Welcome to my blog where I discuss money, investing, politics, and anything else import in the world. I find it surprising that most people in their 30s have very little knowledge or interest in these areas. Of course everyone is interested in money, but very few take the time or have the discipline to properly save and invest it for the future or short term. For those who at least have the interest, I'll write about my experiences and methods of investing, and hopefully give you a head start in investing.

Saturday, March 29, 2008

Bob Brinker MoneyTalk Commentary 3/22/08-3/23/08

Bill Flanagan took over this week. It was amazing to see the types of calls coming in these days and shows a lot about investor confidence. An inordinate amount of people are worried about CDs and brokerages. Even those with insured CDs are getting skittish. At the same time, the fixed income crowd is getting worried about their return dropping, due to the lowering of interest rates, and wondering how to get a better return "safely". Obviously there is no real way to remain at the same level of risk and get a better return, unless you were in some really bad investments.

I think the rest of the show was about his dislike of annuities, which I can't disagree with, but he never really gives the callers a chance to explain the specific terms and quickly shoots it down. I think it would be more effective to spend more time and go through the specifics to show why these are not as good as they seem. The subject probably deserves a series of posts, but the short of why annuities are no good:
  • high expenses
  • low returns
  • fixed returns, rarely stay fixed
  • high surrender charges
  • main purpose is to provide tax advantages, which is of no use if bought within a 401k or IRA
  • surrender charges on early withdrawals
  • usually combines life insurance with investing, which is not synergistic
  • pushed very hard by sales to the uninformed looking for safe investments because of the high commissions

One interesting call was for someone looking to transfer his 8,000 shares up AT&T into a more diversified mutual fund that had similar dividend payouts. Presumably this was because it made up a very large protion of his portfolio. This touches on a common misconception that you need income producing stocks to use the proceeds for expenses or to live off of in retirement. Bob Brinker tries to correct this point quite often, but Bill didn't mention it at all during this call. There really is no reason to limit yourself to dividend funds. You can just as easily sell positions periodically to generate the same income. So you can invest in growth stocks or index funds, both of which have low distributions (which makes them tax efficient), and still get the income you need by selling that 4% per year or withdrawing monthly. I think it must be more of a psychological issue to sell the stocks because it feels like you are losing something forever, but actually it doesn't matter how you pull the money out of your account, whether it is from dividends or capital gains.

Tuesday, March 25, 2008

Diversify: Stay away from individual stocks

Yes, the market overall is not doing great now, but it could be a lot worse if you had a lot of your money invested in some individual stocks like Countrywide or Bear Stearns. Try losing 90% or more on these stocks, instead of 9% on the market. That is why the general rule of thumb is to never have more than 4% of your money invested in a single company. Most investors understand the value of diversity, but still don't follow this rule for a number of reasons:
  • they see stocks like Google, Microsoft, or Apple beating the market regularly and think these stocks are sure bets
  • they think they know a lot about specific companies or industries and feel comfortable taking a gamble
  • they see certain retail products everywhere and think the company must be doing well
  • they work for the company and get discounts on stock purchases, pressured into buying, or free shares as bonuses

Despite any of these reasons, you should try to maintain diversity in your portfolio. This is even more critical if you own a lot of your company's stock, as your employment, retirement, and savings may all be tied to a single company. The moment things turn bad at the company, you could lose all three. For that reason, I would suggest holding even less than 4% of your company's stock. Sometimes it cannot be avoided, such as when you are awarded stock options or shares as compensation. However, if that is the case you should try to maintain diversity by doing the following:

  • immediately exercise options when vested and sell the proceeds to maintain the 4% ratio
  • do not invest your 401(k) in company stock based mutual funds
  • resist enrolling in employee stock purchase plans (even if there is a discount) unless you can immediately liquidate. Avoid costly transaction fees by selling the shares only once or twice a year, reinvesting in diversified funds
  • Balance your portfolio by purchasing enough other funds or stocks to keep that 4% ratio
  • Elect to receive cash bonuses vs. stock or options, whenever possible

This applies equally, whether you are at a public or private company. I have had this situation come up many times at my job, which is privately owned, but does have shareholders. The problem with private companies is that there is no liquid market to sell shares and often there are strict rules as to when and how you can sell them back. I have been awarded bonuses in the form of shares for many years and have no choice in the matter. So I have avoided investing my own money in shares whenever possible. I haven't participated in stock offerings and I have elected to receive cash the one time the choice was offered. I know there can be a lot of pressure to buy company shares to show your committment, but I value my personal financial freedom and philosophy higher than making a good impression and I have had to explain that on more than one occasion.

The stock market has shown to go up over the long term, but individual stocks have not. Stock prices depend on companies constantly growing. It is not enough for a company to continue to make a steady profit every year, it has to continue to increase that profit. So rather than guess which company will continue to grow, keep a broad, diverse portfolio.

Sunday, March 16, 2008

Bear Stearns bail out becomes buy out

It was only Friday that JP Morgan was helping to bail out Bear Stearns with the US Government's backing. Now it apparently has decided that it would be better to acquire the company for far less, just $236 million. Its only assets at this point are probably its office buildings and furniture, as its debts far outway any value of the company. The purchase price equivalent to $2 a share represents a discount of 93% from Friday's close, which itself was already down 47% from Thursday.

Bear Stearns got into liquidity problems when two hedge funds failed last summer and their bread and butter mortgage backed securities suffered huge losses. Banks can take a quick tumble when investors and the financial communites lose faith and begin to pull their money out or stop offering lines of credit, as the only real assets a bank holds are the loans it gives out and the only source of liquidity are investments people make in it. When those both turn sour, things can go bad real quick. Bear Stearns' share price dropped greater than 97% since last Monday's open.

Bear Stearns was less diversified than some of the other financial institutions, but there is no doubt the whole financial sector will feel the pain on Monday. Expect huge losses that drag down the whole market on Monday. This all but guarantees a rate cut of the Fed funds rate of 100 points this Tuesday, with rumors it could go as high as 200 points. It already cut the discount rate 25 points this weekend.

Bear Stearns is feeling the same pain as the investor who was too leveraged in real estate and didn't diversify their portfolio. Only the private citizen won't even be offered the $0.67 on the dollar Bear is getting.

Saturday, March 15, 2008

Bob Brinker MoneyTalk Commentary 3/9-1/10

Bob called for a guaranteed 75 basis point rate cut on March 18, with a slight probability of higher. I wonder how that changes with the latest Fed actions. It looks like we still may get a 50 point cut, but we'll see.

Bob also gave 50% chance of being in a full blown recession, but thinks if it happens, it will only be for the first two quarters of 2008. His guest, Dan Ariely, author of Predictably Irrational, was quite interesting and talked about the psychology of things such as stealing, lying , cheating, and investing.

On Sunday, Bob's guest, Teresa Ghilardu, was an odd choice as she seemed to preach pension and annuity ideas contrary to his often repeated opinion. She was pro pension and annuity (when provided buy the company). In particular, she generalized to always take the annuity rather than the lump sum, when offered. I was waiting to see how long it would take for Bob to jump all over her. He actually tried to give her an out, by saying it was a case by case basis, but she wouldn't bite. She didn't really like giving the investment choices to the person, but wants them to trust in the pension.

Monday, March 10, 2008

Gut Check Time: Do you have what it takes?

So far 2008 has been a real test to see

  • Who really believes in investing for the long term
  • What your risk tolerance really is
  • If you are diversified and trust your asset allocation

Listening to the weekend talk shows and talk around the office, all I hear are people questioning whether they should sell their stocks. However, selling now would be the opposite of what should be done. The time to sell was when you were at record highs, not now that they've pulled back 15%. If you still believe you are investing for the long term and you have a good diversified allocation, then this is the time to buy those beaten down stocks. We may still see some losses ahead, but since it is just as hard to predict a bottom as it is a top, this is a good time to start loading up again.

The only question in my mind is on the commodities front. Gold and oil are at all time highs. Corn is also close to 52 week highs. I have no doubt that oil will continue to do well, but I am not sure how much higher gold and corn will go. So if you have already made gains in these areas, it is time to rebalance your portfolio, if you haven't already.

Corrections like we are currently seeing cleanse the market of inflated prices and nervous investors. This generally keeps the markets healthy over the long term. Kind of like a controlled fire clearing the dead wood from a forest and being beneficial in the long run.

So I will continue to invest twice a month and maintain the faith in my asset allocation.

Sunday, March 9, 2008

My Equity Asset Allocation

I've already described in previous posts how I save/invest for short term goals using Vanguad's Prime Money Market and currently put half of my money there each month. The other half I invest in mutual funds and ETFs for longer term goals (5+ years). If you haven't already, read these posts first: Are you ready to begin investing?, Investing for the Short and Long Term, and Equity Asset Allocation.
I practice the simple philosophy of buy and hold for the long term using inexpensive funds. I encourage you to look at some popular allocations over at Marketwatch.com. I use the U.S. stcok market as my backbone, as I believe it will continue to rise over the long term, but supplement it with some other areas to be even better diversified. I'll go through my target allocation for this year:
  • VTSMX - 50% - This Total Stock Market Index fund is the backbone of my allocation and represents an investment in all U.S. domestic stocks. This includes large CAPs, small CAPs, mid CAPs, etc.
  • VGTSX - 10% - Total International Stock Market Index holds the larger European and Pacific funds, as well as emerging markets.
  • VEIEX -10% - Emerging Market Index increases the exposure to emerging markets, which has had great return recently, although traditionally it is a volatile sector.
  • VGSIX - 20% - REIT Index fund provides a very diversified investment in the real estate market.
  • DBC -10% - Commodity Index ETF that tracks 6 areas: Crude Oil, heating oil, corn, wheat, aluminum, and gold. Provides some inflation protection.

The recent return (as of March 7, 2008) is shown above for this allocation. Obviously, the year to date numbers won't look too good with the recent stock market performance. Also note that DBC has only been in existance for 2 years, so I don't have any five year numbers for it.
My goal for this portfolio was to continue investing in the U.S. stock market which has historically provided solid performance. In addition, diversify into real estate without having to actually buy property and become a landlord. The emerging and international markets also provide weaker corrolated returns, as does the commodities markets, for times when the stock market slows or weakens. I expect oil demand to only increase over the next few years, as will food prices. However, I am not sure how long gold can keep up its pace, but as the dollar continues to weaken it could continue to grow. I'll re-examine the target allocation at years end.
Comment below with your current target allocations.

Saturday, March 8, 2008

Equity Asset Allocation

Before proceeding with determining your equity asset allocation, be sure you have read my previous posts: Are you ready to begin investing? and Investing for the Short and Long Term, where you can determine what type of investing you are ready for and where you should place your money for the short and long term.

Determining your asset allocation is the most important step in investing. This is a long term approach to investing and has been proven to be more important in your success than trying to time the market. A great book on the subject is Asset Allocation: Balancing Financial Risk by Roger C. Gibson. In this post I am just going to concentrate on the equity portion of your investment, but much of this applies to your entire portfolio. I will give a few guidelines for now and next post discuss my current asset allocation.
First there a few assumptions you must agree to before beginning.
  • This is a long term strategy
  • The sectors your are investing in will go up in the long term

Now to the guidelines:

  1. Use a diversified approach. Anyone who has been following the markets the last 3 years can see the value of diversification. We have seen multiple sectors lead the market and then pull back, whether it's been housing, large caps, gold, oil, emerging markets, etc. Your goal is to have exposure in all these areas. Focusing on just one would work if you could always predict which will be the winner this year, but that is nearly impossible. You can certainly overweight your allocation to favor one, but should have exposure in all. To stay truly diversified you need to invest in sectors that are uncorrolated, so that they don't all go up and, more importantly, down at the same time. Everything has some corrolation to one another, but there are different degrees, for instance oil is negatively correlated to large CAP stocks, gold is positively correlated to inflation, small CAP stocks are strongly correlated to larg CAP.
  2. Stay comfortable. You need to be comfortable with the risk level and volatility of your allocation. Just as you have already allocated between equities and bonds to meet your comfort levels with risk and volatility. More volatile areas of the market such as commodities or emerging markets, may not be something you can stomach, even if they are promising higher returns. And this is important because of...
  3. Stick to your allocation. You need to choose an allocation and stick with it. Otherwise you are starting to play the market timing game. Tweaking your target allocation every year after analyzing where things are going makes sense, but do not try to tweak every month.
  4. Don't chase past performance. You need to be forward looking in your allocation. Often areas that have been the biggest losers last year, might be good choices for this year. Likewise, winners at all time highs maybe ready to fall (think real estate, tech bubble)
  5. Low expenses. Choose your allocation first and then find funds with the lowest expense ratios. I believe in sticking with index based funds or ETFs, especially in taxable accounts. This is because they have shown to outperform actively managed funds in the long term, have low expense ratios, and very low distributions since they have a low turnover.
  6. Re-balance your portfolio yearly. After you choose an asset allocation you believe in and are comfortable with, rebalance it at least yearly, or whenever the allocation deviates by 3 or more percent. This ensures that you capture any gains made and transfer them to your lagging sectors. This is a good idea for 401ks and IRAs, however this will trigger capital gains tax in taxable accounts, so an alternative is to rebalance by adding new investments such that you rebalance it.

This brings me to the investing discussion. You can buy shares via lump sum or regular installments throughout the year. A few methods exist:

  1. Dollar Cost Averaging. Where the same amount is invested each time period for each fund according to your allocation. This keeps your investment amount constant, but your purchase amount changes, as you buy more shares when they are cheaper and less when they are expensive.
  2. Value Cost Averaging. You change your investment amount depending on the current value of your investments. You set a target value of growth for each fund each period and only invest enough to bring it up to that target.
  3. My method. My method is a combination of both, I try to constantly maintain my target allocation. So I am in effect rebalancing each period by adding new money.

In my next post I will discuss what my current asset allocation is and invite others to post comments as to what they are using.