Posted: October 10th, 2008 | Author: Joe | Filed under: Investing | Tags: Building Wealth, Investing, Net Worth | No Comments »
I stumbled onto this ultra-simple net worth comparison tool a few days ago.
It’s ultra-simple because it only compares two factors: your age and your income.
The good news is my net worth is 42x greater than the median for my age.
The bad news is my net worth is 22% less than the median for my income.
There’s always the danger of delusion when comparing your finances to those of other people. It can lead you to make false comparisons. Still, I think I’m doing pretty well considering we’ve been living on a single income for 5 years. I suppose maybe I should only use half my income for this comparison then?
Hmm… let’s see… Ah, that’s better. Now my net worth is 4x greater than the medium for my income. I’m not really sure that makes me feel much better though, I mean I may be “gaming the system” a bit here. And what if I’m not? What if the median net worth for my age and income really is that low!
Go ahead, try it yourself and see what you think.
NOTE: I’m not sure what year the data was taken for the comparisons. I suppose the figures represented are about 20% or more off after the recent pummeling in the markets…
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Posted: September 30th, 2008 | Author: Joe | Filed under: Investing | Tags: Building Wealth, Investing, Stocks | 8 Comments »
People complicate investing with various concepts, philosophies and principals. There’s diversification, dollar cost averaging, P/E ratios, yield, growth vs. value, sector rotation, and on and on. But when you strip away all of these layers of complexity, you are left with one cardinal principal of successful investing:
Buy low, sell high.
It’s really that simple when you get down to it. You can follow all the other practices and techniques, but for the most part you don’t make a profit if you don’t sell for more than you buy. Yes, I know there are ways to make a profit when stocks fall, but this is more about the simple and straightforward investor.
Before I move any further, I want to be clear about one thing: What I am about to discuss is primarily for the small investor, and should not be considered for your retirement savings (401(k), IRA, etc..). For those, you should stick to tried and true sector/capitalization diversification, or maybe go with a super-simple portfolio. This is about how to buy low and sell high when trading stocks, not investing for retirement. Now, without further ado, on with the post…
I know, it sounds trite and perhaps a bit condescending to say “buy low and sell high”, but it is often taken for granted. In other cases it can be misconstrued to support market timing, which rarely succeeds over extended periods of time.
I’ve heard buy low sell high sometimes referred to as “buy high and sell higher”, and that’s ok too because it’s the profit we’re after in the end. We don’t want to be concerned with finding the bottom price of a stock per se, just a price that’s lower today than it will be in the future.
The trick of course is knowing when to buy and when to sell a given stock. There’s a Kenny Rogers quote in here somewhere, but I’m going to resist making it. You can thank me later.
As I was saying, this is where many people get into market timing and trying to guess when a stock is at its peak price and they should sell, or conversely when a stock can go no lower and it’s safe to buy. Timing the market is notoriously difficult to do successfully. This is one of the reasons most day traders never become wealthy (fees and commissions on excessive trades is another).
So, if you can’t time the market, how then can you be sure to buy low and sell high?
Well, you can’t be sure. Nothing in the stock market is a sure thing, but there are a few tools you can use to help increase your chances. Actually there are two basic tools, and they exist to help the investor minimize loss and maximize gain. They are the Limit Order and the Stop Order.
Market Orders
To understand a stop order it is first necessary to understand how shares of a stock are purchased normally.
When an investor buys x shares of ABC corp stock, it is executed as a market order (unless otherwise stated). A market order is simply a request to purchase (or sell) shares of a stock at the going price at the time at which the order is processed. It’s that last bit that can get dicey. For instance, you may place an order to purchase stock when you see that the price has fallen to what you consider affordable and close to intrinsic value, but by the time your brokerage firm executes the order the price may have already jumped 5%, thus making you late to the party and missing the boat on that 5% profit. It should be noted that in today’s market where orders are processed much more efficiently and by computer instead of a human, the price differences tend to be less for highly traded stocks. However, for smaller stocks the price fluctuation can still be quite large.
Ok, so that’s the general concept of a standard purchase order. Now on to a Stop Order.
Stop Orders
As an investor, you can’t control when a market order is executed, but you can dictate the price at which the order should be executed.
A stop order is essentially a market order that can only be executed after the share price has passed a specified threshold, as set by the investor.
For example, say you are interested in buying x number of shares of HotStock Inc. It currently trades at $20 per share, but you think it would be a bargain at $15. You would place a stop order for x shares of HotStock Inc at $15 per share. The means that once the share price dropped to $15, your stop order would become a market order and you would buy x shares of HotStock Inc at the current market price.
Conversely, say you already own x shares of HotStock Inc. suppose you bought them at $15 per share and the price is currently $25 per share. You might not want to watch HotStock Inc every minute of the day, but you want to ensure you get some profit on your smart stock pick. You would set a stop order at $20 per share. That way if the price dropped to $20 per share, you would sell your stock, making a $5 per share profit. This is also known as a Stop-loss order, because you are (in theory) stopping your losses before they get too large.
But what happens if the price dropped from $23 per share to $9 per share before your order was executed? In short, it sucks to be you. Your $5 per share profit just became a $6 per share loss. And in the example of using a stop order to buy x shares of HotStock Inc at $15 per share… you could end up buying it on its way to the basement.
This is where Limit Orders come into play.
Limit Orders
A limit order is essentially a stop order with an additional price limit specified by the investor. This additional limit is the price at which the order will be canceled, thus giving additional control and protection over stop loss orders. You can effectively bracket your target price with upper and lower trigger points.
For example, if you want to buy x shares of HotStock Inc. stock, but only if it falls below $15 but not less than $13 per share, then you would place a limit order for x shares at the price of $15 with a limit of $13. If the stock falls below $15 per share, then your order becomes active, but if the price falls to $9 before the order is executed then it will be canceled and no purchase is made. Of course, if the price hovers at $14 and then drops to $9 after you purchased it, you are still at a loss.
You may be wondering if this technique is really that helpful when buying on the upside. After all, what if you set a price of $15 per share on a small company that is not traded heavily and the price has jumped to $25 before your order is executed? You would have bought high and paid much more than you intended. This is where a Stop-Limit Order comes into play.
This is a limit order that has a trigger point (just as any limit order) but also an upper limit at which the order becomes nullified. Think of it as a sort of kill switch. For instance, say you are a momentum investor and want to buy a stock only after it has shown some renewed signs of life. You want to buy x shares of HotStock Inc. stock if the price goes above $15 per share, but less than $17 per share. This way if the stock price has jumped to $25 before your order is placed, your order has been canceled and won’t be placed.
Final Thoughts
Stop and Limit orders are not a magic bullet. They will not make you a successful investor on their own – you still need to do your homework. For instance, you can still guess wrong when determining where to put your stops and limits. Cheap and expensive are subjective terms, and subject to error. But the point is that it does give you some control over what you pay for a stock and how much you will sell shares for. The rest is up to you.
Photo by thelastminute
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Posted: July 11th, 2008 | Author: Joe | Filed under: Investing | Tags: , Building Wealth, Investing, mutual funds | No Comments »
Whether you invest in mutual funds, index funds or exchange-traded funds and whether those funds are held in your 401(k), IRA or 403(b) there are a lot of factors to consider when choosing the right fund.
Here is quick and dirty break down of 5 different types of funds that are common in retirement accounts, and 5 terms commonly associated with those funds and what they mean. Just because you stash away 10% or more of your income doesn’t mean you can ignore where it goes.
I. TYPES OF FUNDS.
1. Mutual Fund.
Mutual funds are the most common investment vehicle for the average person. If you have a 401(k) or a 401(b), chances are very high that you have mutual funds in your portfolio.
A mutual fund is a pool of money collected from institutions and individuals for the purpose of investing in individual securities like stocks, bonds and money market accounts. In an example of a 401(k), you have money taken out of your paycheck each period and sent to your 401(k) account. That money is then used by the 401(k) firm (Fidelity for example) to purchase shares of the mutual fund(s) in your portfolio. Mutual funds are operated by money mangers and it is the money manager that will decide how the money is to be invested.
The advantage of mutual funds is that they offer access to professional investment managers and diversification to small investors that might not have the financial assets to access otherwise. Also, many fund companies waive many of the account fees for investors who invest regularly through payroll deduction for example, so it doesn’t take as much money to start investing.
2. Index Fund.
An index fund is a type of mutual fund in which the money manager chooses the underlying investments to match a specific market index. The most common index fund is probably an S&P 500 index fund, which attempts to match the performance and diversification of the Standard and Poor’s 500 largest U.S. stocks. Beyond this objective, the implied goal of an index fund is to provide broad market exposure (i.e. diversification), average gains and low operating costs (see expense ratios below).
Index funds are cheaper to run than other mutual funds because they are passive investments, meaning that the money manager determines which stocks the fund will hold a few times per year based on the type of index the fund is tracking and buy and hold based on this predetermined mix. Essentially, it’s more like a “set it and forget it” approach than active investing (see below).
The argument for index investing is that some 75% or so actively managed mutual funds fail to beat the index average over the long term (10+ years), so most investors are better off sticking to the average. There are cases in which it is better to avoid the average and focus on fewer stocks, but these are typically viewed as exceptions to the rule. Warren Buffett is a prime example. His approach is the exact opposite of everything I and other sites advocate, but the point is you and I are not Warren Buffett. If we were, we wouldn’t be reading personal finance blogs – we’d be second wealthiest man in the world. 
3. Life-Cycle Fund.
Life-Cycle funds have been called “the future of retirement planning.” These funds are a type of mutual fund in which the asset allocation is automatically balanced (or adjusted) based on the length of time from the present to the time horizon of the fund. This is based on the tenets of diversification and asset allocation as described by modern portfolio theory (MPT) .
For example, MPT says that as an investor nears retirement age, he should invest more in bonds and less in stocks. So if the investor plans on being at retirement age in 2030, he will pick a 2030 life-cycle fund. At the time at which he buys the fund, he is still many years from retirement age so the fund will have 90-100% invested in stocks. By the time 2030 rolls around his fund will have automatically adjusted to something closer to 60% stocks, 40% bonds. It may be 70/30, but the point is the investor didn’t have to think about it – it happened automatically for him. It is because of this age component that life-cycle funds are also referred to as “age-based funds”.
The power of these types of funds is that they are the ultimate in “set it and forget it!” These are funds that work well with the average, lazy investor. Someone who is more concerned with playing World of Warcraft, or keeping tabs on many sports teams for multiple sports in a given season than keeping tabs on their money will do better in this type of fund. This type of fund is not for the DIY investor or someone who wants to be more active in their retirement planning.
4. Load Fund.
A load fund is a mutual fund (or index or life-cycle fund) that carries a sales commission or purchase fee. This extra fee is the load which the fund must bear. It is important to view this load as a weight because it automatically sets the fund back in terms of what it must gain to remain competitive or beat an index fund. Many load funds attempt to beat the average or index of the market. If the fund carries a load of 2%, then the fund must beat the index by 2% to break even. Some funds are worth this, many are not.
If the load is paid at the time of purchase, it is a front-end load. If the load is paid upon sale of the shares, then it is a back-end load. Some funds charge a load for the entire time the fund is held. This type of load is called a level-load.
IMPORTANT NOTE: If a fund limits its level load to no more that 0.25% (the maximum is 1%), it can call itself a “no-load” fund in its marketing literature.
5. Open-End Fund.
Open-end funds are mutual funds that do not have a restriction on the number of shares that can be sold. Open-end funds are required to buy back shares when investors wish to sell. If a fund’s management determines that the assets of the fund (i.e. the money taken into the fund) have grown too much and they are unable to provide the performance they wish, then they can close the fund. Closed-end funds are funds that do not issue more shares and are not required to buy them back. Closed-end fund shares are little bit more like stocks in this regard because if you can’t find a buyer, then you’re stuck with the shares. However, this often leads to higher share value since it creates more demand for the outstanding shares.
II. FUND TERMS.
1. Family Of Funds.
When an investment company, such as Fidelity or Vanguard, offers a mutual fund, that fund is said to be part of that company’s family of funds. This is also called a “mutual fund family” or a “fund family.” Larger investment firms typically offer a larger family of funds and a wider selection of categories to invest in.
2. Diversification.
Diversification is a simple concept of portfolio management. The basis is rooted in the belief that different sectors of the market, or the economy, perform better than other sectors at different times. To put it another way, the stock market as a whole does not always go up. We’re watching this play out now with oil and financial’s. Bank stocks have tanked since the housing bust and subprime loan problems, while oil stocks have boomed with increased demand and speculation.
A properly diversified portfolio, so the theory goes, will hold both financial stocks and oil stocks, thus limiting the damage done by the loss in financial stocks but also limiting the gains made by the oil stocks. Proper diversification yields higher than average return for lower than average risk. Diversification attempts to eliminate one of the biggest sources of lost money in investing: performance chasing. Picking the right stock or sector just before it booms is a great way to build wealth, but it’s also a great way to lose your shirt if not done properly.
Critics of diversification often cite examples like Warren Buffett to show how focusing (the opposite of diversifying) can lead to mind blowing returns and wealth building. While this is true, it often requires a level of investing and business acumen that the average person does not have or is not interested in having. For this reason, diversification is often recommended for most investors.
3. Net Asset Value (NAV).
A fund’s NAV is its share price. The NAV is derived by taking the total value of all the assets held by the fund (subtracting any liabilities) and dividing it by the number of shares outstanding. A mutual fund’s (or index fund or ETF’s) NAV is like a stock’s book value.
A mutual fund’s NAV is calculated once every day and is based on closing market price of the underlying assets held by the fund. Since most mutual funds pay the share holder virtually all of their income and capital gains, the NAV is not considered the best performance gauge.
Conversely, Closed-end funds and ETFs (exchange-traded funds) trade at market value like stocks, so their share price may be at a premium or discount to their NAV.
4. Active Management.
Active managed funds have a manager, or team of managers that actively track the market and determine which assets to buy for a given fund’s portfolio. The managers of these funds use analytical research, market and economic forecasts as well as their own judgement and experience to determine whether to buy, sell or hold an investment.
Actively managed funds are at the opposite philosophical spectrum from index, or passive investments. Proponents say that actively managed funds can out perform the market in general because their managers can take advantage of trends and the mistakes of others. Critics say that actively managed funds are why 75% of all mutual funds fail to beat the index.
5. Expense Ratio.
The expense ratio tells you how expensive a fund is to own. This is sometimes known as the “management expense ratio” (MER), because it is determined by calculating the fund’s operating expenses for the year, and dividing that by the average dollar value of its assets under management. Since operating expenses are subtracted from a fund’s assets, they lower the overall return of the fund. Expense ratio is the single biggest influencer of return that the individual investor can control. You may not be able to pick the sector that will out perform the market over the next 12 months, but you can pick the amount of return you want to fork over to the management of the fund.
Still, it is important to note that operating expenses vary widely from one type of fund to another. But the expense ratio of two similar funds should be considered on an even plain. So, if large cap growth fund A has an expense ratio twice that of large cap growth fund B, then fund A should out perform fund B by at least the difference, or it is not worth its expense.
Technorati Tags: Investing, Building Wealth, Mutual Funds, Index Funds, Life Cycle Funds
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Posted: July 1st, 2008 | Author: Joe | Filed under: Investing, Reviews | Tags: Building Wealth, Investing, Retirement, Reviews, Saving, Savings | 4 Comments »
What I like most about this book is that the author doesn’t try to “sell” stock investing to the reader, but covers the basics like the difference between investing (including stocks, money markets, CDs) and speculating.
At first glance, this book seems very similar to Getting Started in Stocks by Alvin D Hall, but this book is not nearly as nuts and bolts about investing as is Hall’s book.
Mladjenovic covers basic terminology and concepts like: appreciation (capital gain), risk vs. reward, and the concept of yield. He also briefly covers the various Stock Exchanges: NYSE, NASDAQ, AMEX.
But the heart of this book is Mladjenovic’s key success factors.
Key Success Factors:
- Analyze yourself.
- Know where to get information.
- Understand why you’re investing: Seeking appreciation (capital gains) or income (dividends).
- Do your research.
- Understand how the world affects your investments.
- Understand and identify “megatrends”.
Analyze Yourself.
Determine how much you own and how much you owe. This is where the concept of assets vs. liabilities is brought into the discussion. Using these two categories, he encourages the reader to create and assess his personal balance sheet. This exercise not only provides an eye-opening window to the reader’s financial state, but it provides a basic skill that will be used later when analyzing individual companies when looking for stock to buy.
The focus of this step is to determine and understand your Net Worth. Later sections of the book focus on growing your Net Worth.
Know Where to Get Information.
Here, the author stresses the importance of using multiple sources for information and advice. He lists some key online resources, such as U.S. Securities and Exchange Commission (SEC) in general, and EDGAR (the Electronic Data Gathering, Analysis, and Retrieval system) in particular. He covers different kinds of brokers and how to decide the right one for you, but he also discusses how to check the SEC, National Association of Securities Dealers (NASD) and the Securities Investor Protection Corporation (SIPC) to ensure that your broker does not have any black marks on his record. Incidentally, the NASD is currently known as Financial Industry Regulatory Authority (FINRA).
Understand Why You’re Investing.
Know your purpose!
If you want income, invest in dividend paying stock. If you want appreciation (growth) invest in growth (typically non-dividend paying stocks) stocks.
Stocks are a tool, a means to an end. To simply state that you are investing to “get rich” is not a plan. This part of the book covers short term, mid-term and long term goals. The author provides sound examples of when to invest in each type.
In one example, he recounts the story of one man who’s investment “advisor” put his child’s college fund money into Internet stocks circa 1999. Who know’s if this is true, but it is a prime example of why the latest investment fad is not a good place to stash your long term funds. Similarly, don’t have your emergency fund in stocks, but DO invest in stocks for long term like retirement (if your retirement is more than 5 – 10 years away).
This flows nicely into the topic of investing style: conservative vs. aggressive.
Conservative looks for a proven record, large cap stocks with market leadership and perceived clout. Conservative investors are looking for long term, consistent growth, but not a roller coaster ride of growth stocks.
Aggressive investors look for “jack rabbit” stocks with great potential and capital gains possibilities (no dividends). Such stocks tend to be innovative (i.e. new technology or service) and generally small cap.
Do Your Research.
This section is devoted not so much to where to get your research, but what kinds of things to look at when gathering your research. For example, the author discusses comparing a prospective stock to its respective index to see how well it performs against its peers. Most people have at least heard of the Dow Jones Industrial Average (DJIA), but Mladjenovic covers many other indices than just the DJIA. He also recommends visiting www.djindexes.com to analyze each index so that you can understand how they are weighted, and what exactly they track.
A quick visit to the site indicates that there are many indexes, and some are quite exotic like the Dow Jones DIFC Arabia Titans 50 Index. When investing in index funds, it’s best to stick with broad based indexes like the Wilshire 5000 and S&P 500 or sector indexes.
Mladjenovic outlines the following relevant questions when analyzing a company:
- Is the company making more net income than it did last year?
- Are the sales increasing?
- Do you understand the company’s industry?
He suggests that if you’re looking to invest in growth stocks, you should only invest in such stocks IF the company is profitable, AND if you understand where they derive their income AND from where it generates sales. This is good advice, but I’m not sure it pertains only to growth stocks.
Other factors in determine potentially successful stocks:
- Industry buying. Are mutual funds buying the stock you’re looking at?
- Analyst attention. This can offer positive reinforcement IF it backs the research you’ve done independently
- Influential Newsletter. See above.
- Consumer publications. If consumer reports rates a product of your company as good, that’s a positive influential factor.
- Management team. The company should have a management team with a strong history of success.
- Growth of earnings.
- Growth of equity.
- Insider buying. If management is buying, they probably know something good about the company.
Mladjenovic does a good job of covering the basics of risk in growth stocks as well as possible Enron like companies. He uses Enron quite a bit as an example of how the numbers alone are not always enough if the company’s management is corrupt. In my opinion, this is another reason why individual investors should stick primarily to index and mutual fund investing, unless they are really going to take the time to baby sit their individual stocks. However, if investors do decide to take on individual stocks, Mladjenovic does a good job of outlining the application of stop loss orders to limit the downside. Again, he uses Enron as an example here.
Just to round out the section, he discusses IPOs and why they are rarely worth the risk, and covers DRP’s and dividends. He details how to determine when a dividend is “safe” and gives a good overview of the benefits and drawbacks to high yield stocks, and provides safer alternatives (bonds, treasuries, CDs, etc..).
He only touches on covered calls and options, but mostly refers to “Stock options for Dummy’s.” This is probably 1 third up sell, and 2 thirds good sense since these topics are not essential to becoming a solid investor.
Mladjenovic also stresses the importance of paper investing to improve your knowledge and risk tolerance.
Understand how the world affects your stock.
Mladjenovic spends a bit of time discussing various types of economic indicators: coincident indicators, lagging and leading economic indicators (LEI) and how to determine their effect on your investments.
He discusses causes and effects of interest rates, provides a good overview of larger economic indicators and ties it all together with what they mean and how they factor into a stock’s performance.
There is a good overview of how a bull market works (spawning from the bottom of a bear market) and how to avoid being gored by the horns of a mature bull market. He provides strategies for investing in a bear market as well as a bull market.
He also offers many useful links and resources for further study:
www.financialsense.com
www.freemarketnews.com
www.prnewswire.com
www.hoovers.com
Understand and identify “megatrends”.
A megatrend (as defined by Mladjenovic) is a trend that has reaching impact on the population and hence economy and stock market.
Some megatrends are:
- The advent of Internet
- The aging of the U.S. population
- Rising energy prices
- The overheated housing market
- The hot international and emerging market stocks
He spends quite a bit of time talking about another big megatrend: Debt.
I think he gets a bit preachy about debt, energy prices and derivatives though. These are serious topics and carry sway over the economy and the stock market, but at times the tone seems a bit too “sky is falling” to me. That being said, his discussion of the risk that the enormous debt the U.S. government AND citizens have accumulated is pretty scary stuff and should not be looked at too lightly. In the end, I’m probably being a bit too picky here.
Mladjenovic recommends the following to take advantage of megatrends – look for companies with:
- A strong brand (examples include Coke and Microsoft)
- High barriers to entry (example: UPS and FED Ex)
- Focus on research and development (example: Pfizer and Merck)
He wraps things up with a discussion of megatrends for the current decade and past decades: US large cap of the 90′s, Japanese stocks of the 80s, commodities, energy and natural resources of the 70s and 2000s.
Examples of future megatrends are debt, derivatives, aging of the boomers, and emergence of China and India.
Mladjenovic also does a great job of illustrating how the main stream media often amplifies trends just when they are ending, thus acting as a contrarian indicator!
Conclusion.
Stock Investing For Dummies gets at the roots of investing, rather than providing a how to guide. But how you go about investing is as important as what you invest in.
It is for this reason that I believe it makes a great companion read to Getting Started in Stocks by Alvin D Hall, Both books are a good place to start but I think that neither provides enough information on its own for the beginning investor.
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