission to be delinquent in filing key regulatory documents. A "Q" tells a more troubling story -- it's the scarlet letter that tells investors a company is in bankruptcy proceedings. Understanding Stock Tables Once you know what stock symbol to look for the next step is to go onto the World Wide Web or open your daily newspaper’s business section and find your stock table. It will look something like this: Examples of Stock Table: Thursday, May 15, 2006 ABC Corporation 52 WEEKS/HI-LO SYM DIV VOL YLD P/E CLOSE CHANGE $47-$37 ABC 230 335 5 10 $39.50 +$1 ________________________________________________________________________ (52 WEEKS/HI-LO) 52-Week Hi and Low. These are the highest and lowest prices that a stock has traded at over the previous 52-weeks (1 year). This typically does not include the previous day's trading. (SYM) Ticker Symbol. As noted above, this is the unique alphabetic name which identifies the stock on the exchange's ticker. The ticker tape will quote the latest prices alongside this symbol. If you are looking for stock quotes online, you always search for a company by the ticker symbol. (DIV) Dividend Per Share. This indicates the annual dividend payment per share. If this space is blank, the company does not currently pay out dividends. (VOL) Trading Volume. This figure shows the total number of shares traded for the day, listed in hundreds. To get the actual number traded, add "00" to the end of the number listed. (YLD) Column 6: Dividend Yield. The percentage return for the dividend. Calculated as annual dividends per share divided by price per share. (P/E) Column 7: Price/Earnings Ratio. This is calculated by dividing the current stock price by earnings per share from the last four quarters. For more detail on how to interpret this, see our P/E Ratio tutorial. (COSE) Daily Close. The close is the last trading price recorded when the market closed on the day. If the closing price is up or down more than 5% than the previous day's close, the entire listing for that stock is bold-faced. Keep in mind you are not guaranteed to get this price if you buy the stock the next day. Because a stock's price is constantly changing (even after an exchange is closed for the day) the close merely serves as an indicator of past performance. CHANGE) Net Change. This is the dollar value change in the stock price from the previous day's closing price. When you hear about a stock being: "up for the day" it means the net change was positive. Note that many newspapers and some Web sites will often change the sequence of the provided information. Some newspapers may even provide less information, possibly only providing the closing price and not the high and low for the day. Remember, the stock table provides you with essential information about the company's stock price. So being able to understand a stock table puts you one big step closer to becoming a smart investor.
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Some investors are under the mistaken impression that they have no business boning up on financial indicators; that they fall into the domain of pointy-headed economists buried in spreadsheets, charts and graphs.
Not so. An investor who doesn’t understand economic indicators is like a tourist trying to navigate a foreign county without a map. Sooner or later you’ll get lost and it might take you a while to find your way again.
Consequently, it makes sense for investors in the stock market to have a thorough understanding of how the economy works and how economic activity is measured. Here’s a breakdown of the key indicators investors should know about:
-- Business Inventories: A monthly running total of how well companies are selling their products, business inventories are a neon signal to economists and investors alike. The business inventory data are collected from three sources: the manufacturing, merchant wholesalers, and retail reports. Retail inventories are the most volatile component of inventories and can cause major swings. A sudden fall in inventories may show the onset of expansion and a sudden accumulation of inventories may signify falling demand and hence onset of recession.
-- Gross Domestic Product: The gross domestic product (GDP) is the most important economic indicator published. Providing the broadest measure of economic activity, the GDP is considered the nation's report card.
The four major components of the GDP are: consumption, investment, government purchases, and net exports. As the barometer of the nation's total output of goods and services, GDP is the broadest of the nation's economic measures.
-- Consumer Price Index (CPI): The consumer price index (CPI) is considered the most important measure of inflation. It compares prices for a fixed-list of goods and services to a base period. Currently, the base period, which equals 100, is the average prices that existed between 1982-1984.
Unlike other measures of inflation, which only cover domestically-produced goods, the CPI covers imported goods, which are becoming increasingly important to the U.S. economy.
-- Job Growth: Except for the GDP, the government's employment report is the most significant economic indicator reported, setting the tone for the entire month, providing information on employment, the average workweek, hourly earnings, and the unemployment rate.
Economists use payroll jobs data to predict other economic indicators. For example, there is a strong correlation between construction payroll figures and housing starts, manufacturing and industrial production activity, total payroll and personal income. The data is also used to refine GDP estimates.
Consumers feel more at ease when the job market is expanding. But when job growth contracts to 100,000 or less month to month, watch out — the economy could be headed for a slowdown.
-- Consumer Confidence: The Conference Board maintains this index of consumer sentiment based on monthly interviews with 5,000 households. After hitting historical highs last summer, the index has been falling, especially after the terrorist attacks of September 11, 2001.
In bad times or good, consumer confidence serves as a reflection of the nation’s financial health. Sometimes the consumer worries about inflation more than unemployment, and at other times the reverse is true. Consumer confidence is far more important to the financial markets during times of national crisis or panic-such as after the 1987 stock market crash, before and during the 1991 Persian Gulf War, after oil shocks, during recessions and so forth.
As might be expected, consumer confidence is the weakest during recessions, slightly better on average during recoveries, and highest during expansions (like the decade long bull market of the 1990’s.
-- Unemployment Index: The government's employment report covers information on payroll jobs, including employment, average workweek, hourly earnings, and unemployment. Unlike the jobs data, which is a coincident indicator of economic activity (it changes direction at the same time as the economy), the unemployment rate is a lagging indicator. It increases or falls following a change in economy activity. Consequently, it is of far less significance to economists and investors.
In its favor and unlike the payroll jobs data, the unemployment rate is not subject to change. During the past year, the unemployment rate has gradually declined and recently been running at levels below what economists believe to be the "natural rate" or that rate at which sustained unemployment can exist without rekindling inflation. The natural rate has been pegged at 5.5%. Consequently, four months at levels as low as 5.1% have many investors and economists concerned inflation is just around the corner.
-- Housing Starts: This indicator tracks how many new single-family homes or buildings were constructed throughout the month. For the survey each house and each single apartment are counted as one housing start, (a building with 200 apartments would be counted as 200 housing starts). The figures include all private and publicly owned units, with the only exception being mobile homes which are not counted.
Most of the housing start data is collected through applications and permits for building homes. The housing start data is offered in an unadjusted and a seasonally adjusted format. According to the US Census the housing industry represents over 25% of investment dollars and a 5% value of the overall economy. Declining housing starts show a slowing economy, while increases in housing activity can pull an economy out of a downturn.
-- Index of Leading Economic Indicators: The index of leading economic indicators (LEI) is intended to predict future economic activity. Typically, three consecutive monthly LEI changes in the same direction suggest a turning point in the economy. For example, consecutive negative readings would indicate a possible recession.
-- Producer Price Index: The Producer Price Index is a basket of various indices covering a wide range of areas affecting domestic producers. The PPI includes industries such as goods manufacturing, fishing, agriculture, and other commodities. Each month approximately 100,000 prices are collected from 30,000 production and manufacturing firms. There are three primary areas that make up the PPI. These are industry-based, commodity-based, stage-of-processing goods.
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Other good barometers of economic growth include retail sales, employee cost index, factory purchase orders, and new and existing home sales.
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