No matter. You can learn how to start saving for retirement in the five minutes it will take you to read this article, and you can probably start doing it in less than an hour. So if you know that you should start saving for retirement but have no idea where to start, roll up your sleeves, brush off your fear and let’s get started.

Retirement Savings 101

Okay, so why do you even need to save for retirement, anyway? Because lucky for you, thanks to our modern quality of life and medicine, chances are good you will live to a ripe old age. And when you’re approaching 80, you may want to do something other than work. And although Americans receive Social Security benefits after a certain age, our younger generations cannot count on these government benefits alone. They won’t be enough to live on if they’re still around at all. We need to take charge of our own financial future and we do that by saving for retirement. The government will even give us some tax benefits if we do.

Finally, the earlier you start saving for retirement, the better: The more time you let your investments grow, the less money you have to stash away in the first place. (For more about retirement saving basics, read 23 Things Every Beginner Should Know About Retirement Savings).

How to Start

Anybody can start to save for retirement. We’ll cover the two most common ways.

The 401(k) Plan

If you work full-time, ask your human resources manager if your company offers a 401(k) plan or 403(b) plan (if you work at a non-profit). These plans allow you to save for retirement with automatic deductions from your paycheck up to $16,500 a year (in 2010). The best part is you do not have to pay taxes on the money you save. Even better, some employers will match some of your savings (usually a percentage of your salary). When you enroll in your company’s 401(k) plan, you will need to choose among a limited number of investments your plan offers (typically, you are limited to a few choices). Ask to speak with your plan manager for recommendations, or simply choose a target date mutual fund for the year you will retire. These funds are collections of investments that the plan continually adjusts to maintain appropriate risk and return for your anticipated retirement year.

The Individual Retirement Account (IRA)

If your employer doesn’t offer a 401(k) or 403(b) plan or you want another option, start an IRA. You can open an IRA for free and often with no minimum deposit at most any online broker and can invest however you want (in any stock, bond, mutual fund, ETF, etc.) Investors under the age of 50 can contribute up to $5,000 a year (for 2010) to either a traditional IRA or a Roth IRA. These two types of IRAs often confuse new investors, but choosing can be easier than you think:

• Traditional IRA: Money you put in is tax-free (you can deduct the contributions on this year’s tax return). Choose a traditional IRA if you don’t have a 401(k) or other retirement plan at work.
• Roth IRA: You cannot take a tax deduction for the money you put into a Roth IRA, but you won’t have to pay taxes on the money you withdraw in retirement. Choose a Roth IRA if you do have a 401(k) or other plan at work and you do not earn more than the Roth IRA income limits.

Upon opening an IRA, simply set up automatic investments: transfer money from your checking account to your investment account every month or pay period and forget about it, just like employers do with 401(k) plans. Finally, whichever type of IRA you open, you will need to choose how to invest the money. Choosing from the entire universe of investments is more intimidating than selecting from among a few mutual funds in a 401(k) plan, so proceed carefully. You can research investments yourself using a free tool like Morningstar or enlist the help of a financial advisor (paying an advisor big bucks in your twenties rarely makes sense, but you might pay a fee-only planner for an hour session once a year to help you pick out your starting investments). Whatever you do, resist the urge to do a lot of trading: Even if you get lucky, the commissions and fees will eat up your returns, especially when you’re just starting out.

That’s really all there is to starting to save for retirement. Whether you sit down with your HR person at work or open an IRA account at an online discount broker now, you can probably be saving in less than an hour. The only question is: What are you waiting for?

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Obviously, both are important. The younger you are when you start contributing to a 401(k) or IRA, the longer compounding interest will work its magic. At the same time, many of us want to own a home before we turn a certain age, get married, or have kids. And if we’re able, the money-savvy among us would like to buy our home with a substantial down payment (ideally 20 percent).

That’s no small goal.

But can you save for both retirement and a down payment at the same time? And, if you must choose, which should be your priority? The answer is, of course, complicated, and depends on some individual financial factors. But, in general, save for retirement first.

Emotionally, most us of will want to save for a home first. Even if we’re being pragmatic and saving a down payment, a home is tangible, a Roth IRA is not. Financially, however, saving for retirement before a home is the right move.

Historically, over 20-25 years or more, stock market gains far outpace real estate. (And, as an aside, I don’t believe anybody should buy their primary residence as an investment. Yes, professional real estate investors have made fortunes, but it doesn’t mean you will—especially on your own home. Buy your house to live in. Period.)

Examples

Let’s say Jane Investor saves $6,000 a year for five years before turning 25. For the simplicity of this example, Jane tucked the money under her mattress and didn’t earn any interest during that time. Jane has $30,000 to use as a 20 percent down payment on a $150,000 home or invest in a retirement account that will earn an average of seven percent annual returns over the next several decades.

If Jane Makes a Down Payment

Jane’s first home turns out to be ample for her needs, and she stays in her home for 25 years. According to the Forbes report linked above, the average increase in real estate prices between 1980 and 2004 was 274%. Using this figure, Jane’s home would be worth $370,500 and the $30,000 she “invested” as her down payment would now be worth $74,100. (Obviously, she would have been making mortgage payments, building equity, and would make more of a profit on her home, but I omit those gains here to focus only on the initial $30,000 down payment).

If Jane Saves for Retirement

Jane decides to pull the $30,000 out from under her mattress and invest. She works with an investment advisor to build a well-diversified portfolio and, together, they adjust it at least every year. (Although Jane continues to put money into her 401(k), she put this money into its own account and makes no more contributions). Her conservative but intelligent investing yields an average seven percent annual return over 25 years meaning her $30,000 is now worth $162,823. (Note that over the same 24-year period in the Forbes article, the S&P 500 gained more than 1,000%. That would make Jane’s investment worth over $300,000). What would that same $30k be worth when Jane turns 65? A cool $449,234.

The Bottom Line

Unless you are very lucky or very skilled, real estate can’t beat the stock market as an investment. Add the tax advantages of retirement accounts, and I think the answer becomes even more clear: save for retirement first.

There’s No Need to Rent Forever

If you’re concerned about renting for longer than you had planned, don’t be. Rent is not wasted money any more than your electric bill is wasted money. You need electricity, you pay the power company; you need shelter, you pay rent.

But all of this doesn’t mean you need to rent forever and put all of your money into the stock market. But you should probably put money towards retirement—especially in tax advantaged accounts—before you start putting away for a down payment. What does that mean? Follow this simple algorithm to determine what you should save for retirement:

• If your employer offers a 401(k) or 403(b) and matches employee contributions: Contribute the maximum percentage of your salary your employer will match (usually six percent). Then contribute up to $5,000 (if eligible) to a Roth IRA. If you have money left over, save as you wish.

• If your employer offers a 401(k) or 403(b) and does not match employee contributions: Contribute up to $5,000 into a Roth IRA (if eligible) and any extra either to your 401(k) or for other savings goals. (If you earn too much for a Roth, contribute as much as you can to your employer’s plan).

• If your employer does not offer a 401(k) or 403(b): Contribute up to $5,000 a year to either a traditional or Roth IRA and save additional funds as you want.

Once you are saving a reasonable amount for retirement (the greater of the $5,000 IRA cap or 10-15 percent or your salary), feel free to put additional funds towards saving for a down payment. To accelerate your down payment saving, especially when rates at savings accounts are so low, you might consider opening a regular brokerage account and investing some of your savings in the market.

Using an IRA for Your Down Payment

Finally, the IRS allows you to withdraw up to $10,000 from an IRA for a home purchase without paying the standard 10 percent early-withdrawal penalty. There are some rules: the IRS treats a withdrawal from a traditional IRA as income and you must pay taxes. Withdrawals from a Roth IRA for a home purchase are both tax- and penalty-free as long as the Roth is at least five years old.

Although this loophole provides cash-strapped home buyers with an additional source of funds for a down payment, I wouldn’t recommend using it; any money you withdraw now is money that won’t be earning returns, tax-free, for 30 or 40 years.

Do You Need Twenty Percent?

If you follow my recommendation to save for retirement before saving for a down payment, you may be watching your dream of home ownership fade several years into the future. This can be especially true if you live in areas with pricier-than-average real estate markets. (In some parts of the country, $150,000 can buy a very adequate first home; in others, a buyer might have to spend $350,000 or more for a comparable property). Although regional salary differences can make up some of this difference, in these areas cost of living typically jumps faster and higher than pay, according to the Salary.com Cost-of-Living Wizard.

In this situation, you could consider putting less than 20 percent down. (I would still recommend at least 10 percent). If you have been saving for retirement for a few years, have few other debts, and have a responsible notion of how much home you can afford, putting less than 20 percent down on your home shouldn’t be too much of a problem. You’ll need to pay private mortgage insurance (PMI) for as long as you have less than 20 percent equity in your home, but over the long-run the gains your retirement account is making will make up for the money spent on PMI.

What do you think? Do you agree or disagree that saving for retirement should take precedence over putting away for a down payment? What did you do? Are you happy with your decision? Please weigh in with a comment.

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Swinging for the Fences

The Mistake: Making big bets on small iffy stocks.

Why We Do It: We know that it’s wise to invest in companies with strong fundamentals. Unfortunately, we also recognize that there is less upside investing in companies with already-proven track records. They’re profitable. They’re safe. They’re boring.

Young growing companies, on the other hand, promise higher returns. We hear about investors who got in early with Microsoft or Wal-Mart and made a fortune. Trouble is, such successes are rare and “swinging for the fences” is not the best way to build a financial future.

Loading up on risky all-or-nothing stocks is a sure route to investment disaster. Small growth stocks typically just putz along, unless they go belly up (which they often do). Example: Between 1997 and 2002, Nasdaq delisted eight percent of its listed firms each year. That’s approximately 2,200 firms whose shareholders most likely suffered big losses before the stocks were knocked out from the exchange.

How to Avoid It: Strive for consistent growth backed by fundamentals instead of throwing darts at smaller companies hoping that one of them is the next overnight success.

Investing With Your Heart

The Mistake: Investing in a company solely based upon your connection to the company or its products.

Why We Do It: It’s an easy trap to fall into. We can develop emotional attachments to companies and their stocks just like anything else. (For example, we work for the company, our parents spent their entire careers there, or we’re avid users of their products). So we invest in the company on faith rather than fundamentals. Our emotional connections blind us to more important indicators of whether or not the company is a good investment.

How to Avoid It: When we invest, what matters are the quantity and price at which we buy, the quantity and price at which we sell, and any dividends we receive. Period. It’s great that you love Panasonic because you love their new 50” flat-screen HDTV, and their quality product may lead you to research their company as an investment. That’s fine; but don’t let your connection to your TV lead you to invest before doing your homework. Great products and innovative technologies matter when assessing companies, but sound valuations matter more.

Following Trends

The Mistake: Investing with the herd.

Why We Do It: We humans are social creatures. We want to fit in, and we all assume that when masses of people act in a certain way, it must be the right way to do things. It’s hard (and scary) to be different. When there is a massive sell-off on Wall Street, fear combines with our desire to go with the pack and we are likely to sell too when, in fact, prices are going down and we might want to do the exact opposite.

Investing is a psychological balancing act of fear and greed. Too much of either will spell catastrophe. Success comes with taking a calculated risk when the chips are down, and knowing when to get out before the storm hits. Stocks are at their cheapest when everyone else is avoiding them.

Morningstar conducted a study every year for the past several years, which show the performance of unpopular funds. After evaluating which fund categories had the highest money inflows and which categories experienced the biggest money outflows, the asset classes that everyone hated outperformed those that everyone loved in all but one rolling three-year period over the past dozen years.

How to Avoid It: Timing the market is nearly impossible, so don’t try to pinpoint the bottom and top. But do go against the grain once in a while and seek out bargains in overlooked areas of the market instead of buying into the latest “hot” sector.

Ignoring Valuations

The Mistake: Investing in a company without understanding why the stock price is what it is.

Why We Do It: Making great investments requires a lot of research and a solid understanding of how companies and their stock prices are valued. Instead of buying only companies that are undervalued in the market, we often make investments based upon hype. Trouble is, that hype usually means that the company’s stock price is inflated…just the opposite of what we want.

• Great Free Research: Learn more about Morningstar »

How to Avoid It: Making an investment requires a lot of research. Do it. A great investment should not only have great fundamentals of the company you’re investing in, but the price at which it’s trading should be reasonable. It’s possible that a great company has already been over-hyped, leading to a high price tag.

Also, when you buy stock in a company, you become a part owner of that company. The only reason you should buy a stock is that you think the business is worth more than what the market is accounting for. Also, don’t rely solely on earnings. Companies can make accounting-based earnings-per-share say whatever they want them to. Instead, look into a company’s cash flows. You can spot trouble by watching the trend of operating cash flow relative to earnings. Operating cash flows declining relative to earnings may be a red flag worth looking into.

The Bottom Line

Don’t let a single costly mistake ruin your portfolio’s annual performance. Avoid these common blunders and you’ll be light years ahead of the average investor.

About the Author: Stan is a recent college graduate living in New York City, where he works for a trading firm. Before graduating from college, he was already running an investment fund for family and friends. He writes a weekly column providing economic and investing commentary and maintains his own blog, The Zen Financier.

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Bubbles occur anytime asset prices appreciate unrealistically; and they happen more often than we think. In the United States alone we have seen two in the past twenty years: The dot-com bubble in the late nineties and the mid-2000s real estate craze that has resulted in today’s downtrodden economy.

Bubbles happen everywhere. Japan, for example, experienced a huge surge in real estate and stock prices in the late 1980’s. Apartment prices doubled or even tripled in value in only a few years. By 1990, the value of Japan’s real estate had grown to five times the value of the entire U.S.; The Imperial Palace alone was valued as much as the entire state of California.

At the end of the boom, however, Japan’s balloon economy became distressed and fell hard, entering into a decade-long deflationary slump. This so-called lost decade is a painful reminder of what can result from such a bubble. In fact, Japan is still struggling to revive its economy today, in part due to the recent global financial crisis.

Why Do Bubbles Occur?

There is no single, widely-accepted theory to explain why certain assets sometimes grow rapidly and unsustainably.

One theory is that as an economy gains momentum, companies report higher earnings and pay individuals higher salaries. Instead of putting aside money in savings, individuals spend more than they should, purchasing a home that’s beyond their means thinking that as prices appreciate, they will be able to pay it off easily. They may also be more inclined to make risky stock market plays. This causes a contagious domino effect that eventually leads to a bubble.

An alternative theory is that as an expanding economy pumps more money into the financial system (liquidity), borrowing money becomes cheaper. With interest rates down, investors are more likely to leverage their capital by borrowing money from banks and investing in other assets such as real estate. When investors are putting too much money into a limited number of assets, prices rise. Multiply this effect by the number of individuals and large institutions that participate, and you get a classic bubble.

In my opinion, these and other theories are neither right nor wrong; many factors combine to create the “perfect storm” that leads to a bubble.

Should We Prevent Bubbles?

The more appropriate question might be: Can we prevent bubbles?

Although increased regulation can partially depress bubbles, economists have a difficult time accurately identifying bubbles and an even harder time implementing policies that won’t negatively affect other areas of the economy.

Most commonly, the Federal Reserve attempts to stifle bubbles by creating monetary policy aimed at controlling rising asset prices. The Fed increases the federal funds rate when there are inflation concerns and lowers the rate to spur economic growth. And when banks raise interest rates, borrowers have a harder time getting loans to fund investments or small businesses.

But even as the Fed raise interest rates up to 6.75% back in 2006, the U.S. real estate bubble continued to expand until its crash in 2008.

Looking back, bubbles seem obvious. Unfortunately, however, bubbles are difficult to detect as they occur because they typically begin with modest and innocent optimism.

That makes bubbles inherently difficult to stop a bubble from forming. Besides, who wants to be the guy taking away the punch bowl as the party just gets started?

Can Bubbles Benefit the Economy?

Bubbles scar the economy, and the healing process is long and painful. Just look at Japan.

But if you’ve ever enjoyed getting an incredible job offer, earning a plump salary, or making a lucrative investment during a bubble, you might be wondering: “Well, bubbles can’t be all bad”.

One benefit of bubbles are extensive standard-of-living increases for large segments of the population. Bubbles are capitalism’s way of rapidly metamorphosing an economy.

Without the Internet bubble we might have missed companies like AOL, which connected virtually every American household to the Web. Although 1999’s inflated salaries and stock prices are ancient history, the Internet remains and has transformed the way we share information and do business.

Looking back even further, electricity was commercially available in America as early as the 1880s, but utility companies faced certain barriers that delayed the implementation of electricity until the 1920s. The bubble of sorts preceding of the Great Depression contributed to electricity’s spread into rural areas and consequently, electrical household appliances that drastically improved Americans’ way of life.

Not all bubbles are transformational, but those that are enhance our quality of life and pave the way for future innovation. So as we endure the present downturn and look back on the culprit bubble as a cancer, we can remember that this cycle may actually be making our lives better and our economy stronger for the long run.

What do you think? Can bubbles be avoided? Do you see them as good in any way? What do you see as their negative or positive impacts?

About the Author: Stan is a recent college graduate living in New York City, where he works for a trading firm. Before graduating from college, he was already running an investment fund for family and friends. He writes a weekly column providing economic and investing commentary and maintains his own blog, The Zen Financier.

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We might consider professional gamblers—poker players, for example—a breed of speculative investors. Of course, we might also call investment professionals who take wild risks in financial markets gamblers. No matter how skilled the card shark or how practiced the investing maven, one thing is certain: in cards, as in the stock market, there are no guarantees.

Whether we gamble or invest, we take risks in pursuit of potential rewards.

We risk a dollar on a lottery ticket for a potential to win ten million dollars, we risk $25 on a hand of blackjack for the potential to double our money, we risk $5,000 to buy a penny stock for the potential it will triple in three months, or we risk our life’s savings in the stock market for the potential to earn consistent annual returns.

Each risk carries vastly different odds (and potential returns). At the one extreme, the odds you will lose your dollar is good; of winning the lottery, not so good. On the other extreme, the odds of making a modest return on a long-term investment in the stock market is good; the odds you’ll lose a chunk of your savings is much lower.

But are investing and gambling the same? Let’s use an example to find out:

How Three People See Risk

The following describes the attitudes toward gambling and investing held by three individuals: a close friend, my sister, and I.

L (My Friend)

• The Gambler: L became an avid poker player after learning the Texas Hold ‘em in school. He would attend casual tournaments with buy-ins of up to $20 on a regular basis. Also, L funded an account for online poker with at least $400.
  The Investor: L took much interest in the stock market in college as well. He started off small with about $1,000 in a brokerage account. By his senior year, he had an account valued at about $60,000, made possible with $20,000 in margin and $15,000 in credit card balance transfers. Obviously, L doesn’t mind risking borrowed money if he believes it can earn a return. Likewise, L believes it is naïve to leave money in a high-yield savings account if the stock market can offer higher returns.

J (My Sister)

• The Gambler: J has proclaimed that she would never play poker with real money, although she has played a few games “for fun”. J wants to understand the game and enjoy it with friends, but refuses to wager real money.
  The Investor: J does not own any investments whatsoever. Her ideal method of building wealth is a stable, high-paying career. She has shown interest in the stock market and even built a virtual stock portfolio, but that’s where her investing stops. Instead, J funnels most of her cash into her safe but stagnant high yield savings account.

Myself

• The Gambler: Though I am fond of gambling, I rarely put real money down. Aside from occasional friendly poker games, I have only participated in a few “real money” tournaments, none with a buy-in of more than $5. I too caught the online poker bug a while back, but I only funded an account with $25.
  The Investor: I am a conservative investor, but an investor nevertheless. I have roughly $3,000 in a Roth IRA invested in mutual funds and ETFs, nothing yet in individual stocks. I believe investing is necessary in order to prosper, but I take the safe approach by investing in index funds.

This evidence is anecdotal, sure, but I believe that the way a person gambles can predict how that person will invest, and vice versa.

So What?

The parallels between gambling and investing are interesting, but you’re probably starting to ponder a very valid question: Why should we care?

Because we can use the similarity between gambling and investing to measure our own ability to stomach risks and, as a result, make better investments.

Take, for example, the following ubiquitous investing advice:

Your portfolio should reflect your risk tolerance.

That makes sense, but how are you supposed to know what your risk tolerance is? There’s the general rule of thumb that you want less risk as you get closer to needing the money you have invested (in most cases, retirement). But that’s just the start. No two investors are the same.

But if you like a little gamble in your life, in other words, you’re the type who sits down at the blackjack table instead of watching over your friends’ shoulder, chances are you’ll enjoy the ups and downs that come from riskier investments. On the other hand, if dropping a quarter in a slot machine seems like the most foolish use of 25 cents you can think of, you might be more comfortable with conservative investments.

Obviously, the smart investor strives to make sure even aggressive investments are more than just gambles. And a gambler should know that house always wins and that gambling is entertainment…not an investment. Still, the parallels between Wall Street and the Las Vegas Strip endure…and continue to intrigue.

How does your gambling attitude compare to your investing mindset? Does your risk profile for investing deviate from that of gambling? Share your thoughts in a comment.

About the Author: Simon is a recent college grad living in Brooklyn. He writes for an interest rate-tracking Website and maintains his own personal finance blog, the Realm of Prosperity.

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There will always be good times to sell stocks we own, and knowing when to sell is just as important as knowing when to buy. Yet we often find ourselves selling our winners too early and holding onto our losers too long.

Here are some questions to ask yourself to help decide when it’s time to sell your stocks.

Did you make a mistake?

Don’t hold onto a stock you bought for a reason that’s no longer valid. You may have bought stock thinking that management could turn the company around only to later learn that the task was harder than you predicted. Or maybe you hoped that the company would expand into other niches but you overlooked strong competitors in those areas.

Whatever your initial reason for investing, if you learn that it’s no longer the case, cut your losses, sell your stock, and re-evaluate your investing strategy.

Have the fundamentals changed?

Sell your stock if the company has stopped growing, its core business has slipped, or other fundamentals have changed. After several years of accelerated growth, the company you bought has started to show signs of slowing down. There is growing competition in the industry and your company is having a harder time finding profitable new investment opportunities. Could this be the time to reassess the company’s future prospects? If they’re significantly worse than they used to be, it may be time to sell.

Is the stock overvalued?

No matter how great the prospects of a company, the price of the stock still has to be right for a great investment. Popular, thriving companies frequently trade well above their intrinsic value. Trouble is, with such high expectations, the stock may not have much more room to run.

Estimate the stock’s intrinsic value and ask yourself a.) How much more you think the market is willing to pay you than your estimate and b.) How likely it is that your estimated value could go up over time?

You don’t have to sell great companies just because their stock is pricey, but you should be careful when expectations become too high.

Do you need to rebalance your portfolio?

Periodically reassess your portfolio and make changes when needed. Paying attention to your portfolio and periodically making calculated adjustments is critical. For example, if you’ve been slowly buying more and more technology stocks, a regular review of your asset allocation could reveal that your portfolio is too heavily weighted in that area.

Although this may be great if technology stocks are doing well, putting all your eggs in one basket will come back to haunt you later. No matter how profitable a company is, if an investment is a significant portion of your portfolio, it’s time to consider selling some.

Is there something better you can do with your money?

Always look for ways to compound your money at the fastest rate relative to your risk tolerance. There is no shame in selling investments—even those that are undervalued or those where you’ve lost money—to free up cash for another investment that might yield you a higher return.

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For example, if you see that a company’s stock is trading at a large discount from what you think it’s actually worth, you may want to think about selling some stock that you believe has the smallest chance for more growth to free up some cash.

Summary

Before making any investment, research the company’s business inside and out. When you decide to buy stock, consider your exit point as well so that you aren’t stuck holding onto stocks that have small growth prospects. Good luck!

What do you think? When do you sell stock? Share your strategies in a comment.

About the Author: Stan is a recent college graduate living in New York City, where he works for a trading firm. Before graduating from college, he was already running an investment fund for family and friends. He writes a weekly column providing economic and investing commentary and maintains his own blog, The Zen Financier.

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President Obama has proposed financial reform that would limit the size and activities of the largest U.S. banks by separating proprietary trading, hedge funds, and private equity operations from banking (taking deposits and making loans). Theoretically, these reforms would simultaneously reduce the size of these banks and curb risk-taking.

Assuming that the new proposal passes the Senate, how effective will Obama’s proposal be? Will it ensure financial stability and long-term economic growth for the U.S.? Not necessarily. Here’s why.

Bad Timing

Although I do agree that regulations designed to mitigate risk at “megabanks” can contribute to a stable economy and is the right long-term policy, Obama’s timing introducing these reforms could not have been worse.

In a political move to deflect attention away from the Democrats’ huge loss in Massachusetts jeopardizing the healthcare reform, Obama decided to announce his plans for financial reform only a few hours after Goldman Sachs reported better-than-expected earnings attributable, in part, to restricted pay.

The jubilant news that the financial sector, a crucial element to the growth of a nation’s economy, has finally shown evidence of stabilizing was crushed by Obama’s new proposal.

The proposal even called Federal Reserve Chairman Ben Bernanke’s confirmation to a second term into question. (He was confirmed this week by a 70-30 vote, although 11 democrats voted against the confirmation.)

All of a sudden, the prospect of a stable economy recovery seems to have dissipated, and replaced with panic and uncertainty.

Banks are Crucial for Recovery

An economic recovery will require a stable financial system so banks can lend to small businesses, advise firms on raising capital, and spur on the growth of businesses (so that business can hire workers again). With that in mind, a fragile economic recovery is not the best idea to stage a battle with the big players on Wall Street.

By creating greater uncertainty on the profitability and structure of large banks, Obama has, for now, sabotaged any impending recovery. If Obama’s proposal passes, his reforms will hit lucrative divisions of every major U.S. bank…and hard.

Goldman Sachs’ proprietary trading division, for example, which accounts for about 10 percent of the firms’ total revenues, would suffer; JP Morgan Chase’s successful Highbridge Capital hedge fund would be separated from its parent company; Morgan Stanley’s hedge fund and proprietary trading units would be affected; and so on.

When regulations eat away at banks’ profits from these divisions, the banks will have less to lend. That means the economy may continue to drag its feet, slowing the process for a full recovery. So if Obama wants to create more jobs through small businesses, he needs to stabilize the banking system first.

Same Old Lesson

In 1933, the U.S. passed the Glass-Steagall Act in the wake of the 1929 stock market crash. The act separated commercial banks from investment banks, which restricted commercial banks taking on speculative bets with depositors’ money. But Congress repealed the Glass-Steagall Act in 1999 because there was debate over how restricting financial innovation could hurt the industry. Many argued that if banks could diversify their operations, this could lead to a more stable sector.

Now, Obama’s financial reform proposal, though not necessarily the same as the Glass-Steagall Act, certainly echoes it. Will the same debate about limiting market innovation surface again?

Progress is the Result of Careful Risk-Taking

Innovations that improve our standard of living always come with a risk of failure. The Internet boom of the 1990’s revolutionized how we communicate, obtain information, and shape businesses. However, it ended in the early 2000’s with thousands of small online businesses failing, ultimately leading to a recession.

The Internet has been one of the most influential innovations in recent years. It took several thousands of small online businesses to fail to end up with today’s Internet powerhouses such as Amazon, eBay, and Google.

Likewise, financial innovation that improves efficiency of the free markets can only be developed through risk-taking. Unfortunately, the current financial crisis accelerated with the securitization of mortgages during the time of the seemingly never-ending real estate bubble. The good news is that we can learn from our mistakes, making progress towards greater transparency and efficiency.

Summary

So is Obama’s new proposal the cure for stabilizing large banks? Although to American’s angry with Wall Street’s past missteps the regulations may sound great, we can’t believe that we’re out of the woods just yet. There are more questions now than before, which means that we may face an even longer recovery period.

What do you think? Do you agree that tighter regulation on Wall Street is a bad idea or think that the Obama administration is doing the right thing? Should the same banks that take our deposits and give us mortgages be allowed to continue running riksy proprietary trading divisions and hedge funds? Share your thoughts in a comment.

About the Author: Stan is a recent college graduate living in New York City, where he works for a trading firm. Before graduating from college, he was already running an investment fund for family and friends. He writes a weekly column providing economic and investing commentary and maintains his own blog, The Zen Financier.

Related posts:

1. Obama's Economic Plan: What Do You Want to See?
2. The Inverse Relationship Between Gold and the Dollar
3. The Economy: I Want YOU to Spend Your Money

With over 800 ETFs in the U.S. and total ETF assets recently surpassing the $1 trillion mark [WSJ sub. req'd.], the ETF industry is certainly growing fast. But where are ETFs going? Let’s take a look.

Active vs. Passive

Actively-managed ETFs began to pop up in 2007 but have recently gained momentum due to their advantages over traditional mutual funds. Both actively-manged ETFs and mutual funds offer a low cost of entry and the convenience of having professional managers handle your money. However, ETFs typically have lower expense ratios, better tax advantages, greater trading flexibility and more transparency of underlying holdings than mutual funds.

One feature of ETFs is that their holdings are disclosed on a daily basis, creating greater transparency for individual investors.

Initially, this may seem counter-intuitive, as individuals could easily use the disclosed holdings to construct their own portfolios without paying a fee. To avoid this issue, ETF funds disclose their holdings daily after the markets close, to eliminate “front runners”.

Another concern is the lagging performance for actively managed funds overall. Historically, active managers haven’t been too successful when comparing their track record against passive funds.

Nevertheless, actively managed ETFs seem ready to explode. As of now, there are 15 funds but that could rise to more than 40 soon with the number of issuers willing to take a chance.

Specialization of ETFs within Asset Classes

Another theme to look for is the expansion of ETFs that are specialized within an asset class. There has been an increasing number of Commodity, Fixed Income, and Currency ETFs coming into the market with a focus on expanding within specific asset classes.

For example, United States Natural Gas Fund (UNG) is an ETF that tracks the front month of a natural gas futures contract. Two months ago, United States 12 Month Natural Gas Fund (UNL) was introduced to reflect the average prices of 12 consecutive months’ futures contracts equally weighted, instead of just the front month.

This trend can also be seen in Fixed Income, where investors now have the option of investing in all different types of ETFs including a 1-3 Month T-Bill ETF (BIL) or a 20+ Year Treasury Bond (TLT) depending on their investment strategies.

This specialization and expansion of ETFs within asset classes should provide sophisticated investors with plenty of tools to construct their portfolios.

Value & Region Based ETFs

You can now even invest in ETFs based on your faith. On December 21, 2009, the first Christian ETF (FOC) hit the market. This fund tracks a Christian index, which excludes companies involved in gambling, anti-personnel landmines, tobacco, alcohol, pornography, abortion, and/or stem cells.

For those who are strongly religious, these ETFs are a perfect solution to diversify across a broad range of stocks without worrying about investing in companies that are out of line with their faith’s beliefs.

Similarly, Geary Advisors LLC has recently launched two state-based ETFs: Oklahoma ETF (OOK) and a Texas ETF (TXF). These ETFs track indices that seek to measure the performance of publicly traded companies that are headquartered in Oklahoma and Texas, respectively.

These ETFs give individuals living in Texas and Oklahoma the opportunity to invest in their own state. Furthermore, Geary Advisors is now working on different types of state-based ETFs, including a mid-cap Texas ETF as well as a small-cap Texas ETF.

Summary

The ETF business has grown exponentially in recent years. Has it expanded too fast too soon? Despite its success, ETFs may have reached a saturation point with investors; there are many funds that aren’t able to gain traction due to lack of interest. These funds die slowly, shriveling up from lack of assets.

With the continuous inflow of new, exotic ETF funds, check the daily volume of the funds are before investing in them so you aren’t stuck with anything you can’t get out of.

About the Author: Stan is a recent college graduate living in New York City, where he works for a trading firm. Before graduating from college, he was already running an investment fund for family and friends. He writes a weekly column providing economic and investing commentary and maintains his own blog, The Zen Financier.

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1. All About Exchange-Traded Funds (ETFs)
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3. The Top 15 No-Load Mutual Funds for 2009

A Roth IRA conversion allows you to pay income taxes on money you have invested tax-free in a traditional IRA this year instead of when you withdraw the money at retirement. (Because once you convert to a Roth IRA, distributions at retirement are tax-free).

Roth conversions are hot because as of Jan. 1, 2010, the IRS lifted income limitations on converting a traditional IRA to a Roth IRA. Formerly, conversions were only available to investors with a modified adjusted gross income (MAGI) of less than $100,000. Because investors who earn more than a certain amount also cannot contribute to Roth IRAs, a Roth IRA conversion presents a new opportunity to many investors to take advantage of the Roth IRA’s benefits. Additionally, there’s a special rule this year only that allows investors to recognize all of the conversion income in the 2010 tax year or split it equally between the next two tax years (2011 and 2012).

Read This First! Despite all the buzz about Roth conversions, only a relative few investors should use them. If you’re currently eligible to contribute to a Roth IRA or have a Roth 401(k) at work or you can’t contribute to a Roth but are planning on converting and using assets in your traditional IRA to pay income taxes for the conversion, stop. You probably shouldn’t convert and probably don’t need to read this.

Still curious? Okay. Before we examine exactly who should consider an IRA conversion, here’s a quick refresher of IRA basics.

Roth IRA vs. Traditional IRA

Traditional IRA: Contributions to a traditional IRA are tax-deductible the year you make them but come retirement, withdrawals are taxed as income. If you’re not covered by an employer-sponsored retirement plan like a 401(k), there’s no income limit for deducting traditional IRA contributions.

If you do have a 401(k) or other employer-sponsored plan a traditional IRA contribution is fully deductible for 2009 up to IRA contribution limits. That’s $55,000 for single filers; phase-outs begin between $55,000 and $65,000. For married couples filing jointly, “deductibility” phases out between $89,000 and $109,000 (or between $166,000 and $176,000 if one spouse doesn’t have an employer-sponsored plan).

Traditional IRAs make sense if you can deduct all of your contributions, but since long-term capital gains are taxed at a lower rate than ordinary income, if you cannot deduct contributions, you’re better off investing in a regular brokerage account.

Roth IRA: Contributions to a Roth IRA are not tax-deductible, but your earnings can be withdrawn tax-free after age 59-and-a-half.

In 2009, single filers’ ability to contribute to a Roth IRA phases out if MAGI is between $105,000 and $120,000. For married couples filing jointly, eligibility phases out between $166,000 and $176,000. Whether single or married filing jointly, filers may only contribute up to $5,000 total to all IRAs.

If you qualify for either a Roth IRA or a fully-deductible traditional IRA, most experts advise contributing to a Roth IRA if you have many years to go before you retire and you expect to be in a higher tax bracket at retirement.

Indeed, many financial writers herald the Roth IRA as the greatest financial product around. If you’re eligible, you should certainly contribute to a Roth IRA. But why wouldn’t you want to convert a traditional IRA to a Roth IRA?

Who Should Convert

You should consider a Roth IRA conversion if:

• You earn too much to contribute to a Roth IRA.
• Your employer does not offer a Roth 401(k) option.
• You have a sizable balance invested in a traditional IRA.

Does this sound like you? Then it is still possible to tap a Roth IRA’s potential benefits by converting some or all or your traditional IRA money to a Roth IRA. You should consider converting if:

• You expect to be in a higher tax bracket at retirement.
• You have a long time to go before retiring or
• you don’t plan to use the money and want to leave it to heirs. And:
• You’re not going to use IRA assets to pay income taxes on the Roth conversion.

Although I run the risk of oversimplifying a rather complex financial planning decision, if most of the above situations don’t apply to you, I would not consider a Roth IRA conversion. Even if you have a big traditional IRA balance, I would simply focus on making Roth contributions going forward. Come retirement, you’ll have to pay taxes on some income, but not all.

So You Want to Convert

If you convert a traditional IRA to a Roth IRA, you will pay income taxes on the amount in your account (but avoid the 10 percent early withdrawal penalty that you would pay for a cash distribution before retirement, as long as you reinvest in a Roth appropriately). In 2010 only, you can pay the taxes on that “income” this year or over the next two years (2011 and 2012).

It’s important to consider that depending on your traditional IRA balance, converting could put you into a higher tax bracket this year and, of course, you’ll need to come up with the cash to pay that tax bill.

As I mentioned earlier, if you pay the taxes from your IRA, you would lose the potential benefit of tax-free growth on that amount which significantly deflates the value of the conversion in the first place.

If you’ve gotten this far and still think a Roth conversion is right for you, contact an investment professional. (If you don’t have one, at least call the 800 number of the brokerage that holds your IRA). And after you convert, you’ll probably want a tax professional on your side as well. A Roth Conversion is big opportunity for some investors, but not all. Good luck!

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1. Roth IRA or Traditional IRA: What Do You Do?
2. Don't Forget April IRA Contributions
3. You Need a Roth IRA

If you’re considering whether to invest in gold, it’s important to understand the close relationship between the value of gold and the value of the dollar.

A Brief History of Gold and the Dollar

To understand how and why gold has had such a historical run-up, a little history lesson on the relationship between gold and the dollar is helpful.

The relationship between the dollar and gold is tied to the concept of tangible assets vs. financial assets. To put it simply, gold has real value, while the dollar is a representation of real value.

In 1944, the Bretton Woods Agreement launched the first system of convertible currencies and fixed exchange rates, requiring participating countries to maintain the value of their currency within a narrow margin against the U.S. dollar, which was fixed at a rate of $35 per gold ounce.

However, in the 1950s and 1960s, the increasing supply of U.S. dollars along with capital outflows aimed at Europe’s postwar recovery put downward pressure on the dollar.

Eventually, a series of dollar devaluations in the early 1970s ended the Bretton Woods system, allowing the dollar to be freely traded and freely sold, beginning the long drawn-out period of the falling dollar.

An Inverse Relationship

Perhaps one of the most well-known relationships in currency markets is the inverse relationship between the U.S. dollar and the value of gold. This relation occurs because gold is typically used as a hedge against inflation through its intrinsic metal value. As the dollar’s exchange value decreases, it takes more dollars to buy gold, increasing the value of gold.

While the dollar’s value is at risk of fluctuation through shifts in monetary policy, gold’s value is largely determined by supply and demand, without interference from shifts in monetary and corporate policies.

Between January 1999 and May 2008, the correlation between the two has been a staggering (-0.84), indicating a very close negative correlation.

As with any close relationship between two assets, the gold-dollar inverse relationship has not been without periods of temporary decoupling. The most significant exception to this rule occurred between April and December 2005 when the correlation between gold and the dollar was as high as 0.66. During this period, the U.S. raised interest rates while China revalued its currency, giving them an opportunity to snatch up gold and other commodities.

Monetary Policy Effects on Gold

The dollar’s value is largely determined by monetary policy enacted by the Federal Reserve Bank. Over the last few decades, the Fed has used the federal funds rate as a tool to control inflation and stimulate the economy and in doing so, has also impacted the price of gold.

In plain English, when the central bank lowers the federal funds rate, banks can lend to other banks at lower interest rates which, in turn, makes lower interest rates available to borrowers. And when rates are lower, borrowers have a greater incentive to take out loans (to start businesses, for example). This type of policy increases the supply of money in the system.

Conversely, if the central bank becomes concerned that there is too much money flowing around, it will raise interest rates to pump money back out of the system, curbing the risk of inflation.

As you can imagine, as the central bank lower interest rates, more money is printed. This lowers the value of the dollar and, consequently, raises the value of gold. Likewise, a rate increase strengthens the dollar and devalues gold.

Gold’s Current Rally

Gold is in the midst of a great bull market because interest rates have been at historic lows for such a long period of time.

Towards the end of 2008, small businesses sputtered and the economy stumbled. In response, the Federal Reserve cut rates to stimulate borrowing and spending—an attempt to cushion the blow of a souring economy. These low rates have been virtually unchanged since November 2008. In response, gold has enjoyed a run throughout 2009 as investors worried about inflation.

Should You Invest in Gold Now?

This is a tough call. Although inflation concerns are legitimate, gold has been making new highs during the last couple months leading many to wonder if it might be running out of steam. My gut feeling tells me that all the media attention gold has been getting as a safe haven for inflation has put gold into “bubble” territory.

Although inflation is still a concern, Americans are spending a lot less and a stable economic recovery is a much bigger concern at this point than rising inflation. Once the economy shows any signs of surviving on its own without government aid, the central bank will most likely raise rates quickly, to subdue any risk of inflation.

I would advise against investing in gold for now, but if you are interested in gold, the best and easiest way to gain exposure is through ETFs. Make sure you do your research before making an investment!

• Read More: How to Invest in Gold

What about you? Are you bullish on gold? Would you consider buying gold despite its recent run up?

About the Author: Stan is a recent college graduate living in New York City, where he works for a trading firm. Before graduating from college, he was already running an investment fund for family and friends. He writes a weekly column providing economic and investing commentary and maintains his own blog, The Zen Financier.

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2. Stocks Plunge on Lehman, Merrill Failures: What Does It Mean for You?
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