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December 9, 2008

QUESTION: Is Daimler responsible for the payment of a corporate bond even if Chrysler goes bankrupt?

--Ken

ANSWER: With the scope of any government rescue plan still up in the air, it's natural to worry about securities connected to the car maker. But based on all the information we could gather your bond appears safe to hold, even if Chrysler succumbs to the worst. A spokesman for Daimler, the German parent of the awkward and unsuccessful corporate marriage of Detroit and Stuttgart, confirms that all DaimlerChryler-issued bonds remain Daimler's responsibility. (Daimler sold majority ownership of Chrysler to Cerberus Capital Management last year.)

That's fortunate for bondholders, since the possibility of a Chrysler bankruptcy remains very real. In general, bondholders of companies filing for Chapter 11 usually get a fraction of the value of their bond holdings if a company emerges from bankruptcy. Bondholders usually get paid after secured creditors like banks but ahead of stockholders. It's explained here by the Securities and Exchange Commission.

Steven Lubben, a corporate bankruptcy expert and professor at the Seton Hall University School of Law in Newark, N.J., says bondholders, along with other unsecured creditors, generally shouldn't count on getting much money back, though they may get some fraction of their holdings reissued as convertible stock. Stockholders often get nothing.

"In a bankruptcy case, being in the middle would be being at the bottom," he says of bondholders. "It's better than being a shareholder of a company that's in Chapter 11, but not much. In a reorganization, it's quite common to convert unsecured creditors into new shareholders and lop off the old ones."

December 8, 2008

QUESTION: I have access to real-time quotes. I see a stock quoted at, let's say, $99/share. I put in an instantaneous buy ticket online and it shows I bought the stock for $101.36, let's say. I don't believe the stock price moves that quickly. Why the large differential?

--Joel S. Feldman

ANSWER: A real-time stock quote is no guarantee that you'll get the price you see when you place a buy order, for several reasons. First, stock prices can move quickly, especially if you're trading based on news. Second, a quote of $99 means that's the last price the stock traded at. Stocks carry bid and ask prices that indicate where you can sell and buy now, respectively. For a stock of that price, the spread between the bid and ask can be a dollar or more.

Third, bid and ask quotes are for specified numbers of shares. If you're buying more shares than are on offer at the ask price, your trade might be executed at a higher price. Fourth, trades placed online are sometimes held up for review by a broker (to determine, for example, if a margin account has sufficient buying power).

If you suspect you got a bad execution, ask your broker to review the trade. They'll have access to a detailed history of bid and ask prices at the time you placed the trade. (They might even provide you with that information, so you can see for yourself.) If they conclude that you're due a better price, they'll contact the exchange or market maker that executed the trade and have the price adjusted.

December 5, 2008

QUESTION: I was just downsized, and this tough market has me wincing at the thought of rolling over my 401(k). Should I wait it out?

--Michelle Russo

ANSWER: There s no reason to wait it out. Rolling over your 401(k) is just a transfer from one holding place for your retirement savings to another. It s not like changing mutual funds or selling a stock, in which paper losses become real ones. There is no penalty for rolling your 401(k) into an IRA, says Ron Roge, of investment advisory firm R.W. Roge & Co.

In addition, moving into an IRA has some benefits if you're looking to change investments, Roge says. An IRA gives you more flexibility, because you ll usually have more choices. Many 401(k) plans are limited to a few investment options or a single fund family. See recent 401(k) articles at SmartMoney.com.

QUESTION: Is it smart to dump my small-cap and midcap losers and buy the now depressed blue-chip stocks, hoping that when the market does rebound the blue chips will come back faster?

--Joseph Tang

ANSWER: Moving big chunks of money around based on sophisticated trading strategies, be they market timing, sector rotation, long-short, growth vs. value, or, in your case, flight to quality, is usually best left to professional traders and registered investment advisors. Since it's impossible to know which asset classes, sectors and strategies are going to work at any given time, the soundest approach is to diversify your portfolio more broadly than ever and maintain a disciplined dollar-cost averaging plan. Avoiding a lump-sum investment lessens the likelihood of buying at a market top.

True, blue chips might come roaring back, but then let s not forget the astounding bull run small caps so recently enjoyed. The small-cap benchmark Russell 2000 index more than doubled from 2003 to 2007. In more recent, and less pleasant, history, the Russell is off 40% (as is the S&P 500 index), while the blue-chip Dow Jones Industrial Average has fallen 35%. One could even argue that small caps have a better chance of racking up bigger gains much faster than the quality large-cap stocks. Then there s the complicating reality that small-cap value happens to be the best-performing asset class over long periods of time. And as for midcaps, well, our SmartMoney screener has been spitting out some intriguing ideas lately, too.

So at this point it might be wisest to go with a so-called lazy portfolio, which typically consists of four to a dozen highly diversified and cheap index funds or exchange-traded funds. Money manager Merriman Berman Next publishes suggested lazy portfolios for free on its FundAdvice.com web site. Note that even their Fidelity Balanced portfolio still allocates about 25% to small caps alone.

December 4, 2008

QUESTION: I'm thinking about opening up an account with an online broker. Which ones do you prefer? I'm concerned about fees, account balances, minimum balances, etc.

--Robbie Pope

ANSWER: SmartMoney s Annual Broker Survey is a great place to research online brokers. This comprehensive guide covers everything from commissions and fees to research and trading tools. Once you ve narrowed down your options, make sure to read the fine print. Cheap trading commissions and other enticing offers often come with strings attached.

December 3, 2008

QUESTION: I'm 19 and in the military. I'm wondering if it's a good time for me to jump into the market. I received some extra pay and was thinking of getting a mutual fund. What would you recommend?

--Steven

ANSWER: It's very commendable of you to start thinking about investing and saving at such a young age. With stocks trading at depressed levels and given your long horizons, you should have ample time -- decades, really -- to weather the inevitable ups and downs that will eventually grow a small starting stake into a healthy nest egg.

A diversified mutual fund is a good place to begin. Individual stocks carry too much risk, plus the brokerage fees will put you in the hole from Day 1. You might want to start with an inexpensive no-load balanced fund that holds both stocks and bonds. You ll get the benefit of professional management and exposure to two uncorrelated asset classes. As your portfolio grows you can check out our mutual fund center for additional ideas.

Importantly, don't forget to put your money to work a little at a time at regular intervals. That's a strategy called dollar-cost averaging. It helps reduce the chance of buying at a market top, a risk you'd run with a lump-sum investment.

QUESTION: I have been watching some inverse ETFs such as UltraShort MSCI Emerging Markets ProShares (EEV) . EEV is based on the underlying MSCI Emerging Market Index and is supposed to move double the opposite direction of that index. Therefore, in theory, if the emerging-market index goes down 1%, then EEV should go up 2%. Over the last four months the emerging market index has dropped 50%. Therefore, EEV would've been expected to go up by around 100%. It hasn't. How can that be?

--Mike

ANSWER: You're right to be skeptical of leveraged ETFs. UltraShort MSCI Emerging Markets ProShares is a good example of why many experts don't recommend these for individual long-term investors. Take a look at EEV's prospectus and you'll see that its goal is "daily investment results," not necessarily long-term ones. On "a given day" it tries to do twice the opposite of the MSCI Emerging Markets Index. On some days it s successful. For instance, on Dec. 2, EEV closed down 12% while the MSCI Emerging Markets Index closed up 6%. On other days it isn t successful.

That s because there are multiple moving and complex parts here. If a leveraged ETF has a string of losses, with the effects of compounding, those losses can have a significant impact on long-term performance. This can help explain why year-to-date EEV is up just 10% even though the index is down 42%. Bottom line? These ETFs, even though they're correlated with indexes, have the same problem as any other investment: Their strategies aren't guaranteed to achieve their goals.

December 1, 2008

QUESTION: Why is it that investors are buying stocks in companies that are on the verge bankruptcy like AIG (AIG) and General Motors (GM) ? Is there any benefit to buying at this price, and what would be the worst-case scenario of my investment?

--Mike Ghazala

ANSWER: Let's get right to the point: The worst-case scenario is you lose your entire investment. When a company files Chapter 11 the business is reorganized, but there's no guarantee shares will be worth anything once the company emerges from bankruptcy protection. Ditto for a Chapter 7 bankruptcy liquidation, in which a company's assets are sold off. Rules governing corporate bankruptcies generally dictate that secured and unsecured creditors -- banks, bondholders and the like -- get paid off first. Stockholders are last in line, and often there's nothing left by the time their turn comes around. If there are assets remaining, stockholders may receive shares in the newly reorganized company.

So why do investors buy shares of companies on the verge of bankruptcy? Some may truly believe the company will avoid disaster and bounce back, making the shares an attractive long-term investment. More often than not, though, investors are looking to make a quick buck on a short-term trade. In that case fundamentals are thrown out the window. Hedge funds and institutional trading desks are often involved in highly leveraged trades of these extremely volatile stocks. With such heavy hitters in the game, and so much uncertainty surrounding the companies, we recommend that individual investors keep their distance.

One other note: Even in bankruptcy a company's shares may continue to trade, often for pennies apiece. While the low price might be tempting, liquidity is spotty because the stocks are usually forced to trade over the counter rather than on a major exchange like the NYSE.-Protected Securities, known as TIPS, is to hedge against the corrosive effects of rising prices. The static interest paid out by typical fixed-income investments loses its buying power over time as the cost of goods increases.

That's why TIPS make sense in an inflationary environment. As inflation, as measured by the Consumer Price Index, rises, the principal of your TIPS is adjusted upward, as are the interest payments. The opposite occurs during periods of deflation, or falling prices. Some economists fear the U.S. could be facing a protracted bout of deflation.

Whether to buy or sell TIPS depends on what your aim is and where you think the economy is headed. If you're looking for near-term outperformance and think we're in for a prolonged slowdown, then it's not a great time to buy since inflation isn't a big factor when the economy stalls. As for selling, if you own TIPS that are near maturity it's probably best to hold on. A nice feature of TIPS is that you'll get back your original principal even if a declining CPI has pushed the adjusted principal below that level. With deflation a looming threat, that's a nice guarantee to have.

QUESTION: When I retire, is it possible to roll over my 403(b) into a Traditional IRA account. When I roll over the 403(b) into the Traditional IRA, would it be possible to invest everything in municipal bonds so I don't have to pay taxes when I withdraw the funds for retirement?

Angela Tulshi

ANSWER: Similar to a 401(k), a 403(b) is a retirement savings plan primarily used by teachers. It is possible once you retire to roll over your 403(b) into a Traditional IRA account and invest all those assets in muni bonds. But that isn't the best use of either muni bonds or your IRA for two reasons.

First, once you start taking the money from your Traditional IRA it'll get taxed as ordinary income, says Michael Gibney, president of the Financial Planning Association of New Jersey. So, even if you have all of your IRA invested in muni bonds you will still have to pay taxes when you withdraw the money.

Second, IRAs already allow you to grow assets tax deferred. Therefore the tax advantages of muni bonds are wasted in an IRA. Instead, put muni bonds in taxable accounts. For recommendations of muni bond mutual funds, a good alternative to individual muni bonds, read our story.

November 26, 2008

QUESTION: I have a child in the fourth grade in Maryland and one in kindergarten. Is this a good time to be starting a 529 or is it better to wait for the markets to recover?

Simon Winter

ANSWER: The short and sweet answer is: Don't wait. When investing and starting a 529 savings plan is precisely that it's always best to buy low. "Waiting for the market to rebound is the equivalent to waiting for the price of a gallon of milk to go from $2 to $2.50 before buying. You simply wouldn't do that," says Ted Toal, certified financial planner at Triton Wealth Management in Gaithersburg, Md. You want to get in when the market is going through a temporary downturn like it is now. No one knows when stocks will recover. And besides, by the time they do, you'll be too late and will have missed out on some gains.

Toal suggests investing in a target-date portfolio like the one offered by Maryland's college savings plan and managed by T. Rowe Price (TROW) . Target portfolios work by investing according to the child's age: more aggressive investments when the child is young shift to more conservative holdings (like cash and fixed income) as he nears college age. This plan also offers a nice tax deduction: For each beneficiary, you can deduct up to $2,500 of contributions each year from state taxes.

QUESTION: My wife and I have an annuity with AIG (AIG) . I am over 65 and she is over 62. I am concerned about AIG given all the bad publicity. Is our money safe there or would you recommend taking it out?

Norm Allen

ANSWER: The principal on your annuity with AIG is safe. It's protected by a strict financial requirement that insurance companies must maintain cash reserves equal to the withdrawal value of every annuity account. And if AIG suffers a complete meltdown, policyholders will have plenty of time to come up with a backup plan. "An insurance company wouldn't go out of business tomorrow," says Scott Simmonds, an independent insurance consultant based in Saco, Maine. "Regulators wouldn't allow that to happen. There would be a gray period."

November 25, 2008

QUESTION: Is now the best time to buy TIPS? Is it too late to sell TIPS, or should I just hold on to them for a couple of years?

Paul Freedman

ANSWER: The primary goal of Treasury Inflation-Protected Securities, known as TIPS, is to hedge against the corrosive effects of rising prices. The static interest paid out by typical fixed-income investments loses its buying power over time as the cost of goods increases.

That's why TIPS make sense in an inflationary environment. As inflation, as measured by the Consumer Price Index, rises, the principal of your TIPS is adjusted upward, as are the interest payments. The opposite occurs during periods of deflation, or falling prices. Some economists fear the U.S. could be facing a protracted bout of deflation.

Whether to buy or sell TIPS depends on what your aim is and where you think the economy is headed. If you're looking for near-term outperformance and think we're in for a prolonged slowdown, then it's not a great time to buy since inflation isn't a big factor when the economy stalls. As for selling, if you own TIPS that are near maturity it's probably best to hold on. A nice feature of TIPS is that you'll get back your original principal even if a declining CPI has pushed the adjusted principal below that level. With deflation a looming threat, that's a nice guarantee to have.

QUESTION: When I retire, is it possible to roll over my 403(b) into a Traditional IRA account. When I roll over the 403(b) into the Traditional IRA, would it be possible to invest everything in municipal bonds so I don't have to pay taxes when I withdraw the funds for retirement?

Angela Tulshi

ANSWER: Similar to a 401(k), a 403(b) is a retirement savings plan primarily used by teachers. It is possible once you retire to roll over your 403(b) into a Traditional IRA account and invest all those assets in muni bonds. But that isn't the best use of either muni bonds or your IRA for two reasons.

First, once you start taking the money from your Traditional IRA it'll get taxed as ordinary income, says Michael Gibney, president of the Financial Planning Association of New Jersey. So, even if you have all of your IRA invested in muni bonds you will still have to pay taxes when you withdraw the money.

Second, IRAs already allow you to grow assets tax deferred. Therefore the tax advantages of muni bonds are wasted in an IRA. Instead, put muni bonds in taxable accounts. For recommendations of muni bond mutual funds, a good alternative to individual muni bonds, read our story.

November 24, 2008

QUESTION: If a company files for bankruptcy, what happens to the stockholders?

Richard

ANSWER: It depends on whether the company files for Chapter 11 or Chapter 7 bankruptcy protection, but in either case shareholders see their equity stakes severely depleted or destroyed. Chapter 11 generally refers to the reorganization of a business while operating under bankruptcy-court protection; Chapter 7 generally refers to the liquidation of any assets.

In the case of Chapter 11 the company's stock may continue to trade while the firm reorganizes, but it won't be worth much, if anything. In the case of Chapter 7 the company goes out of business, usually wiping out common shareholders, who are last in line (behind secured creditors, bondholders and preferred shareholders) to collect anything that's left from selling off the business in pieces. Companies that declare bankruptcy also stop paying dividends.

November 20, 2008

QUESTION: I'm 71, retired and don't need the money yet, but should I keep Dodge & Cox (DODGX) ? Can it come back from the big hit it's taken this year?

Joe Dion

ANSWER: Dodge & Cox has had a bad year. Its flagship stock fund is down 47% after making bad bets on financial companies like Wachovia (WB) and American International Group (AIG) . But, since you don't need to take your money out yet, it's worth considering the fund's past performance. As Morningstar recently pointed out, the fund has done well in years following bad markets, such as in the early 2000s. Its 10-year annualized returns put it in the top 1% of its category. Past performance doesn't guarantee future performance, but bear in mind that several of the fund's managers have had more than $1 million of their own money invested in the fund. That shows internal conviction in their strategy. The fund is also cheap with a 0.52% expense ratio. If you have a five-year time horizon, why sell now with the market down? It may be worth giving managers a chance to recoup some losses before moving on.