Friday, April 27, 2012

Taking a Hands Off Approach to Investing

Constantly monitoring investments can be challenging and depressing. When our investment goes down, we are discouraged. When it goes up, we feel good. But some recommend just letting the market go through its ups and downs and eventually corrections occur in your favor. Watching every rise and fall can lead us to "analysis paralysis" where we are over analyzing everything to death so we do nothing. Some mutual funds for instance are actively managed and some are passively managed. We pay more for those that are actively managed by professionals. Actively managed annuities and whole/variable/universal life insurance policies can often be poor choices for a portfolio due to high management fees that will eat into your return on investments. Many financial experts recommend buying a term life policy, then augmenting it with mutual funds, IRAs and/or a 401k. But, sometimes a basic index fund that mimics the performance of an index such as the S&P 500 can be a good choice. In 2011, investors would have done better with an index fund 84% of the time when compared to an actively managed fund. This statistic comes from this article by consumer advocate Clark Howard:

Facebook, Google, Amazon, Apple, which one does not belong?

Soon, Facebook will have its IPO (initial public offering) and its stock will "go public" so everyone can buy a piece of the social media juggernaut. Some may put it in the same category as Google, Amazon and Apple, but I would not. Facebook will not have the staying power of those companies. In attempts to take over much of the internet, many sites now want you to sign in via Facebook. It is hard to put a valuation number on Facebook, just like other social media companies since they usually lose steam over time and fade away (remember My Space?) It seems like the best time for Facebook to have gone public would have been about 5 years ago, when it was relatively unknown outside of a few college campuses. At that point, its meteoric growth was still ahead of it. This article has some good points about Facebook's valuation:

Thursday, April 26, 2012

The Psychology of Investing

Buy low, sell high. We have all heard the mantra. But, what happens when you buy an investment, it goes down and down, and when do you sell it rather than continue to take losses? Well, you actually have not lost anything (or gained anything) until you sell. So, on paper a stock may be down 40%, but if you hold onto it, there is a chance it will bounce back. When the market overall is down, we don't seem to hear much about buying. When it is up, people often become enthusiastic about investing. But, in fact, that is just the opposite of what we should do. It makes me think of the Seinfeld episode where George Costanza made it his mission to do the opposite of everything he normally does. Did it work? Yes, to some degree, but of course that approach can be taken too far. Do you want to do the opposite of Warren Buffet or the complete opposite of everything that is recommended in Forbes, Kiplinger's or The Wall Street Journal? No, that would be foolish. Sometimes it is hard to admit we have made a mistake when watching an investment we have purchased, and we tend to hold on to bad investments, in hopes that they will bounce back. If a stock has strong fundamentals and it seems to be just a temporary slump, then hold onto it. Other times stocks will go down and keep going. I bought GM a few years ago, never dreaming it would go bankrupt, but it did and I rode the stock all the way down. Maybe selling at a 10% loss would have been better than dealing with a 100% loss. No doubt, it would have been better. My Toyota (TM) investment is down 35%, but I think it will come back eventually. The natural disaster in Japan and the recalls and lawsuits hurt the company dearly. But, it will come back (I hope). Say you have a stock that is up 20%, but you don't want to sell, hoping it will keep going up. Sometimes it is better to take your gains and get out. But, I can't make those decisions for others. Do your homework by checking out news articles about the company, look at the financial statements, examine the transactions by insiders such as corporate officers and see what the experts are recommending. It can be a bumpy ride, but if we ride out the ups and downs over the long haul, most people do well. Those who are against taking chances with their portfolio should probably stick to mutual funds, which will automatically diversify the investment decisions and lower the risk for you.

Sunday, April 15, 2012

Investing Does Not Have to be Brain Surgery

So many people are intimidated when they hear the term investing. Many find it to be a complex subject, or even a boring one. It does not have to be complex or boring. If you have ever watched Jim Cramer's show on CNBC, you know that people can make it exciting. It is complex if you are looking to be a day trader and buy and sell throughout the day, tracking even the smallest movement of individual stocks. But most are not planning on doing that. Often times, over thinking our investment choices leads to "analysis paralysis". In that case, people get so overwhelmed that they fail to make any changes to their portfolio, fearing that they will do something wrong. We need to find a happy medium when it comes to monitoring our investments. Here are a few rules of thumb that I follow.

1. Decide your level of risk. If you want to play it safe with investments, that is fine. There are choices ranging from mutual funds, to exchange traded funds (ETFs), to certificates of deposit (CDs), to index funds, which will track the performance of a particular fund, such as the Dow Jones Industrial Average or the S&P 500. But, not every investment is created equal. All mutual funds are not winners. Track their average returns from the past few years and see how that fund has performed. Also look at the expenses and fees that are associated with that investment. If your local bank is selling CDs and they only will generate 1 or 2% per year, then that is not a wise investment. Playing it too safe means you will have a small return on your money, if you have any return at all. If inflation is at 3% per year and your investment is returning 3% per year, then you are not ahead of the game. Individual stocks can generate big gains, but they are risky. You could always have a portion of your portfolio set aside for individual stocks, but don't invest money here that you cannot afford to lose. Some tech stocks tend to be volatile, meaning they move up and down rapidly from day to day. These can be bought and sold for short term gains. The first rule of investing is to buy low and sell high. Maybe a stock could be bought for $10 per share, then sold a week later at $20 per share. That is good, but you have not actually doubled your money since you need to consider brokerage fees and tax implications that occur when you sell. So, think before you buy, and think again before you sell.

2. Are you investing for the short term or the long term? Investing for the long term is often accomplished through a 401k plan that includes an employer match. Many 401k plans will allow you to choose from several mutual funds that will comprise your retirement fund. A 401k plan will grow in a tax deferred environment, so that is a big advantage. A Roth IRA is a good choice too, since you pay taxes when it is bought, but then do not need to pay taxes when it is withdrawn, as long as you are past age 59.5. Young people can afford to take more risks than older people since young people can have time available to make back their losses. If you are investing for the short term, individual stocks will often not be a good choice, but they tend to do well over the long haul. Stocks that pay dividends can be a good choice. They are often paid by companies with a long track record of good, stable, financial performance, such as is the case with Procter and Gamble. Dividend stocks often do not have the rapid growth of a company like Google, but they do well over time, and re-investing dividends can add up to a lot of money.

3. Don't put all of your eggs in one basket. In other words, diversify. If you want to buy Apple stock, for example, that is fine, but don't put 100% of your investing funds into one stock. Maybe buy a tech stock and an auto stock and a retailer along with a pharmaceutical stock. Many financial experts recommend spreading around your investments so that each sector has no more than 20% of your money. Diversify your choice of investment vehicles as well as your individual choices. Those who are successful might invest in real estate, stocks, bonds, mutual funds, cash, savings bonds, treasury bills and an IRA. Don't overlook the international funds, since we are in a global economy and significant gains can be made by investing in overseas funds. We have experienced how the debt crisis in Europe has had a ripple effect on US markets.

4. Start early. How early? As early as possible. I wish that I had bought stocks as a teenager. If I did, I would have 25-30 years of growth behind me. Those who start investing early can build a bigger retirement nest egg to protect against financial hurdles that so many face during their golden years. People are living longer. If a person retires at age 65, they might live to 85, so they need 20 years of funds available. Don't assume that social security will still exist 15 or 20 years from now. It might, but don't assume that social security will be a part of your retirement income, since it might not be. It is best to err on the side of caution and save as if social security will not be there. If it is, great, you will do even better financially than you once thought. Also, if social security is solvent, there will be a higher payout if you retire at age 65 versus age 62, and even more of a payout if you can hold on until 70. Someone who starts investing at age 25 versus age 35 will make a lot more to go towards retirement. Time is the best friend of investing. Compounding interest multiplies faster than you think.$1 million dollars at retirement with 6% growth will give you $60,000 per year to live on without touching the principal. $60,000 is good now, but if retirement is 25 years away, the real spending power of that amount will be a lot less. Financial expert Suze Orman recommends taking out no more than 4% of the total value of your nest egg each year during retirement. At age 70.5, it is a requirement to start taking a minimum amount of money out of the 401k and/or traditional IRA. Otherwise, a 50% penalty plus normal income tax will be accrued.

5. Don't get sucked in by fads that you hear about through the media. An example of this is investing in gold. Recently when the commodity of gold reached an all time high, there were commercials and media pundits recommending that people invest a portion of their portfolio in gold. What is the cardinal rule of investing? Buy low, sell high. Why would one want to buy something when it is at an all time high? If you go to a department store and see a sweater that is normally $20, and it is marked up to $50, will you want to buy it? Of course not. Now, selling gold at an all time high would make sense, but not buying it. Financial experts will vary in their advice regarding commodities. Most will say that if you want to invest in commodities, make it a small percentage of your portfolio, maybe 5%. Then again, some suggest zero percent.

* Some information from The Money Class, by Suze Orman

Sunday, April 1, 2012

An Emergency Fund will Help You be Ready for a Rainy Day

As a kid, many of us had parents who would recommend saving for a rainy day. That is good advice since rainy days will come and we don't know when. Financially speaking, every day is not sunny, where we have plenty of money to pay our bills and have money left over. In this economy, no one has a job that is rock solid secure. What do you do if your car breaks down and you need $750 to pay for repairs? If you don't have an emergency fund, many would pay for these repairs with a credit card. The problem with that is the interest charged by credit card companies, which can be as high as 25%. If an emergency fund is available, money can be used from that fund and you are charged zero interest. Therefore, the money needs to be liquid, meaning that we can have easy access to it with no penalties for withdrawals. Money that is tied up in stocks or a 401k or a certificate of deposit is not liquid. Cash in a safe or in a savings account is liquid. Emergency funds should be only used in emergencies, such as paying for medical bills, household repairs or car repairs. An emergency fund should not be used for a shopping spree at the mall or to pay for a vacation. Dave Ramsey recommends that $1000 is a good starting point for building an emergency fund. Over time it should grow bigger and bigger. Suze Orman recommends an emergency fund that is equal to eight months of a household's income. Emergency funds are important for households as well as businesses. I have heard about businesses that go under due to having a couple of months where the cash flow was less than normal. Businesses or households need to save when times are good, so that when money is tight, they have a reserve of cash. The key to financial fitness is being aware of the big picture, not just looking at making it day by day. Those who thrive are the ones who plan for the future. For example, contributing to a 401k with an employer match starting at age 25 versus age 35 can make a significant difference.