MONEY

14 Ways to Fail at Investing and 5 Ways to Succeed

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PM Images—Getty Images

Fear, greed and an inability to admit past mistakes could be holding you back.

There are many reasons why people don’t succeed in investing. Whether it’s information overload, impatience, a lack of necessary tools or simple bad luck, plenty of things can derail a good plan.

In most cases, though, it’s the investor who’s responsible for his or her own failure. We make decisions based on emotions and character traits that steer us in the wrong direction. The field of behavioral finance tries to make sense of the thoughts and feelings that compel us to make financial decisions that are not in our best interests.

The Academy of Behavioral Finance & Economics identifies more than 100 traits and tendencies that can lead to poor investment decisions. Among the most prevalent:

  1. Greed, or a desire to get rich.
  2. Fear of change.
  3. Failure to admit past mistakes.
  4. Preference for avoiding losses rather than making money.
  5. Fear of making the wrong decision.
  6. Overconfidence, or believing we know more than we actually do.
  7. Herd mentality — the tendency to mimic others in order to conform, coupled with the belief that a large group could not possibly be wrong.
  8. Failure to focus on relevant data while concentrating on minutiae.
  9. Belief that past experiences or outcomes, positive or negative, will occur again.
  10. Unwillingness to wait for a bigger payoff later, preferring to settle for whatever we can get now.
  11. Overreliance on the most recent information.
  12. Assumption that previous success was due to our own knowledge rather than simply a rising market.
  13. Looking only for information that validates our decisions or choices.
  14. Confusing familiarity with knowledge.

Since we as investors may not be aware of our own tendencies, how can you avoid these pitfalls?

One way is to put a structure in place for investment decisions — clearly defining what you’ll do and when you’ll do it. With a solid framework, the mind games that impair decision-making won’t sabotage your investing. Here are five steps to build such a structure:

  1. Know your investing goals.
  2. Create a written plan that spells out exactly how your investments will be managed. This plan is also called an investment policy statement.
  3. Design a portfolio that uses prudent methodology.
  4. Regularly monitor that portfolio.
  5. Rebalance the portfolio (as needed) based on the investment policy statement.

Having a structure like this to rely on when making decisions — even when tempted by irrational tendencies — can help improve the outcome for many investors.

So, have you been sabotaging your own investing success? If you’re not sure — or if you’re sure that you have been — a professional advisor can help you put a stop to unproductive behavior. If you choose to get help, look for a fiduciary investment advisor who always puts your interests first.

But even if you don’t work with an advisor, make sure you have a clear structure in place to help you make investing decisions and avoid the behavioral pitfalls that plague many investors.

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MONEY stocks

What’s in Store for Stocks in the Coming Week

A trader looks at stock prices on a screen while working on the floor of the New York Stock Exchange shortly before the closing bell in New York August 26, 2015.
Lucas Jackson—Reuters A trader looks at stock prices on a screen while working on the floor of the New York Stock Exchange shortly before the closing bell in New York August 26, 2015.

Is the worst of the sell-off over, or is this just the quiet before the next storm?

After a quiet end to a frenetic week on Wall Street—in which the Dow fell as much as 1,000 points only to rebound by about as many—the question on everyone’s mind is the same…

What’s in store for stocks in the coming week?

Will the market get off to a another frenzied start like it did on Aug. 24, when news about China’s market crash and economic woes sent the Dow plunging? Or is the worst of the storm behind us, and will equities begin to grind out gains from here on out?

To answer that, you have to pay attention to the following:

* The Chinese stock market

Wall Street usually dances to the beat of its own drum, but in jittery times, global markets tend to move in unison.

That’s what happened in the global financial crisis in 2008. And that’s what’s been happening since Aug. 17, when China’s stock market slide began to spread around the world.
^SSEC Chart

^SSEC data by YCharts

So Sunday night, when the Asian markets begin trading, you’ll have a sense of whether Wall Street will be in a good or bad mood come Monday morning.

Fed Chatter

Toward the end of the week, remarks by Federal Reserve officials did as much to move the market as real economic data. When New York Fed president William Dudley on Wednesday said the case for raising interest rates in September was “less compelling” in light of the recent market shocks, Wall Street soared.

But in subsequent days, several officials including Cleveland Fed president Loretta Mester, Kansas City Fed president Esther George, and St. Louis Fed president James Bullard have all said the economy remains strong enough for a rate hike.

So will the Fed increase rates in September or not?

The next big speech comes on Saturday, when Fed vice chairman Stanley Fischer is expected to talk about inflation at a meeting in Jackson Hole, Wyo. Expect investors to react immediately Monday morning.

* The Real Economy

The big debate last week was whether the stock market plunge was foreshadowing a potential recession. By Friday, the bulls had made a convincing argument that a recession was not in the cards, which allowed the market to recover.

This week, investors will be looking for confirmation.

On Tuesday, they’ll be looking at the ISM Manufacturing index, which gauges factory activity throughout the country. Any reading above 50 is considered a sign of growth, and for 31 straight months, the industrial economy has been expanding.

The bulls will be looking for another reading above, or at least on par, with July’s reading of 52.7.

The Job Market

No matter what happens in China, the U.S. economy won’t go into recession if U.S. companies are seeing sufficient demand to step up hiring. This week, there will be two key reports that speak to jobs.

The first is indirect. On Tuesday, investors will get an update on auto sales. Thus far in 2015, auto sales are trending toward their best year in more than a decade.

If motor vehicle sales continue on this pace, it would speak to the underlying strength of the labor market. After all, only consumers who are confident about their job security and wages will hit the showrooms.

Then on Friday comes the Labor Department’s actual jobs report. Wall Street believes the U.S. economy produced around 220,000 nonfarm jobs in August. If the economy hits this mark, it should put a rest to recession talk and fears over a rate hike, says Kate Warne, investment strategist for Edward Jones.

After all, we’ve seen “job creation at more than 200,000 a month for a while,” Warne says. “That’s not an economy that could be snuffed out by a mere quarter-point rise in short-term interest rates.”

MONEY stocks

Why McDonald’s May Start Skimping on Dividends

US-MCDONALDS
PAUL J. RICHARDS—AFP/Getty Images A McDonald's Big Mac, their signature sandwich is held up near the golden arches at a McDonalds's August 10, 2015, in Centreville, Virginia.

If it doesn't find a way to grow business, dividend increases could come to a halt.

McDonalds MCDONALD'S CORP. MCD -0.24% wasn’t immune to the market sell-off earlier this month. Sure, it wasn’t hammered as hard as high-flying growth stocks, but a 4% pullback on a stalwart like McDonalds is worth looking into. One of the great things about dividend paying cash cows like McDonald’s after share prices decline is the their dividend yields go up, making them more enticing for income-seeking investors. Trading around $95, and with a dividend yield of 3.4%, is it a good time for income investors to buy McDonalds stock?

McDonald’s dividend history
McDonald’s is a familiar name in the income-investing world. And it should be. Since the company first paid a dividend in 1976, the company has raised its dividend every single year. Even recently, McDonald’s dividend hikes have been meaningful. In 2012, 2013, and 2014, McDonald’s increased its dividend by 10%, 5%, and 5% again, respectively.

But as can be seen by reviewing the McDonald’s dividend increases in the past three years, the company has been less aggressive in these increases lately. There’s a good reason for this. Its free cash flow, or operating cash flow less capital expenditures, has leveled off in recent years. Indeed, McDonald’s free cash flow in the trailing 12 months of $4.3 billion is still below it’s $4.4 billion in the free cash flow in 2011, when its free cash flow peaked. With free cash flow growth coming to a halt in recent years, it’s no longer is easy for management to justify 10% annual increases in its dividend.

McDonald’s dividend potential
But by how much is McDonald’s dividend growth limited, going forward?

Income investors can get some insight into whether or not McDonald’s dividend growth is constrained or not by looking at the company’s dividend payout as a portion of free cash flow. Of McDonald’s $4.3 billion in free cash flow in trailing 12 months, the company paid out $3.2 billion in dividends, or about 75% of its free cash flow. So, there is some wiggle room for McDonald’s dividend — and some room for dividend increases even if McDonald’s free cash flow doesn’t grow. But investors should take note that historically McDonald’s has usually paid out a much smaller portion of free cash flow in dividends than its paying out today. For instance, in the years leading up to the 2007 and 2008 recession, McDonald’s was paying out less than half of its free cash flow in dividends. It stands to reason, therefore, that in the future it won’t be as easy for McDonald’s to increase its dividend as it has been in the past.

Longer term, the fact that McDonald’s hasn’t given investors any evidence it is on a path to turn its free cash flow around back toward growth is a real concern. If the company doesn’t find a way to begin growing its business again, dividend increases could come to a halt. After all, McDonalds can’t increase its dividends beyond annual free cash flow without eating into its cash position.

A similar theme in McDonald’s dividend payouts can be seen by analyzing its payout ratio, or its dividends as a percentage of earnings. During the last five years, McDonald’s payout ratio has been climbing.

MCD Payout Ratio (TTM) Chart

MCD PAYOUT RATIO (TTM) DATA BY YCHARTS

McDonald’s dividend increases, therefore, are certainly facing some headwinds. Going forward, investors shouldn’t expect meaningful dividend hikes.

It may be wise for income investors interested in McDonald’s stock to wait for sure signs of a return to free cash flow growth. Without it, dividend increases aren’t as certain as they have been in the past.

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MONEY Opinion

Amazon Is Right to Give Up on the Fire Phone

The Fire Phone was too late to market and didn't have any compelling features to set it apart from entrenched competitors.

Amazon’s AMAZON.COM INC. AMZN -0.07% foray into smartphones was always destined to fail. The e-commerce giant was simply way too late to the market. The Fire Phone didn’t have any compelling differentiating features (Dynamic Perspective was little more than a novelty gimmick) while it stuck with conventional pricing, putting it in direct competition with entrenched rivals.

It’s tempting to pin the blame on Jeff Bezos since he was reportedly “obsessed” with the Dynamic Perspective feature, which required incredible development resources and delayed the device for years, according to a former executive. It was hardly a surprise when Amazon took a $170 million inventory charge mere months later because the Fire Phone just wasn’t selling.

The Wall Street Journal is now reporting that Amazon is giving up on Fire Phone. Despite the fact that it’s only been a year, it’s about time.

Fire Phone crashes and burns
Amazon has reportedly laid off dozens of engineers at its hardware division, Lab126. The company has also restructured Lab126, consolidating two hardware development departments into one. A large-screen tablet may also be shelved as well as a few other odd devices like an image projector. Amazon is still hard at work on other hardware projects, though, like a computer that can take orders via voice commands or a different spin on a 3D interface meant for a tablet.

The layoffs run counter to a Reuters report last year that Amazon was actually planning to dramatically expand its Lab126 head count over the next five years, even after it took the Fire Phone writedown and realized the product was a flop. For once in its life, Amazon seems averse to plunging an endless amount of money into a new initiative. Cost cutting is largely how Amazon crushed analyst estimates last quarter, posting a $92 million profit and sending shares soaring.

What about tablets?
Once upon a time, the Kindle Fire tablet was the best-selling Android tablet. Amazon was one of the first companies to launch a smaller tablet, but once it enjoyed demonstrable demand, the traditional players all jumped in. These days, Amazon’s position in the tablet market has weakened significantly. IDC estimated that unit volumes in Q4 2014 fell by a whopping 70% to 1.7 million. Amazon disputed those figures, but naturally declined to provide any hard data to substantiate its claims. Amazon is not included in the top five vendors for IDC’s Q2 2015 figures. Technically, Huawei and LG tied for fourth and fifth with 1.6 million units each.

The WSJ also says that Amazon’s product mix is heavily skewed toward the lower-end versions of its e-readers and tablets, which also makes plenty of sense. But competition at the low end is particularly intense, while the iPad has a 76% share of the premium tablet market in the U.S. (priced at $200 or above). Amazon will likely shift development resources toward these lower-end tablets, while focusing on new product categories like Echo.

Why that’s the right call
Strategically, Amazon’s hardware has always served as a form of shopping portal, a gateway into Amazon Prime, if you will. For the longest time, Amazon’s strategy was to sell hardware at cost and profit later when people purchased digital content or physical products. That’s why Fire Phone’s pricing was so Un-Amazon because the company was hoping to profit up front (and later on).

If the value in Amazon’s hardware lies in its ability to sell more stuff, then first-party smartphones and tablets are decidedly not the best use of developmental resources. People already have smartphones and tablets with Amazon’s app loaded on them, so third-party devices are already shopping portals. Instead, new categories and form factors are where the real opportunity lies, such as the $5 Dash buttons or Echo or any other type of centralized order-taking machine.

These types of hardware products are true differentiators that also support the core e-commerce business, and we all know how much Bezos hates “me-too” devices.

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TIME stocks

A Japanese Day Trader Made $34 Million In the Market This Week

JAPAN-STOCKS
KAZUHIRO NOGI—AFP/Getty Images Japan's Nikkei index had its biggest one-day fall in nearly 10 months in the wake of Monday's carnage on Wall Street.

Not everyone's afraid of volatility

One of the iron-clad laws of trading is that you can’t time the market.

Of course, there’s always the exception that proves the rule. According to a report in Bloomberg, day trader in Japan perfectly timed the global market meltdown this week, netting himself a cool $34 million in the process.

The trader, known only by his internet handle “CIS,” believed there would be a sharp downturn in the markets, and had been “shorting futures on the Nikkei 225 Stock Average since mid-August.” By Monday of this week, he was looking at a paper profit of $13 million, but he didn’t stop there. He wagered that once the U.S. markets opened to a global selloff, it would force the markets lower in Japan too.

After doubling his winnings, CIS pivoted betting correctly that the market had bottomed.

“I do my best work when other people are panicking,” the trader told Bloomberg.

MONEY stocks

This Could Throw Cold Water on the Dow’s 1,000-Point Rebound

150827_INV_AnotherBigDay
Richard Drew—AP Specialist Charles Boeddinghaus, center, works on the floor of the New York Stock Exchange Thursday, Aug. 27, 2015.

Despite two strong days for the market, investors shouldn't assume this sell-off is over.

For the second straight day, stocks soared on better-than-expected economic news.

After Thursday’s jump of more than 369 points, the Dow Jones industrial average is now up nearly 1,000 points in the past two days.

While that doesn’t erase the Dow’s 1,900-point decline between Aug. 17 and Aug. 25, the bounce back went a long way toward calming nerves on Wall Street.

Don’t be surprised, though, if the jitters return on Friday or next week.

Why?

For starters, in volatile times investors have a tendency to take profits heading into a weekend — if for no other reason than to guard against potential surprises that might hit the Asian markets before trading begins in New York on Monday.

It’s also important to remember why stocks surged on Wednesday and Thursday in the first place.

Rate Hikes May Be Off

When stocks were plummeting at the start of this week, investors feared that cratering equities might be signaling a much weaker than expected economy ahead.

But on Wednesday came what Wall Street interpreted as good news: A key Fed official indicated that as a result of recent global market shocks, the case for the Federal Reserve hiking interest rates in September was “less compelling.” That means the Fed isn’t likely to tap the economy’s brakes anytime soon.

Then the Commerce Department reported that orders for durable goods rose faster than expected, damping down recession worries.

And on Thursday, the Commerce Department came back and revised its earlier assessment of economic growth in the second quarter. Instead of growing at an annual rate of 2.3% as was thought, U.S. GDP actually expanded a robust 3.7% in the spring.

That seemed to slam the door on all this recession talk.

However, some market watchers believe the GDP report also may have reopened the door to the Fed raising rates in September.

Rate Hikes May Be On

Brian Singer, a portfolio manager at William Blair, says the new batch of good economic data — and Wall Street’s positive reaction to it — will likely trigger “a cat and mouse game between the markets and the Fed” that could go on for a while.

Here’s how that game is played: When there’s good economic news and equity prices rise, that’s likely to renew talk of rate hikes. And such talk is likely to be jeered by Wall Street in subsequent days.

Conversely, if there’s weak data that sparks a market sell-off, that will likely prompt speculation that the Fed will postpone rate increases. And that could push the equity markets higher.

So investors should brace themselves for ongoing volatility.

A Third Option

To be sure, there’s a small but growing group on Wall Street that believes a September rate hike would actually be bullish, not bearish.

“If anything, if the Fed were to raise rates that would send a signal that the Fed believes economic growth is strong enough to withstand higher rates,” says Kate Warne, investment strategist at Edward Jones. “To us, that’s good news, not bad news.”

Conversely, if the Fed keeps rates at zero — and begins talking up the need for further stimulus through yet another round of quantitative easing, “that would be a huge confidence crusher,” says Liz Ann Sonders, chief investment strategist at Charles Schwab.

At the very least, a Fed rate hike in September “takes off the table one of the market’s big uncertainties,” says Scott Clemons, a managing director for Brown Brothers Harriman.

That’s the uncertainty of when the Fed will finally pull the trigger.

But for now, the cat and mouse game goes on.

TIME Markets

U.S. Stocks Close Higher Following Chinese Market Gains

Market
Andrew Burton—Getty Images Traders work on the floor of the New York Stock Exchange during the morning of Aug. 27, 2015 .

The Dow climbed close to 370 points on Thursday

U.S. stocks are closing sharply higher after China’s main stock index logged its biggest gain in eight weeks. A report also showed that the U.S. economy expanded at a much faster pace than previously estimated.

The Dow Jones industrial average climbed 369.26 points, or 2. 3 percent, to 16,654.77 on Thursday. That took the two-day gain for the index to almost 1,000 points.

The Standard & Poor’s 500 index gained 47.15 points, or 2.4 percent, to 1,987.66. The Nasdaq composite gained 115.17 points, or 2.5 percent, to 4,812.71.

Energy stocks surged as the price of oil jumped 10 percent.

Bond prices were little changed from Wednesday, keeping the yield on the benchmark 10-year Treasury note at 2.18 percent.

MONEY stocks

Amazon Is No Cash Cow

Inside New Amazon.com Inc.'s Fulfilment Center
Bloomberg via Getty Images An employee selects goods from bays of merchandise as she processes customer orders at the Amazon.com Inc. fulfillment center in Poznan, Poland, on Friday, June 12, 2015.

The company's free cash flow is greatly exaggerated, and a big chunk of it is unsustainable.

Retail giant Amazon AMAZON.COM INC. AMZN -0.07% seems to be on a roll. The stock surged following a better-than-expected earnings report last month, and the company’s cash flow figures are exploding. Over the past 12 months, Amazon has produced a staggering $8.98 billion of operating cash flow and $4.37 billion of free cash flow. Both dwarf the $188 million net loss the company posted over the same period.

Earlier this year, I argued that Amazon’s free cash flow figures are deceptive. The company finances billions of dollars of additional capital spending using capital leases, and this greatly inflates Amazon’s free cash flow. Including the $4.7 billion of assets Amazon acquired under capital leases over the past year, its adjusted free cash flow is actually negative.

I also argued separately that the nature of Amazon Web Services, where servers and computing equipment get depreciated over just a few years, is largely responsible for the vast increases in Amazon’s operating cash flow. Even a structurally unprofitable cloud infrastructure business can produce rapidly growing operating cash flow as long as cash keeps getting poured into it.

Today, I want to ask a simple question. If Amazon decided it was big enough and stopped investing for growth, how much cash could be sustainably pulled out of the business each year, after all necessary expenses are paid? This is similar to Warren Buffett’s concept of “owner earnings,” which he first introduced in his 1986 letter to shareholders of Berkshire Hathaway.

The cash flow numbers that Amazon reports suggests that the answer to this question is measured in the billions of dollars. But a big chunk of Amazon’s cash flow is unsustainable, and a deeper look at Amazon’s cash flow is required.

The search for sustainable cash flow
Amazon’s $8.98 billion of operating cash flow over the past 12 months can be separated into a few different sources:

Source Amount
Net income ($188)
Depreciation and amortization $5,557
Change in working capital $541
Change in deferred revenue $1,065
Stock-based compensation $1,755

ALL VALUES IN MILLIONS. “OTHER OPERATING EXPENSES” AND “OTHER EXPENSES” AREN’T INCLUDED.

Buffett defines owner earnings as net income plus depreciation, amortization, and certain non-cash items, minus the average amount of capital expenditures necessary to maintain long-term competitiveness. Amazon spent a total of $9.32 billion, both directly and through capital leases, on capital expenditures over the past 12 months, but only a portion of that is required to maintain the business.

Estimating maintenance capex is difficult, and there are very few companies that explicitly break down capital spending into maintenance spending and growth spending. The annual depreciation charge is typically in the ballpark of the maintenance capex required to maintain a business, although that’s an imperfect estimate. It’s possible that Amazon could end up spending less than depreciation on maintenance capex, which would create a source of cash flow, although likely not a very big one. It’s also possible that Amazon would need to spend more, particularly for AWS, in order to maintain its competitive position.

What we can safely say is that whatever sustainable cash flow that can be generated through the difference between deprecation and maintenance capex will be a fraction of the total depreciation charge. Most of that cash flow will be balanced out by capital expenditures necessary to keep Amazon competitive in the long run.

Working capital is typically a drain on cash flow as a company grows, but Amazon operates with a negative cash conversion cycle: It collects payments from customers before it pays suppliers. As Amazon grows, this creates a source of cash flow each year.

Ultimately, this extra cash flow is a good thing, but it’s not sustainable. It exists only as long as Amazon keeps growing. The moment Amazon stops growing, the $541 million of cash flow derived from changes in working capital over the past 12 months goes away. This cash flow is just the result of the timing of payments and thus can’t be sustainably pulled out of the company.

Amazon Prime, which charges customers $99 per year for free shipping and other perks, is another source of cash flow for Amazon. When Amazon receives a Prime subscription payment, it books it as deferred revenue, which is then recognized as revenue over the course of the year. As the Prime membership grows, the increasing deferred revenue balance creates cash flow for the company.

Deferred revenue rose by $1.065 billion over the past 12 months, mostly because of the growth of Prime, which is billed annually, but also in part because of the growth of AWS, which is billed monthly. It should be obvious that this isn’t a sustainable source of cash flow; the moment the Prime membership base stops growing, most of this operating cash flow disappears. Prime, in fact, doesn’t even need to be profitable for it to produce cash flow. It only needs to grow.

The last item is stock-based compensation. This $1.755 billion of operating cash flow is sustainable as long as employees continue to accept stock as compensation, but it dilutes existing shareholders.

This isn’t the kind of non-cash charge that Buffett was talking about. Amazon would need to pay employees more cash if it stopped handing out stock as compensation, or it would need to spend cash on buybacks if it wanted to keep the share count constant. For the same reason that selling additional shares and treating the proceeds as sustainable cash flow doesn’t make sense, stock-based compensation shouldn’t be treated as a source of sustainable cash flow.

Not exactly a cash cow
Amazon’s trailing-12-month net income is currently negative, but if the company stopped investing in growth, presumably its utilization of its existing fulfillment centers would rise, since the company is likely adding them ahead of actual demand. In a no-growth scenario, Amazon’s net income would likely rise as well, producing a source of sustainable cash flow for the company. Exactly how much cash flow this would generate is hard to say; I doubt that Amazon would be able to raise its prices by very much, since that would allow a competitor to undercut it on price.

A big chunk of Amazon’s operating cash flow, coming from changes in working capital, changes in deferred revenue, and stock-based compensation, is unsustainable in the long run. This amounts to about $3.36 billion over the past 12 months. Improvements in net income and the difference between deprecation and maintenance capex would act as sources of cash flow in a no-growth situation, but I think it’s safe to say that the amount of cash that can be sustainably pulled out of Amazon if the company stopped investing for growth is very likely less than the free cash flow Amazon reported for the past 12 months.

Free cash flow is supposed to represent the cash flow left over after investments in growth. In light of this, it shouldn’t be surprising that Amazon’s debt, including outstanding capital leases, has ballooned over the past few years as it’s invested in growing the business:

End of 2010 End of 2014
Debt $184 million $9.6 billion
Outstanding capital and finance leases $457 million $4.2 billion
Total $641 million $13.8 billion

SOURCE: AMAZON 10-KS.

Amazon’s cash flow numbers certainly look impressive, so much so that operating cash flow and free cash flow are the first two figures mentioned in a typical Amazon earnings press release. But Amazon isn’t the cash flow machine it claims to be. Cash flow numbers are certainly useful to investors, but they shouldn’t be blindly accepted. Buffett had something to say about this in his 1986 letter to shareholders:

Why, then, are “cash flow” numbers so popular today? In answer, we confess our cynicism: we believe these numbers are frequently used by marketers of businesses and securities in attempts to justify the unjustifiable (and thereby to sell what should be the unsalable).

Amazon has a great sales pitch, but its cash flow numbers aren’t quite what they seem.

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MONEY mutual funds

Millennials in Target Date Funds Got Hit Hardest by Stock Selloff

Market
Andrew Burton—Getty Images A trader works on the floor of the New York Stock Exchange during the morning of August 27, 2015 in New York City. Dow Jones Industrial Average stocks continued their rally, opening approximately 200 points higher today.

Young investors with 2060 target date funds lost 10% of their savings between July 17 and August 24.

As the stock market has whipsawed over the past two weeks, young workers who have all their retirement funds tied up in long-range target-date funds may have been the hardest hit.

The average 25-year-old fully invested in a 2060 target-date fund series saw a 10% decline in account value from the market’s recent peak on July 17 through Monday’s close, according to Morningstar – close to the 10.96% decline of the S&P 500 over that period.

Meanwhile, the average 65-year-old set to retire this year and invested in a 2015 TDF series saw just a 5% decline.

Even if stocks continue to rebound in the days ahead, the experience of watching value shrink may be an eye-opener to new investors who might not have thought about their risk tolerance before.

Target-date funds are designed to adjust an investor’s risk as retirement age approaches, through what is called a glide path. The farther out the fund’s end date, the higher the stock allocation. Investors in 2060 funds have equity exposure ranging from 83% to 94%, says Janet Yang, director of multi-asset-class manager research at Morningstar. In the 2015 funds, aimed at workers who will be retiring very soon, average equity exposure is just 42%.

The popularity of these funds in retirement plans is surging. Vanguard reports that 88% of the 401(k) plans it serves offered TDFs last year, up 17% from 2009. Four out of 10 plan participants are wholly invested in a single TDF, Vanguard says, and 64% of participants use them to some extent.

Many young workers are now automatically enrolled in 401(k) plans and put into a default allocation that typically is a target-date fund.

On the plus side, especially for young and inexperienced investors, these funds seem to have handcuffed the worst investor behaviors, like frequent trading. Asset-weighted average investor returns in TDFs are 1.1 percentage points higher than the funds’ average total returns, according to a Morningstar study published earlier this year.

“Sometimes, ignoring your investments can be a good thing. You’re less likely to pull your money out after it loses 10%, and then you’re still invested when the rebound comes,” Yang says.

But how will younger auto-piloted investors – now experiencing their first wild market swings – handle the volatility?

“We’re defaulting millennials 90% into stocks without ever finding out what their tolerance for risk might be,” says Michael Kitces, founder of the XY Planning Network, a network of fee-only advisers specializing in serving Gen X and Gen Y clients. (Kitces also is a partner and director of research for Maryland-based Pinnacle Advisory Group, a wealth management firm).

Kitces worries that the current volatility will lead to adverse outcomes for young investors. “We’re taking people who don’t need to be that aggressive and given them more risk than they can tolerate. What we’re going to do is turn them into lifelong bond investors – and that will cause them problems 30 years from now,” he says.

There has been plenty of selling out of target-date funds this week. Aon Hewitt, which administers more than 500 defined-contribution plans covering more than 5.7 million workers in the United States, reports that trading activity on Monday was seven times the normal level, and it was one of the highest trading days on record. 30% of Monday’s selling came from TDFs – equal to the share that came out of large U.S. equity funds.

“That tells us that people are looking at TDFs the same as any other investment,” says Rob Austin, Aon Hewitt’s director of retirement research.

More Options

Default investor options for 401(k) plans, which are regulated by the U.S. Department of Labor under the Employee Retirement Income Security Act, are not limited to target date funds. The Labor Department also allows balanced funds and managed funds, which give workers professional one-on-one portfolio guidance.

Managed accounts also give workers a human being to talk with when things get scary – but just 3% of plan sponsors pick managed account services as a default option, according to a Towers Watson survey.

“When the market gets volatile, you don’t have someone to talk to if you’re in a TDF,” says Wei-Yin Hu, vice president of financial research at Financial Engines, one of the leading firms providing managed account services. “You can’t call your TDF and ask if your allocation is still right for you, or what you should do now that you’ve lost 10% in a downturn.”

Kitces urges target-date investors to assess their comfort with risk by taking a well-designed risk questionnaire like the one offered for $45 by Finametrica. If you are not comfortable with the level of risk in your TDF, consider shifting to a closer-date target series with less equity exposure.

“It’s not too late for young people to dial down their exposure to a level they can tolerate,” he says. “Make a change when things are down 10% instead of 40%. Things can get worse, and then you’ll make really non-rational, emotional decisions.”

MONEY stocks

Wall Street Is for Sale, But It’s Still Not Cheap

Market
Andrew Burton—Getty Images Traders work on the floor of the New York Stock Exchange during the morning of August 27, 2015 in New York City. Dow Jones Industrial Average stocks continued their rally, opening approximately 200 points higher today.

The selloff lowered asking prices, but most U.S. stocks are still no bargain.

During more than a week of stock market sell-offs, investors have been exhorted to use declines to pick up bargains – and with a 7.7% drop on the S&P 500 since August 17, stocks have certainly gotten less expensive.

To determine how cheap they are, investment pros look at yields, earnings and more. By several of those metrics, the bottom line is this: U.S. stocks are not wildly expensive, but they are not the screaming bargains that might pull value-minded investors back into the market.

“We are not getting to a point where it’s attractive, it’s just not as expensive,” said Michael O’Rourke, chief market strategist at JonesTrading in Greenwich, Connecticut.

That is because investors are willing to pay more for companies that are expecting strong earnings growth. But with Chinese demand weakening, oil prices slipping and the dollar remaining strong even after slipping a bit in the last few days, analyst expectations now are that S&P 500 earnings will fall 3.3% from a year ago in the third quarter, according to Thomson Reuters data.

And that makes even less-expensive stocks still pricey.

Here are a few ways to look at stock prices now.

Earnings – Even after Wednesday’s buying spree, the S&P 500 stock index was selling at roughly 15.8 times its expected earnings for the next 12 months. That is lower than this year’s peak of 17.8 but not far from the average of about 16 since January 2000, and well above the 10.5% hit during the last market correction in August 2011.

“Low interest rates have juiced equity valuations to levels more consistent with a rapidly growing global economy than one still stuck in first gear,” Nicholas Colas, chief market strategist at Convergex in New York, wrote in an overnight note to clients.

On a 14-times earnings scenario, a multiple more in line with slow earnings growth, the S&P 500 should be closer to 1,700 – more than 10% lower than Wednesday’s close – a level that would drag the index into a bear market.

Dividend yields – For some, the argument that there is no other asset besides stocks to invest in due to rock bottom yields in U.S. government debt continues to hold. The S&P 500’s dividend yield of 2.57% recently ticked above the 10-year yield according to data from Thomson Reuters Datastream and Fathom Consulting.

This was the case on and off since the start of 2015 until April, and the norm between late 2011 and mid 2013 – a period of strong gains for the stock index. But it has only happened one other time in the last 20 years, between December 2008 and April 2009.

Earnings yield – At above 6%, the earnings yield on the S&P 500 compares favorably with the 10-year Treasury note yield, now just under 2.2%. Analysts say that when the earnings yield is more than twice the yield of the Treasury benchmark it historically augurs gains for stocks.

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