Helping you Achieve what matters most.

The “Consumer Assistance to Recycle and Save Act of 2009”, better known as “Cash for Clunkers” has been approved by congress. The final regulations have not been issued yet, but here is a summary of what know so far.

If you buy or lease a new car or truck, between July 1, 2009 and November 1, 2009, the government will buy your old vehicle for up to $4,500.

The following are the general requirements to be eligible (Note these requirements are for a new car, the requirements for a truck are similar, but with different fuel efficiency standards):

The old car must:

• Be in drivable condition
• Be less than 25 years old
• Achieve a combined 18 mpg or less
• Have been owned by you for at least 1 year
• Have been insured for the past year

The new car must:

• Have a suggested retail price of $45,000 or less
• Achieve a combined 22 mpg or greater
• Be leased for 5 or more years or if purchased may not be resold immediately

If the fuel efficiency of the new car is 4 mpg greater than that of the old car, the purchaser is eligible to receive a credit of $3,500. If the fuel efficiency difference is 10 mpg the credit is $4,500.

The funding for the program has been trimmed to $1 billion from the original $4 billion, so if you qualify and are planning to purchase a new vehicle, we encourage you to do so early.

Full details of the program, including fuel efficiency tables and requirements for trucks are listed on the government’s web site www.cars.gov.

I had a good discussion today with my son, Ben (saying discussion may be misleading because we texted back and forth, but that is a different subject). He wanted to know why the Dow Jones Industrial Average was up 200 points after GM announced bankruptcy. It was a great question and presented an opportunity to discuss the apparent disconnect between the current news and the reaction in the capital markets.

Obviously, the GM bankruptcy is neither good news nor a surprise. And the idea of the government taking over another corporate icon is more than a little concerning. So, why did we see a 200 point rally?

The key appears to be expectations. Think of attending a show which received poor reviews. If your expectations are low enough, the actual performance can be mediocre, but you may end up pleasantly surprised.

The stock market works in much the same way. Investors analyze all of the information they have available to them and form opinions regarding the future value of individual stocks. If the current information is bleak enough, almost any outcome is likely to be better than expected and the market can react positively once the actual information is released.

Certainly most investors expected GM to declare bankruptcy. The primary questions were how long the process will take, how much it will cost and how many people will lose their jobs. The ability to quickly form an agreement between the firm’s creditors, its unions and the government was a pleasant surprise, boosting the market on what is certainly not a positive event.
In related news, today we learned that Travelers and Cisco will be added to the Dow Jones Industrial average, replacing GM and Citigroup. This news drove up the price of the stocks being added to the index as many index funds and formula-based investment managers will now be required to hold these stocks. This is known as the reconstitution effect. It happens when, prior to the reconstitution date (the date when the swap will be made), traders purchase large numbers of shares of the stock being added to an index, driving up the price with the knowledge that index funds and other investment managers will be required to buy the stock on the reconstitution date, regardless of the price on that day. This reconstitution effect is one of the hidden costs of index investing and is a benefit of owning structured portfolios such as the DFA funds, which do not have this requirement. If you would like additional information on the reconstitution effect, please send us an email and we will forward a more detailed explanation to you.

Discussion and analysis of individual companies is certainly an interesting exercise (witness the popularity of CNBC). However, long term investment success is better attained by managing risk through broad diversification among both industries and asset classes. It may not be as interesting to watch and discuss, but building wealth for a secure financial future should be based on sound financial principles, not television hype.