We first discussed the cloud computing trend on March 2, 2009. Although we did not officially recommend Salesforce (CRM) we highlighted how Salesforce was using “the cloud” to their advantage. Since then, CRM has grown an astounding 235%! CRM has risen on the strength of their market position and industry trends in cloud computing. In January, we posted a cloud computing follow-up discussing other merits of the technology. It’s time to revisit the cloud.

Large organizations are abandoning boxed software and opting for more agile software that is supported off-site – cloud computing.  According to the National Institute of Standards and Technology, cloud computing incorporates five essential elements:

• On-demand self-service
• Broad network access
• Resource pooling
• Pay-for-use service
• Elastic scale

Providers market the services in three different models: software-as-a-service, platform-as-a-service, and infrastructure-as-a-service. Software-as-a-service (SaaS) delivers a complete single software solution as opposed to a shelf-bought application. A SaaS example for customer relationship management would be Zoho or SalesForce. Platform-as-a-service (PaaS) is more complex. It offers development and middleware hosted by the vendor – and is more expensive for businesses. An example of PaaS would be Google AppEngine or Long Jump. Finally, infrastructure-as-a-service  (IaaS) is the raw infrastructure for things like servers and storage. IaaS is sold by companies like Amazon Web Services and GoGrid.

Morningstar recently joined the cloud computing conversation.  They distinguished the “public cloud” from the “private cloud”. The public cloud relates to applications like Google docs or Yahoo mail. These applications are shared by multiple users. On the other hand, the private cloud relates to enterprise-level solutions like the ones offered by the companies above. These services are usually behind a company firewall and only available to company users.

Businesses are moving towards the private cloud for one primary reason: support. The companies that support these services the best will do well as large companies move their antiquated software into cloud services. That will help marketers of cloud services. We expect even more momentum to build in the cloud computing space. Make sure you get in on the action.

Disclosure covering writer, editor, publisher, and affiliates: Long QQQQ. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

The goal of capital distribution is NOT to outlive your retirement nest egg, but to maintain the desired lifestyle for you and your loved ones through your non-working years. Capital distribution (not to be confused with capital gains distribution) is about spending your retirement savings the best way for your unique situation.  Here are three common strategies:

1) Annuities

One way to generate income during your retirement is with an immediate annuity, sometimes called an income annuity.  This is not the same as a fixed or variable annuity. An immediate annuity is similar to a self-funded pension. You deposit a chunk of cash with an insurance company and they pay you a certain dollar amount over a period of time. There are different distribution options related to spousal benefits, number of payments to be made, immediate or deferred payments, etc.  No matter the options chosen, the mechanism is the same: give an insurance company some money, and they pay you back every month until you and/or your spouse die.

The risks of this approach can relate to your life span, market risks, performance risk, and whether the insurance company stays solvent. Also, if you die after receiving the first payment, your family may lose the majority of your initial deposit if you did not cover that contingency in the annuity contract.

In addition, a typical annuity payment is fixed even if the market goes up. You may find you have given up some potential opportunities for growth. Finally, you must consider the risk that the insurance company may go bankrupt and will no longer make good on their end of the contract. Annuities can be an effective capital distribution method, but they’re not appropriate in all situations.

2) Systematic Withdrawals

Another way to finance your retirement is through systematic withdrawals.  There are two main methods: constant dollar and constant percentage.  Just as you once saved money systematically and let dollar cost averaging work for you, so also you can systematically pull money from your retirement account on a monthly, quarterly, semi-annual, or annual basis.  The constant dollar withdrawal plan has the benefits of convenience and consistency.

However, there can be a major risk with constant dollar withdrawals.  When you withdraw money from your retirement account during a bear market, you’re locking in a permanent loss to your portfolio. Some advisors suggest that this method, known as “reverse dollar cost averaging,” can be a great detriment to your portfolio when you make withdrawals during a bear market – which you almost certainly will if you live long enough.  So beware of the additional risks associated with constant dollar withdrawals.

Another systematic withdrawal option is the constant percentage method.  Instead of consistently taking out the same dollar amount, regardless of economic climate, you take out a constant percentage, thereby limiting your realized losses in a falling market and not compounding the losses to your nest egg.  The risk is that very few people want their retirement budget to be a slave to the market.  Less consistency in income streams means less ability to plan future life events.

3) Strategic Withdrawals

The final type of capital distribution is a strategic withdrawal of retirement savings.  There are several ways to implement this method. For instance, you can categorize your savings in buckets: low-risk, medium-risk, and higher-risk investments. A strategic withdrawal would be pulling funds from a lower-risk investment regardless of where the market is.  This reduces the negative effects of market risk on your retirement savings.  The risk is that this strategy requires some sort of market-timing plan.  It takes more time and expertise and is far from full proof.

Building a retirement income plan is one of the most important investment decisions that you’ll consider.  While these are three conventional methods used, they certainly aren’t the only ones.  Like most things in life, generally one size does NOT fit all.  Mixing a few of these methods or others may be the optimal blend for your income plan.  Also, often the right method is dependent on the type of assets you’ve saved: individual securities, pooled investments, employee pensions, or a mixture.  All have benefits, but all have risks as well.

Before implementing any of these strategies, discuss your situation with a qualified investment advisor. A professional can guide you through different ways to distribute your assets during retirement so you don’t outlive your savings.

But there is another way to invest: systematic investing.  Many individual investors subscribe to this method by making periodic moves into the market.  We’ve alluded to this method before.  Transferring a portion of your paycheck into a predetermined investment removes much of the worry from the investment process.  To illustrate, check out this helpful Savings Calculator.

Since most investors use systematic investing through a 401k plan or other retirement plan, it would be beneficial to explain the rationale.  One type of systematic investment plan is dollar cost averaging, sometimes referred to as a “constant dollar plan”.  Dollar cost averaging is a potential way to smooth out market fluctuations on the cost of an investment.  The normal method involves setting aside (usually) monthly income to invest in stocks, ETFs, mutual funds, or other investments.  The cost of your investments varies over time so you rarely pay the same price for shares.

This can be beneficial.  One result of dollar cost averaging can be that you buy more shares when the price is low while fewer shares are purchased at higher prices.  This happens due to the cyclical nature of the market.  In a rising market, your average cost per share is lower than what they are currently worth.  In a falling market, your average cost per share may be lower than the average share price – but is often still better than lump sum investing at the beginning of the year.

The following chart illustrates dollar cost averaging with mutual fund shares in a fluctuating market.  In this example from Wells Fargo, a lump sum investment is compared to a dollar cost average strategy using a $1,000 investment per month.  The link provided also gives informative examples of how both strategies perform in hypothetical rising markets and falling markets.

You can run different examples using different investment amounts.  Here’s another helpful calculator that contrasts lump sum investing and dollar cost averaging.

As you will see at the links provided, dollar cost averaging can be an effective and useful strategy in optimizing performance, but certainly not always.  It’s not a magic bullet.  A credible argument can be made that lump sum investing can be effective as well, especially if you can find the low point of a market that is ready to start going up.

Still, there are three important benefits to dollar cost averaging.  First, you’re saving – always a good thing.  Second, you’re NOT over-thinking the timing of your investments, often a losing proposition for many investors.  By avoiding enormous investment decisions about when to make lump sum investments, you preserve your mental energy for life’s other concerns.

Finally, by investing systematically, you can overcome the natural inclination to procrastinate. Most importantly, you’re establishing good investing habits – a challenge we all face.  For most, it’s a good plan to save a portion of your income, invest systematically, and take advantage of a cyclical market by dollar cost averaging.

If you have a lump sum to invest, dollar cost averaging is an important option to discuss with your investment professional.  The results can be surprising.

There are many approaches to managing risk.  One of the more popular methods is “targeted relative volatility” where a portfolio tries to match the volatility of a benchmark.  Unfortunately,  because volatility is not constant  the volatility of a portfolio using this approach will also not be constant.

I have a different view.  I try to reduce relative volatility when the market is experiencing increased volatility and try to increase relative portfolio volatility during periods of decreased market volatility.  The net result is that portfolio volatility is much more consistent relative to the market – the volatility of volatility is lower.

A few weeks ago, I had the privilege of seeing a paper presented, Alpha Generation and Risk Smoothing using Volatility of Volatility.  The author and presenter was Tony Cooper of Double-Digit Numerics, Auckland, New Zealand.  Tony looks at volatility of volatility, which he refers to as “vovo”, from a new and promising perspective and proposes methods for mathematically managing volatility.

Tony says it is difficult to predict stock market returns but relatively easy to predict volatility.  His framework produces a formula in which returns become a function of volatility and therefore more predictable.  He goes on to show that the strategy produces excess returns as the upside of leverage without the downside.

His approach is to estimate volatility using an EGARCH model and employ leveraged funds to adjust portfolio leverage.  There is an excellent discussion on leveraged funds and volatility drag.  He asserts that many of the “negative” effects of leveraged funds are not induced by the leverage.  Instead, they are a function of volatility and are present even in non-leveraged funds.  The leverage just magnifies the volatility.

The paper has excellent graphs showing the effects of leverage and identifying the historically optimum leverage for selected markets.  Tony observes that most equity markets benefit from some leverage but that none will reward a leverage of 4.

The paper illustrates how to implement a Constant Volatility Strategy and an Optimal Volatility Strategy.  As part of the backtesting and benchmarking process, the results of additional strategies are described.  For those of us who do not relish leveraged funds, the vovo approach also works when restricted to a maximum leverage of one.

As mentioned earlier, I got to see a presentation of Tony’s paper.  The occasion was the annual conference of the National Association of Active Investment Managers (NAAIM), of which I am a board member, earlier this month in Orlando.  Tony won this year’s Wagner Award for Advancements in Active Investment Management.  I encourage anyone seeking additional information to download the complete paper at the NAAIM site.

Jeff Benjamin of Investment News was at the conference.  As part of his interview with Tony Cooper, Jeff asked him what he intended to do with the prize money.  Tony’s response was that he “would like to invest it in a targeted-volatility ETF as soon as one is created.”  I too would be interested in such a product.

Since Tony’s vovo strategy fits very well with my desire to achieve more consistent volatility within the portfolios I manage, I will be studying the paper in more depth in the weeks and months to come.

Disclosure covering writer, editor, publisher, and affiliates: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

That’s one reason we wanted to highlight another approach to portfolio management: Risk Wise Investing

Regardless of your investing philosophy, there’s always a risk your investments will lose value.  Recent market volatility is a good reminder of this reality.  Formulated by Michael Carpenter in his 2009 book Risk Wise Investing (2009), this concept looks for a better definition of investment risk.  Carpenter tries to teach investors how to manage it effectively. His website explains…

“The Risk-Wise Investor offers a totally new, user friendly, non-technical way for you to better understand and manage investment uncertainty and risk. This practical guide outlines an easy and effective, personalized risk management planning process that will allow you to plan for and deal with investment risk in bull, bear, and uncertain markets. It will also help you improve the likelihood of achieving your long-term investment goals, while minimizing the likelihood and the impact of unpleasant, negative surprises.”

Carpenter’s contribution to portfolio management is two-fold. First, he simplifies the risk side of the risk/reward investment equation. He develops several less technical (read: less mathematical) tools investors can use to manage portfolio risk. This allows average investors to try their hand at risk management without a scientific calculator. If you’re looking for a risk-management method to review, check out Chapter 11.

Second, Carpenter delves into more psychological aspects of investing by reviewing how risk affects a person. Since investors are not robots, we have to remember our human habits, characteristics, and limitations. He explores deeper aspects of behavioral finance by reviewing how the human body and brain can actually counteract sound judgment. Labeling it the Biology or Physiology of Risk, he shows how our nature affects our investment decision-making process, and how to overcome this challenge.

We can learn several things from Carpenter’s approach. For one, risk-management doesn’t always need to be mathematically modeled. In fact, over-quantifying risk can be detrimental to common sense. Simple tools sometimes give us a better perspective. Another ironic discovery is how Carpenter’s Physiology of Risk is somewhat more scientific than the financial side.  He takes behavioral finance to the next level. Time will tell if the Risk Wise Investor becomes as influential as other competing portfolio theories.

The Chartered Financial Analyst Institute published a similar list: 12 Common Mistakes Investors Make.  I have modified and expanded their thoughts based on my own experience.  I hope it helps your investing endeavors.

1) Not Having A Strategy

Probably the most common mistake for new investors is trading without a strategy.  Subscribing to a list of hot stocks is not a strategy – at least not when it’s the only thing you use.  Educate yourself.  Don’t worry if it takes some time before you buy your first stock.  Understand your strategy and make decisions that match your strategy.

2) Not Knowing Your Limitations

Competition for success in the financial markets is fierce and brutal.  If you think you can make a few bucks per trade because of your good data, fast computer, and superior trading abilities, think again.  You are up against the most sophisticated investors in the world with the best equipment money can buy.  You won’t win at that game – at least not consistently.  Try to understand what you can and can’t do in the markets and act accordingly.

3) Acting on Tips

You’re listening to a friend or relative describe in hushed tones the next big Apple, Google, or Starbucks.  Greed takes control as you unconsciously turn off the fear alarm.  You’re sucked into the story so you buy the stock.  Then you buy just before the  stock tanks along with your hopes.  Acting on stock tips is an easy mistake when you don’t have a coherent strategy.

4) Having Unrealistic Expectations

Way too many so-called “educators” teach investors unrealistic expectations about their portfolios.  Infomercials abound with rags-to-riches millionaires who started with $10,000 and are now living on a beach.  These are not typical results, even if they’re true.  Make sure you understand the realistic possibilities for returns over time.

5) Letting Fear Paralyze You

Especially after the 2008-2009 crisis, it’s easy to blame others for your market losses.  Yet fear may be even more of a threat to your portfolio. Warren Buffett is fond of saying, “Be fearful when others are greedy and to be greedy only when others are fearful.”  Emotional investing can be just as bad on the selling side as it is on the buying side.  Don’t let fear stop you from making good investment decisions.

Far too often, we as investors seek market commentary, opinions, forecasts, strategies, trading ideas, and hot tips.  We often overlook the bigger picture, and more important aspect of investing –  investment management.  Investment management, also known as portfolio management, is the professional management of various securities and assets, to meet specified investment goals for investors.  Investors can be institutions like banks, pension funds, or insurance companies.  They can also be private investors like Michael Dell, Oprah Winfrey, or you.  As the various investment markets continue to offer investors choppy waters, more and more folks are exploring the idea of investment management.  Perhaps you’re interested in professional investment management and if that’s the case, here are some things to consider.

Investment management is both an art and a science.  It’s an art in the sense that professional investment managers are responsible for securing portfolio return against the backdrop of an often unpredictable and illogical marketplace influenced by the visceral responses of emotional investors.  Just as importantly, investment management is the science of controlling and mitigating risk while seeking to optimize portfolio returns.   There should always be a process to managing money, and a credible investment manager will always have a stringent investment philosophy with a disciplined and consistent process for evaluating risk.   The most successful investment managers will balance both risk and return, not trading one for the other.  According to Aswath Damodaran of the Stern Business School at NYU, an investment management process includes six different aspects. They include:

1) The Big Picture of Investment Management:  Before considering whether you need professional investment management, you should understand the nature of the business.  You don’t have to be an expert, but it’s good to know the natures of risk, return, the market, trading costs, time horizons, and so forth.

2) Client Goals:  Different clients have different needs. A 30-year old who just inherited a million dollars will have different goals from a 60-year old with a million dollar nest egg. The time horizon for retirement is much longer for the 30-year old compared to the 60-year old.  A clear understanding of tolerance to various risks is mandatory.  Good investment managers always consider their client’s investment goals paramount.

3) Asset Allocation:  Contrary to popular opinion, the stock market is not the only market in investment management.  There are both international and domestic stocks, bonds, real estate, commodities, precious metals, cash equivalents, and other assets.  Asset allocation refers to the unique mix of different investments that managers use to construct portfolios.  Some managers rely strictly on longer term “strategic” asset allocation, while others may employ shorter-term “tactical” shifts in an attempt to reduce risk.

4) Security Selection:  After choosing the appropriate assets to invest in, investment managers then choose what they determine to be the best securities for those assets.  For instance, if managers determine that US large cap stocks will match the client’s goals, they may choose to buy shares in the S&P Deposit Receipts ETF (SPY).  You want an investment manager with good understanding of the different securities available.  It is important to address individual security risk at this stage.

5) Execution:  Execution refers to the buying, holding, and selling of different investment securities. There are nuances of each market and pitfalls that chip away at returns. That’s why it’s important to use an investment manager who can navigate the sometimes-treacherous waters of the market.

6) Performance Evaluation:  After you have been with an investment manager for awhile, it’s good to review their performance.  Have they met the investment objectives that you agreed to when you signed up?  Keep in mind, it’s not just about returns, but the risk and volatility associated with that performance.  This is best looked at over a full market cycle, which is often several years.  Is the portfolio a reflection of the type of vehicle needed to get you to your goal?  If not, it may be time to reconsider your relationship.

At first glance, it appears the six aspects outlined above are missing an important element – risk management.  However, if you look closer, you will find that risk management is an integral part of every aspect rather than being a stand-alone section.  It is so important that it should  be addressed at every step.

This overview should serve to introduce the concept of investment management and some things to look for when evaluating it.  All six of these aspects work in relation to controlling the risk in an investor’s porfolio while seeking an optimal return that is appropriate for one’s goals.  If you are currently interested in finding out more about investment management, a great place to start is with our affiliate Capital Cities Asset Management.  You can contact them at (800) 767-2595 to discuss your needs or to schedule a free investment consultation.

Though most publishers tack on tiny disclaimers saying something like “past performance is not indicative of future results,” investors still try to predict future results.  Just find a winning pattern in the past, create rules that would have successfully traded that pattern, and institute a system for future trades.  It’s a little more complicated than that, but you get the picture.  This is basically what we do with our free trading strategy: Market Leadership Strategy.

Investors sometimes try to ride the momentum of whatever worked well last year.  This isn’t necessarily a good strategy, though.  Let’s look at the top three stocks for 2007 and 2008 and how they fared in the following year.

To be fair, the 2008 results were not large cap stocks.  But then again, most large caps were crushed in 2008.  They just serve to show you that a good year does not another make.  Here are the banner year results coupled with the not-so-great following year.

2007 Winners

Mosaic (MOS)
+342% in 2007
-63.3% in 2008

Consol Energy (CNX)
+ 122.7% in 2007
-60.0% in 2008

Hess Corporation (HES)
+103.5% in 2007
- 46.8% in 2008

2008 Winners

Emergent Biosolution (EBS)
+415% in 2008
-47.9% in 2009

Star Scientific (STSI)
+379% in 2008
-80.4% in 2009

Mexco Energy Corporation (MXC)
+237% in 2008
-19.6% in 2009

Should you expect the same sort of thing from top stocks of 2009 in 2010?  Indeed, past performance is not indicative of future results.  That might be especially true of the big winners.  In fact, you might reconsider if the following stocks are on your buy list for this year.  Here are the top-five large cap stocks that appreciated 300% or more in 2009.

XL Capital (XL)
+395.4% (3.70 > 18.33)

Advanced Micro Devices (AMD)
+348.1% (2.16 > 9.68)

Ford (F)
+336.7% (2.29 > 10.00)

Genworth Financial (GNW)
+301.1% (2.83 >11.35)

Micron Technologies (MU)
+300% (2.64 > 10.56)

Disclosure covering writer, editor, publisher, and affiliates: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

Estimates differ as to whether this holiday season will be as strong as last year.  Seniors are not receiving a cost of living raise as in years past, which could mean fewer toys from Grandma and Grandpa.  With unemployment now reaching into double digits, there will probably be fewer gadgets, less debt, and more enjoyment of the things that money can’t buy.

As for investors, the question for this holiday season is should you buy or should you sell?

If you’re bearish, you might consider a short-term position in ProShares’ UltraShort Consumer Goods ETF (SZK).  This ETF seeks 200% of the inverse of the Dow Jones U.S. Consumer Goods Index daily performance.  SZK should do very well if holiday sales are slower than expected.  Bear in mind, SZK has been on a downward trek for the past several months.  If you’re not averse to bottom fishing, you might catch it at a nice low.

If you’re bullish, you can buy any number of a long Consumer Discretionary ETFs.  The most popular is the Consumer Discretionary SPDR (XLY).  You could get more aggressive with Proshares Ultra Consumer Goods ETF (UGE).  Pricing for UGE has roughly followed the market in recent months, except on a 2X basis.

The other way is to contribute is by funding your own consumer-driven economic stimulus: buy stuff.  But make sure you’re getting the most for your dollar.  CNNMoney.com published their 11 Big Black Friday Deals.  It includes everything from LCD televisions, TomToms, digital cameras and slow cookers. Of course, you can always wait for the Thanksgiving newspaper to get the latest local deals.

If you’re more interested in tech gadgets, CNET published their Five Black Friday Deals You Shouldn’t Miss.  One of the deals that piqued my interest was Bing’s (Microsoft’s new Search Engine) Gold Rush program.  They’re offering 3%, 10%, and sometimes 35% cashback for online shoppers.  If you’re buying online, you might want to check out Bing first.

Disclosure compliant with FTC 16 CFR Part 255 covering writer, editor, and publisher: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

The Great Depression taught Americans about thrift, a virtue largely absent from society in recent years.  Now thrift is mainstream once again. Opulence is out and living frugally in. The New York Times points out these new realities…

“Millions of Americans spent years tapping credit cards, stock portfolios and once-rising home values to spend in excess of their incomes and now lack the wherewithal to carry on. Those who still have the means feel pressure to conserve, fearful about layoffs, the stock market and real estate prices.

Some suggest the recession has endured so long and spread pain so broadly that it has seeped into the culture, downgrading expectations, clouding assumptions about the future and eroding the impulse to buy.”

In addition to curbing their purchase decisions, consumers are saving more. According to the Bureau of Economic Analysis, Americans saved 2% of their income in 2007. The savings rate has improved to over 4% in recent months – a 100% improvement motivated by economic uncertainty.  We’re living in an age of scarcity now – or so thinks the culture.

Why this change? The US economy has lost 6.7 million jobs since the onset of the recession in December 2007. Everyone knows someone who has lost a job, making the income problem palpable. Many have lost income due to the downturn, making the problem real. Some could lose our jobs in the next round of cuts, making the problem scary. No wonder consumers are thrifty these days.

With consumers accounting for around 70% of the US economy, investors should take note of the renewed sense of value. Companies known to provide products and services at a better price will do better than those perceived as more costly. Whether or not the short-term rally continues, look to the new value culture for new opportunities.