Sunday, August 14, 2011

Downgrade- Stick To Your Guns

In the 1960s, a college professor named Eugene Fama published a thesis on his theory called the "efficient market hypothesis." Fama claims in essence, that whatever price a stock is at reflects exactly what that particular stock is worth. Fama assumes that with all the rapidly accessible information investors can use to help them make decisions, the entire body of investors can price a stock of a company exactly what it is worth.

Fama's theory is not accepted by many investors because of the fact that many people are speculators ( people who form a theory or conjecture about a subject without firm evidence.) Just because people are buying a particular stock does not mean it is worth anything. Fama's theory was essentially debunked with crashing of the dot-com bubble. Many of the internet start-up companies of the '90s had no real value or earnings, but people were   buying them like they were going out of style!

With the downgrade of the United States's credit-worthiness on August 5, 2011, the stock market naturally lost a lot of money. Depending on your investment strategy, you may have sold a lot of your portfolio, or just held the course. I went into about 90% cash a few days before the downgrade, because i was worried about the congressional debt-ceiling debate. I didn't even see a downgrade coming! Luckily it was a good move, but it was not in my investment strategy.

Sticking to a strategy is the wisest thing you can do. It keeps you on track, honest, and makes investing a bit more automatic and less of a hassle. Having a strategy can also help you measure performance and make changes accordingly to your under-performing securities.

Since I do not agree with the "efficient market hypothesis," I sold in early August because I detected panic in the market. This was my first time in my investing career I had to stray from my plan, but in a way I just created a new strategy. I was confident in my decision and that is what matters most. Investing does not have to feel like gambling (even though we all can say it sure feels like it sometimes.)

-If your investments are handled by a professional, trust them. If you don't trust them, find a new manager you do trust. Let them help you, but always know what they are doing.

-If you manage your own investments, have a time maybe 2-4 times a year to rebalance your portfolio if you are not very active.

-If you manage your own money and are actively investing or trading, stick to your guns!  


Sunday, June 5, 2011

Little Things In Life

So I was at fast food resturant today (i know,gross, but funds and convienence won that battle). An old timer walks past me, newspaper in hand and says, "How are you doing today young man?" I tell him im doing great and he goes and sits down with his coffee. I ask him what he was up to, he says, "Well, i'm going to meet my buddies here, drink some coffee and we are going to tell each other lies for about half an hour." LOL! I extend my hand for a handshake, he accepts, and I leave. 

Lesson learned: Old people are smart, and above all, funnier than younger people, no contest. It meant a lot that he asked me how my day was, seeing that I was a complete stranger. Sometimes we get too involved with our own lives and forget that there are a few other billion people on this fine rock we call Earth. A simple "How are you" goes a long way, well, at least for me.

Sunday, May 29, 2011

Dear Diary

There is an old Spanish proverb that says, “Tomorrow is often the busiest day of the week.” This quote applies to many aspects of life, and goes very well with personal finances as well. The most recent example in my life that comes to mind when I read this quote is actually writing this blog!

I would love to tell you that the extent of my procrastination is writing blogs, however, that would be a lie. A big, fat, gigantic, outrageous lie! I write blogs because I like to share what I know with others, but I also get to learn a lot, and keep myself honest.

I absolutely love the season of summer. Warm weather, outside exercise, BBQs, camping, travel, and many other great activities fill our schedule. Unfortunately, with that comes increasing expenditures for many people. It is easy to make the excuse, “It happens…” But our overall financial plan suffers greatly from this mentality.

When I first started taking an honest look at my finances, this thing called the spending diary was brought to my attention. A spending diary is simply a way to log all inflows and outflows of cash for you or your family. These spending diaries can take the form of a physical diary, with pen and paper. Or it can be of the electronic variety. I use the computer program, Quicken, to track my cashflow. But there are other electronic diaries available. A popular, FREE website that I have heard great things about it, is

The two most important things you can do to ensure a successful spending diary is to:
Account for EVERY dollar (The electronic diaries are great for this because they are typically linked to your checking account. The one pitfall is if you withdrawl cash from ATMs on a regular basis, you will need to manually account for that.)
Make categories. If you are diligent about accounting for every dollar, but fail to categorize each dollar spent, you will have lots of data, but no conclusions to draw from them. Some good example categories I have a lot of entries in are usually things like coffee shops, eating out, groceries and things like that. If you have solid categories and are good about accounting, you can draw conclusions like, “Holy crap! I spent 10% of monthly income this month of mocha lattes!” Or perhaps something good, like, “I am unstoppable! I was able to put away 15% of my annual income into my retirement accounts this year!”

Having the ability to draw conclusions is not guaranteed to make us take action on “sinkholes” in our income, but at the very least, it is quite the sobering wake-up call!

You are the only person who is able to change the way that your money is spent. Television, the internet, magazines, and “the Jones’s” should not be a guide or an excuse to how you utilize your monetary resources. Some people spend too much, and some people could probably benefit from spending a little more (I know that our economy agrees, too!) The bottom line is everyone’s situation is different, and once you have some goals set, it is up to you to get the ball rolling, and make those goals a reality.

Sunday, May 22, 2011

Big Brother, Little Brother- Mutual Funds vs. ETFs

The world of investing never ceases to stop confusing me…It seems as though every time I learn about something new within investing, I always get left with ten new questions about what I have just read. It is truly a vicious cycle. It was the other day that I had just purchased a new mutual fund, when I got to thinking that I also own some ETFs (exchange traded funds.)  Then I also got to thinking that I do not even truly know all the main differences between the two. Through a little research I hope to truly unlock the main differences between mutual funds and ETFs.

For those who don’t want to read a lot, I will break down my conclusions for you right now. Please read on, though, for more explanation if you want to know more. Keep in mind, these findings may vary from fund to fund, but overall my na├»ve little mind thinks they are pretty sound.

Dividend & Cap Gains Reinvestment
Mutual Fund
Investment Choices
Mutual Fund

Mutual funds have significant seniority to ETFs. The first mutual fund that resembled anything that we see today was called the Wellington Fund. It went public in 1928 and was the first open-ended fund, that’s holdings included stocks and bonds. Open-ended simply means that the funds can issue new shares as they see fit, as well as buy back shares when investors wish to sell. Before that time, property trusts were what investors would invest in to get a “mixed bag” of securities. At this time, there are about 6800 mutual funds, not including the funds who have other sister funds in the same share class.

ETFs hit the scene in the United States in 1993. The first ETFs were the SPDRs (Standard and Poor’s 500 Depository Receipts.) The SPDRs are still around today, one of the more popular ones being the S&P 500 Index (ticker symbol: SPY.) As of April 2011, there are 1038 ETFs.

So the real question is what are the similarities and differences between mutual funds and ETFs? Well, that is a great question. Find out next week for more information….just kidding.
The first criteria I would like to explore are expenses. Surely there will be outliers on the cheap and expensive end for both mutual funds and ETFs, but there is a general average that we can look at.

When you buy a mutual fund, make sure you purchase one that is a “no-load” mutual fund. If it has a load, it means you are paying commission to the broker who sold it to you. You may also be required to pay a transaction fee for buying or selling the mutual fund, so be sure you do some research on costs and fees before you make a purchase. According to Investopedia, the average equity mutual fund has annual expenses ranging between 1.3-1.5%. These numbers represent the percentage of the cut that the house (the fund) will take back to cover its own expenses; for example, paying the fund managers who research which securities to acquire. These expenses can go even higher if you are purchasing an international or specialty fund. They can also go lower if you are purchasing an index fund. Do take expense ratios into serious consideration before purchasing. If a fund has an expenses ratio of 1.5%, you will need to get an annual return on that fund of 11.5% to get yourself a 10% return.

An index fund is a fund who tracks a specific index. I mentioned earlier the SPDR S&P 500 Index, which simply just follows the average movement of all 500 of the stocks that make up that index. There are also mutual funds and ETFs which track the Dow Jones Industrial Average, the NASDAQ, and also sector indexs. A sector index is a fund that will move with the average of a specific sector; for example, I own an ETF called SPDR Select Energy (ticker symbol: XLE.) This fund tracks the average movement of all the energy stocks in the S&P 500 index. So essentially it is an index within an index.

Index funds usually always have lower expenses because they are typically not actively managed. An actively managed fund simply means that a fund manager is behind the wheel, and will buy and sell securities as they see fit, so the fund’s holdings are constantly changing. An index fund is usually not actively managed because it just tracks an index; there is no managing necessary.

ETFs basically have mutual funds beat on expenses hands down. There are not loads on ETFs. You will pay a commission to purchase ETFs to your broker, just like any normal stock because ETFs can be traded intraday just like stocks. So overall, when it comes to expenses, ETFs will take the win.

Another category of criteria I would like to explore is dividend and capital gains reinvestment. If you are deciding between a mutual fund or ETF whose holdings have securities that pay a dividend, you are now stuck in a conundrum.

With mutual funds, when you first purchase the mutual fund, typically you are asked if you would like to reinvest the dividends and capital gains you earn. In most situations, this is a good thing. It is good because you can essentially get more shares, commission-free. The dividends or gains are just added to your total dollar amount invested in the mutual fund.

On the contrary, with ETFs, you cannot get capital gains or dividends reinvested. This is because ETFs are sold as shares. You must pay the current bid price for a share, you cannot purchase a partial block like you can with mutual funds. And when you do make an ETF purchase, you will have to pay your broker a commission.
So depending on your situation, reinvestment can be really handy for you. If you already own the mutual fund, it is implied that it is a fund you like, so owning more, commission-free, is a good thing.
Current scorecard: Mutual Funds-1……….ETFs-1

The next category is liquidity. This is going to be an obvious one, but it should be highlighted anyway for those who do not know.

Let’s say that it is a Monday at noon. If I place an order to buy a mutual fund, I will not see the mutual fund in my portfolio until the next trading day. I also cannot really determine what price I will pay for the mutual fund, because orders are filled at the end of the day, using that day’s ending NAV (net asset value) price. It is doubtful that the price will fluctuate too much, but it is still a valid consideration.

And then there was the ETF. These things are named after their excellent liquidity. They can be traded intraday, at a moment’s notice. There is no waiting for money or no NAVs. You can also use options with ETFs, or short them.

ETFs definitely win the liquidity battle, hands down.

Next up, we have the investment choices category. As I stated earlier, there are currently about 6800 mutual funds. And there are currently 1,038 ETFs…………I think the winner is pretty obvious, but I’ll say it anyway. Mutual funds have more options to invest in different securities.

In conclusion, there are many different factors you should consider before purchasing a fund. As with almost all things finance-related, everybody's situation is going to be different. There is no clear cut winner that I can find in the battle between mutual funds and ETFs. I have not even gone over all the differences between the two if you can believe it. 

The fund world is constantly evolving. ETFs are increasing in number very fast and will one day probably outnumber mutual funds. When they day comes, they may be a better option, but until then, the battle continues...

Tuesday, May 17, 2011

Risky Business

Stocks, bonds, mutual funds, ETFs……….So many choices, so little time. How is one to know where to put their funds when we are constantly bombarded by advertisements and talking heads saying this, and saying that?

I would first like to say, take EVERYTHING you hear and read about investing with a grain of salt. Let’s say for instance that you purchase a book about algebra. Upon completion of reading that book, it would be logical to assume that if given a test about algebra, you would be able to do pretty well.  You would think that once you indulge yourself with a certain amount of business news, you would get a general picture of what is going on. In my experience, that is not true. The markets don’t work in a way that is “predictable.” That is why it is dangerous to think that opinion columns are anything more than they are; they are just opinions. The only facts you can trust are the numbers.

Once you have blocked out the market “noise,” you can take a deep breath and breathe easy. You will need to do this because in order to figure out what good investments are best suited for you, you are going to need to do some serious soul searching.

When it comes to investing money in any capacity (stock market, real estate, collectables,) there are two primary objectives:
Be able to sleep at night (confidence in investments)
Maximize highest returns possible

Risk tolerance is a huge part of basic investing. Knowing your risk tolerance is very important. Typically risk tolerance can be gauged by age, but it can also be gauged by personality type. You never want to try to invest in a “home run” investment if it will cause you loss of sleep or regret. Any money you might make off this investment is irrelevant because it will all leave your pocket in the form of stress-induced medical bills anyway. So leave them alone.

It is a dark and scary world when you are just starting out investing if you know little or nothing at all. My first taste of investing in securities (stocks, bonds, etc.) was through my old employer’s 401(k). This particular 401(k) had limited investment opportunities. In hindsight, I am very thankful for that. It made it simple for a newbie to get their feet wet with the markets.

After the 401(k), I got an IRA (specifically, the Roth variety.) This basically opened Pandora’s Box for me. I had infinitely more investment choices than the 401(k), and infinitely more opportunities to lose money (which I did at first.) I had a pretty high risk tolerance, and I wanted to maximize my returns, but I hadn’t done my homework on what types of securities were good for me.

I am glad I was able to create my own “investment horror story” because I really learned a lot from it, and I would encourage you all to not get too bent out of shape when you have defeats.

So before you start thinking about what types of securities to invest in, do give considerable amount of thought to what type of person you are. It may also help to consult a financial planner or utilize other forms of resources. One resource I like is a risk tolerance test. It will help you look at yourself by asking you some basic questions. These types of tests are widely available on the net. Here is one to get started with, from one of my favorite magazines, Kiplinger (personal finance)

Monday, May 16, 2011

When Will You Retire?

I have two questions to ask. When do you want to retire? When will you retire? defines the word retire as “to withdraw from office, business, or active life, usually because of age.”

Many of us will retire because we have reached an age where working becomes too hard. Many of us will also retire simply because we don’t want to work! We will have worked the majority our life, and when we reach our designated retirement age, it is time for something else. Something like traveling, spending time with family, gardening, volunteering within the community, golf, you name it. The main thing I would hope that you would take from this post is that if you haven’t started thinking about retirement yet, I strongly urge you to start thinking about it. If you have started thinking about retirement, but haven’t taken action, I strongly urge you to start taking action.

I hate to be the bearer of bad news, but retirement takes more work these days than it did for our grandparents and parents. The pension plans our grandparents and parents are familiar with were referred to as “defined benefit plans.” The amount of income you would receive in retirement was determined by a formula. A typical formula looked something like this:

Number of years worked x salary at retirement age x accrual rate= Final accrued amount (can be disbursed monthly or as lump sum, but typically disbursed as a lump sum.)

Today our employer sponsored retirement plans usually take the form of a 401(k). The difference between the 401(k) and the pension plans lies in the fact that with the pension plans, the final amount received in retirement depended on a formula. With the 401(k), the final amount received at the time of retirement depends on investment performance, meaning your contributions to your 401(k) are not guaranteed to increase, and they stand a chance of possibly decreasing. While unlikely to decrease throughout the whole time you are contributing, depressions and recessions can have a huge negative impact on your contributions in a given time frame.

For example, someone who was planning on retiring in 2009 may have had their plans put on hold due to the stock market tanking. According to MSN Money, Investors in Fidelity Investments' 401(k) plans saw their balances shrink by 27% in 2008, says Fidelity, the nation's largest administrator of retirement plans.” Fidelity is a huge brokerage house, which lends credibility to that statistic being a good sample to gather data from. While not everyone who was investing for retirement saw a 27% loss, most did.

The reason I post the statistic from Fidelity is not to segway into a discussion about investment choices, it is just to further enforce the point that our retirements are more in our hands than they have been before. Although there are certain funds that will make “smart” investment choices for you based on the year or decade you plan on retiring (called target date funds,) it would be prudent to educate yourself on basic investing principles, if you haven’t already.

With this knowledge, you can prepare your portfolio (the combination of stocks, mutual funds, bonds, ETFs, etc. you own) to perform the best during good times, and limit losses during depressions and recessions.

If the things I have mentioned here sound like pig latin, there is a plethora of financial resources you can get your paws on to assist you on your quest for financial literacy. Please e-mail me if I can be of assistance in that.

Plus, when you start talking about the stock market at your next cocktail party, you will more-than-likely be seen as intellectual. This has always puzzled me because we all need to retire someday, right?! 

Friday, May 13, 2011

The Genie Fable

When I hear or read something particularly profound, I have a tendency to want to write it down or save it, so I have access to it at a later date. This tendency was stimulated when I read a part out of the book, The Snowball: Warren Buffett and the Business of Life by Alice Schroeder.
On page 571, Schroeder quotes Buffett saying,
 “When I was sixteen, I had just two things on my mind-girls and cars…” “I wasn’t very good with girls. So I thought about cars. I thought about girls, too, but I had more luck with cars.”

“Let’s say that when I turned sixteen, a genie had appeared to me. And that genie said, ‘Warren, I’m going to give you the car of your choice. It’ll be here tomorrow morning with a big bow tied on it. Brand-new. And it’s all yours.’

“Having heard all the genie stories, I would say, ‘What’s the catch?’ And the genie would answer, ‘There’s only one catch. This is the last car you’re ever going to get in your life. So it’s got to last a lifetime.’

“If that had happened, I would have picked out that car. But, can you imagine, knowing it had to last a lifetime, what I would do with it?”

“I would read the manual about five times. I would always keep it garaged. If there was the least little dent or scratch, I’d have it fixed right away because I wouldn’t want it rusting. I would baby that car, because it would have to last a lifetime.”

“That’s exactly the position you are in concerning your mind and body. You only get one mind and one body. And it’s got to last a lifetime. Now, it’s very easy to let them ride for many years. But if you don’t take care of that mind and that body, they’ll be a wreck forty years later, just like the car would be.”

“It’s what you do right now, today, that determines how your mind and body will operate in ten, twenty, and thirty years from now.”

That’s some heavy-duty stuff, right?

It may not be clear exactly why I would post this on a site about finances, but if you think about it, our finances are used for life; to have the best one possible. Taking care of these things in a proactive manner is going to make potentially tough situations, far less stressful for ourselves later on in life. Before we really start hitting the numbers (I am scared for this, too) and hard data, I think it is good to prepare our minds mentally for just why we are worrying about finances. We could be out doing anything else, but we are here. And call me crazy, but I think it because you are smart. So really, I think this little nugget of wisdom is more than applicable to our situation.

Plus, Warren Buffett said it. And that’s all that really needs to be said about that!