How Do You Invest a Big Inheritance?


OK, so let’s say old Aunt Lizzie has died (the aunt who you don’t remember seeing since you were five, and just remember that she had a lot of cats) and she has left you $100,000.  You aren’t sure why she left you the money, but now you have a bunch of cash and want to try your hand at investing.

Let’s assume further that you already have an emergency fund (cash) of 3-6 months worth of expenses, a retirement account set up that is full of mutual funds and the like, you don’t have credit card debt, you have the house on a fixed 30 year or — even better –15 year loan, and you have the kid’s college account set up and ready to go.  If any of these are not the case, take care of these first – you aren’t ready to start investing in stocks.

So the question is, how do you invest all of this money, starting from a such a large sum?

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Well, given the recent run-up, you might not think the market is particularly attractive right now, and probably will be heading down for a while.  You could be wrong, however, and all of that federal funds money may finally start the lending flowing and we could see 20,000 on the Dow in a year.  What the market will do over the next few years will also not matter a whole lot in 10-20 years.  There is therefore no reason to wait, but there also is no reason to jump in with both feet.
First of all I would determine how much of the $100k I was wanting to preserve and not put substantially at risk, and how much I was wanting to grow more rapidly with a bit off added risk.  Personally, I might decide that I wanted to preserve $40,000-$50,000 of it through diversification.   (Others who are more risk averse might want to put $70,000-$80,000 in mutual funds.  If you really don’t want to mess around with individual stocks, you would be just fine putting it all into mutual funds.)  This I would put in 2-3 index funds.  Here one might see declines of 20-30% on some years, but this will be rare, and with time this money should grow at an average rate of about 10-15% per year, doubling each 5-7 years.  Here I would put some in now, wait a few months, and put in more, taking about 6 months to a year to become fully invested.

With the rest I’m looking to take a bit more risk for the chance at larger returns through investing in individual stocks.  I know that any one stock could collapse, but it could also grow by thousands of percent.  By buying a few carefully picked stocks I’m hoping to get at least one that grows for years and beats the overall market.

Anytime a large sum is to be invested, even if the market doesn’t look so unstable as it does now, it is always wise to wade in slowly.    I would start by picking 2-3 stocks that have good long-term prospects (see the stock picking category of the blog).  Buy a few hundred shares of each of these — about equal dollar  amounts.  Then watch them for a while, hoping that they will drop a bit and you can buy more shares for a bit less.  Add to positions that do.

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Once you have the initial positions, set up, wait about three months.  Check on the positions then and see if the companies still have the fundamentals you thought they did.  If they do, invest more in the 1-2 stocks that have lagged the others – buy low.  Continue to do this, adding a few hundred shares every three months, until you have about 500-1000 shares of each.  You may have $30-$80,000 of the money invested by this time, with $10-$30k in each stock.  If this is too much for you to lose, choose six stocks instead, making each position $5-$15k.  If this is still too rich, choose 10.   If you are still too worried, individual stock investing is not for you.  Buy three or four nice ETFs or index mutual funds and sleep easy at night.

At this point, start to look for another good stock in which to invest the remaining funds if money remains.  As the positions grow, sell off some shares if any of the positions become too big for you to lose – bad things happen some times.  Put some of this money in other individual stocks or add to existing position.  Diversify the rest to preserve the capital you’ve gained.  If any of the companies lose the qualities for which you bought them, sell them off and put the money into something else.  Also, see if you can save some money from your occupation and continue to add stocks to your portfolio.

Hopefully Aunt Lizzie’s gift will lead to a large portfolio of stocks and be worth many times the original gift 20 years into the future.  If this happens, maybe take $100,000 and give it to a grandchild.  Put it in an index fund or ETF when they are twenty and you will have paid for their retirement.  Do it when they are two, and you will have created a multi-millionaire.

Have a question?  Please leave it in a comment.  Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

What is a Short Sale?


The term “short sale” has come more into the popular vernacular lately in reference to the real estate transaction in which the lender allows the borrower to sell a house for less than is owed for the property.  In stocks and other securities a short sale is something entirely different.  Today I will discuss short sales as they relate to securities.

In securities, a short sale goes as follows – An investor (or speculator) calls her broker and says that she wants to sell 100 shares of company XYZ short at $50 per share.  Her broker goes out and borrows the shares (usually from someone who has a margin account who is currently on margin) and then sells the shares for $50.  The broker deposits the proceeds, less commissions, in the investor’s account.  At some later date, to close the transaction, the investor must purchase the shares, replacing those that were borrowed.  (Note that this person will probably not know that the shares were every borrowed, and if he decides to sell his shares during the period shares from another person must be found and used for the sale.)  If the company pays a dividend while the short seller still has the position open she must pay the dividend to the person from whom the shares were borrowed (who again doesn’t know they are gone).

 

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If the investor who did the short sale is able to buy the shares back at a lower price, say $40 per share, she will make the difference in price ($50-$40)x100 = $1000, minus commissions and any dividends she had to pay.  If the stock rises above the price she sold them for and she closes the position, she will lose money.  Obviously, stocks are sold short when an investor thinks it will decline in price.  Because stocks naturally tend to increase in price (because of inflation if nothing else), selling short is not a long-term strategy.

Now that I’ve explained the basics, you may wonder if short selling is a good strategy for and investor.  After all, why not make money when the market is going down as well as when it is going up.  The issue is that you really don’t know very often when the market will be going down.  You can certainly tell when the market is overpriced, but that does not mean that the market won’t continue to be overpriced, or even get more overpriced, before stocks finally pull back.  Sometime earnings will also increase rapidly, making stocks fairly priced again.

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There are maybe two situations where short selling might be worth it.  The first is called selling short against the box.  In this strategy you sell short shares of a stock you already own, telling your broker that you want to sell short against the box.  He will then borrow and sell some shares, yet leave your original position alone, meaning that you’ll have both a long position and a short position.  When you are ready, you simply tell your broker to wash the two positions and you close both sides.  The reason for doing this is if you want to take a profit in case the stock is about to decline, but want to move the gain into a future year for taxes.

The other time is when the market is really, really overpriced and ready for a fall, or you see something coming like the 2008 housing crisis, and you want to protect your portfolio without selling everything.  In this case, you can take some short positions, effectively going neutral or near neutral on the market, as a way to protect yourself,  For example, in 2007 I was shorting mortgage companies since I figured they would decline when the housing boom ended.

 

 

Have a question?  Please leave it in a comment.  Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Don’t Conserve – Use the Water You Need


If you live in a desert with a very limited water source and there are a lot of people around, ignore what I am about to say.  If you live in a place where water falls from the sky regularly, let me be a Green heretic and go against the common wisdom by saying:

Use all of the water you need.

Doing so makes the most sense financially, and really sets us up to be able to provide for future needs.  Here’s why:
A utility needs to maintain a certain amount of equipment.  They also need to do functions like billing and customer service.  All of these things require a certain number of people.  Once you get past a certain threshold of water production, the number of people needed does not change that much if you increase the amount of water needed.  You still need a certain number of people to maintain the equipment, and usually you’ll just buy the same numbers of larger equipment if you need more production, rather than buy more pumps, motors, etc….  The larger equipment in fact will usually be more efficient, meaning the cost to produce each gallon will decline as the utility produces more water.

 

              

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The other factor is that most of the cost is people, not electricity or other resources.  Sure, you will use more electricity cleaning and pumping more water, but again the cost per gallon produced will probably decline as you use bigger, more efficient equipment.  Unless the number of customers changes dramatically, you’ll also still need to be paying the same number of people to send out bills, maintain equipment, and do other administrative tasks.   In fact with modern computer tools, things like billing cost about the same whether you have a million customers or two million.  Customer interaction things like the service desk are the only areas where more employees may be needed.  If you cut the use per customer, you’ll save a little on electricity, but you’ll still have all of the other costs.  Since the utility will be producing fewer gallons, yet their costs will stay about the same, you’ll end up paying more for less water.

So lets say that you decide to turn off the water while you soap up in the shower, then just turn the water on briefly to quickly wash off, cutting your shower water usage from 20 gallons per shower to three gallons.  You might be able to cut your water bill by doing this.  But let’s now say that everyone in the town does so, such that the utility now sells 5 million gallons of water each year instead of 10 million.  They still have the same equipment, which they’re probably paying off on a 30-year bond or something.  They also still have the same number of customers, meaning they will still need to send out the same number of phone calls and send out the same number of bills.  They also have the same number of homes to supply, meaning they’ll need to do the same number of repairs and upgrades.  They might even discover that sewer line repairs will become more frequent since there will be less water mixed in with the sludge, causing pipes to clog.  The result will be that you’ll end up paying the same amount each month for your water bill as you were when you took a regular shower, yet you’ll have a miserable shower in the morning instead of a pleasant one.

 

 


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Utilities are also loath to cut employees, so they probably won’t slash staff even if they didn’t need as many people.  They’ll also still need to pay off the equipment they bought when there was more demand, so they’ll still need the same amount of money to operate.  They have no competitors so it isn’t like customers will transfer somewhere else if prices are raised, and the regulators aren’t likely to demand that they cut staff or swallow the costs of equipment they purchased when there was more demand, so the utilities can just say they need to raise prices due to cuts in usage and they’ll be able to do so.  You use half of the water, but your bill stays the same since the price per gallon doubles.

So instead of conserving and saving, use what you need.  This doesn’t mean that you should be wasteful with water.  Don’t leave a hose on, running water down the street all day for no reason.  Don’t leave the shower running through the night while you sleep.  It just means to use what you need to live a comfortable life so that the utility will set themselves up to produce that much water.

 


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But what about the power usage?  Shouldn’t we save the energy needed to make water?  The free markets have a great way of figuring out ways to meet needs.  If everyone cuts back to nothing, such that the amount of power we produce is easily made using existing technologies and infrastructure, we’ll never see improvements.  We want people to be building the infrastructure and developing the technologies we need to supply the power needed int he future.  If we use the amount we need (again, not being wasteful), we’ll see people come forward to build the needed infrastructure and make power more efficiently and with resources we don’t currently use extensively like biomass, solar, and wind.  So we can either conserve and be miserable, never providing entrepreneurs and industrialists with the incentive to improve things, eventually needing to cut back even further as populations expand, or we can use what we need and provide the funding and incentive to make cold fusion or cars that run on water.  I say use what you need.

Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.