Reversion to the Mean

One of the most important concepts in investing is reversion to the mean. This is a fancy way of saying things tend to return to normal.

You have probably noticed that like a pendulum the stock market is subject to wide swings up and down, and like a pendulum spends little time in the middle. This is true of the market as a whole and in the groups and individual securities that make up the market. Everything seems to go too high or too low.

Look at the chart above of the S&P 500 rolling monthly returns from 1975 to 2006. The mean (average) return for this period was about 13% but the rolling annual returns varied from up almost 50% to down nearly 30%. While there is no rhyme or reason to the swings of this pendulum you should be able to see that when things look the best you should be taking some profit, and when things look the worst you should be buying bargains. Trouble is this goes against what comes naturally.

This process of reversion to the mean takes place in all subsets of the market too. Remember tech stocks in late 99 and early 00? Or telecom? Or oil? For the last few years small caps have been outperforming and many on Wall Street have predicted a resurgence in large company growth that has yet to materialize, but has shown recent strength relative to small and mid size companies. Maybe it is finally time for their reversion to the mean.

The first step to profiting from this phenomenon is to recognize its existence. The next step is to have the discipline and courage to act. Remember, things are never as good or as bad as they seem.

technorati tags:Finance, investing, Stocks

More Miscellany

Want to know how inflation impacts your money? Here is a site that will tell you how much purchasing power your dollar has lost. Inflation Calculator.

With fuel prices rising you might want to know how far you can travel for each dollar you spend. Look at Miles per Dollar.

Keeping up with the Joneses got you down. You are not alone. Read more here.

Time Warp

Beloit College publishes a list each year of things that make the freshmen class unique. Some of the differences in perceptions of the world are quite remarkable. For freshmen entering college this year:

• The Soviet Union has never existed
• There has always been only one Germany
• DNA has always been admissible in court
• Google has always been a verb
• Bar codes have always been on everything
• Madden has always been a game, not a Super Bowl winning coach
• Reality shows have always been on television
• They have always been searching for "Waldo"
• Television stations have never ended the broadcast day playing the national anthem
• Professional athletes have always competed in the Olympics

You can read the entire list here.

Miscellaneous

Here are a couple of links to essays by Kathy Sierra you may enjoy. Nothing to do with financial planning, just some observations on life.

You Won't Regret It

The Clueless Manifesto

The Estate Plan For Your IRA

Assets can transfer to your heirs in one of two ways when you die. They can transfer by will, which includes probate court and public filing of related documents, or they can transfer by contract.

The advantages of having your assets transfer by contract include:

• Privacy - The details of a contract are private and not subject to the public scrutiny of your will and the probate system.
• Speed - Contractual agreements transfer outside of the probate process and so are not subject to the delays that often arise during probate.
• Expense - By transferring assets outside of the probate process you and your heirs could save significant money in probate fees (these fees vary from state to state).
  

Examples of assets that transfer by contract include accounts or assets titled Joint Tenants with Right of Survivorship, Transfer on Death and Pay on Death accounts, Life Insurance and Annuity contracts, Trusts, and your IRA and 401k accounts if you complete the beneficiary forms correctly.

When you first establish an IRA or 401k, an annuity or life insurance contract, you are provided a form to name beneficiaries. If you fail to complete these forms the assets will usually pass back into your estate and become part of the probate process. By naming a beneficiary or beneficiaries you can let these assets transfer by contract. You should also name contingent beneficiaries and choose whether you want the assets to transfer per stirpes or per capita. By filling out these beneficiary forms you are insuring that your wishes are honored after your death.

Many people name only a spouse as a beneficiary. If the couple have children or grand children they wish to provide for they should consider making them contingent beneficiaries to preserve the tax benefits of an IRA (however if the children or grandchildren are minors be sure a guardian has been named or the funds will be encumbered until the courts name a guardian).

Currently only surviving spouses can transfer assets from their deceased spouse's 401k to their own IRA, but the recently enacted Pension Protection Act of 2006 will extend that privilege to any beneficiary after 2007.

The bottom line is beneficiary forms are an integral and important part of your estate plan. Choosing the right way to transfer these assets can save time and money, but can also be confusing. If you are unsure how to proceed choose a professional to help you, but don't delay.

technorati tags:Finance, estate planning, IRA

The Security Of Your Securities

On more than one occasion a client has come to me with securities they have found or received from an inheritance that they cannot find a value for. Sometimes it is a company that is now defunct, or it could be that there was a buyout or merger in the past where the original company is no longer in existence. But they have a certificate and no idea of the value.

Sometimes when a client has a relative die they know the deceased had shares of a company but they can't locate the certificate, or they receive a dividend check from a company they knew nothing about.

Having physical possession of stock and bond certificates can make things hard for your heirs and yourself. If a certificate is lost or stolen the owner must complete an affidavit with the facts surrounding the loss or theft, obtain a indemnity bond to protect the corporation and the transfer agent against the possibility that the certificate may be presented later by an innocent purchaser, and the request must be made before must be received before the company receives notice that the missing certificate has been acquired by another bona fide purchaser. Indemnity bonds generally cost about 2% of the value of the lost certificates.

In the event of a corporate merger or acquisition you may overlook the instructions for having certificates of the new company issued and your heirs may not know what happened to the company you originally invested in. If the certificates become part of your estate an affidavit of domicile and copy of your death certificated must be sent to each company to have the shares reissued to your heirs.

Finally, if you wish to sell your shares they must be presented and deposited with a broker dealer before they can be sold. This could cause an inopportune delay in executing your sale.

Having your certificates held in an investment account can make things much easier. You will be informed of any corporate actions requiring your attention, any changes in corporate name, merger, or acquisition will be handled by your custodian, your shares will be in a safe place, will be available for sale on any day the market is open, and if you die your heirs only have one entity (your brokerage firm) to provide with affidavit of domicile and death certificate.

technorati tags:Finance, stock certificates, financial planning