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Ask MAX: Gold or Silver

December 8, 2005

Dear MAX,

I hear a lot about buying gold, but what about silver? Is it a better buy and will it appreciate more quickly?


Dear Wendell,

Gold gets most of the precious metals investing attention because gold bugs and other crazed anti-central bank fanatics think that gold is money, not a mere commodity like silver or platinum. Get these quacks going on about the good ole’ days and they will wax poetic about how unstable the world has become since we got off the gold standard — ignoring the 13-fold increase in stock prices and explosive growth in the economy that has happened since Nixon put the gold standard to rest for life (we hope). Meanwhile, gold and silver are still cheaper than they were over twenty years ago.

Why gold remains the object of affection by anti-paper (fiat) money zealots is a mystery other than the nostalgia for the golden age of money. Platinum makes more sense in many ways — its worth more per ounce so it can be hoarded for less money, and smuggled out of a government gone wild with less difficulty. Platinum disguises better than gold — which looks like gold. Platinum is popular with the hip-hop community, who sets the trends in jewelry for many. Moreover, platinum has more industrial uses, notably catalytic converters in cars. Silver’s main use — in the film business — is in decline what with digital photography.

Silver may get a pop shorter term if Barclays Global can get their silver exchange traded fund launched. Two recent gold ETFs helped create demand for the metal itself as billions of investor dollars found an easier way to effectively hoard gold than well… hoarding gold.

Me, the last time I recommended gold funds was in 2001 when nobody wanted anything to do with “stupid” gold — the worst long-term performing fund category in the world (I gave up way, way too early on the great come back in gold as well). I’d consider gold again as a speculation when nobody talks about gold but quacks. Right now it’s way too mainstream a speculation.

Besides, the IRS doesn’t even consider precious metals an investment. When you sell gold or silver at a gain, you pay taxes as if it was a “collectible." It's not an investment where you can benefit from low long-term capital gains rates. Since there will never be a dividend from owning gold, all you can hope for is capital gains. From the IRS point of view, gold and silver is no different than a beanie baby.

Thanks for the question.


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Ask MAX: Should I sell based on Cramer's warning?

November 3, 2005

Dear MAX,

I'm 25 and live in Brooklyn. Jim Cramer said the market is going to crash with the economic news of the last three weeks. Should I sell all my stock funds and buy bonds?

Brooklyn, NY

Dear Yehuda,

Take your hands off your keyboard and step away from your E*TRADE account. Jim Cramer is probably wrong, and is definitely not the guy to go to for sound investing advice.

We love watching Cramer's new show as much as the next guy. We love his sixteen-cups-of-coffee delivery, his aggressive-as-a-rabid-Pit Bull stock picks, even the dopey sound effects. 'Mad Money' is unquestionably the liveliest show on the toned-down, post-Enron, post-Nasdaq 5000 CNBC.

But while Cramer is a bright guy with a lot of real world investment experience, his show is first and foremost entertainment. We wouldn't base our investment decisions on Cramer's television rants any more than we would on the advice Uncle Earle gives us at Thanksgiving dinner. Okay, Cramer is probably a safer bet than Uncle Earle, but you should be wary of all famous (and oft-wrong) market prognosticators.

While Cramer's dire warning of things to come may make you want to log on and start selling, his track record on his new show proves that he's not exactly the Amazing Kreskin. According to booyahboyaudit.net, a website that tracks Cramer's Mad Money stock picks, he's recommended 290 stocks since late July 2005. 116 (40%) of those stocks have gone up since his recommendation while 171 (60%) have gone down. The Tampa Bay Devil Rays had a better winning percentage than that last season, and they finished dead last in the AL East.

Neither Cramer nor anyone else can tell you with anything approaching certainty where the market is headed in the short term, and anyone who tells you they can is either lying or crazy. Selling all your stocks in favor of bonds would certainly be the right move if Cramer is right, but what if he's not?

Investing is all about playing percentages and hedging your bets. Sure, the market is more likely to perform poorly if valuations are at historic highs, and the market should do well if valuations are low. Neither event is guaranteed or even mildly predicable over just a few months. When the forecasting methodologies we use to manage our private accounts or the MAXadvisor Newsletter indicate we should focus on one fund category over another, we know there is a reasonable chance things won't proceed as expected. In fact, when we make changes to our portfolios we do so with the full knowledge that our forecast might be dead wrong. We might think there is an 80% chance that international stocks are heading for trouble, but you have to prepare for the 20% chance that the market will continue to rise.

Our MAXadvisor Newsletter's Aggressive Growth model portfolio is currently 80% in stock funds, 20% in bond funds. If we felt stock funds in general were due for lackluster returns, we wouldn't sell all of our stock fund positions and allocate the entire portfolio to bonds or cash; the most we'd do is reduce our stock position by 10% to 15% and choose lower risk stock funds for the stock allocation. This kind of re-allocation would give us adequate protection from the potential market drop (given the higher risk profile of the portfolio) but keep us aggressive enough if the market didn't fall.

There is almost no situation where a twenty-five year old investor like yourself shouldn't have a fairly significant portion of their portfolio in stocks, unless you were planning to make a major purchase, and hence would have a lower risk tolerance as you would need your portfolio too soon to take full market risk. Even the MAXadvisor Newsletter's Safety portfolio (the most risk-averse portfolio in our lineup, appropriate for the most nervous or those living off retirement income) has a 25% allocation to stock funds. The reason for that is because sometimes holding some of your money in riskier positions can reduce the overall risk of your portfolio by increasing diversification. Our Safety portfolio's stock allocation makes the overall portfolio less volatile if the stock market moves in a different direction than the bond market. Over the longer term, stocks offer some degree of insurance against a killer to an all bond portfolio: inflation.

Where do we think the market is heading? While we aren't terribly bullish about the short term, we certainly aren't predicting a major market collapse. Don't forget bonds - unlike in 2000 - aren't underpriced compared to stocks and are automatically worthy of a huge allocation every time you get jittery about stocks. Yes, there is a chance that Cramer is right and stock prices are about to fall over a cliff. There's also a chance that the market is about to take off like a rocket (and if it does, watch Cramer change his tune in a hurry). We're aware of both of these possibilities and have built our model portfolios to withstand the drops and take advantage of the launches. You should too.

Thanks for the question.


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Ask MAX: Should I Invest in a Loaded 401(k)?

October 7, 2005

Dear MAX,

I recently started my first job that has offered a 401(k) plan, and I was very excited to begin investing. The problem is, the funds in the plan are load funds, and after being a fan of your site I know that load funds should be avoided at all costs. Should I invest in my company's loaded 401(k) plan?

Fort Dodge, ID

Dear Yousef,

We've reviewed hundreds of 401(k) plans for our Private Management clients and for investors who have used our MAXadvisor 401(k) Planner service. While many of those plans offer funds that normally charge a sales load to investors outside of tax-deferred accounts, the vast majority of those plans waive the regular load charge to people who invest through a 401(k) plan. We've often seen Templeton funds offered without a load charge through company-sponsored retirement plans that would cost investors 5.75% if they bought it at Etrade outside of their 401(k).

There are, however, some very lousy 401(k) plans out there that do, inexplicably, force participants to pay load charges. The dubious rationale behind paying load charges is that some investors need help choosing the funds that are best for them from the ten-thousand plus funds available. How this rationale holds up in a 401(k) plan in which investors have limited choices is beyond us.

You can find out if your 401(k) plan is loaded by asking your company's plan administrator (although if he was dumb enough to choose a loaded plan in the first place, there's a pretty good chance he won't know if the funds in it are load funds or not), and by reviewing your plan's literature. Don't be shy about calling your provider and asking them whatever questions you need to, either.

What should you do if you determine that your plan does, in fact, offer only load funds? Well, as much as it pains us to say it, you might want to go ahead and invest in your plan's load funds anyway – as long as your company matches your 401(k) contributions. The 'free money' your employer gives you through a matching program would more than make up for whatever load charges you are forced to pay. There is no sweeter deal in the investing world than 401(k) matching funds; take advantage if you can.

If your company doesn't have a contribution matching program, you should tell your job to take their 401(k) plan and shove it—you ain't investing there no more. You'd be better off investing the money you would have contributed to a 401(k) in quality no-load funds through a Roth IRA account. While you won't get the same up-front tax break you would by investing in your company's 401(k), you will enjoy tax-free withdrawals after you pass retirement age.

And even though you're a new employee who probably doesn't want to make waves, as soon as you're comfortable you and some co-workers should approach your plan's administrator and ask them to please, for the love of Pete, find a better 401(k) plan. There are many solid plans out there to choose from, none of which are loaded.

Thanks for the question.

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Ask MAX: A Good Place for Some Short-Time Money?

September 22, 2005

Dear MAX,

I'm 32 and have been saving pretty heavily for three years. I was planning on buying a house, but there is also a possibility that I will use the money to start a business. I should have enough money accumulated to make the down payment in roughly one year, but I want to have access to the money in the interim in case I go the business route. I realize that stock funds are too volatile for short-term savings so I am wondering; what is a better place than my bank's low-interest savings and checking accounts to keep my money safe for such a short period of time?

Tempe, AZ

Dear Chris,

You're right on about stock funds being too risky for a short-term investment. There really is no stock or bond fund that is immune from at least some degree of volatility. Even the MAXadvisor Newsletter's Safety Portfolio can get hit with short-term losses, which is exactly what investors like you don't want when they absolutely, positively don't want to suffer any loss of capital.

As you mentioned, your bank's savings accounts are certainly safe (in fact, they are largely insured by the government), but the amount of interest they generally pay is so low (especially for smaller balances) that you could do almost as well burying your loot in the backyard. Fortunately there are several attractive options for a guy in your position. Here's our short list:

1. The ING Direct Orange Savings Account is an ingenious little product that has no minimum balance requirement, pays a great rate, and is remarkably convenient. ING pays a variable (meaning it moves with prevailing interest rates) 3.30% Annual Percentage Yield on all funds in the Orange account, starting with the very first dollar deposited. Compare this to the 0.25% some bank savings account pay.

The Orange Savings Account links to your ordinary low interest checking account. You can transfer money between your checking account and higher yield Orange Savings Account online, through their Interactive Phone Service, or by speaking with an ING representative. You can also set up an automatic savings plan that allows you to have a fixed amount of money regularly transferred to your Orange account from your linked checking account. ING says the movement of money, back and forth, generally takes about three business days. You can't pay bills directly from the ING account, and like your bank account, the Orange Savings Account is FDIC insured.

2. Another attractive option is to invest in a low-cost money market fund. Money market funds are NOT FDIC insured, but in practice they don't really need to be. Historically, investors have never lost a dime in money market funds (a few came close before fund companies stepped in and reimbursed losses).

The Vanguard Federal Money Market Fund (VMFXX) currently coughs up a nice 3.25% yield, comes with a low 0.30% expense ratio, and requires only $3,000 to invest. Vanguard has several low fee money market options with slightly different risk profiles and yields, including tax-free, municipal bond-based choices. Vanguard also offers automatic investing and withdrawal plans, but moving money into and out of the account at frequent intervals isn't as convenient as ING's setup. You can get check writing privileges on your Vanguard money market fund, which ING Orange doesn't offer. A Vanguard Money Market fund is a particularly good option for investors who plan on moving some or all of their cash into a Vanguard fund at some point in the future.

3. For investors that have a significant amount of cash sitting at a discount broker waiting for a dip in the market, we strongly suggest moving that money out of the broker's low-yielding sweep account into a higher-yield but still ultra-safe, short-term bond fund. While Vanguard funds are not generally available without paying a commission to buy or sell at most discount brokers, there are some solid non-Vanguard options that are.

We like the Payden Limited Maturity Bond fund (PYLMX) for this purpose. The fund sports a low, 0.40% expense ratio and a minimum investment of $5,000. The fund doesn't charge a redemption fee, so you have the flexibility to move in and out of it freely, but make sure your broker doesn't impose a redemption fee of his or her own (some do).

For those who want to save below the $5,000 minimum, consider SSgA Yield Plus (SSYPX), a fund very similar to our Payden choice with a $1,000 minimum but a slightly higher expense ratio of 0.57%. If your time horizon is over 180 days you should be able to buy both of these funds with no commissions or fees. Unlike your brokerage sweep account, you can't automatically settle trades with the balances in these ultra short-term bond funds; you will have to sell the funds a few days before you need the money to make any new purchases.

Thanks for the question,


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Focus On: Utilities

September 1, 2005

(Published 09/01/05) One of the hottest fund categories over the last three years (ending 8/31/05) has been utilities. The three-year total return for the Dow Jones Utility index is a whopping 90% –double that of the S&P500 over the same time period. The typical mutual fund in this category scored a whopping 73% return. Our favorite in this category, the American Century Utilities fund (BULIX), which has appeared in several of our MAXadvisor Newsletter model portfolios, scored a 77.5% return over the same three-year period.

With investor excitement for utilities stocks at the highest levels since the days before the Enron debacle, we are finally downgrading utilities to a negative rating. We think utilities funds should underperform the market and 60% of stock fund categories in the next one to three years.

Utilities has been one of our favorite categories since we started the MAXadvisor Newsletter. From April 2002 through the end of January 2004 we gave the sector our highest rating (Most Attractive – should outperform the market and 80% of stock fund categories over the next 1 to 3 years). Then, for the next eight months, we maintained a positive rating (Interesting – should outperform the market and 60% of stock fund categories over the next 1 to 3 years). We then downgraded utilities to a neutral, and finally sold much of our utility stakes in our model portfolios a few months ago. But even after our downgrades, the funds in the category just kept climbing higher.

Despite the sector’s continued outperformance, we’re now more confident than ever that a utilities downturn is imminent. The only reason we’re not downgrading to our worst rating is that new utility funds are not sprouting up like mushrooms (new fund launches are one of the strongest contrarian signals of trouble ahead for a category), but existing utilities funds and ETFs are hugely oversold already. The iShares Dow Jones U.S. Utilities Sector Index Fund (IDU) has $800 million in assets. Our own favorite, Utilities SPDR (XLU), has an unbelievable $1.97 billion in assets.

For comparison, the Technology SPDR (XLK) – which is also a portfolio holding of ours – has around $1.3 billion. The only sector ETF with more money is the Energy SPDR (XLE), and we just slapped our worst rating on natural resource funds – the category energy falls under.

Can you imagine utilities funds being more popular than tech funds? Certainly not a few years ago. This is why utilities have doubled the market return in the last three years – nobody wanted anything to do with these during the dot-com bubble. Between Enron’s collapse and stories of over-leveraged, new-economy-style energy companies teetering on the edge of bankruptcy, the stocks had nowhere to go but up. The fact that a utilities index paid almost 6% in dividend yield didn’t entice anybody.

The ultimate buy sign was when Vanguard decided to convert their utility fund (one of the only good, low-fee funds around, our former top favorite and portfolio holding) into a plain-vanilla, dividend income fund. Vanguard did this in late 2002 because they couldn’t give away shares of a utility fund at the time.

But the category has now come full circle. This is not a good time to buy utilities funds. It is a good time to sell, which is what we’ve been doing all year in our newsletter and other portfolios. Performance has brought utilities stocks back to their pre-Enron levels, when utilities stocks were priced as if failure in their leveraged business models was impossible.
Worse, yields have fallen near proportionally with the rising prices (dividend increases haven’t come close to matching stock price appreciation). Today’s utility buyer is getting a dividend yield perhaps 1% over the S&P500 (3% instead of 2%) and about the same P/E ratio for owning heavily regulated businesses in one of the slowest growth and oldest economy areas around.

Sure, new home buying will lead to some growth, but come on, is your run-of-the-mill electricity utility going to grow earnings like other components in the S&P500 – like Pfizer, Wal-Mart, and Microsoft? Utilities are supposed to be cheap; they are a nice bond alternative that can perform better with inflation because dividends can go up with price increases, but that’s about it. Today’s utility fund buyer is looking at the near doubling over the last three years while ignoring the fact that utility stocks are going to have a tough enough time keeping pace with the market over the next few years (much less outperforming even more).

We’re sticking with our two lone favorites here largely because there are not too many compelling choices – at least since Vanguard made their utility fund disappear. Does Vanguard regret this move now? Maybe. They launched a couple utility index funds last year (their original utility fund was actively managed). The first was an ETF, Vanguard Utilities VIPERs (VPU), followed a few months later by one admiral class open-end fund with a $100,000 minimum, Vanguard Utilities Index Fund Admiral Shares (VUIAX). Both are fine alternatives to our picks below as well.

Most utilities funds are load funds because brokers need something to sell to widows and orphans and still land commissions since churning a stock account for those needing fixed income and low-risk could get them into trouble. What few utility funds are available without a load are fairly expensive. Since utilities should be bought primarily for yield, this is unacceptable. At the current paltry utilities yields, a 1.2% expense ratio quickly turns a utility fund dividend yield into an S&P500 index fund yield because fund fees are paid with dividends first.

We had our highest rating on down-and-out utilities back in 2002 and 2003. In 2004 the area was about the hottest this side of energy. Money keeps dumping into utilities stocks, and dividend yields are now paltry after even more big gains in stock prices in 2005 (beyond what we expected). Given the likely business growth, this is bordering on absurd. When interest rates move up this hot area is going to fall.

Category Rating: (Weak) – should underperform the market and 60% of stock fund categories

Previous Rating (08/31/05): (Neutral) - Should match the markets return and perform in the middle of other stock fund categories

Expected 12-month return:-2%

1. American Century Utilities Inv (BULIX) 8/02 77.52% 38.99% 9.52% 33.69%
2. Utilities Select Sector SPDR (XLU) 1/04 43.98% 34.61% 9.07% 34.09%

Focus On: Convertibles

June 1, 2005

(Published 06/01/05) You can tell a lot about what’s hot and what’s not in mutual funds by just watching Vanguard.

Investors got gold fever? Vanguard closed their precious metals fund. Bond investors have no more Enron and WorldCom type fears? Vanguard closes their high yield bond fund. ETFs all the rage? Vanguard launches VIPERs. Nobody wants anything to do with utilities stocks? Vanguard re-badges their utilities fund as a plain-vanilla dividend growth fund.

We watch Vanguard closely, not just because several of their funds are in our model portfolios and on our favorites lists, but because Vanguard offers a strong signal of what smart investors should avoid or invest in.

Lack of investor interest is a good thing. Two of the hottest areas in the market over the last few years have been utilities and natural resources. Vanguard couldn’t give away their utility fund, so they gave it a strategy-altering makeover. American Century couldn’t find buyers for their global natural resource fund (an old holding in our newsletter) so they liquidated it. Both would have been up around 60% or more had they stuck by those funds as out-of-favor categories came back.

In 2003 plain old convertible bonds were on fire. Vanguard Convertible Securities (VCVSX) was up 31%. By 2004, investors were piling into Vanguard’s Convertible bond fund. In May when the fund neared a billion in assets, Vanguard simply had to shut the door. We dropped the fund as a favorite soon after, in August 2004.

From April 2002 until the end of September 2004 we had the convertible category rated 2 – Interesting. We had a convertible bond fund in our two safest model portfolios for much of this period. At the end of September 2004 we skipped 3 – Neutral and downgraded the convertible fund category to a 4 – Weak. (Too much of a good thing.)

Then a funny thing happened – convertible funds started to stink. Vanguard Convertible Securities was down 5.12% for the year to date as of May 31st, although it has recovered a bit recently.
Another funny thing happened: a half billion (about 50% of total assets) vanished from Vanguard Convertible Securities in a matter of months. In March of this year, Vanguard even opened the fund to existing investors while assets under management continued to drop (previously the fund was hard-closed, meaning essentially nobody could buy). Still, the assets fell.

On June 23rd Vanguard announced the fund was now open to new investors once again, but with a couple caveats: 1) the minimum is raised from $3,000 to $10,000, and 2) the fund will slap a 1% redemption fee anybody (who buys after September 15th 2005) selling within a year.

So now that the performance chasing investors have left the convertible bond market, we can safely upgrade the category to 3 – Neutral. We can also add Vanguard Convertible Securities back to our favorites list, it will join our other favorite pick and former portfolio-holding Northern Income Equity (NOIEX). Unlike Vanguard’s previously bloated fund, this fund has done fine over the last year, up about 11% landing it in the 10% of similar funds, although the fund underperformed when convertibles were red hot in 2003.

Category Rating: (Neutral) - Should match the markets return and perform in the middle of other stock fund categories

Previous Rating (12/31/05): (Weak) – should underperform the market and 60% of stock fund categories

Expected 12-month return: 5%

1. Northern Income Equity Fund (NOIEX) 9/01 32.82% 12.75% -1.43% 8.89%
2. Vanguard Convertible Sec (VCVSX) 5/05 0.00% 0.00% 0.00% 1.19%

The Great Real Estate Bubble

March 23, 2005

Broadly speaking, there are three asset classes: stocks, bonds, and real estate. Cash, or money market funds, are really just a type of bond – very short term and very safe. While investors can gain access to all three with mutual funds, most own real estate directly. For many, real estate is their biggest, and often their best investment.

There are three main reasons real estate has generally been a successful investment for most people: 1) by buying a home, investors are effectively paying themselves rent 2) a mortgage is essentially a forced savings program paid into each and every month 3) because of the nature of the investment, real estate investors tend to avoid the poor decisions they make when they invest in other major asset classes.

Unfortunately, this last factor may be changing.

The main reason investors should worry about real estate bubbles is this: most experts say that real estate bubbles are simply impossible – at least on a national scale. In a recent article posted on bankrate.com, David Lereah, chief economist for the National Association of Realtors, was quoted as saying, "There is no national price bubble. Never has been; never will be."

This may go down as one of the most infamous quotes in investing history, up there with respected Yale economist Irving Fisher, who in 1929, shortly before the great stock market crash, proclaimed that “stock prices have reached what looks like a permanently high plateau".

With investing, there is no such thing as “never”. The fact that something hasn’t happened in the past does not mean it can’t happen in the future.

People like real estate. They trust it. They can live in their investment. After a sharp bear market and numerous Wall Street scandals, the same can’t be said about stocks. Much of this good feeling was capped off with recent massive gains in real estate prices around the country, notably in certain hot markets.

The sentiment could be summarized by a short piece on CNBC to plug her show by the vivacious and orange-tinted Suze Orman:

Hi everybody I’m Suze Orman. Now have you noticed that the markets really haven’t gone anywhere over the past year or so? What should you be investing in? I’m here to tell you that I still believe the number #1 investment for you is real estate…”

We have two reasons for being skeptical about Suze’s claim. For one, she has been wrong in the past - some have poked fun at her for being a big proponent of “the Cubes” or QQQ (recently changed to QQQQ), the Nasdaq 100 Index ETF back in the stock bubble years - an investment choice still down around 70% from the high. Two, we disagree with her because we think real estate doesn’t really beat the stock market over long time periods because of the nature of homes vs. stocks.

Recent memory aside, home prices do not climb much faster than inflation over time. There is a sound economic reason for this – homes can be built out of materials that are highly correlated to inflation. Even the cost of labor used to build a home is closely tied to inflation. Home prices are capped at a slim margin over the cost of building a new home, and the cost of building a home tends to move with commodity prices and labor costs.

This is not to say fortunes can’t be made in real estate - notably with coastal homes that are in limited supply or from buying in an out-of-favor neighborhood before it becomes popular. But for many, homes are the ultimate commodity investment - it works mostly because so much money is plowed into it (divert 30% of your income each month into anything and it will be worth a small fortune someday).

The reason we recommend real estate in general as an asset class over real commodities is that real estate can be rented for income, and income producing ability (now or in the future) is the true definition of an investment over a mere speculation like hoarding copper.

Investors often look to real estate when stocks let them down. The last true real estate bubble in America took place in the early to mid 1920s – the great Florida land grab. What really kicked off the rampant speculation by individuals was a sour stock market. From peak to trough in 1919 to 1920, the Dow suffered a 47% drop – one of the fastest and most furious in history.

Early gains made by speculators in Florida’s development led to wild stories of easy riches that sucked in more and more money – into dumber and dumber investments (sound like the tech boom to anyone?). Before long, hucksters were selling underwater land as the next multimillion dollar hotel location to greedy investors looking to flip their way to instant wealth. The expression, “If you believe that, I’ve got some swampland in Florida for you” lives on to this day.

Investors also like leverage. Borrowing makes the relatively low risk world or real estate investing as exciting as . . . well, tech stocks. Today it is not uncommon for someone with very average credit and only a moderately stable income to plunk down $25,000 on a $500,000 home. If the home climbs 20% to $600,000 (which it has been doing for years now, so why should it stop...) the investor turns $25,000 down into $125,000 safely. Try doing that in stocks!

On the other hand, somebody who borrows $475,000 (to buy a $500,000 house that cost $300,000 a few years ago, and could be worth that much again) could lose his job and be unable to make the payments—that will climb if interest rates go up. It’s pretty hard to turn $25,000 into a negative $175,000 with stocks.

A recent real estate broker’s guidebook on New York and Florida (that looks like a stock analyst’s report) noted some startling price trends: 2-4 family townhouses in Brooklyn were up 174%, studios in New York City up 20%, lofts up 35%. More startling was the time frame of the big returns: 1 year.

Everyone is so sure that real estate will continue to move onward and upward that the cost of buying a home is now at record highs in relation to the cost of renting the same property. In some hot markets it costs just 50% or less of what it would cost per month to buy to simply rent. It is entirely possible that an investor would do better renting the house they want to buy, and parking the difference each month in an index fund – at least for shorter periods of time of 1 – 7 years.

More sobering is the thought that the relationship between renting and buying could become exaggerated quickly if rates rise (which increases the costs of home buying) or if rents fall (which could happen in a recession). Suddenly homes may not be just 25% overpriced, but perhaps 40%.

Is 25% overpriced a bubble? It is when the average home only has about 50% equity on the books. In other words, if homes fell 50% in price, there would be no equity left in residential real estate, and the outstanding mortgage debt would exceed the market value of the property.

This is startling because homes are now our greatest asset. Today, total household wealth is higher than ever, largely because appreciating home prices have made up for any losses in stocks.

Saying that only some regional markets are overpriced is like saying only some stocks were overpriced in the 2000 stock bubble. Therefore, buying – even on margin – is safe. Florida, New York, California, New Jersey, Massachusetts, Connecticut, and Las Vegas represent more than 50% of the total market cap of all U.S. property, so it’s hard to say the bubble is only localized. Exxon Mobil (XOM) wasn’t overpriced in 2000, but Cisco (CSCO) was.

Brokers used to let customers buy stocks on up to 90% margin because stocks were a sure thing. After the crash of ’29 people realized the error in their logic.

Maybe real estate won’t crash. Maybe prices will just stay at the current levels until fundamentals catch up. Maybe we’ll never learn the risks of 5% down. Let’s hope so – an economy partially fueled by home equity loans can’t take a bear market in home prices.

Better if we think a bear market in real estate is something that doesn’t exist.

Ask MAX: Can I build a fund portfolio with just $17,000?

March 16, 2005

Dear MAX,

I read your article that recommended that investors with less than $15,000 invest in a Vanguard fund. Well, I have $17,000 to invest, and wanted to know how I should invest it. I took your risk quiz and am a moderate investor. Thanks.

St. Albans, Maine

Dear Leena,

You’re referring to this article in which we advised Matthew, a young Navy sailor serving in Iraq, to invest in the Vanguard LifeStrategy Growth fund via an auto-investment plan. Matthew was starting out with just $2,000 (while adding $500 per month), and we told him to invest in this single Vanguard fund because it would give him a high degree of diversification (this particular fund is a collection of funds that owns other Vanguard funds) with a low initial investment requirement.

We told Matthew to stick to the Vanguard LifeStrategy Growth fund until he had grown his portfolio to $15k, then to come back to us to discuss where he should go from there. While the fund has risen more than 5% since Matthew asked his question back in November, we’re pretty sure he hasn’t reached the $15k threshold yet – but we’re guessing he wouldn’t mind if we answer your question in the meantime. You are starting out with more money than Matthew, but you are facing similar problems. Every investor, no matter how much money they are starting out with, should aim for certain goals when building an investment portfolio: diversification, low fees, and the right risk level.

The idea behind diversification is to spread your money into distinctly different investments, so the chances of them all going south at once is pretty remote. Purchasing even a single mutual fund automatically provides a certain level of diversification by taking your money and investing it across all the equities the fund owns. However, true diversification means more than owning 30 energy or tech stocks – besides owning stocks from different industries you need to own stocks and bonds from around the world. Mutual funds make this feasible.

The problem is that diversification can require a fairly large upfront investment – even with mutual funds. Every mutual fund has a minimum investment requirement, a minimum amount of money an investor needs to invest in that fund. Some fund’s minimum investment is just $200 – others won’t let investors in with less than $250,000.

Investors like Matthew who are starting out with a small amount of money have very little choice but to invest in a fund of funds (like Vanguard LifeStrategy Growth), that gives them diversification with a low initial investment requirement because the fund owns other Vanguard bond and stock funds.

An investor like you, with a bit more money to invest, has more options than Matthew, but you still need to be very aware of fund minimums, and to spread your investment money over enough funds to give you a well-diversified portfolio.

Impossible, you say? No, it’s not. It just so happens that our MAXadvisor Newsletter offers a low-dollar portfolio, along with six other higher-minimum portfolios that subscribers can build into their own brokerage accounts.

Currently, the newsletter’s Low Minimum portfolio holds five funds, and can be built with just ten thousand dollars (even less in an IRA account, as some funds lower their minimums for IRA investors). Here is a snapshot of the current allocation to our Low Minimum portfolio, which includes the fund name and ticker symbol, the percentage or the Low Minimum portfolio each holding currently comprises, and the minimum investment of each fund (please keep in mind that these allocations could change at any time):

SSgA MSCI EAFE Index (SSMSX) 10% ($1,000)

Pennsylvania Mutual (PENNX) 20% ($2,000)

Vanguard LifeStrategy Growth (VASGX) 35% ($3,000)

SSgA High Yield Bond (SSHYX) 10% ($1,000)

American Century International Bond (BEGBX) 25% ($2,500)

US stocks: 45%
Non US stocks: 15%
Bonds: 40%

This portfolio covers your whole investing nut, giving investors exposure to foreign equities through the SSgA MSCI EAFE Index fund, and to foreign bonds through the American Century International Bond fund. The Vanguard LifeStrategy Growth fund pops up again to bring large cap stocks to the portfolio party, and Pennsylvania Mutual is a great, lower-fee small cap offering. U.S bonds of various risk levels come from the SSgA High Yield Bond fund and the bond portion of Vanguard LifeStrategy Growth. While this portfolio contains some fairy risky funds, collectively the portfolio is appropriate for a moderate-to-growth investor. The portfolio has returned 10.48% in the last twelve months ending 01/31/05, and 28.49% since inception April 1st, 2002.

While an investor with more money to invest will have access to even cheaper funds and can customize their diversification to a greater degree than investors with less money, the Low Minimum portfolio above proves that you don’t have to be Bill Gates to build a solid mutual fund portfolio.

Thanks for the question. We’re giving you a free subscription to the MAXadvisor Newsletter so you can track our Low Minimum portfolio yourself.


Want to ask MAX a question of your own? Send him an email by clicking here. Please include your name and where you live.

Ask MAX: Can I convert my regular IRA to a Roth IRA?

March 3, 2005

Dear MAX,

Can I convert my regular IRA to a Roth IRA, and should I?

Santa Fe, NM

Dear Holly,

First, let's tackle the "can you" part of your question, then we'll move on to the "should you".

Can You? The answer to this question is relatively simple to determine. You can convert from a regular to a Roth IRA if your adjusted growth income is below $100,000. That figure applies to both single filers, married couples filing jointly, and heads of household.

If you're married and you're filing separately, you're out of luck. Rules concerning conversions specifically forbid married persons filing separately from converting their IRAs.

That's about all there is to the "can you" part. But now things get a bit more complicated.

Should you? Let's get the bad news out of the way first: If you convert from a regular to a Roth, you could be liable for a big tax hit on your IRA money. Convertees are responsible for paying taxes on any and all money they contributed to their regular IRA that they deducted from their taxable income. That means that all that income tax you didn't have to pay when you made the original contribution is suddenly due to Uncle Sam, in one big, ugly chunk.

The amount you pay in taxes is determined by your current tax bracket. If you have $100,000 in your account, you may wind up with an immediate tax bill of $25,000, if you are in the 25% tax bracket. If you are in the 33% tax bracket, you would owe $33,000.

The thought of writing a check that big to the IRS is enough to stop many a potential regular-to-Roth converter dead in their tracks. But despite the potentially horse-choking tax bill, a conversion from a regular to a Roth IRA is a good way to go for certain people.

If you're a younger investor (we couldn't help but notice that you coyly declined to reveal your name in your question), a Roth conversion is probably a good idea. That's because you have plenty of time before retirement to make up the money you lost to taxes during the conversion.

Certain older investors can benefit from a conversion as well. Roth IRA contributions are taxed (or rather made with after-tax dollars); distributions are not taxed. Regular IRA contributions are not taxed; distributions are. If you are fairly sure you'll be in the same (or higher) tax bracket when you become eligible for distributions, and you don't plan on taking large distributions for at least five years, a Roth IRA conversion could end up saving you a bundle in taxes over regular IRA distributions.

(If you'll be retiring or you're planning to begin taking distributions from your regular IRA in less than five years, converting to a Roth is not an option. Convertees who begin taking distributions within the five-year window will have to pay a 10% penalty on the distributed money.)

Another point to consider is whether or not you will depend on your IRA for income when you retire. In a traditional IRA, you must begin taking distributions at age 70 ½. If your retirement plan isn't counting on those distributions to sustain you in your golden years, then a conversion to a Roth may be a good idea. Because you aren't forced to touch the money you have in your Roth IRA account, it can continue to grow and grow. That means you could throw yourself a hell of a party when you reach your 100th birthday, or you could pass your Roth onto your kids, tax free.

Still can't decide if converting is the right move for you? The good people at H&R Block have a great little conversion calculator that can make the choice a little easier. Click here to give it a try.

Thanks for the question.


Want to ask MAX a question of your own? Send him an email by clicking here. Please include your name and where you live.

Focus On: Natural resource funds

March 1, 2005

(Published 03/01/05) When we started the MAXadvisor Newsletter in early 2002, natural resources was one of only three stock fund categories that had our top rating of “Most Attractive”. We give this rating to fund categories we think will beat the U.S. stock market and 80% of fund categories over the next 1 to 3 years.

It turns out that our optimism for this category was well-founded. Natural resources funds have been near the top of stock categories over the last three years.

As we often do when an area comes into favor, we downgrade the ratings – but not until we think things are really getting overblown. We kept natural resource funds at a “Most Attractive” until May of 2004, when we downgraded the category to “Attractive” (these funds should beat the market and 60% of fund categories).

The category kept performing well, so we downgraded the category again to “Neutral” in October of 2004. The million dollar question: what should we do now?

It’s not enough for us to recommend an out-of-favor category that goes on to do well. We need to tell you when to sell, or at least cut back on your stake of categories that have done well but are heading for a downturn. This is where things get a little tricky. To be perfectly frank, we tend to get out of hot categories a little too early, as long-time subscribers to MAXadvisor (and MAXfunds readers) know. Real estate and precious metal funds come to mind.

Natural resource funds have been hot because commodities have been hot. These funds largely own mining and energy related companies. Until more resources can be explored for and produced, stocks in the category tend to do well when natural resource prices rise.

Natural resource stocks have also done well because they were cheap before but aren’t so cheap now – valuation expansion. Nobody wanted anything to do with such dull, old-fashioned businesses back in the new economy days. Today, the benefits of buying a business on the cheap are obvious, as are the negatives from paying too high a price. The five-year average annual return on the typical natural resource funds is about 18% - good enough to turn a $10,000 investment into $23,000. (The five-year average annual return on tech-nology funds? Try a negative 21% per year, enough to turn a $10,000 nest egg into a $2,700 cracked egg.)

Among the signs we look for that a category might be heading south are 1) huge inflows of fund investor money in the category, 2) new category focused mutual funds being launched, 3) increased ‘buzz’ about the category, 4) over-stretched valuations.

1) Inflows And this is where we are a bit on the fence concerning the natural resources sector. We’ve seen big flows of cash to energy funds. One of our favorite funds in this category, Vanguard Energy, just closed with $6.5 billion in assets. It had $2.5 billion in 2003 and $1.3 billion in 2001. Shareholder inflows to funds here make us negative on natural resources.

2) New Funds As for new funds, there have been a few, notably Guinness-Atkinson Global Energy (GAGEX) – a decent but expensive choice (full disclosure: Jim Atkinson of Guinness Atkinson is a former MAXfunds executive). We’d like to see more fund launches to really mark a top here. The “new fund” signal produces no clear verdict one way or the other on the future of natural resources.

3) Increased Buzz Recent trends suggest that you just can’t get away from Johnny-come-lately energy bulls. I’m not going to name names, but guys I recall touting tech stocks five years ago are now ga-ga over Exxon- Mobil. Amazing how the new economy gurus crossed over to the old economy. Too bad they didn’t change their minds earlier. They could have saved investors some money…
And of course, the experts talk a good game, and energy seems to make sense. Things look good for energy stocks, which is why they’re up a gazzilion percent, for Pete’s sake! Many natural resource funds were up 15% or more last month alone! But then, didn’t tech stocks look pretty good back in the day?

This week on CNBC one energy bull showed a chart of energy stock’s percentage of the S&P500. Unlike tech stocks, which peaked out as a bigger chunk of total market cap in the S&P500, energy stocks are a mere 10% or so. This analysis was compelling because we look at the bigger parts of the S&P for contrarian signals as well. Then he went on to show how energy stocks used to be 20% or more of the index a few decades ago. So therefore, we have got a long way to go in this new bull market in energy.

Or do we? A few decades ago we didn’t have mega cap software and computer companies with billions in earnings. By the same historical logic, buggy whip stocks should stage a comeback. What about textiles? Agriculture? Railroads? Autos? Tech bubble or no, companies like Microsoft earn billions and deserve to hog up some of the index – the economy has evolved to the point where old industries like transportation and energy will never be the percentage they once were in the stock market, or in the economy for that matter.

4) Valuations While energy earnings are very strong right now, they are tied to sky high oil prices. While there is no law that says oil prices have to fall again, they could, and drastically. With commodities, you’re always one global recession away from a 50% haircut in prices. Profits could get cut sharply at energy companies in short order. Does Microsoft have to worry about such a situation? Maybe commodity based businesses should have lower P/Es than stocks that are more in control of their own near term destiny.

Even worse, Vanguard Energy now has a LOWER dividend yield than the Vanguard 500 Index – 1.1% compared to 1.6% (only some of this is because of slightly higher fees on the former). This is troubling because energy stocks are largely owned for dividends as long term growth prospects are expected to be average at best. Stock valuations point to a below average future for energy stocks.

Three out of our four sell-warning bells are ringing; the other (new fund launches) isn’t giving us a clear indication one way or the other. Our signals are clear – natural resources stocks have peaked. We’re now downgrading the category - for the first time in MAXfunds history - to a negative rating.

We are dropping the category; going to a “Least Attractive” should under-perform the market and 80% of stock fund categories over the next 1 to 3 years.

We recommended an energy fund in our 2004 hot sheet and we own energy funds in many of our managed accounts. We are now in the process of selling at least part of the stakes and locking in these gains – something you should consider if you followed our advice with this area in recent years.

When you do sell, be wary of short term redemption fees and short term tax rates if you own these big-gain funds in taxable accounts. Vanguard Energy is up 50% over the last year- you don’t want to pay a short term tax rate on that gain if you can push it off a few weeks and trigger a long term gain.

Remember the golden rule of fund investing with MAXadvisor: The (fund) customer is (almost) always wrong!

Sell when they buy and buy what they sell and you’ll do just fine over time.

Category Rating: (Weak) – should underperform the market and 60% of stock fund categories

Previous Rating (12/31/05): (Neutral) - Should match the markets return and perform in the middle of other
stock fund categories

Expected 12-month return: 5%

OUR FAVORITIE natural resources FUNDS
1. T. Rowe Price New Era Fund (PRNEX) 9/01 101.71% 80.95% 10.96% 38.67%
1. Vanguard Energy Fund (VGENX) 9/01 138.38% 117.61% 14.78% 49.65%
2. Excelsior Energy & Natural Resources Fund (UMESX) 9/01 101.37% 80.60% 14.16% 48.20%
3. iShares Goldman Sachs Natural Resources Index (IGE) 4/04 40.64% 31.91% 11.89% 37.93%