Technique matters a lot in tennis, golf, basketball and a host of other sports and activities. It also matters to investors. If a middle income American approaches investing--especially long term retirement saving--the right way, he or she can be hundreds of thousands of dollars better off when receiving the retirement watch, than someone's whose technique is poor. Here are a few basic pointers that can take you a long way.
Calculate your net worth regularly. Keeping score is essential. You have to know if you're making progress. You'll need to know when you're not making progress or losing ground, so you can take action to turn the tide. Knowledge can be painful in times of market downturns, but avoiding reality won't improve your retirement finances. You may or may not have a fixed saving goal. Having a goal is good, but not essential. See http://blogger.uncleleosden.com/2007/04/goals-for-retirement-saving-and-why.html. But it's essential to know where you stand. That knowledge alone will keep you focused on building wealth for the future. Calculate your net worth at least every three months. See http://blogger.uncleleosden.com/2007/04/secret-to-building-wealth.html.
Automate the saving process and use retirement accounts. Participate in any 401(k) or equivalent retirement plan your employer may offer. Maximize the amount you contribute. Some people think you might want to contribute only enough to get an employer match and then contribute to a Roth IRA; this isn't a bad idea but you have to be conscientious about the Roth contributions because they aren't necessarily automatic (read on for the solution to this problem). If you don't have access to an employer sponsored plan, open an IRA--or a Roth IRA if you think your future tax rates will be higher than today's--and arrange with your bank to have funds transferred every month (or every two weeks if you are paid on a biweekly basis) to the IRA. It's a good idea to use retirement accounts like 401(k)s and IRAs because they are separate from your regular bank and securities accounts, and the money in them is harder to spend before retirement. For more information, see http://blogger.uncleleosden.com/2007/04/automate-to-accumulate.html.
Average returns take you to Lake Wobegon. Money managers (such as those at actively managed mutual funds) usually don't perform as well as market averages like the S&P 500. There are a number of reasons for this, including their higher trading costs and their compensation. But the bottom line is you are likely to end up with less. Focus on long term gains. Stick with index funds and other low cost investments. If you aim to get the market average for a return, you'll probably end up doing better than average. For more, see http://blogger.uncleleosden.com/2007/06/why-average-investor-does-well.html.
Keep it simple. Investing is, among other things, a sales transaction. A financial firm is the seller and you're the buyer. Complexity favors sellers and places you at a disadvantage. The seller will naturally know more about the product than you will. The law requires that sellers of financial products make a variety of disclosures to buyers. But even if those disclosures are made, the seller will probably still have a better understanding of the product than you will. So you may have trouble figuring out if the product is truly to your advantage. The complexity of some annuities and other insurance products, and some leveraged ETFs, is so great as to make them virtually opaque. Investing in opacity isn't a good idea. Complex products also tend to have higher costs, which negatively impact investor returns. Stick to index funds, and maybe some individual stocks and bonds. Plain old bank CDs aren't bad when the markets seem turbulent. If you don't understand a financial product, avoid it.
The easiest budget of all--save a good percentage of your income (especially if you're self-employed). Budgeting sucks and it seems like every month something comes up that you didn't anticipate. Then, there are the "discussions" with your significant other about how much should be allocated to what expenses, and also last week's rampage off the budget. If you want a simple way to budget, don't focus on how much you spend, but instead on how much you save. Target a good-sized percentage of your monthly income (10% is good, 15% is much better, and 20% is a home run), and make sure that come hell or high water you save at least that much. If replacing your car's exhaust system one month prevents you from hitting your goal, then add enough more the next month or two so that you backfill the deficit. The percentage-of-income-saved method allows you to avoid a lot of handwringing over lattes or not, and inter-spousal sniping, while meeting retirement goals. If you can consistently save 15% to 20% of your earnings over the course of a 30 to 40 year career, you could end up with enough to pretty much maintain your pre-retirement lifestyle during your golden years. If you're self-employed and have an uneven income, it's particularly important to save a good-sized percentage of your income because you can't easily automate the saving process. For more, see http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html.
Build your benefits. Even though private sector employers are abandoning pensions faster than New York high society abandoned Bernie and Ruth Madoff, just about everyone has the equivalent of a pension through the Social Security system. Although much maligned and stereotyped, Social Security is the port in the storm for tens of millions of Americans. The longer you work, the greater your benefits will be. Even though the level of Social Security benefits is subject to the whim and caprice of Congress, the tenure of members of Congress is subject to the whim and caprice of voters (including most of the tens of millions of Social Securities recipients). Whatever Congress may do in the future about Social Security benefits, it won't destroy the system and you'll be better off by working longer. If you're fortunate enough to have access to a pension, work as long as you can to boost your benefits. You'll sleep better, without having to buy a new mattress, if you can count on the automatic deposit of a monthly check. For more, see http://blogger.uncleleosden.com/2007/05/how-to-retire-without-saving.html.
Attitude. Perhaps the most important factor, but the hardest one to control, is how you view money and saving. If you look at them the right way, you'll do fine. Understand that you have a finite stream of income during your life. If you spend your money, you can't save it. It's gone forever, and you're left with the now diminished remainder of your finite stream of lifetime income. Saving is a choice, not a sacrifice. Money saved now builds security for the future. Because your lifetime income is finite, you can economize now or economize later. Consider that eating dog food in your old age probably won't be a high point of your life. Remember that savings generate returns that can be compounded, so they may increase your finite lifetime income. Save enough, and you'll hit a financial home run by compounding. (See http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html.) This isn't about being greedy in an unseemly way or living like a pauper during your working years. It's about common sense and living within your means. If you adopt the right attitude, you'll establish control over your finances, and that will give you a very good feeling.
Showing posts with label investment guidelines. Show all posts
Showing posts with label investment guidelines. Show all posts
Wednesday, November 11, 2009
Wednesday, April 29, 2009
Investing in Discouraging Times Can Be the Essence of Simplicity
Some financial advisers have been moving away from traditional diversified asset allocations and recommending strategies involving structured products, computerized trading models, hedge funds, commodities, and other alternative investments. While these types of investments used to comprise, perhaps, 10% or 15% of an investor's portfolio, some advisers now recommend a much higher level, even up to 100%.
There are a variety of problems with these alternative products. They can be expensive (in terms of fees and trading expenses), opaque (in terms of what they actually involve) and unpredictable. Worst of all, they can be significantly more complex than traditional stocks, bonds and cash equivalents like money market funds.
Complexity is biggest problem of all. If there's a single reason why Wall Street crashed and we're now in the worse recession since the Great Depression, it's that Wall Street got so entangled in complex financial products that even many of its most sophisticated financial engineers and most seasoned executives couldn't figure out how bad things would get. If these people can't handle complexity, how would an ordinary investor deal with it?
Another problem with these complex approaches is that they can mask a fundamental truth: you can't get something for nothing. By now, one would think that's clear. After all, the entire game with derivatives was that somehow risk could be shifted in some magical way to stabilize the financial markets. The joke was on everyone who actually believed that. These new, alternative investment strategies appear to rest on the implication that there is a way to attain portfolio stability while still getting good returns. The last year and a half should have taught investors that there is no easy money in the financial markets.
When you can't stand the ups and downs of the financial markets, reduce your risks by simplifying your portfolio. Decrease the percentages of stocks and bonds you hold and increase the amount of cash and cash equivalents. Two years ago, many investors might have 60%, 70% or more of their portfolios in stocks, 15% or 20% in bonds, and 0 to 10% in cash. Today, if you've developed a heightened appreciation for prudence and stability, put 30% or 20% or even less of your portfolio in stocks and much more in bonds and cash. If you really can't stand volatility, put everything in cash. The great advantage of this approach is that you have a comparatively easy time figuring out what your risks are, and you can easily adjust your risk levels to whatever you're comfortable with. The costs of this approach can be modest, especially if you use low cost index funds.
Keep things simple. There's no need to follow the smart money. The smart money brought us the current financial and economic mess. Investors who think for themselves are the most likely to do well.
There are a variety of problems with these alternative products. They can be expensive (in terms of fees and trading expenses), opaque (in terms of what they actually involve) and unpredictable. Worst of all, they can be significantly more complex than traditional stocks, bonds and cash equivalents like money market funds.
Complexity is biggest problem of all. If there's a single reason why Wall Street crashed and we're now in the worse recession since the Great Depression, it's that Wall Street got so entangled in complex financial products that even many of its most sophisticated financial engineers and most seasoned executives couldn't figure out how bad things would get. If these people can't handle complexity, how would an ordinary investor deal with it?
Another problem with these complex approaches is that they can mask a fundamental truth: you can't get something for nothing. By now, one would think that's clear. After all, the entire game with derivatives was that somehow risk could be shifted in some magical way to stabilize the financial markets. The joke was on everyone who actually believed that. These new, alternative investment strategies appear to rest on the implication that there is a way to attain portfolio stability while still getting good returns. The last year and a half should have taught investors that there is no easy money in the financial markets.
When you can't stand the ups and downs of the financial markets, reduce your risks by simplifying your portfolio. Decrease the percentages of stocks and bonds you hold and increase the amount of cash and cash equivalents. Two years ago, many investors might have 60%, 70% or more of their portfolios in stocks, 15% or 20% in bonds, and 0 to 10% in cash. Today, if you've developed a heightened appreciation for prudence and stability, put 30% or 20% or even less of your portfolio in stocks and much more in bonds and cash. If you really can't stand volatility, put everything in cash. The great advantage of this approach is that you have a comparatively easy time figuring out what your risks are, and you can easily adjust your risk levels to whatever you're comfortable with. The costs of this approach can be modest, especially if you use low cost index funds.
Keep things simple. There's no need to follow the smart money. The smart money brought us the current financial and economic mess. Investors who think for themselves are the most likely to do well.
Tuesday, June 12, 2007
Exchange Traded Funds for Beginners
A relatively new product of the financial services industry has been getting a lot of publicity lately. That's the exchange traded fund, or ETF. The ETF is type of mutual fund that you can buy or sell while the stock market is open. By contrast, traditional mutual funds are bought or sold only after the stock market closes. (You can send in an order for shares of a traditional mutual fund any time, but the order will be filled only after the market closes, at a price based on the closing prices of the stocks and/or bonds that the mutual fund holds.) Although ETFs have been around for about 15 years, they have attained widespread popularity only recently. If you're unfamiliar with them, here are a few basic points.
1. ETFs generally have low costs and expenses, but you have to buy them through a stockbroker. That means you pay a commission. In addition, ETFs have two prices in the market: the "ask" price at which you buy them, and the "bid" price at which you sell them. The "ask" price will be higher than the "bid" price, and the difference between the two--called the "spread"--is a cost of investing. That's because if you buy at the ask price and immediately sell, you'll lose some money from selling at the lower bid price.
Consequently, ETFs are not always the lowest cost product. A low-cost traditional mutual fund may actually be cheaper, because you can buy it without paying a commission or incurring the "bid-ask spread" as a cost of investing. If you're saving small amounts at a time (e.g., $100 or $200 a month), a traditional mutual fund is a cheaper way to invest than an ETF.
2. ETFs are based on market indexes--in other words, the stocks or bonds they hold are the same ones that comprise a market index. For example, an ETF that mimics the S&P 500 will hold the 500 stocks in that index. ETFs started off with broadly based market indexes, like the S&P 500, and were often good choices for long term investment. However, more recently, ETFs have been created to represent increasingly narrow sectors of the stock markets--like just telecommunications stocks or stocks of one particular country. The narrower the index, the more risky the ETF, because it is less diversified. It may provide excellent returns, or terrible losses. The more you invest in narrowly-based ETFs, the more attention you'll have to pay to the overall diversification of your portfolio. In other words, the more work you'll have to do managing your money.
3. ETFs are often tax efficient, in that they are not required to distribute capital gains each year to investors. Investors report gains on their tax returns only when they sell their ETF shares at a profit. But a carefully managed mutual fund can also achieve a high degree of tax efficiency.
4. ETFs theoretically should trade at the same price as the aggregate prices of their underlying assets. This, however, doesn't always occur. Variations in supply and demand at any particular moment can cause an ETF to trade at a discount or premium to the value of its underlying assets. In addition, technical market problems can cause pricing problems. Trades that occur in the underlying stocks and bonds necessarily are reported after they occur. There is always a time lag between trade prices of the underlying assets and the trade price of the ETF. While the time lag may be minor in normal market conditions, when things become hot and heavy, trade reporting in the underlying assets may become delayed, and discrepancies between the value of the underlying assets and the price of the ETF can occur. If this happens, you could pay too much (or get a bargain) on ETF shares. Conversely, you might sell at a price that either is too high (good for you) or too low (bad for you). But, because you won't know about the trade reporting problems, you won't have any idea until after-the-fact whether you got a good or bad price.
5. You can trade an ETF like a stock. In other words, you can own it for minutes, or even seconds, and then sell it. You can sell it short, buy it on margin, use a limit order and the like. Some people may be tempted to trade ETFs short term because they have so many trading options. Stock brokers may encourage such short term trading because it generates commission income for them. However, the history of the stock markets teaches that short term trading generally is less profitable than long term buying and holding. Indeed, many people lose money, rather than make it, when engaged in short term trading. Be cautious using ETFs for short term trading. With their commission expenses, the bid-ask spread, interest charges on margin debt and the risks of trading short term, ETFs probably offer the typical individual investor few advantages, if any, for short term trading.
The ETF is a good long term investment option. If you buy and hold it, you get the most out of it. If you trade ETFs short term, you might money. But you might lose it. You wouldn't use a spoon to eat a steak. Don't use an ETF in ways that aren't likely to help you.
Crime News: whatever financial shape you're in, be glad you don't have to steal toilet paper. http://www.wtop.com/?nid=456&sid=1164394.
1. ETFs generally have low costs and expenses, but you have to buy them through a stockbroker. That means you pay a commission. In addition, ETFs have two prices in the market: the "ask" price at which you buy them, and the "bid" price at which you sell them. The "ask" price will be higher than the "bid" price, and the difference between the two--called the "spread"--is a cost of investing. That's because if you buy at the ask price and immediately sell, you'll lose some money from selling at the lower bid price.
Consequently, ETFs are not always the lowest cost product. A low-cost traditional mutual fund may actually be cheaper, because you can buy it without paying a commission or incurring the "bid-ask spread" as a cost of investing. If you're saving small amounts at a time (e.g., $100 or $200 a month), a traditional mutual fund is a cheaper way to invest than an ETF.
2. ETFs are based on market indexes--in other words, the stocks or bonds they hold are the same ones that comprise a market index. For example, an ETF that mimics the S&P 500 will hold the 500 stocks in that index. ETFs started off with broadly based market indexes, like the S&P 500, and were often good choices for long term investment. However, more recently, ETFs have been created to represent increasingly narrow sectors of the stock markets--like just telecommunications stocks or stocks of one particular country. The narrower the index, the more risky the ETF, because it is less diversified. It may provide excellent returns, or terrible losses. The more you invest in narrowly-based ETFs, the more attention you'll have to pay to the overall diversification of your portfolio. In other words, the more work you'll have to do managing your money.
3. ETFs are often tax efficient, in that they are not required to distribute capital gains each year to investors. Investors report gains on their tax returns only when they sell their ETF shares at a profit. But a carefully managed mutual fund can also achieve a high degree of tax efficiency.
4. ETFs theoretically should trade at the same price as the aggregate prices of their underlying assets. This, however, doesn't always occur. Variations in supply and demand at any particular moment can cause an ETF to trade at a discount or premium to the value of its underlying assets. In addition, technical market problems can cause pricing problems. Trades that occur in the underlying stocks and bonds necessarily are reported after they occur. There is always a time lag between trade prices of the underlying assets and the trade price of the ETF. While the time lag may be minor in normal market conditions, when things become hot and heavy, trade reporting in the underlying assets may become delayed, and discrepancies between the value of the underlying assets and the price of the ETF can occur. If this happens, you could pay too much (or get a bargain) on ETF shares. Conversely, you might sell at a price that either is too high (good for you) or too low (bad for you). But, because you won't know about the trade reporting problems, you won't have any idea until after-the-fact whether you got a good or bad price.
5. You can trade an ETF like a stock. In other words, you can own it for minutes, or even seconds, and then sell it. You can sell it short, buy it on margin, use a limit order and the like. Some people may be tempted to trade ETFs short term because they have so many trading options. Stock brokers may encourage such short term trading because it generates commission income for them. However, the history of the stock markets teaches that short term trading generally is less profitable than long term buying and holding. Indeed, many people lose money, rather than make it, when engaged in short term trading. Be cautious using ETFs for short term trading. With their commission expenses, the bid-ask spread, interest charges on margin debt and the risks of trading short term, ETFs probably offer the typical individual investor few advantages, if any, for short term trading.
The ETF is a good long term investment option. If you buy and hold it, you get the most out of it. If you trade ETFs short term, you might money. But you might lose it. You wouldn't use a spoon to eat a steak. Don't use an ETF in ways that aren't likely to help you.
Crime News: whatever financial shape you're in, be glad you don't have to steal toilet paper. http://www.wtop.com/?nid=456&sid=1164394.
Monday, May 21, 2007
Scam Alert
It's past midnight and you've been in the bar for a while. Maybe you've had two or three drinks, or maybe a bit more. You're still alone and some of the people around you are starting to look better than they did a half an hour ago. One of them walks up and says, "I just won the lottery. Would you like to see the $20,000 shower curtain in my apartment?" Are you going to fall for this?
You're living paycheck to paycheck, and any time you have to buy both bread and potatoes at the grocery store, you wreck your budget for the week. Someone who is nicely dressed, sports an expensive watch, and drives a luxury car approaches you and says, "Would you like to get in on an investment that pays 10% a month? You can double your money in less than a year. Look at what it's gotten me!" Will you fall for this?
Life has taught you, in at least some settings, that desperation isn't an excuse to do something dumb. There's no exception to this rule when it comes to money and finances. There's always someone with a good story who wants to take your money. How many people are waiting around to give you money? The next time you hear a smooth sounding story about easy money and no risk, put your hand on your wallet and excuse yourself to take a walk around the block from which you don't return.
Here are some common scams that you may encounter.
1. Internet fraud: be wary of unsolicited e-mails or instant messages promoting investments, or which direct you to websites that promote investments. Always research the investments--see if any independent source of information will verify the claims made. When in doubt, don't invest.
2. Foreign exchange trading scams: foreign exchange, or "forex," trading basically involves betting that one currency (let's say the Japanese yen) will increase or decrease in value against another currency (let's say the Swiss franc). This is a zero-sum game--if one currency gets stronger, the other one by definition gets weaker, and if you don't win, you'll lose. Legitimate forex trading involves millions and even tens of millions of dollars per transaction, and is for the big dogs on Wall Street. There are, however, lots of opportunities for ordinary investors to be ripped off in foreign exchange scams. Avoid this stuff.
3. Oil and gas scams: with the prices of oil and gas scaling Mount Everest, energy and alternative energy scams are now a dime a dozen (and not even worth that much). Research energy investments carefully, and always look for independent verification. Independent verification means you, on your own, should find legitimate sources of information that support the claims made. Don't rely on sources of verification provided by the promoter of the investment--those sources could be in cahoots with the promoter. When in doubt, don't invest.
4. Affinity fraud: some of the lowest forms of life in the financial markets take advantage of social or religious ties to defraud investors. This is called "affinity fraud." For example, a crook might join a congregation, win over one or two prominent members, and use their respected status to convince other members of the congregation to invest in a scam. Or else, a member of a minority group might try to sell phony investments to other members of the same minority group. In these cases, the crooksters exploit the natural human tendency to trust those who have something in common with you. Stay vigilant whenever anyone wants to take your money. Invest in an asset, not in a person.
5. Prime Bank investments: an endemic problem in the financial markets is the prime bank fraud. Scumbag promoters offer you a chance to get into investments offered by "prime banks," which are supposed to be prominent foreign banks that ordinarily serve only the ultra-rich. These investments are touted as high return, low risk and tax free. None of that is true. You're more likely to encounter a swimming pool in the Sahara than a real prime bank.
The North American Securities Administrators Association, which is composed of the state securities regulators in the U.S., has put together a longer list of scams du jour. Go to http://www.nasaa.org/NASAA_Newsroom/Current_NASAA_Headlines/6669.cfm.
The elderly are among the most likely to be victimized by fraudsters. If you have elderly parents or grandparents, try (gently) to keep an eye on their financial well-being.
Crime News: Is this your parakeet? http://www.nbc4.com/news/13352686/detail.html. If so, the police may have your camera.
You're living paycheck to paycheck, and any time you have to buy both bread and potatoes at the grocery store, you wreck your budget for the week. Someone who is nicely dressed, sports an expensive watch, and drives a luxury car approaches you and says, "Would you like to get in on an investment that pays 10% a month? You can double your money in less than a year. Look at what it's gotten me!" Will you fall for this?
Life has taught you, in at least some settings, that desperation isn't an excuse to do something dumb. There's no exception to this rule when it comes to money and finances. There's always someone with a good story who wants to take your money. How many people are waiting around to give you money? The next time you hear a smooth sounding story about easy money and no risk, put your hand on your wallet and excuse yourself to take a walk around the block from which you don't return.
Here are some common scams that you may encounter.
1. Internet fraud: be wary of unsolicited e-mails or instant messages promoting investments, or which direct you to websites that promote investments. Always research the investments--see if any independent source of information will verify the claims made. When in doubt, don't invest.
2. Foreign exchange trading scams: foreign exchange, or "forex," trading basically involves betting that one currency (let's say the Japanese yen) will increase or decrease in value against another currency (let's say the Swiss franc). This is a zero-sum game--if one currency gets stronger, the other one by definition gets weaker, and if you don't win, you'll lose. Legitimate forex trading involves millions and even tens of millions of dollars per transaction, and is for the big dogs on Wall Street. There are, however, lots of opportunities for ordinary investors to be ripped off in foreign exchange scams. Avoid this stuff.
3. Oil and gas scams: with the prices of oil and gas scaling Mount Everest, energy and alternative energy scams are now a dime a dozen (and not even worth that much). Research energy investments carefully, and always look for independent verification. Independent verification means you, on your own, should find legitimate sources of information that support the claims made. Don't rely on sources of verification provided by the promoter of the investment--those sources could be in cahoots with the promoter. When in doubt, don't invest.
4. Affinity fraud: some of the lowest forms of life in the financial markets take advantage of social or religious ties to defraud investors. This is called "affinity fraud." For example, a crook might join a congregation, win over one or two prominent members, and use their respected status to convince other members of the congregation to invest in a scam. Or else, a member of a minority group might try to sell phony investments to other members of the same minority group. In these cases, the crooksters exploit the natural human tendency to trust those who have something in common with you. Stay vigilant whenever anyone wants to take your money. Invest in an asset, not in a person.
5. Prime Bank investments: an endemic problem in the financial markets is the prime bank fraud. Scumbag promoters offer you a chance to get into investments offered by "prime banks," which are supposed to be prominent foreign banks that ordinarily serve only the ultra-rich. These investments are touted as high return, low risk and tax free. None of that is true. You're more likely to encounter a swimming pool in the Sahara than a real prime bank.
The North American Securities Administrators Association, which is composed of the state securities regulators in the U.S., has put together a longer list of scams du jour. Go to http://www.nasaa.org/NASAA_Newsroom/Current_NASAA_Headlines/6669.cfm.
The elderly are among the most likely to be victimized by fraudsters. If you have elderly parents or grandparents, try (gently) to keep an eye on their financial well-being.
Crime News: Is this your parakeet? http://www.nbc4.com/news/13352686/detail.html. If so, the police may have your camera.
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