Kids Or Cash: The Modern Marriage Dilemma

For prospective parents, weighing the decision to have children has not gotten any easier. According to a 2008 study by the United States Department of Agriculture (USDA), parents who grossed at least $56,870 a year spend a total $291,570 to raise a child to the age of 18.

In the U.K., the cost of raising a child to the age of 21 outside of expensive London is estimated to be about £180,000 (about US$297,000), according to a 2006 survey by the Liverpool Victoria Society. The financial dilemma, therefore, is similar for many developed countries. If household incomes were unlimited, the decision to raise children might be a strictly personal choice. In reality, however, the decision to have children is also a financial one. In this article, we'll provide some food for thought from the financial side of the equation.

The Expenditures
If $291.570 sounds like a lot of money to you, consider that the statistics cited in the study are actually lower than the cost of raising a child because they are based on the cost of raising the younger child in a household that consists of two adults and two children. To estimate the cost of raising an only child, all expenses should be multiplied by 1.25. (For further reading, see Don't Forget The Kids: Save For Their Education And Retirement and Investing In Your Child's Education.)

Family Income	Family with Two Children	Only Child
Up to $56,870	$210,340	$262,925
$56,870 to $98,470	$291,570	$364,462
Over $98,470	$483,750	$604,687

Figure 1: The cost of raising a child to the age of 18 for different income classes in two-parent families Source: Expenditures On Children By Families (2008), USDA.

Figure 2 shows the breakdown of the average expenses for a two-child family earning more than $56,870 per year. Where does all the money go? These are the major expenses cited in the USDA study:

Housing	32%
Food	16%
Transportation	14%
Clothing	6%
Healthcare	8%
Childcare and Education	16%
Miscellaneous	8%

Figure 2: A breakdown of the average child-raising expenses for the younger child of a two-child family. Source: Expenditures On Children By Families (2008), USDA.

Of course, the old adage "the more you make, the more you spend" certainly applies to child rearing. Families earning a higher pretax income spend considerably less to raise a child to age 18. Lower-income families spend less to raise their children because they are financially unable to offer them the same amenities available to higher-income earners.

Being a "DINK"
Families that consist of two working adults and no children (also known as dual income with no kids, or DINKS) are sometimes stereotyped as hedonists or are decried by child-rearing families as shirking their moral imperative to procreate. Righteous indignation aside, a quick reality check will help us focus strictly on the economic aspects of the child/no child decision.

According to the U.S. Census Bureau, traditional families - defined as a married couple with children - represented 26.3% of the U.S. population in 1990. By 2002, that number had declined to 23.6%. It fell again in 2007, to 22.5%. A similar trend can be seen in England and elsewhere in the industrialized world.

The Economics of Family
Economics quite obviously plays a role in the decline of traditional families. People are waiting longer to get married and are having fewer children, in part because life is becoming increasingly expensive. (To read more about weddings, see Revealing The Hidden Costs Of Weddings.)

Young couples also face the financial challenges of paying off student loans while paying for other living expenses such as rent/mortgage, car payments, food, clothing, utilities, and saving for retirement. (See Delay In Savings Raises Payments Later On and The Indiana Jones Guide To Getting Ahead.)

No Kids? Why Get Married?
Love and affection aside, coupledom provides greater financial stability than going it alone. When both people work, all but the most foolhardy couples enjoy significantly greater financial benefits than other families. So, smart couples can leverage marriage to increase income and decrease expenses. Instead of making two rent or mortgage payments, these couples make one. Likewise, most utility bills have a minimum payment that would be higher if the couple was living apart than the incremental increase in living together. The most financially savvy couples live on one income and save the rest. They usually have two employers from which to choose health plans and won't have to worry about bankruptcy if one income earner is temporarily unemployed.

Economically speaking, the absence of children results in lower fixed expenses. It also results in more money to spend. Regardless of your feelings about children, the bottom line is that you can do a lot of nice things for yourself, your spouse and your finances with the hunreds of thousands of dollars that it takes to raise a child to age 18.

Conclusion - Kids or No Kids?
Economic reality forces tough choices. The decision to have children is a politically sensitive topic; those who have children abhor the cold economic reality that DINKS factor into their equation, while some DINKS maintain the view that unchecked population growth contributes to environmental strain. In the end, having children is still a deeply personal and challenging choice - just remember to add the financial implications of raising children into the equation. You need to review your personal situation and make the choices that are right for you and your family, whether it will consist of two people or 10.

by James E. McWhinney

James McWhinney has been a professional writer for nearly two decades. He has worked for many of the nation's top mutual fund providers and banks in addition to numerous magazines, websites and other publications. He specializes in financial services and travel.

Read more: http://www.investopedia.com/articles/pf/06/kidsorcash.asp#ixzz1Q9rZ6RFo

The Rectangle Formation

The rectangle is a classical technical analysis pattern described by horizontal lines showing significant support and resistance. It can be successfully traded by buying at support and selling at resistance or by waiting for a breakout from the formation and using the measuring principle. (To brush up on support and resistance, read Support And Resistance Reversals.)

The Rectangle in Classical Technical Analysis
The rectangle formation is an example of a "price pattern" in technical analysis. Price patterns derive from the work of Richard Schabaker, considered the father of technical analysis, and Edwards and Magee, who wrote what many consider the bible on the subject. (To learn more about technical analysis, see our Technical Analysis tutorial.)

This period of technical analysis derives from a time when charts were kept by hand on graph paper and even simple moving averages (SMA) had to be maintained by hand or with the use of a large, clunky adding machine. (To learn more about how technological advances changed the world of finance, read From The Printing Press To The Internet and The History Of Information Machines.)

Rather than modern technical analysis, which relies on indicators, such as moving average convergence divergence (MACD), technical analysts assumed that price patterns repeat themselves over and over throughout time. Pattern recognition meant pattern prediction and thus trading profit. (Learn more about moving averages in Moving Average MACD Combo and our Moving Averages tutorial.)

Many of the price patterns are based on geometrical figures. There are ascending, descending and symmetrical triangles, pennants and wedges. Occasionally, more fancifulshapes are seen, such as the head-and-shoulders formation. (For a closer look at the head-and-shoulders pattern, read Price Patterns - Part 2.)

The Rectangle: Supply and Demand in Balance
A price chart or graph may be thought of as an X-ray of supply and demand. Figure 1 describes a rectangle pattern where supply and demand are in approximate balance for an extended period of time. The shares move in a narrow range, hitting resistance at the rectangle’s top and finding support at its bottom. The rectangle can occur over a protracted period of time or form quickly amid a relatively wide-ranging series of bounded fluctuations. Schabaker notes that it can approach a square in its proportions. In any case, it is a pattern which shows trader indecision, one in which the bulls and bears are approximately equally powerful. (For a refresher on supply and demand, read Economics Basics: Demand And Supply.)

Figure 1

Most technicians agree, the rectangle can serve as either a reversal or continuation formation. As a reversal pattern, it ends a trend either up or down. As a continuation pattern, it signifies a pause in the prevailing trend, with the expectation that the prior trend will eventually resume. In either case, the rectangle shows a tug of war between buyers and sellers. Ultimately, either accumulation or distribution prevails, and the shares breakout or breakdown. (Read more about how to profit during breakouts and breakdowns in Trading Failed Breaks. Learn about confirming trends in Trend-Spotting With The Accumulation/Distribution Line.)

"Significant" Support and Resistance
The concepts of support and resistance are critical to understanding the rectangle formation.

• Support is defined as any price point below the current market price where buying should emerge to create, at least temporarily, a pause in a downtrend.
• Resistance, on the other hand, is any price above the current market price where selling should emerge to create, at least temporarily, a pause in an uptrend.

In a rectangle, what may be referred to as "significant" support or resistance emerges - that is, a price level returned to again and again. Whereas trendlines in technical analysis are typically drawn on a diagonal, the diagramming of support and resistance requires horizontal trendlines. (Read more in Track Stock Prices With Trendlines.)

ImClone Systems: an Example of a Rectangle Formation
Figure 2 of ImClone Systems (IMCL) employs open-high-low-close bars (rather than candlesticks) and is absent of any indicators, such as MACD. The only addition is a 30-week moving average (MA), which could have been calculated in the classical era. (Read about the ImClone meltdown in Trader’s Corner - Shoot The Moon…And Hit It!)

Figure 2

Several observations are worth making on this chart. First, note that an intermediate uptrend line, in force for approximately one year, is broken. The break shows the uptrend has ended. Thus, the prolonged rectangle can either be a reversal or consolidation formation. Until there is a breakdown or breakout from the confines of the rectangle - roughly $37.50 to $47.50 - the pattern's interpretation is uncertain.

Second, horizontal lines drawn on the chart denote significant support and resistance. Significant support was first established in September, tested twice in the early part of the year and retested in June. At each test of support, there was sufficient buying interest to drive the stock higher.

Significant resistance at $47.50 was first touched in August, then probed in October, April and July. At each juncture, the sellers overwhelmed buyers, and the stock receded. This vacillation between significant support and resistance creates the rectangle shape.

One final observation is the slope of the 30-week MA. Of all moving averages, this may best describe the trend. It relates to the rectangle by showing the sideways nature of the formation. In an uptrend or downtrend, the 30-week MA will slope up or down, not sideways. Note how in the early stages of the chart it sloped higher, mimicking the uptrend. Later it flattened and began to slope sideways, showing the prolonged consolidation.

Trading the Rectangle
The following are two basic strategies for trading a rectangle:

• The first is to buy at support and sell at resistance (one can also sell short at resistance and cover the short sale at support). To mitigate risk, in case the stock breaks down from support, a very tight stop can be employed of perhaps 3%. For example, if one bought ImClone at $37.50, the stop-loss would be 3% lower than $37.50 or $1.12. The trader would exit the position if the stock hit $36.38 ($37.50-$1.12).
• Another method to trade the rectangle is to wait for the breakout. As with all technical patterns, this breakout should ideally occur on above-normal volume. To know when to consider exiting the trade, the trader could use the measuring principle described below. (Learn more about volume in Gauging Support And Resistance With Price By Volume.)

The Measuring Principle
The measuring principle allows you to set a specific minimum price target. Such a target should give you the objectivity to hold during periods of minor countertrend movement.

The measuring principle works with any well-defined technical analysis pattern, such as a rectangle or triangle. To calculate the minimum target, first establish the height of the pattern. In the case of ImClone Systems Figure 3 shows the calculation as follows:

Top:	$47.50
Bottom:	$37.50
Height:	10.00 points

Figure 3

For a bullish breakout, once the height of the pattern has been established, add the difference to the breakout level. Since the breakout level is $47.50 and the height 10 points, the minimum target is $57.50. Of course, it may take some time to reach the target, so the trader must be patient. As well, the measuring principle is a statement of probability, not a guarantee. The trader will carefully monitor the technical picture of the stock despite the target. (Read more in The Anatomy Of Trading Breakouts.)

How was the rectangle in IMCL resolved? Bristol Myers Squibb bid $60 a share to acquire the 83% of ImClone it did not already own. Shareholders who had seen their stock go nowhere for a year, and saw the shares close at $46.44, woke up the next morning to find their stock had opened at $64.16, well beyond the minimum target set by the measuring principle. Those who traded the rectangle, in this case, turned out not to be "square."

Conclusion
In summary, the rectangle is a classical technical analysis pattern bounded by significant support and resistance and described by horizontal trendlines. The pattern can be traded by buying at support and selling at resistance or buying the breakout and employing the measuring principle to set a target.

by Melvin Pasternak

Dr. Melvin Pasternak integrates technical and fundamental analysis in his approach to the stock market. He has taught both of these disciplines for more than 15 years to T.D. Waterhouse investors as well as a college-level course. For almost five years, he wrote a newsletter aimed at short-term investors called The Swing Trader. He is also the author of "21 Candles Every Trader Should Know", which teaches how to use Japanese candlesticks and indicators such as stochastics in short-term trading.

Read more: http://www.investopedia.com/articles/trading/08/rectangle-formation.asp#ixzz1Q9rCE9Sp

Traditional MBA Or Business Graduate Degree?

Young professionals and recent college grads who wish to advance their careers often look upon a Master of Business Administration (MBA) degree as a means for achieving their professional goals. While there are exceptions, MBA programs are generally two-year commitments that may instill training and knowledge in specific fields (information technology, finance, etc.) as well as management skills that require soft and intangible skill sets (teamwork, leadership, negotiation).

The latter approach attempts to enhance managerial skills with the aim of progressing the professional's career, which comes with added responsibilities, expectations and a larger scope of assignment. In other words, many young professionals pursue an MBA in order to better position themselves for a vice president, CFO or CEO job in the future.

It is possible, however, to attain higher levels of responsibility and visibility within your organization by pursuing an advanced degree in business that is not an MBA. The academic universe offers a variety of programs that are tailored to individual goals and circumstances. An MBA program generally emphasizes a case study approach as it develops and molds future business leaders out of class participants possessing varied educational backgrounds, work experiences, career goals, and skill levels. (For background reading, see The Real Cost Of An MBA.)

MBA Characteristics
An MBA is a one-size fits all product, instilling just enough functional knowledge (in statistics, accounting, finance, etc.) while equipping and molding students with business skills that may be utilized in a whole host of future situations and settings. Real world case studies can involve finding the optimal debt-to-equity mix for a publicly-traded company, solving logistical scheduling problems for a transportation company, or coming up with a differentiated and innovative marketing campaign for a brand new product. Most MBA programs push students to secure a summer internship with a company and/or an ongoing consulting/CO-OP project with an organization as part of the emphasis on grooming future generalist managers.

While popular media may be heavily skewed in its coverage towards the one-size fits all approach of a MBA, young professionals – given their career interests and personal goals – may instead be more suited to either a more specialized and technical program or a more research-intensive, academic program. (For some other options, check out Alternatives To Business School.)

Alternative Master's Programs in Business
There is a broad array of advanced programs being offered by colleges and universities across the United States. For instance, a professional can obtain a graduate degree in the following fields:

1. Master of Accounting
2. Master of Taxation
3. Master of Finance
4. Master of Statistics
5. Master of Actuarial Science
6. Master of Risk Management / Insurance
7. Master of Organizational Behavior
8. Management
9. Master of Economics

More Flexible Than an MBA?
Programs within specific functions of a company or organization, such as the above, can typically range from one-year to three-year programs. An applicant without a spouse or family has the option of opting for a shorter and more intensive one-year or two-year program. However, those who want to keep earning a salary and/or have family obligations to attend to can often request the dean of the program to extend the duration of his or her program in order to pursue a part-time schedule. Because universities are motivated to attract talented candidates into their master's programs for positioning and ranking purposes, they can offer flexibility for those they are confident have the ability to complete the requirements of the advanced degree.

An MBA is not typically required to make partner at a CPA firm. So it may make sense for a degreed accountant or CPA to invest his or her time and money in a master's degree in accounting or taxation instead, allowing him or her to focus on priority areas or interests such as regulatory compliance, estate planning or financial reporting. Clients of the CPA firm can spend hundreds of dollars for each hour of the CPA's time, and they will want practical, immediate, and effective solutions to their accounting or tax problem. A research or consulting firm may also want similar expertise from a credited statistician or an economist. (To learn more, see CPA, CFA Or CFP – Pick Your Abbreviation Carefully.)

Should a professional decide to become a specialist in his or her field and work on cutting-edge issues or advances, a graduate level degree (such as a master's or PhD) with guidance, can provide the opportunity to conduct research in emerging issues and areas deemed important either by industry, the government or the academic community. Generating new findings in your field can be an exciting way to contribute and shape initial impressions on new areas. A summer internship at an investment bank or Fortune 500 company, after your first year in the MBA program, won't get you there. You'll probably be working on a cookie-cutter process improvement project or product analysis assignment. (For more, see CFA, MBA… Or Both?)

Conclusion
If you want to become a generalist manager, CFO or division president, an MBA may be the right tool for you. However, if you enjoy being a subject matter expert such as an economist, an estate planner, a tax accountant, a statistician, a risk management consultant or an actuary, you may want to consider an advanced degree in your field. (For more, read Business Grads, Land Your Dream Job.)

by Marv Dumon

Marv Dumon serves as Business and Finance Examiner and International Sports Examiner for Examiner.com. He previously served as a mergers and acquisitions advisor for a middle-market financial services firm. Dumon's background includes experience in consulting, finance and operations. He received BA, BBA, and MPA degrees from The University of Texas at Austin.

Read more: http://www.investopedia.com/articles/professionaleducation/09/business-grad-degree-vs-mba.asp#ixzz1Q9qqfD7F

Rules For Post-Recession Investing

Despite the pundits' pronouncements of green-shoots or signs that the economy is on the mend, many investors remain scarred and understandably sensitive to the previously unimagined threats to capital market stability. In many cases, not only have they reduced their equity exposure to levels that will not help them beat inflation, many have pulled out of the publicly-traded markets entirely, and remain on the sidelines.

Return to Investing
If you are planning to retire on the assets you have accumulated or are accumulating, you need to get exposure to the equities markets and you need to do that sooner rather than later. Global equities markets work and you deserve your share of the positive long-term returns they generate.

Generally, market declines cause panic, to quote a study by DALBAR - a leading developer of measurement systems for intangibles, such as customer behaviors, in the financial services industry. A 2003 study by DALBAR found "motivated by fear and greed, investors pour money into equity funds on market upswings and are quick to sell on downturns." The report goes on to say that in the past 19 years, the average equity investor has earned 2.57% annually compared to 12.22% for the S&P 500 Index. This study clearly illustrates the "reactive" nature of today's investors and just how much it costs them in return. It's important to recognize how much emotions influence investing decisions most often to investors' detriment.

Keys to Excellent Returns
As investors slowly emerge from their fear-induced stupor, it is important to review important principles which have provided excellent risk and inflation-adjusted returns over the last 50 or more years. With these foundational principles in place, the investor will be ready to participate in the global capital markets.

• Don't Forget About Your Risk Tolerance
  Return statistics are perhaps the most quoted numbers in personal finance and investing. Quantitative measures of risk or volatility are undoubtedly the least quoted. When you look at your risk tolerance, consider three factors: capacity to take investment risk, need to take investment risk and desire to take investment risk. There are many questionnaires and other tools online that attempt to help investors measure these variables. Use them as a sanity check for your own measures given your previous investment experiences.
  
• Draft and Sign an Investment Policy Statement (IPS)
  Institutional investors, like pension funds and university endowments, have a document which defines the types of investments allowed in their portfolios. Good fiduciary investment managers have an IPS for each of their clients. An IPS takes all the relevant inputs and creates your own personal investment plan and diversified asset allocation. Essentially, the IPS helps you stick to the plan and tells you what to do when in doubt.
  
• Keep The Investment Decisions Simple
  With an IPS in hand, you now have specific marching orders to populate your portfolio with actual securities. Index mutual funds and exchange-traded funds (ETFs) reduce costs and provide broad exposure to specific asset classes. To my knowledge, no one has been able to "beat the market" year in and year out, so active investment management is not a reasonable option. Keep costs low and stay invested. That is how the race is won and your goals are achieved.

These are foundational steps in the construction of your portfolio. The next question is, "How should you get back in?" This question essentially refers to the two primary options: put it all in at once or stage the money in over time. Which is best?

All at Once
For investors who have just experienced one of history's most challenging economic periods, this option must seem the least interesting. However, in a world where market timing does not add additional return and where the expected returns are positive, it makes the most sense. Any averaging-in strategy will keep money out of a rising market. Nevertheless, averaging techniques remain very popular in the financial press and in practice. The reason for this is primarily because it feels good.

Averaging Into the Market Over Time
If you accept that you need exposure to the equity markets, there is a high probability that you will consider averaging into the market versus making a lump sum investment. Given that likelihood, what is the best way to average into the market? Quite simply, it depends on larger financial planning concerns like your need for cash and outstanding obligations. Beyond that, the options are innumerable: contribute a set amount; a set percentage of the remaining balance; a fixed dollar amount; a variable amount based on fluctuations in the market; a variable amount on a random schedule and on, and on. Here are a few important considerations as you consider your strategy:

• Formalize the plan by writing it down.
• Be careful of executing too many trades thereby incurring very high transaction costs. The research overwhelmingly states that the benefits are marginal at best and most likely are negative, so don't erase the emotional benefit by piling on hundred or thousands of dollars of trading fees. No-transaction fee mutual funds can be beneficial in this area.
• Be careful of dollar-cost averaging up. If the market is rising, you will be buying higher and higher levels. Remember, the market has had, and we expect that it will continue to have, a positive bias as global economies continue to rise. If you divide your investment into too many pieces, you will end up investing the money over an ever longer period of time and therefore increasing the probability of dollar-cost averaging up.
• Try to divide the investments among the least correlated assets. For example if you are going to invest $10,000 into five different investments, try to pick U.S. large cap, international large cap, commodities, real estate and maybe fixed income.

Conclusion
No one really knows when it is "safe" to get back into the markets, or whether the market is experiencing a dead cat bounce, sucker rally, V-shaped recovery or W-shaped recovery. You will not receive an email, phone call or other advance notice saying, "Now is the time!" More than likely, when the news is rosy and you start feeling safe about getting back in, you will have done irreparable damage to your ability to keep pace with the market. Do your best to keep emotions out of your investments and jump in.

by Rob Gordon and Jason Whitby

Rob Gordon, CFP, AIFA, has worked in personal financial planning and investment management for 10 years providing financial planning and investment management for a wide variety of clients and institutions. He also spent four years as a commodities trader with British Petroleum. Additionally, his professional experience includes work in economic development with the U.S. Peace Corps in Central America. He has a Bachelor of Arts degree in economics from Dartmouth College and an MBA from the Darden School at the University of Virginia. He is a Certified Financial Planning practitioner (CFP) and an Accredited Investment Fiduciary Analyst (AIFA).



Jason Whitby, CFP, CFA, MBA, AIF, has been working in the financial services industry since 2001, providing financial planning and investment management for high-net-worth clients and institutions. His prior experience encompasses security research, portfolio construction and risk management. Prior to his financial services career, Whitby was employed in the semiconductor industry working in engineering, sales and finance. He has a Bachelor of Science degree in chemical engineering from Purdue University and an MBA from Santa Clara University with a concentration in finance. Additionally, he is a Certified Financial Planning practitioner as well as a Chartered Financial Analyst and an Accredited Investment Fiduciary.

Read more: http://www.investopedia.com/articles/stocks/09/returning-to-stock-market.asp#ixzz1Q9qS2WvD

7 Ways To Recession-Proof Your Life

Are you worried about how a recession might affect you? You can put your fears to rest because there are many everyday habits the average person can implement to ease the sting of a recession, or even make it so its effects aren't felt at all. In this article, we'll discuss seven ways to do just that.

No. 1: Have an Emergency Fund
If you have plenty of cash lying around in a high-interest, Federal Deposit Insurance Corporation (FDIC)-insured account, not only will your money retain its full value in times of market turmoil, it will also be extremely liquid, giving you easy access to funds if you lose your job or are forced to take a pay cut. Also, if you have your own cash, it won't be an issue if other sources of backup funds dry up, such as a home equity line of credit. (For related reading, see Are Your Bank Deposits Insured? and Bank Failure: Will Your Assets Be Protected?)

No. 2: Always Live Within Your Means
If you make it a habit to live within your means each and every day, you are less likely to go into consumer debt when gas or food prices go up and more likely to adjust your spending in other areas to compensate. Debt begets more debt when you can't pay it off right away - if you think gas prices are high, wait until you're paying 29.99% annual percentage rate (APR) on them. (Learn how to stick to your budget every day in Squeeze A Greenback Out Of Your Latte and Nine Reasons To Say "No" To Credit.)

To take this principle to the next level, if you have a spouse and are a two-income family, see how close you can get to living off of only one spouse's income. In good times, this tactic will allow you to save incredible amounts of money - how quickly could you pay off your mortgage or how much earlier could you retire if you had an extra $40,000 a year to save? In bad times, if one spouse gets laid off, you'll be OK because you'll already be used to living on one income. Your savings habits will stop temporarily, but your day-to-day spending can continue as normal.

No. 3: Have More Than One Source of Income
Even if you have a great full-time job, it's not a bad idea to have a source of extra income on the side, whether it's some consulting work or selling collectibles on eBay. With job security so nonexistent these days, more jobs mean more job security. If you lose one, at least you still have the other one. You may not be making as much money as you were before, but every little bit helps.

No. 4: Have a Long-Term Mindset With Investments
So what if a drop in the market brings your investments down 15%? If you don't sell, you won't lose anything. The market is cyclical, and in the long run, you'll have plenty of opportunities to sell high. In fact, if you buy when the market's down, you might thank yourself later. (To learn more, read The 3 Most Timeless Investment Principles, Four Tips For Picking Stocks In A Recession and Market Bottom: Are We There Yet?)

That being said, as you near retirement age, you should make sure you have enough money in liquid, low-risk investments to retire on time and give the stock portion of your portfolio time to recover. Remember, you don't need all of your retirement money at 65 - just a portion of it. The market might be tanking when you're 65, but it might be headed to Pamplona by the time you're 70.

No. 5: Be Honest About Your Risk Tolerance
Yes, investing gurus say that people in certain age brackets should have their portfolios allocated a certain way, but if you can't sleep at night when your investments are down 15% for the year and the year isn't even over, you may need to change your asset allocation. Investments are supposed to provide you with a sense of financial security, not a sense of panic.

But wait - don't sell anything while the market is down, or you'll set those paper losses in stone. When market conditions improve is the time to trade in some of your stocks for bonds, or trade in some of your risky small-cap stocks for less volatile blue-chip stocks. If you have extra cash available and want to adjust your asset allocation while the market is down, however, you may be able to profit from infusing money into temporarily low-priced stocks with long-term value.

The biggest risk is that overestimating your risk tolerance will cause you to make poor investment decisions. Even if you're at an age where you're "supposed to" have 80% in stocks and 20% in bonds, you'll never see the returns that investment advisors intend if you sell when the market is down. These asset allocation suggestions are meant for people who can hang on for the ride.

No. 6: Diversify Your Investments
If you don't have all of your money in one place, your paper losses should be mitigated, making it less difficult emotionally to ride out the dips in the market. If you own a home and have a savings account, you've already got a start: you have some money in real estate and some money in cash. In particular, try to build a portfolio of investment pairs that aren't strongly correlated, meaning that when one is up, the other is down, and vice versa (like stocks and bonds). (Read more about this important investing strategy in Introduction To Diversification, The Importance Of Diversification and Diversification Beyond Equities.)

No. 7: Keep Your Credit Score High
When credit markets tighten, if anyone is going to get approved for a mortgage, credit card or other type of loan, it will be those with excellent credit. Things like paying your bills on time, keeping your oldest credit cards open, and keeping your ratio of debt to available credit low will help keep your credit score high. (To learn more about your credit score, see Five Keys To Unlocking A Better Credit Score and The Importance Of Your Credit Rating.)

Conclusion
The best part about these habits is that they won't only serve you well during times of recession - they'll serve you well no matter what's going on in the market. But if you implement these financial strategies, a recession is less likely to have a significant effect on your financial situation.

by Amy Fontinelle

Amy Fontinelle is a financial journalist and editor for a variety of websites, public policy organizations, and book publishers. She has written hundreds of published articles and blog posts on topics including budgeting, credit management, real estate and investing. Her articles have been featured on the homepage of Yahoo! and on Yahoo! Finance, Forbes.com, SFGate.com and numerous local news websites

Read more: http://www.investopedia.com/articles/pf/08/recession-proof-your-life.asp#ixzz1Q9pjafWl

Einstein's Stock Tips: Gravity and Growth

Albert Einstein changed the universe from a mechanical construct where all things follow a set of static rules to a place where everything, including time and space, is bent by relativity. Although the theory of relativity is important in the study of physics, it also offers an interesting view into the world of investing. This article will use some of Einstein's main discoveries to gain some perspective on the problem of telling real growth from irrational pricing.

Determining True Value
When considering the problem of gravity, Einstein encouraged people to picture a man in a box that is traveling through space at a uniform velocity. For example, Person A on earth and Person B in a rocket - unaware that he is in a rocket - will both draw the same conclusions about their planet's gravity. When they drop an object, it falls toward the floor. However, if the rocket stops moving, Person B will realize that he is wrong - in the split second before momentum smashes him against what he thought was the ceiling. (To learn more about momentum, read Momentum Trading With Discipline.)

This theoretical situation is easily extended to the stock market. If we imagine gravity as the true value of a stock (or the true worth of the company it represents) and the rocket as a shooting star (a stock with a value that quickly inflates without reference to the value of the underlying company) we can apply relativity to tell the difference.

One of the biggest challenges is trying to remove yourself from the market in order to see both the rockets and the heavenly bodies. One of the places investors should search is the balance sheet. The balance sheet can be used to compare the stock price relative to its earnings per share (EPS) and examine whether the price is justified by its price-to-book ratio (P/B ratio), or is just based on analyst enthusiasm. (For related reading, see Clone Cost Reveals True Value.)

Mass Vs. Fuel
In order for a heavenly body to increase the amount of gravity it exerts, it has to increase in mass. The same is true for stocks; companies must expand in order to increase in value. This can be done by adding mass in the form of acquisitions and expansion into new markets. An increase in "gravity" can also be achieved by restructuring inefficient areas in the company. (For more, see Cashing In On Corporate Restructuring.)

Care must be taken when selecting what mass to add. The assets must have good "density" in that they already have reasonably good cost/gain ratios and that they will fit into the makeup of the company. When building a successful company, you need compatible components. We will look at compatible mass when considering the opposite of a heavenly body.

A rocket, or a stock that has detached from the value of the company and is accelerating, may take acquisitions, but the acquisitions merely provide "fuel" to the acceleration. This often happens when the management of the company realizes its stock - and the company - is going to crash. The company will act aggressively in order to nurture the impression that it is growing in leaps and bounds, but the acquisitions are often zombies. (For more insight on crashes, read Bouncing Back From A Portfolio Hit.)

Sometimes, this sleight of hand is easily revealed, for example, when a company begins buying assets completely unrelated to its business model. Because these assets aren't compatible with its basic business model, they merely serve as fuel to inflame public perceptions about the value of the stock and the direction of the company. This can also be seen in investment funds that jump late into strong performers in order to appear aggressive before quarterly earnings come out.

Velocity, Time and Risk
There are momentum investors and traders who try to catch rockets on their way up and time it so they can jump off the investment when it reaches the apex of its flight. It is an extremely risky practice. Too often, people tend to look at risk in the stock market like risk in real life. (For related reading, see Personalizing Risk Tolerance.)

However, when timing stocks, the risk is difficult to calculate. If a stock takes off at Point A and will crash at Point B, properly timing it in order to profit will be difficult because its crash can be caused by random elements, such as an industry rumor or other noise. Additionally, like a rocket, an unstable stock has a velocity. Velocity has a warping affect on time – the more velocity something has, the larger the impact it has on the passage of time.

In terms of trying to trade at the top of a stock's rise, the faster a stock gains value, the smaller the margin of error becomes. Consequently, the time to make such a decision is shortened exponentially. So, breakneck velocity combined with uncertainty of the endpoint makes a rapid and fatal ride for most investors.

Conclusion
The theory of relativity is an odd place to look for advice on investing, but by framing investing problems in new ways, we can sometimes see things that were closed to us before. Physicist and investors share the common problem of making accurate observations in a world that refuses to sit still and wait.

by Andrew Beattie

Andrew Beattie is a managing editor and contributor at Investopedia.com. He operates the Wandering Wordsmith blog, and can be reached there.

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Lobbying: K Street's Influence On Wall Street

Author Donald E. deKieffer of "A Citizen's Guide to Lobbying Congress" (2007) notes, "there is not an American today who is not represented (whether he or she knows it or not) by at least a dozen special interest groups."

Power and influence are the trademarks of Washington D.C.'s K Street, a major thoroughfare that is known as a hotbed for lobbyists, advocacy groups and think tanks. Investors may be more familiar with Wall Street newsmakers like Goldman Sachs (NYSE:GS) and ExxonMobil (NYSE:XOM) than the names of the most influential lobbying firms on K Street, but the stealth-like qualities of K Street lobbying firms adds to the mystique of these behind-the-scenes dealmakers, earmark creators and legislative advocates.

Through the use of contacts, promises and political will, money is allocated and laws are written in response to designs laid out by lobbying firms. Let's explore how these groups' powerful influence can shape the marketplace and impact your investment portfolio.

What Is Lobbying?
Lobbying is the act of persuading lawmakers to make decisions regarding legislation and appropriations in favor of individuals or interest groups. The right to "peaceably assemble, and to petition the government for a redress of grievances" is protected by the First Amendment of the U.S. Constitution. As such, governments, universities, corporations, mom and pop businesses, nonprofits and individuals recognize the power of lobbying and hire firms - or do the legwork themselves - to ensure that their interests are presented to legislators on Capitol Hill. The lobbying firms often employ well-connected former congressional members. For example, Bob Dole, a former Republican Senate majority leader, was hired by lobbying firm Alston & Bird LLP in 2003.

The term "lobbying" is rumored to have its origin from the nineteenth century, when legislators would meet in the lobbies of the Willard Hotel in Washington, D.C., to push the agenda of a particular group.

A satirical view of lobbying is portrayed in the 2006 film "Thank You for Smoking", in which a tobacco industry lobbyist is given the job of promoting smoking to the public just as the health risks of cigarettes are coming to light. The lobbyist's seemingly impossible task - and the arguments and twisted logic he often employs to make his case - highlight what are often perceived as the negative aspects of lobbyists' influence on government. The shifty side of the lobbying business was brought to light in 2005 during the trial and eventual conviction of Jack Abramoff, a former K Street lobbyist found guilty of fraud, tax evasion and conspiracy to bribe public officials.

Lobbying and Your Portfolio
The best way to spot companies that may benefit from the lobbying dollars spent on Capitol Hill is to monitor the records kept by the Center for Responsive Politics (CRP) at Opensecrets.org. Investors can also review the Washington Post, and news site Washingtonian.com for current lobbying news and any projects being taken on by a company's director of government affairs. It is possible that the companies or entities that spend the most stand to outperform their competition, but just as in politics, nothing can be considered a sure thing.

Types of Lobbyists
Influential lobbying firms represent large entities like foreign governments, states, universities, hospitals and corporations. Other large and small lobbying firms may specialize in fields like health and education policy, international trade and small business. Lobbyists representing nonprofits like the Alliance/Advancing Nonprofit Healthcare also exist. In other cases, individuals like Brian Hart can make lobbying a personal crusade. After losing his soldier son in Iraq in 2003, Hart lobbied Congress for armored Humvees and body protection for U.S. troops until, in January 2004, the Army agreed to double its order of armored Humvees .

Law Firm Lobbying vs. Private Lobbying
In terms of ownership, law firms tend to operate major lobbying firms. However, as of 2008, private lobby shops are becoming increasingly popular, and are operating unconstrained by the American Bar Association (ABA) restrictions followed by law firms. For example, the Dewey Square Group, which at one time advocated for "Mayors Against Illegal Guns", and the Ogilvy Government Relations, which counts the National Rifle Association (NRA) among its clients, are both owned by the U.K. based marketing services company WPP. There are also independent and volunteer lobbyist firms. The American League of Lobbyist (ALL) is a nonprofit organization that offers a comprehensive list of lobbyists and their areas of interest.

Funding
Lobbying fees can fall between $700,000 to $1 million per year depending on the project in question or the needs of the advocate. According to the CRP, the top three lobbying firms in 2007, Patton Boggs LLP, Akin Gump, and Van Scoyoc Associates earned $42.2 million, $31.7 million and $25.3 million in fees, respectively. In other words, the top three lobbying firms generated $99.2 million in fees during 2007, compared to $86 million in 2004. The CRP also notes that total lobbying spending has increased from $1.45 billion in 1998 to $2.82 billion in 2007.

By Issue and Client
According to the CRP, issues related to the federal budget and appropriations have outpaced all other causes from 1998 to 2008. Top issues following appropriations include health issues, taxes, defense and transportation. The top spenders by client records indicate that the U.S. Chamber of Commerce has been the top spender, having paid out over $398 million during the same time frame, followed by expenditures by the American Medical Association (AMA) and the multinational conglomerate General Electric (NYSE:GE).

Examples of Influence
The hands that can affect these decisions may go unseen, but the following examples offer some illumination in industries that have been touched.

1. Pharmaceuticals
   According to the Center for Public Integrity, the pharmaceutical industry spent a record $168 million in 2007 lobbying on Capitol Hill. Among other achievements, pharmaceuticals' lobbying efforts helped them avoid media restrictions related to their drug advertisements in the U.S. Major drug companies with strong ad campaigns affected by this decision include Bristol-Myers (NYSE:BMY), Pfizer (NYSE:PFE) and Eli-Lilly (NYSE:LLY). (To read more about drug manufacturers, see Measuring The Medicine Makers.)
   
   
2. Defense
   Washingtonian.com named the Podesta Group as one of the "50 Most Influential Lobbying Firms" in 2007. Along with representing large petroleum firms, the firm also lobbies Congress on behalf of defense contractors Lockheed Martin (NYSE:LMT) and General Dynamics (NYSE:GD). (For related reading, check out The Evolution Of Sinful Investing and Industries That Thrive On Recession.)
   
   
3. Oil Services
   Washingtonian.com also named Ogilvy Government Relations as one of the "50 Most Influential Lobbying Firms" in 2007. When a Chinese oil company attempted to buy Union Oil Company of California, Ogilvy led the charge against the deal, allowing its client Chevron (NYSE:CVX) to under-bid and win the battle for the takeover. (To read about investing in this industry, see A Guide To Investing In Oil Markets.)
   
   
4. Telecommunications
   During the first quarter of 2008, telecommunications providers, including AT&T (NYSE:T), Verizon (NYSE:VZ) and Comcast (Nasdaq:CMCSA) spent nearly $13 million on lobbying fees, seeking protection from surveillance lawsuits tied to illegal wire-tapping implemented after the September 11, 2001 attacks. (For related reading, check out Terrorism's Effects On Wall Street and Free Markets: What's The Cost?)

The Bottom Line
It is clear that lobbyists have gained considerable influence in Washington and their work can affect corporate performance and, as a result, financial outcomes for shareholders. Staying on top of the actions that the companies in your portfolio take on Capitol Hill is just one more way to get to know your investments and get a better sense of how they are likely to perform in the future.

by Gregory S. Davis

Gregory is a freelance writer for Investopedia.com. He has a consulting background in the banking, telecommunications and healthcare fields. Gregory is a graduate of the Wharton School of Business. Click here to visit his website.

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4 Key Indicators That Move The Markets

Every week, dozens of economic surveys and indicators are released and reported on in the business news. In fact, there are so many - and the data often makes such small moves - that it can be easy to overlook the importance of this data on the markets. However, as an educated investor, it's important to keep your finger on the pulse of the economy, and indicators are an important way to do that. This article will examine some of the most important economic and market indicators for investors to monitor. Get to know them, and you'll be better prepared to anticipate and react to future market developments.

Tutorial: Economic Indicators

Employment
Perhaps the most important indicator of the health of the economy is employment. On the first Friday of each month, the U.S. Bureau of Labor and Statistics releases its monthly unemployment report and nonfarm payroll; these indicate the current unemployment rate and how many jobs have been gained or lost by the U.S. economy, respectively. Market participants eagerly await these reports, and they often result in some of the biggest one-day movements in both bond and stock markets. The employee situation report also influences other important indicators, such as consumer confidence and consumer sentiment.

Because consumers make up nearly 70% of U.S. economic activity, the state of the labor market is of paramount importance to the overall well-being of the economy. This means that a weakening or strengthening labor market can influence the economy. For example, a weakening labor market often translates into lower corporate profits. The basic premise is that when people are out of work, they cannot buy homes or make the necessary purchases that drive corporate profits. (To learn more about the unemployment rate, see The Unemployment Rate: Get Real.)

Inflation
The mandate of the Federal Reserve is to promote economic growth and price stability in the economy. Price stability is measured as the rate of change in inflation, so market participants eagerly monitor monthly inflation reports in order to determine the future course of Federal Reserve monetary policy.

There are many indicators of inflation, but perhaps most widely known is the Consumer Price Index, or CPI. The CPI measures the change in consumer prices and theoretically determines to what extent life is getting more expensive for the average consumer. Another important measure is the Producer Price Index, or PPI. PPI fluctuations measure the rate of change in inflation for producer goods; if these prices increase substantially, it is more likely that companies will eventually pass the price increases along to consumers. Many economists and market participants prefer to analyze both CPI and PPI without the impact of food and energy, as these industries are known to be very volatile.

Market participants also keep track of the price of key commodities such as oil. Since oil is such a key component of economic activity around the globe, its price is worth paying special attention to. Increases in the price of oil can sometimes have offsetting effects. However, higher oil prices can lead to higher prices for a wide variety of goods because oil is part of many materials as well as a determinate in the cost of transporting goods waiting to be sold. (For more on inflation and the economy, see The Importance Of Inflation And GDP.)

Inflation is a useful metric of corporate valuation because the discount rate to perform discounted cash flow analysis factors is the rate of inflation. Higher inflation corresponds with a high discount rate and subsequently lower project value. On the other hand, deflation is also dangerous because decreased revenue means future layoffs for firms that cannot maintain their full workforce.

Consumer Activity
Changes in the activity level of consumers have a direct impact on corporate profits and the level of stock prices. There are several ways of measuring consumer activity. (What people buy and where they shop can provide valuable information about the economy. To learn more, see Using Consumer Spending As A Market Indicator.)

One of the most popular ways is to measure consumer confidence. There are several measures of consumer confidence; all are designed to determine how consumers feel about their economic prospects in the coming months. The theory is that when consumers feel more confident, they are more likely to spend; conversely, they are less likely to spend when they feel less confident. Also, because markets are forward looking, there is a tendency for stock prices to reflect the future opinions of consumers today. Another measure of the consumer is retail sales. While consumer confidence is forward looking, retail sales indicators reveal historic shopping patterns. (For more insight, read Understanding The Consumer Confidence Index.)

The housing market serves as another vital economic indicator. Although housing is highly localized and difficult to measure on a national basis, there are several indicators that do a reasonable job. Market participants pay attention to monthly releases such as housing starts, building permits and new home sales in order to get a reading on the level of activity in the housing market. Market watchers also monitor price changes through a variety of indicators such as the S&P/Case-Shiller Home Price Index which monitors home price changes in 20 large American cities. By synthesizing a variety of housing reports, market participants can deduce whether or not people are willing to make large purchases.

Investor Activity
In addition to economic indicators, market participants focus closely on measures of investor activity for market clues. Despite popular belief, the best time to invest is not when everyone is bullish but instead when most investors are bearish. If everyone else is bullish, there is no one left to buy and drive prices higher - but this does, of course, depend on your investment strategy. Therefore, readings of investor sentiment are important. A variety of indicators are available. Some are published by large investment firms or research firms, which periodically poll their clients to determine market consensus.

As overseas investors have become increasingly important participants in the U.S. financial markets, measures of their activities have garnered more attention. One of the most closely watched reports focuses the purchase of U.S. Treasuries by foreign central banks. When central banks are buying more Treasuries, interest rates often head lower – when rates are lower, stock prices tend to move higher. The reverse – less buying, higher interest rates and depressed stock prices – also tends to hold true.

Other important market indicators include advance/decline ratios and the number of new highs and new lows in the market. These readings indicate how healthy the overall stock market is and can provide confirmation as to the "quality" of a stock market advance or decline.

The Bottom Line
Knowing what economic and market indicators move markets is only half the battle; the real trick is interpreting the indicators and determining their likely market impact. In addition to the absolute level of an indicator, two other important factors to consider are the trend in the indicator and the market's expectation for that indicator. Taken together, these often determine the market's reaction to a given economic or market report. Learning to anticipate the market's reaction to various indicators requires careful monitoring of financial markets as well as experience interpreting these reports. As with most aspects of investing, hard work and persistence will help an investor determine the likely reaction to economic and market data. (To learn more about indicators, check out Leading Economic Indicators Predict Market Trends.)

by Brian Perry

Brian Perry is the author of From Piggybank to Portfolio: A Financial Roadmap for New Investors (2011) and also serves as a portfolio manager/strategist at an asset management firm. Brian has contributed numerous articles to investment industry publications, is a frequent speaker at investment conferences and charity events, and has appeared on NBC news to discuss the financial markets. Brian previously worked as a fixed income trader for an investment bank, where he was responsible for trading government, corporate and emerging market securities. Brian has a bachelor’s degree in finance from Villanova University, an MBA in international business from National University, and a master’s degree in international affairs from the Fletcher School at Tufts University. He also holds the designation of Chartered Financial Analyst (CFA).

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The History Of Money: Currency Wars

Money has played a very important role in every war since its creation. Ancient kings played with the percentages of precious metals in their coins to create more money to raise armies, feudal lords tried to undermine each other's treasuries and counterfeiters have run rampant throughout history. The most famous currency war, however, took place between the British Empire and its colony in America.

Tutorial: Investing 101

Currency Wars
In the 17th century, England was determined to keep control of both the American colonies and the natural resources they controlled. To do this, the English limited the money supply and made it illegal for the colonies to mint coins of their own. Instead, the colonies were forced to trade using English bills of exchange that could only be redeemed for English goods. Colonists were paid for their goods with these same bills, effectively cutting them off from trading with other countries.

In response, the colonies regressed back into a barter system using ammunition, tobacco, nails, pelts and anything else that could be traded. Colonists also gathered whatever foreign currencies they could, the most popular being the large, silver Spanish dollars. These were called pieces of eight because, when you had to make change, you pulled out your knife and hacked it into eight bits. From this, we have the expression of, "two bits", meaning a quarter of a dollar. (To read about money's beginnings, see The History Of Money: From Barter To Banknotes.)

Massachusetts Money
Massachusetts was the first colony to defy the British. In 1652, the state minted its own silver coins, including the pine-tree and oak-tree shillings. It circumvented the British law stating that only the monarch of the British empire could issue coins by dating all their coins 1652 - a period when there was no monarch. In 1690, Massachusetts issued the first paper money as well, calling it bills of credit.

Tensions between America and Britain continued to mount until the Revolutionary War broke out in 1775. The colonial leaders declared independence and created a new currency called "continentals" to finance their side of the war. Unfortunately, each government printed as much as it needed without backing it to any standard or asset, so the continentals experienced rapid inflation and became utter worthlessness. This discouraged the government from using paper money for almost a century.

Aftermath of the Revolution
The chaos from the war left the monetary system in America a complete wreck. Most of the currencies in the newly formed United States of America were useless. The problem wasn't resolved until 13 years later in 1788, when Congress was granted constitutional powers to coin money and regulate its value. Congress established a national monetary system and created the dollar as the main unit of money. There was also a bimetallic standard, meaning that both silver and gold could be valued in dollars and used as money. (For related reading, see The Gold Standard Revisited.)

It took 50 years to get all the foreign coins and competing state currencies out of circulation, but by the early 1800s, the U.S. was ready to try the paper money experiment again. Bank notes had been in circulation all the while, but because banks issued more notes than they had coin to cover, these notes often traded at less than face value.

In the 1860s, the U.S. created more than $400 million in legal tender to finance the Civil War. These were called greenbacks simply because the backs were printed in green. The government backed this currency and stated that it could be used to pay back public and private debts. The value did, however, fluctuate according to the North's success or failure at certain stages in the war. Confederate dollars, also issued during the 1800s, followed the fate of the confederacy and were worthless by the end of the war.

Aftermath of the Civil War
Following its victory, the U.S. government got the National Bank Act through congress (February 1863). This act established a monetary system whereby national banks issued notes backed by U.S. government bonds. The government then choked out notes from state banks by taxation. The U.S. Treasury then worked to get greenbacks out of circulation so that the national bank notes would become the only currency.

During this period of rebuilding, there was a lot of debate over the bimetallic standard. Some were for using silver to back the dollar, others were for gold. The situation was resolved in 1900 when the Gold Standard Act was passed. This meant that, in theory, you could take your money to Fort Knox and exchange it for the corresponding value in gold. Another innovation brought the Federal Reserve into being in 1913. The Federal Reserve was given the power to steer the economy by controlling money supply and interest rates on loans. (For more insight, see The Gold Standard Revisited.)

Gold No More
In 1971, the U.S. dollar moved off the gold standard. The significance of moving away from the standard is that it became possible to create more money than there was gold to back it. Money's value was now decided purely by its purchasing power as dictated by inflation. There is no shortage of people who believe this is going to cause the end - with the dollar going the way of its forefather, the continental. There is a danger of losing the value of the dollar, but now it is backed by the health of the American economy. If the economy takes a nosedive, the value of the U.S. dollar will drop both domestically through inflation, and internationally through currency rates. Fortunately, the implosion of the U.S. economy would plunge the world into a financial dark age, so many other countries and entities are working tirelessly to ensure that never happens. (To learn more, read What's the relationship between a country's currency and the strength of its economy?)

Money in the Future
Although the paper bills we carry around now have high-tech watermarks and security threads, the future of money is moving toward cards and chips. One day, a chip in your wallet may register purchases just by waving it over a product you want to walk out with - no clerk, no smile, no "hi my name is" badge. Internet currencies, such as the Paypal system, are also contenders for the next generation of money as the world becomes more interconnected. Many nations are still worried about cash they can't track or tax, but an internet economy is as inevitable as a free-trading America was. Money has changed a lot since the days of shells and skins, but its main function hasn't changed at all. Regardless of what form it takes, money offers us a medium of exchange for goods and services and allows the economy to grow as transactions can be completed at greater speeds.

To read more about money and currencies, see What Is Money?

by Andrew Beattie

Andrew Beattie is a managing editor and contributor at Investopedia.com. He operates the Wandering Wordsmith blog, and can be reached there.

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An Introduction To Sovereign Wealth Funds

Sovereign wealth funds have attracted a lot of attention in recent years as more countries open funds and invest in big-name companies and assets. Some experts estimate that all sovereign wealth funds combined to hold more than $3 trillion in assets in 2008, a number that is expected to grow relatively rapidly. This has given way to a wide concern over the influence these funds have on the global economy. As such, it is important to understand exactly what sovereign wealth funds are and how they first came about.

What Is A Sovereign Wealth Fund?
A sovereign wealth fund is a state-owned pool of money that is invested in various financial assets. The money typically comes from a nation's budgetary surplus. When a nation has excess money, it uses a sovereign wealth fund as a way to funnel it into investments rather than simply keeping it in the central bank or channeling it back into the economy. (For background reading, see What Are Central Banks?)

The motives for establishing a sovereign wealth fund vary by country. For example, the United Arab Emirates generates a large portion of its revenue from exporting oil and needs a way to protect the surplus reserves from oil-based risk, thus it places a portion of that money in a sovereign wealth fund. Many nations use sovereign wealth funds as a way to accrue profit for the benefit of the nation's economy and its citizens. (To read more about the risks associated with oil, see A Guide To Investing In Oil Markets.)

The primary functions of a sovereign wealth fund are to stabilize the country's economy through diversification and to generate wealth for future generations.

History
Although sovereign wealth funds have attracted a lot of publicity only recently, the first funds originated in the 1950s. Sovereign wealth funds came about as a solution for a country with a budgetary surplus. The first sovereign wealth fund was the Kuwait Investment Authority, established in 1953 to invest excess oil revenues. Only two years later, Kiribati created a fund to hold its revenue reserves. Little new activity occurred until three very major funds were created:

• Abu Dhabi's Investment Authority (1976)
• Singapore's Government Investment Corporation (1981)
• Norway's Government Pension Fund (1990)

Over the last few decades, the size and number of sovereign wealth funds have increased dramatically. In 2008, there are more than 50 sovereign wealth funds, and the U.S. Department of Treasury estimates that these funds hold more than $3 trillion dollars in assets. (For more on the role of the U.S. Treasury, read The Treasury And The Federal Reserve.)

Commodity Vs. Non-Commodity Sovereign Wealth Funds
Sovereign wealth funds can fall into two categories, commodity or non-commodity. The difference between the two categories is how the fund is financed.

Commodity sovereign wealth funds are financed by exporting commodities. When the price of a commodity rises, nations that export that commodity will see greater surpluses; conversely, when an export-driven economy experiences a fall in the price of that commodity, a deficit is created that could hurt the economy. A sovereign wealth fund acts as a stabilizer to diversify the country's money by investing in other areas. (Read more in Commodity Prices And Currency Movements.)

Commodity sovereign wealth funds have seen huge growth as oil and gas prices increased between 2000 and 2008. At the end of 2007, commodity financed funds totaled more than $2 trillion. (Before getting in on the oil and gas markets, read Oil And Gas Industry Primer.)

Non-commodity funds are typically financed by an excess of foreign currency reserves from current account surpluses. Non-commodity funds totaled $1.2 trillion at the end of 2007, which is three times the total three years earlier.

Currently, the majority of funds are financed by commodities, but non-commodity funds may reach 50% of the total by 2015.

What Do Sovereign Wealth Funds Invest In?
Sovereign wealth funds are traditionally passive, long-term investors. Few sovereign wealth funds reveal their full portfolios, but sovereign wealth funds invest in a wide range of asset classes including:

• Government bonds (Read about the advantages of a variety of bond types in Too Many Bonds To Choose From?)
• Equities (Learn how to avoid the dangers of equity investing in Mitigate Your Equity Risk.)
• Foreign direct investment (Read Evaluating Country Risk For International Investing for more on investing overseas.)

However, a growing number of funds are turning to alternative investments, such as hedge funds or private equity, which are not accessible to most retail investors. The International Monetary Fund reports that sovereign wealth funds have a higher degree of risk than traditional investment portfolios, holding large stakes in the often volatile emerging markets. (Read about how private equity has become more accessible in recent years in Private Equity Opens Up For The Little Investor.)

Sovereign wealth funds use a variety of investment strategies:

• Some funds invest exclusively in publicly listed financial assets.
• Others invest in all of the major asset classes.

Funds also differ in the level of control they assume when investing in companies:

• There are sovereign wealth funds that place a limit on the number of shares bought in a company and will enforce restrictions to either diversify their portfolios or to adhere to their own ethical standards. (Read about one role of ethics in investing in Change The World One Investment At A Time.)
• Other sovereign wealth funds take on a more active approach by buying larger stakes in companies.

International Debate
Sovereign wealth funds represent a large and growing portion of the global economy. The size and potential impact that these funds could have on international trade has led to considerable opposition, and the criticism has mounted after controversial investments in the United States and Europe. Following the mortgage crisis of 2006-2008, sovereign wealth funds helped rescue struggling Western banks CitiGroup (NYSE:C), Merrill Lynch (NYSE:MER), UBS (NYSE:UBS) and Morgan Stanley (NYSE:MS). This led critics worry that foreign nations were gaining too much control over financial institutions, and that these nations could use that control for political reasons. This fear could also lead to investment protectionism, potentially damaging the global economy by restricting valuable investment dollars. (Read more about protectionist strategies in The Basics Of Tariffs And Trade Barriers.)

In the United States and Europe, many financial and political leaders have stressed the importance of monitoring and possibly regulating sovereign wealth funds. Many political leaders assert that sovereign wealth funds pose a threat to national security, and their lack of transparency has fueled this controversy. The United States addressed this concern by passing the Foreign Investment and National Security Act of 2007, which established greater scrutiny when a foreign government or government-owned entity attempts to purchase a U.S. asset. (Read more about issues of transparency in foreign investment in Why Country Funds Are So Risky.)

Western powers have been guarded about allowing sovereign wealth funds to invest and have asked for improved transparency. However, as there is no substantive evidence that funds are operating under political or strategic motives, most countries have softened their position and even welcomed the investors.

Conclusion
The size and number of sovereign wealth funds continues to grow, assuring that these funds will remain a crucial part of the global economy in the future. One report projects that if sovereign wealth funds continue to grow at their current pace, they will exceed the annual economic output of the United States by 2015 and that of the European Union by 2016. The emergence of sovereign wealth funds is an important development for international investing, and as regulation and transparency issues are resolved in the coming years, these funds are likely to take on a major role in shaping the global economy.

by Richard Wilson

In addition to writing for Investopedia, Richard Wilson runs a popular hedge fund blog and is the founder of the Hedge Fund Group (HFG). Wilson is a hedge fund consultant for a third party marketing firm and also runs ThirdPartyMarketing.com.

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