Thursday, February 23, 2012

Inflation and Investments

When it comes to inflation, the question on many investors' minds is: "How will inflation affect my investments?" This is an especially important issue for people living on a fixed income, such as retirees. Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every dollar you own buys a smaller percentage of a good or service. The value of a dollar does not stay constant when there is inflation. The value of a dollar is observed in terms of purchasing power, which is a tangible good that money can buy. When inflation goes up, there is a decline in the purchasing power of money. For example, if the inflation rate is 1% annually, then theoretically a $1 pack of gum will cost $1.01 in a year. After inflation, your dollar can't buy the same goods it could beforehand.

There are several variations on inflation:

Deflation is when the general level of prices is falling. This is the opposite of inflation.

Hyperinflation is unusually rapid inflation. In extreme cases, this can lead to the breakdown of a nation's monetary system. One of the most notable examples of hyperinflation occurred in Germany in 1923, when prices rose over 2,000% in a month!

Stagflation is the combination of high unemployment and economic stagnation with inflation. This happened in industrialized countries during the 1970s, when a bad economy was combined with OPEC raising oil prices.

Economists debate the causes of inflation, there is no one cause that's universally agreed upon, but at least two theories are generally accepted: Demand-Pull Inflation, which can be summarized as "too much money chasing too few goods". In other words, if demand is growing faster than supply, prices will increase. This usually occurs in growing economies. Cost-Push Inflation – Is when companies' costs go up, they need to increase prices to maintain their profit margins. Increased costs can include things such as wages, taxes, or increased costs of imports.

The impact of inflation on your portfolio depends on the type of securities you hold. If you invest only in stocks, worrying about inflation shouldn't keep you up at night. Over the long run, a company's revenue and earnings should increase at the same pace as inflation. A problem with stocks and inflation is that a company's returns tend to be overstated. In times of high inflation, a company may look like it's prospering, when really inflation is the reason behind the growth.

Fixed-income investors are hurt the worst by inflation. Suppose that a year ago you invested $10,000 in a Treasury bill with a 10% yield. Now that you are about to collect the $11,000 owed to you, is your $1000 (10%) return real? NO! Assuming inflation was positive for the year, your purchasing power has fallen and so has your real return. We have to take into account the chunk inflation has taken out of your return. If inflation was 2%, then your return is really 8%.

Inflation-Indexed Bonds
There are securities that offer investors the guarantee that returns will not be eaten up by inflation. Treasury inflation-protected securities (TIPS), are a special type of Treasury note or bond. TIPS are like any other Treasury, except that the principal and coupon payments are tied to the CPI and increase to compensate for any inflation. Because these securities are so safe, they offer an extremely low rate of return. For most investors, inflation-indexed securities simply don't make sense.

Tuesday, February 14, 2012

How to Invest In Private Equity

Private equity is capital made available to private companies or investors. The funds raised might be used to develop new products and technologies, expand working capital, make acquisitions or strengthen a company's balance sheet. Institutional investors and wealthy individuals are often attracted to private-equity investments. This includes large university endowments, pension plans and family offices. Their money goes into pools that represent a source of funding for early-stage, high-risk ventures and plays a major role in the economy. Often, the funds will go into new companies believed to have significant growth possibilities in industries such as: telecommunications, software, healthcare and biotechnology. Private-equity firms try to add value to the companies they buy, with the goal of making them even more profitable.
Private equity investing is not easily accessible for the average investor. Most private-equity firms typically look for investors who are willing to commit as much as $25 million. Although some firms have dropped their minimums to $250,000, this is still out of reach for most people, but there are ways the average investor can dip their toe into the private equity waters.

Fund of Funds
A fund of funds holds the shares of many private partnerships that invest in private equities. It provides a way for firms to increase cost effectiveness and thereby reduce their minimum investment requirement. This can also mean greater diversification, since a fund of funds might invest in hundreds of companies representing many different phases of venture capital and industry sectors. A fund of funds has the potential to offer less risk than you might experience with an individual private-equity investment due to its diversification. The disadvantage is that there is an additional layer of fees paid to the fund of funds manager. Minimum investments can be in the $100,000 to $250,000 range.

Private-Equity ETF
You can purchase shares of an exchange-traded fund (ETF) that tracks an index of publicly traded companies that invest in private equities. Since you are buying individual shares over the stock exchange, you don't have to worry about minimum investment requirements. However, like a fund of funds, an ETF will add an extra layer of management expenses that you might not encounter with a direct, private-equity investment. Also, depending on your brokerage, each time you buy or sell shares, you might have to pay a brokerage fee.

Special-Purpose Acquisition Companies (SPAC)
You can also invest in publicly traded shell companies that make private-equity investments in undervalued private companies. But they can be risky. The problem is that the SPACs might only invest in one company, which won't provide much diversification. They may also be under pressure to meet an investment deadline as outlined in their IPO statement. This could make them take on an investment without giving it thorough due diligence.

There are several key risks in any type of private-equity investing. As mentioned earlier, the fees of private-equity investments that cater to smaller investors can be higher than you would normally expect with conventional investments, such as mutual funds. This could reduce returns. Additionally, as private-equity investing opens up to more people, the harder it could become for private-equity firms to locate good investment opportunities.

Thursday, February 2, 2012

Understanding How to Trade

Describing a trader’s journey is very similar to climbing up a large set of stairs; it takes time to get from the bottom to the top. A great deal of time and energy must be poured into learning how to trade. Often traders try to rush the process and as a result usually end up hurting their accounts.

It is imperative to follow some set of rules in order to keep your emotions in check. A “trader checklist” will help you sort through noise and find only the highest probability trades. It is common to see traders “go on tilt” as they get frustrated or lazy after a string of bad trades. Traders that let their emotions take control of their decision making settle on trading anything they can find, instead of mining through the market searching for only the highest probability trades. Often inexperienced traders find one variable they like and enter into a trade. They soon find out that their rate of success when doing so is extremely low. By forcing a stock to meet a larger set of criteria, the probability of a successful trade greatly increases.

Moreover, it is crucial to have all the professional tools in front of you, just like a doctor having all his surgical tools in front of him when operating. It is common to see novice traders aggressively buy and sell stocks without having a complete trading platform or an understanding of what exactly is in front of them. Sure, there are cases when a trader can make a successful trade while not utilizing all the information available. However, probability is against you. Therefore, the longer you participate in such an action, the likelihood of losses increases.

It is important to use any vital information that is readily available. Some of these include a Level 2 or ECN window, a tape, a limit open book (especially when trading NYSE), charts, and the overall market (SPY/S&P futures) or the sector ETF the stock most highly correlates with, as well as other stocks that are in the same sector that are known to trade similar with it.



Disciplined trading

The Equity Scholar Team