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Monthly Archives: March 2010

How much should you be saving?

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How much should you be saving?

  • Consider your Needs & Wants
    • Needs – Think of the costs you incur each month to cover your basic necessities…shelter, food, electricity, transportation, clothing, debt payments.
      • The cost of your needs can be adjusted, but they tend to be less flexible than your Wants.
    • Wants – Think of the costs you incur each month to cover items that satisfy your life-style, hobbies, other activities.
      • Wants tend to be more flexible than your Needs because they are not actually necessary items in your life.  If you give up your hobby, you might be sad.  If you give up food, you will eventually die.
  • The amount left over after you’ve covered your monthly Needs and Wants is what you can save/invest.
    • Should you save what’s left over?
      • Maybe….
        • Do you have debt?  If so, the annual interest rate you’re paying on that debt is most likely higher than any risk-free investment you could otherwise invest in.
          • Focus on paying down debt…especially credit card or any other high interest debt you have.  The debt with the highest interest rate should be 1st in line to be paid off. (Your home mortgage can be written off at tax time, so this is an exception)
        • Do you have a cash reserve?
          • Do you have money in a easily accessible account that can be used if something major happens in your life?  How many months would this money last if it had to cover your monthly Needs and Wants?  Build up a fund of reserves before you run off into the market.
        • If you have the two items above taken care of, then it’s time to go out and invest!
        • Set future goals and determine how your level of savings/investing fits in with reaching those goals by whatever future date you have set.

How to Protect Your Portfolio Against Inflation (Ignore the wind)

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Using commodities to hedge against inflation.

  • If you’re worried about the impact inflation will have on your portfolio in the future, investing in commodities can be a good defensive strategy.
  • Commodities are typically the first area to experience inflation when it hits an economy.
    • Commodities are made up of a number of raw materials – most of these materials serve as the first step in the production process.  Thus, they are often where we see inflation starting.
  • Commodities are traded on a market known as the futures market.
    • The futures market is made up of contracts to purchase specific commodities at a future date for a specific price.
      • When inflation sets in for a certain commodity (or commodities), prices increase based on the level of inflation and therefore cause the futures contracts to increase in price.
        • Holding a futures contract prior to the onset of inflation enables you to sell that contract at a profit after inflation has started to occur.
          • Buy the contract – inflation occurs – contracts market value rises – sell the contract at the new higher price – protect yourself against inflation.
  • An easy way to gain exposure to commodities is through commodity focused ETFs and Mutual Funds.

Real Estate Investment Trusts (REITs)

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Real Estate Investment Trusts (REITs)

  • Companies that invest directly in real estate and trade on exchanges as a stock.
  • Enable you to invest in various types of commercial and residential real estate without having to actually purchase a property.
  • REITs by law must pay 90% of all taxable earnings out to shareholders.  Thus, you typically will find REITs paying sizable dividends.
  • REITs typically aren’t thought of as growth stocks, which means you should not expect a lot of price appreciation per share.
  • When you’re thinking of investing in real estate, consider if investing in a REIT would be a better option
    • Easier entry and exit from your investment (trades on an exchange).
    • No need to secure a loan (You purchase on a per share – not per property).
    • No need to search for the property and identify a renter.
    • REITs benefit from economies of scale (Example – With a large number of units, they will have a lower per unit maintenance bill than a smaller operation.).
    • Greater diversification is possible through owning REITs than would be by owning a few properties.

Where to find good investment ideas?

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Where do I often find good information about potential investments?

Publications

  • Kiplinger’s monthly personal finance magazine.
  • The Kiplinger Letter – published weekly
  • Smart Money – The Wall Street Journal’s monthly personal finance magazine
  • Forbes – Business bi-weekly with an emphasis on investing
  • Barron’s – Ended finance/investing publication published by the Wall Street Journal
  • A number of other great newsletters and magazines exist, but the above list are the ones I’m most familiar with and have found most useful.

Websites

  • Seeking Alpha - A compilation of financial/investment professionals blogging about everything under the sun regarding investments and finance topics.
  • Yahoo! Finance – A great starting point for initial research into a company.  Lots of resources in one area.
  • If you have access to research reports on companies, I would leverage that information.  I use the Standard & Poor’s reports that cover a significant amount of companies.  Scottrade’s research tools include these reports

Other Sources

  • Conferences – Investing conferences are a great way to obtain a lot of exposure to new ideas, companies and investing concepts.  It’s a great learning experience & you will probably come away with a handful of solid investing ideas.
    • MoneyShow hosts 2 or 3 conferences across the US annually.  I went to their last investing conference in S.F.  They have another coming up in Las Vegas in May.  You do not have to pay to register.

Basic Bond Pricing

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Bond Pricing

Par Value – Initial offering price of the bond (typically $1,000 for corporate, $5,000 for municipal and $10,000 for federal)

Coupon Rate – This is the interest rate you expect to receive annually over the life of the bond.  Typically made in semi-annual payments (2 times a year).

Maturity Date – The date when the bond will come due.  You no longer are receiving any coupon payments and your initial investment is paid back in full.

Primary Market – This references when the bond is first sold by its institution.  The bond sells at par value.

Secondary Market – After the bond has been taken by an investor the investor can sell the bond to other investors.  The bond may or may not sell at par value to other investors.

Premium or Discount – If a bond sells for less than par value, then it’s selling at a discount (less than $1,000 for a corporate bond).  If a bond sells for greater than par value, the it’s selling at a premium (greater than $1,000 for a corporate bond).

What causes bonds to sell at a premium or discount? – When the going interest rate changes (coupon rate) for bonds with certain maturity dates, this will cause the bond to sell for a premium or a discount.

  • Rule – If the going rate is now higher than what your coupon rate is, then your bond will sell at a discount.  If the going rate is now lower than what your coupon rate is, then your bond will sell at a premium.
  • Do a search for a bond price calculator or formula if you need the exact number.

What are Bonds? & Bond Credit Ratings

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Bonds

  • Bonds are debt notes issued to the public/investors.
    • As a bond holder you receive a premium (coupon rate – think interest rate) for lending your money to a company or government.
    • At the end of the bond’s life you expect to receive your principle (initial investment back).
  • Companies and governments that issue bonds receive a credit rating.
    • Based on the credit rating, the company/government will have to pay a higher or lower premium to attract investors.
      • The higher the rating a company/government has, the lower the rate that must be offered.
      • Ratings go from AAA to D.
      • Bonds with lower ratings have a higher chance of defaulting (not paying you what you were stated)
  • The length of the bond’s life also impacts the coupon rate (premium) that must be offered to attract investors.
    • Rule of thumb – the longer the maturity date the greater the premium offered compared to bonds with lesser maturity dates.

Penny Stocks – The Allure & Risk

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Penny Stocks

  • Often times investors are drawn to penny stocks because, “If they only go up a few cents, I will make a 50% return on my investment.”
  • Penny stocks are almost always growth companies that are young and/or have a very narrow area of business.
  • Risks
    • Many penny stocks have a low level of trading volume, which can cause large price fluctuations (for better or worse).
    • Small and young companies often have a difficult time borrowing/raising funds.
      • When funds are gained it is often at a higher cost than more established larger companies.  Interest payments then would be higher than ‘normal’ and make it more difficult for the company to return a profit and find additional lenders.
      • It’s very important to be able to raise funds when a company is growing.
    • One problem with the operation or business model can derail or doom the company.
    • Inexperienced leadership / management exists at a higher rate throughout these companies.
    • Make sure to check the number of shares outstanding when looking at penny stocks.
      • When you only get a few cents per share, often times these companies have a very large amount of share outstanding.  Thus, if a very large supply exists it will take a very large movement in demand to make the stock price jump.

Initial Public Offerings (IPOs)

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Initial Public Offering (IPO)

  • The first instance of a private company going public.
    • Anyone access to the stock market can now be an owner of the company.
  • IPOs raise money for the corporation.  By selling shares, the company gains funds to do X, Y or Z.
    • Though money is gained the current owners have a reduced share of ownership in the company.
  • IPOs are typically most plentiful during bull markets.
    • The owners who have decided to take the company public will want to get the highest value for their initial offering.  Bull markets tend to bring higher IPO prices than bear markets.
  • IPOs are not necessarily a way to make some “easy money.”
    • Being completely new to the market, it is difficult to gauge how the stock’s price will behave until the company sets forth a track record.
      • A IPO stock offering might start off hot one day and be very cold the next.

Leveraging Retirement Accounts

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2010 contribution limits to both IRA accounts is $5k.  If you’re over 50 in 2010, then it’s $6k.  Click here for the IRS Rules.

IRA

  • Enables you to save money for retirement tax free.
    • Example – I make $50k and put $2k towards my IRA account.  The IRS evaluates my taxes based on income of $48k, not $50k.
  • Money withdrawn before 59.5 years of age is subject to early withdrawal penalties.
  • When you begin withdrawing your money during retirement your money will be taxed then.
    • You and I do not know what tax rates will be in place X number of years into the future.

Roth IRA

  • Enables you to save money for retirement on money that has already been taxed.
    • If you make$50k this year and save $2k to your Roth IRA, the IRS still looks at your income as $50k.
  • Since your contributions have already been taxed, you can withdraw your principle (initial investment amount) without penalty prior to retirement.
  • All earnings will be penalized, if withdrawn prior to age 59.5.
  • To qualify for tax free distributions, you must be over 59.5 and your contributions must have been in the Roth IRA account for at least 5 years.

401(k)

  • Provides a way to save money tax free for retirement.
  • Often times companies will match a percentage of each $1 you contribute to their 401(k) plan.
    • When this happens you not only get a bonus from avoiding taxes, but you are receiving a bonus from your employer.
  • In 2010 the maximum contribution you can make to a 401(k) is $16.5k.
  • After you’re 59.5 years of age you can begin to withdraw funds from your account without penalty – your withdrawals will be taxed regardless.

Please note that the guidelines above applied to the most general cases.  Exceptions to these rules does exist.  Consult the IRS’s home page for the most up-to-date information.

Using Trends to Identify Long-Term Investments

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Trends & Investing

  • Identify a new or upcoming trend and consider what companies will be impacting by this trend.
  • Consider how this trend will impact other industries/businesses.
  • Take the companies and/or sectors you identify and investigate to see if they’re positioned best to profit from the trend.

A company that is positioned well to benefit from a trend is less dependent upon ultra-successful management decisions.  A boat in a swift moving river does not need a strong rowing team to move fast.