Invest in Brazil?

Brazil has the seventh largest economy in the world and the fifth largest as measured by land mass. With a population of 193 million and a 2 trillion dollar economy, it is a political and economic leader in Latin America. However, social and economic problems have kept it from being an effective global power. In the future, economic growth may drastically change the role of Brazil in our world.

Why Invest in Brazil

The booming global demand for commodities, particularly energy and agriculture, is a major proponent of a robust Brazilian economy. Brazil is now a global power in natural resources and agriculture; two of my top global investment trends that I expect to enjoy strategic advantages for decades to come.

Brazilian exports are booming; and include aircraft, electrical equipment, automobiles, ethanol, textiles, footwear, iron ore, steel, coffee, orange juice, soybeans, and beef. It can meet growing demand for its’ products with an ample and efficient work force at competitive prices. Billions of dollars in infrastructure investment is currently benefiting the country as they prepare to host both the 2014 World Cup and the 2016 Olympics.

Brazil has been increasing its’ presence in international financial and commodities markets and is perfectly situated to take advantage of global growth trends. Many financial experts include Brazil in their risk on risk off trading. This means Brazil is considered a major player in world growth. Therefore, when investors want to invest in global growth, they should have Brazil as a part of their asset allocation.

Invest in Brazil Stocks with ETFs

Investing in Brazil Stocks through ETFs is how most investors should invest in Brazil. Since diversification is always paramount to reduce risk; an Exchange Traded Fund (ETF) is the most cost effective means to invest in Brazil. Here are ETFs traded in the United States:

Brazil ETFs based on Market Capitalization:

Ishares MSCI Brazil Fund ETF (EWZ)

Global X Brazil Mid Cap ETF (BRAZ)

Market Vectors Brazil Small-Cap (BRF)

MSCI Brazil Small-Cap Index Fund (EWZS)

 

Brazil Sector ETFs –

EGS INDXX Brazil Infrastructure ETF (BRXX)

Global X Brazil Consumer ETF (BRAQ)

Global X Financials ETF (BRAF)

 

Brazil Leveraged ETFs -

ProShares Ultra MSCI Brazil ETF (UBR)

ProShares Ultra Short MSCI Brazil ETF (BZQ)

 

Investing in Brazil

Brazil is well positioned to participate in global growth trends. Investors who want to participate in growth of the Brazilian economy can invest in Brazil stocks through a variety of Brazil ETFs.

(Disclosure: The Arbor Asset Allocation Model Portfolio (AAAMP) has a 1.3% position in BRF and 1.2% position in EWZ; no positions in BRAZ, EWZS, BRXX, BRAQ, BRAF, UBR, or BZQ on 2/12/12.)

 

Weekend Reading

Despite last week’s slight increase in employment; other factors should cause investors to be cautious. Insider selling, enthusiastic retail stock buyers, collapsing global trade, and high event risk are all factors that should affect portfolio asset allocations.

Here is Weekend Reading sorted from shortest to longest:

The Designated Driver – Investing is a game of probabilities. – Capital Observer

Indicators may signal why the market is Stubborn Like Ox – Capital Observer

Anyone thinking about investing in Penny Stocks should read Do Penny Mining Stocks Count as Investments? – Canadian Capitalist

We’re Officially in a Stock Picker’s Market – Wall Street Daily

Petroleum 3-Month Rolling Average Turns Sharply Lower; Negative Shipping Rates; Collapse in Global Trade – Mish’s Global Economic Trend Analysis

What Christians Should Keep In Mind While Planning For Retirement – One Money Design

Warren Buffett: Why Stocks Beat Gold and Bonds – CNN Money

What is Deflation – Definition, Causes, & Effects – Money Crashers

 

Carnivals I’ve Participated In:

Carnival of Financial Planning – Personal Finance Edition #223

Carnival of Wealth, Ronald Reagan’s 101st Birthday Edition

Carnival of Financial Camaraderie #19 – The Super Edition

Totally Money Carnival – Super Bowl Edition     

 

Related Reading: Weekend Reading Archives

Bank Stocks

Bank stocks are no longer investments for “widows and orphans”, but are instead, high risk investments with erratic dividends. Their volatility and undependable dividend payouts are symptoms of long term problems for the banking system.

In our last post we looked at why investors should Avoid Value ETFs and Mutual Funds. I pointed out that value ETFs and mutual funds are loaded with financial services stocks that used to be safe dividend paying stocks but are now high risk investments.

Bank stocks are large percentages of many value stock portfolios; and are being considered for purchase by individual investors because they can be bought for a fraction of the price they traded for a few years ago. I have avoided bank stocks for many years and, after careful examination, will not be adding any now either. Here is my analysis.

We know that most bank stocks have been volatile and poor investments the last few years. I’m not saying these investments won’t have periods in which they do well. If a stock falls from $50 to $2 and then rises to $4; I realize if you buy at $2 you have a 100% gain. My point is you need to realize what you are buying. Are you looking for a trading opportunity or a long term investment? While banks stocks used to provide security, dividend income, and moderate consistent growth; there are plenty of reasons to believe those days are over.

Long Term Problems for Bank Stocks

Let’s look at the long term problems of the banking system that make bank stocks high risk investments for the foreseeable future:

Political Risks – Everyone hates the banks right now

Failing Mortgages – Still millions of underwater mortgages on the books (and more coming!).

Deflation – Housing prices are still falling!

 

Litigation and Settlement costs over mortgage putbacks.

Regulatory reforms adding costs and making loans harder to make.

Exposure to Europe.

Lack of Transparency – What exposure do they have to derivatives?

When Interest Rates Rise – Banks are getting a free bailout from the Federal Reserve artificially holding down rates. What happens when rates rise?

Balance Sheets need improvement as requirements for additional capital make lending harder and less profitable.

Lack of Credit Growth – Banks have thrived for decades on ever expanding credit. Credit is shrinking now.

Does This Mean You Shouldn’t Buy Bank Stocks?

The point of this post is not to keep you from buying bank stocks. Everyone has their own personal risk parameters. There may be a price where it’s worth the risk to own a particular stock. The point of this article is that bank stocks are a completely different investment from what they were in the past. They are no longer steady dividend investments for “widows and orphans”.

Bank stocks are high risk investments with erratic dividends because the banking system environment has changed. Be sure you understand the risks, and possible rewards, before making an investment.

 

Avoid Value ETFs and Mutual Funds

Investors, especially value investors, should avoid most value ETFs and mutual funds because they are over weighted in high risk investments. As a value investor I am always looking for stocks that sell at low prices compared to their potential cash flow and risks associated with the underlying company. What was value and low risk in the past is not necessarily value and low risk today.

Most Value ETFs and Mutual Funds Are Loaded With Financial Services Stocks

Financial services, and particularly Bank Stocks, used to be the investment choice for “widows and orphans”. In other words they have been, in the past, considered safe dividend paying stocks with low volatility. The world has changed and these stocks are now investments with huge risks and considerable volatility.

So now value funds that used to have steady low volatility dividend paying stocks now own risky high volatility stocks with erratic dividend payouts. The question is: Are you getting what you intended when you buy these funds?

The percentage concentration of financial stocks in value funds is not insignificant. Many of these funds have considerable exposure to financial stocks.

Examples of Percentages of ETF Portfolios in Financial Services

iShares S&P500 Value Index Fund (IVE)              22.6%

iShares S&P500 Growth Index Fund (IVW)            3.8%

iShares Russell 2000 Value Index Fund (IWN)      23.0%

iShares Russell 2000 Growth Index Fund (IWO )    2.9%

As an investor interested in Value Investing Strategies; it is important to not get caught up in labels, but understand what you are buying. Sometimes investments are not what you think they are; so do your homework. An ETF or mutual fund investment labeled “growth” may have more value or less risk than an investment labeled “value”.

Many value investing funds have heavy exposure to financial service stocks which used to be stable dividend companies but are now volatile stocks with erratic dividends. Value investors should consider investing in individual undervalued stocks; but avoid value ETFs and Mutual Funds, until the environment for financial service stocks has changed.

Related Reading: Investment Portfolio Management

(Disclosure: The Arbor Asset Allocation Model Portfolio (AAAMP) is 2.5% long iShares Russell 2000 Growth (IWO) on 2/7/2012)

Personal Finance Investing

A round up is a blog editor’s best picks from the blogosphere. In the process of research and hosting the Self Directed Investing For Retirement Carnivals I run across excellent articles from a variety of great blogs. This is my way of sharing with you what I believe to be some of the best personal finance and investing posts.

The Advantage To Being a Small Investor – Business Insider

Markets Race Out of 2012 Gate - Investing Caffeine

10 Ways to Destroy Your Portfolio – Investing Caffeine

Capitalism is NOT a Zero Sum Game! – Investor Junkie

What is ETF Contango? – Investor Junkie

Return on Enterprise Value (ROEV) Backtest  -Fat Pitch Financials

Five Ways to Recover From Your Investing Mistakes – Money Qanda

Diversification Strategies for Better Bond Upside - Darwin’s Money

Freedom Cannot Coexist With an Income Tax – Thousandaire

The Gene Mauch Rule for Investing Success – Balance Junkie

The Secret to Successful Investing Can Be Reduced to Two Simple Words – Simply Investing

My Stock Fell 20% – Should I Buy More or Sell? – Financial Highway

7 Companies With Unrivaled Economies of Scale – Dividend Monk

Your President is Lying About a “Strong Dollar Policy” – Why Dollar Weakness Matters – Darwin’s Money

The Future Value of Your Roth IRA – Bible Money Matters

“Timing the Market” Using Stock Valuations – Mint

 

Related Reading: Best of Personal Finance Investing Blog Posts

 

Investment Decisions

Investment decisions influenced properly by the concept of probability can maximize positive outcomes. In our last post, Making Probability Theory Practical for Investment we discussed how understanding probability would help us avoid short term prognosticators and concentrate on a long term investment plan. Now I want to concentrate on how investors can implement a long term plan using probabilities to increase and maximize positive outcomes.

The following two investment strategies combined will maximize your probability of meeting your goals for those who are willing to take a long term view.

Asset Allocation Investment Decisions

Although short term movements in the stock market are random; the positive bias makes long term investing much more certain.  We know that investing when valuations are low always produces positive rates of return when time horizons are 15 years or more. Rob Bennett at A Rich Life has done extensive research on this subject including a Retirement Calculator using different valuation scenarios. I encourage you to examine his tools for learning this important concept.

A flexible or tactical asset allocation strategy  is an important concept in using probability to improve your investment outcomes. Investing during periods when valuations are low greatly improves portfolio returns. Investing during periods of high valuations produces below average rates of return, even in the long run.

Stock Selection Investment Decisions

Valuation also works when making stock selection investment decisions. If you buy a variety of individual stocks with good fundamentals at low valuations the probability of positive outcomes is much greater than average.

My single favorite stock valuation calculation is ROEV, or Return on Enterprise Value (ROEV). This ratio compares the cash flow to the current market price of the company with an adjustment for its balance sheet. George at Fatpitch Financials has published a ROEV Backtest that demonstrates the value of this powerful investment research tool.

Dynamic Duo of Investing

A valuation based tactical asset allocation strategy with a ROEV individual stock selection strategy makes a powerful risk adverse combination. This dynamic duo of investing would change the investment world if people would follow it. But they don’t. They let greed and lack of knowledge lead to making investment decisions with poor probabilities. You know what works now.  There are many choices out there; only you can choose your path. You can make low probability investment decisions or high probability investment decisions.

Do you have the discipline to make high probability investment decisions?

Making Probability Theory Practical

One of my favorite sayings is “Anyone who tells you they know what the stock market will do in the short term is either a fool or a liar”. The market cannot be predicted on a daily, weekly, monthly or yearly basis. This is NOT true for long periods of time; but we will talk about that later.

Probability Theory Illustrated

So how do some people correctly predict short term movements with great accuracy? Let’s look at probability theory illustrated in a simple example. If you flip a coin you have a 50% probability of heads and a 50% probability of tails. If you ask 1000 people to predict the outcome of a single coin flip the probability is 50% will predict correctly and 50% will get it wrong. Flip the coin twice and the odds are only 25% of predictors will guess both flips correctly. The accuracy will fall with each additional coin flip. At the end of 10 coin flips the odds are 1 out of 1000 will have predicted every coin flip correctly. Is that person the best prognosticator? These are completely random events and the odds were 1 out of the 1000 would get ten correct guesses in a row.

Probability in Investment

Although the stock market is much more complex, the same concept of probability in investment applies. Studies have shown that short term returns in the stock market are random, although with a positive bias. The positive bias is the difference between the coin toss example and the stock market; meaning there will be more positive than negative outcomes over time.

If you have enough prognosticators (and we do!); there will be a few who are able to successfully predict the short term moves in the stock market over several or even many time periods. Unfortunately, people begin to believe the stock market prognosticators are infallible and more and more people follow their advice. The more successful the predictions the greater number of followers. In addition to more followers, investors become more confident in their abilities, and make larger and larger bets. After all, the predictor has been correct many times; they must know more than anyone else? Of course, this is incorrect.

Inevitably the odds eventually catch up with the prognosticator. They guess incorrectly, and many people are harmed. But more damage can be done with a few incorrect guesses than all the correct guesses combined. That is because few are following when the prognosticator first starts his predictions. But at the end many people are following and many will most likely be making much greater bets than they were in the beginning. This is one of the reasons people get disenchanted with investing. They make poor investment decisions; usually based on greed and lack of understanding. They don’t have a solid investment plan.

It is easy to become lazy and attempt to follow an investment guru instead of implementing a sound investment plan. But there are no short cuts in investing. Any investment philosophy that is going to get you rich quickly is a scheme that will end badly.

Fortunately, for those willing to be patient and implement a long term investing plan, probability comes close to guaranteeing positive outcomes for those who do their homework. The stock market can be predicted in the long run.

In my next post, “Investment Decisions: Asset Allocation, Stock Selection, & The Dynamic Duo of Investing” we will look at two investment strategies that increase your probability of investment success to nearly 100%.

Building Savings in a Low Interest Rate Environment

Having an adequate emergency money fund is the foundation of a solid financial plan. Just as you would place a solid foundation before building your home you need a solid emergency savings fund for unexpected needs.

Emergency Money

Emergency money is money kept safe and separated from all other activities including your investment portfolio. Emergencies are unplanned events that cannot be foreseen or predicted such as losing your job or extraordinary medical expenses. Needing a new appliance or repair is not an emergency but an ongoing expense that should be budgeted for.

The lack of emergency money leads families to borrow at high interest rates, sell assets in a distressed situation, or borrow from family or friends when unplanned events occur. Statistics show Americans are dangerously illiquid. Making plans to have emergency money can give you peace of mind, reduce stress, provide extra income, and provide the foundation for a solid financial plan.

Building an Emergency Fund

Most financial experts recommend an emergency fund equal to 6 -12 months of expenses. Since one of the main emergencies we want to protect against is losing a job, I think being conservative and saving 1 year of expenses makes sense; after all, it’s taking a long time to find a job today.

I like to use three tiers of liquidity for my emergency fund.  I keep $5 – 10 thousand dollars in a money market fund. A money market is ultra-safe and extremely liquid. Money markets allow you to write a check to meet an immediate need.

My second tier is $15,000 + in a bank certificate of deposit (CD) which pays a little interest and provides for my banking relationship to be completely free. Two or three checking accounts and a few services can add up to $20-40 in bank fees. Saving $240 per year in banking fees provides a 1.6% return on a $15,000 CD savings account. Saving $480 per year in fees provides a 3.2% return on a $15,000 CD. There is no reason to give any of your hard earned money to a bank for fees; plus you earn interest on your CD.

My third tier of emergency funds is placed in United States Government Saving I-Bonds. Many years ago I started putting a few hundred dollars a month into a Treasury Direct account tied to my checking account. The $30,000+ in that account is now earning 3.06% (current rate from Nov. 2011 to April 2012). This money is a little less liquid but safe and available for large emergencies.

Emergency Savings

Emergency savings will give you the ability to meet your unplanned needs and avoid borrowing at high interest rates or selling assets at distressed prices. A segregated emergency money fund will provide peace of mind knowing your financial plan is built on a solid foundation for meeting your needs and long term wealth building.