ASK THE FOOL

Prepare for Disability

Q: Is disability insurance worth it? – B.H., Philadelphia

A: Disability insurance can seem expensive, but that’s because there’s a good chance you will use it. Think of it as income insurance, since it’s really all about protecting your income stream, should you not be able to work. We often worry about and plan for death, but we ignore the possibility of an extended period of disability. According to some reports, nearly half of all mortgage foreclosures are due to disability. Data from the Society of Actuaries suggests that at age 35 you have a 50 percent chance of being disabled for at least three months before age 65. If disaster strikes, you don’t want to end up wiping out all your savings trying to get by.

Even if your employer provides you with disability insurance, do a little research to make sure that it’s sufficient. If not, purchase additional insurance.

Learn more about insurance matters in general and disability insurance in particular at www.fool.com/insurance, www.insure.com, www.ahip.org and www.pueblo.gsa.gov/cic_text/employ/lt-disability/insurance.htm.

Q: Do you recommend any investment newsletters? – P.D., Syracuse, N.Y.

A: Newsletters can get expensive, and not all are worth the high price. But a few have a record of providing superior investment ideas as well as educational commentary that can sharpen your skills.

One newsletter we like is “Outstanding Investor Digest.” It’s pricy at about $300 per year, and issues arrive infrequently, but it runs rare transcripts of talks by investing giants who might offer you ideas that more than pay for the subscription. Read more about it at www.oid.com or call (212) 925-3885 for more information. The Motley Fool offers a few newsletters, too, focused on high-dividend stocks, underpriced stocks, fast-growing companies, and more – try them for free at www.fool.com/shop.

FOOL’S SCHOOL

The Churned Investor

You may think of churning as how butter is made. But there’s another meaning of the word, and it’s worth learning about, as ignoring it can cost you. As the Merriam-Webster dictionary explains, to churn financially is “to make (the account of a client) excessively active by frequent purchases and sales primarily in order to generate commissions.”

Take a stroll down Wall Street and listen intently, and you might hear the sound of stockbrokers and money managers shaking and shuffling your portfolio. The system is flawed, both for stockbrokers and mutual fund managers, and as a result the portfolios of individual investors can suffer. Billions of dollars are lost each year due to churning.

You see, many stockbrokers are paid based on the number of trades they make in your account, not how well that account performs. (Are you beginning to see why some brokers like to interrupt your dinners with cold calls, trying to get you buy into some “amazing opportunity”?)

Even if your broker is good and has you invested in growing companies, she might still frequently be moving you out of one good company and into another. Each transaction results in a profit for the brokerage – regardless of how it fares for you.

Churning is also a problem in the mutual-fund industry. Fund managers are so pressured to beat the market over short periods that they can’t simply be patient with solid investments that are temporarily doing poorly. Mutual funds that buy and sell often have what is called a high “turnover rate.” It shouldn’t surprise you that the funds with the highest turnover rates are often those that consistently lose to the market.

Finally, we investors ourselves engage in churning, if we have short attention spans and are impatient.

Churned investors are hurt by not only excessive commission costs but also taxes. Any stocks you’ve held for more than a year get taxed at the preferable long-term capital gains rate, which is 15 percent for most people. Short-term gains are taxed at your ordinary income rate, which can be as high as 35 percent, more than twice as much.

MY SMARTEST INVESTMENT

Drip, Drip, Drip

Back in 1995, I ran across The Money Paper newsletter (www.moneypaper.com) and through it began investing in companies inexpensively, via dividend reinvestment plans (DRIPs). I was able to buy one share of a company I was interested in for the price of one share plus a $15 fee. Then I bought additional shares of it and other companies. I now have a nice portfolio featuring companies such as Altria, Ameren, Bank of America, Genuine Parts, Hawaiian Electric and more. As I learned more, I disposed of some early investments and focused more on firms paying significant dividends. – George Galton, Moreno Valley, Calif.

The Fool Responds: Investing through DRIPs makes a lot of sense for most of us. You do have to keep good records of all your purchases, but you get to invest in many great companies without paying hefty trading commissions. Learn more at www.fool.com/school/drips.htm and from the DRIP Investor newsletter at www.dripinvestor.com. And at www.broker.fool.com, learn about Sharebuilder, which lets you buy stocks for $4 per pop.

FOOLISH TRIVIA

Born 37 years ago in San Francisco, where I sold records and jeans, I’m now one of the planet’s top specialty retailers, with more than 3,100 stores and annual revenues topping $16 billion. In addition to stores carrying my company name, I also run stores that might seem targeted at babies, retired seamen, and politically corrupt, unstable governments. In 2004, I unveiled a new brand, Forth & Towne, to serve women over 35. I employ more than 150,000 people. My ticker symbol evokes satellite-based navigation systems. Who am I?

Last Week’s Trivia Answer: Based in a New York town that bears my name, I’m a diversified technology company. I use my expertise in specialty glass, ceramic materials, polymers and the manipulation of the properties of light to develop, engineer and commercialize significant innovative products for the telecommunications, flat panel display, environmental, semiconductor and life sciences industries. I pioneered Pyrex and ceramics for automotive catalytic converters. There’s a good chance you have some of my wares in your cupboard. I employ about 26,000 people and rake in more than $4 billion annually. Who am I? (Answer: Corning)

THE MOTLEY FOOL TAKE

Illinois Tool Works

So, how would you like to have about one-fifth of your revenue tied to cyclical industries such as automobiles and new housing? That’s the case for Illinois Tool Works (NYSE: ITW), and it seems like a lot of people worry more about that 20 percent than the other 80 percent.

This industrial conglomerate’s recently reported fourth-quarter results were impressive. Revenue was up 8 percent over year-ago levels, operating income climbed 11 percent, and net income rose 12 percent (with earnings per share rising 17 percent).

Maybe that doesn’t sound too special to you, but check out some other numbers. Free cash flow was up about 37 percent for the quarter and 24 percent for the full year. Return on invested capital (ROIC) was up to about 20 percent for the fourth quarter – roughly double the company’s estimated cost of capital. Those are numbers that captivate a value investor’s heart.

Management has hinted that we might expect more acquisitions during the coming year. Given this company’s history of integrating new companies and generating good returns from them (check out that ROIC again), investors should look forward to the new arrivals.

The current stock price doesn’t represent a screaming bargain, but given the firm’s strong historical cash flow and ROIC performance, it merits a spot on the watch list in the hope of a temporary stock price swoon.