Become An Owner Instead of a Worker


When we’re young, we trade our health for money.  We work long hours.  We lift heavy things and wear down our tendons. We spend hours typing or doing other repetitive motions that cause carpal tunnel syndrome.  We spend hours on our feet and wear down the disks in our backs and develop heel spurs.

We trade this wonderful gift of youth and health that we’ve been given, the ability to keep pushing it for may hours, to bounce back when we fall down and heal fast when we get cut, for cash by working way too many hours.  We go in before dawn and leave after dark, never getting out to see the sun and the woods and the oceans.  We work hard to go on a vacation, which is then rushed and filled with work thoughts and emails back to the office the whole time.  We buy large, beautiful homes that we spend all of our free time maintaining and cleaning when we aren’t working to pay the mortgage.  We buy things on credit and then spend a quarter to half of our time working to pay interest payments.

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While we’re young we can make extra money by just pushing it a little harder.  We can make that car payment if we work overtime on weekends so we can drive that shiny new car to work and have it sit in the parking lot all day, slowly decaying away.   We can take on that second job and get all of the cable packages and five different web streaming services.  We can keep buying clothes to impress people we don’t like and buying all of the latest gadgets to look good for people we don’t even know.

When we get old, we trade our money for health.  Any money we’ve saved up through those long hours of work goes to treatments, surgeries, and drugs to reduce the pain our weary bodies feel.  We spend money to try to have the ability to walk and run and jump and heal like we did so easily while we were young.  We get surgeries to be able to walk after long hours of carrying heavy loads have destroyed our knees.  We buy prescriptions to lower our blood pressure after years of sitting idle at a desk, eating poorly, and letting our health decay.

Stop.  Stop today.  Stop right this minute and change your life.

Become an owner instead of a worker.  Instead of getting that new car, drive your old one for a few more years and send those car payments you would have made into a stock mutual fund and become an owner in a group of companies.  Buy a smaller house for cash and invest the money you save on interest.  Stop buying things to impress people and just buy what you need so that you can spend time with your family who don’t care what the label on your blouse or jeans says.

Start building a portfolio so that you will be getting dividend payments and capital gains instead of paying interest payments and penalties.  Let others work for you so that you don’t need to work those extra hours.  Expand your lifestyle by waiting a little while to buy things, instead investing the money in mutual funds, then using the distributions from those mutual funds to add to your income.  Direct some of that money back into buy more mutual funds, and your income will expand on its own.

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Everybody can become an owner.  You can start a mutual fund account with Schwab for only $1.  You can start investing through Vanguard funds for only $3,000 ($1,000 if you start a retirement account).  Start an account and start sending a little of your paycheck in each month to build your wealth.  Own things.  Build things.  Stop just using all of your effort to generate entropy.  Stop having your money flow into your back account through direct deposit and then back out again to bills through auto pay without your even seeing it.

The next SmallIvy book, Cash Flow Your Way to Wealth, will be coming out in about a month.  It gives the game plan to go from worker to owner.  Subscribe to this blog to make sure you get your copy when the time comes and don’t miss out.

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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.

Hedging Strategies to Protect Yourself Against a Market Drop


With the big run-up in stocks this year and many people expecting a pull-back or an outright bear market, perhaps you’re getting nervous and looking for ways to protect the gains you’ve made.  Hedging refers to taking positions that will reduce your loss should the market drop while still allowing for gains should the markets continue to perform well.  Today I thought I’d discuss some hedging strategies for those who are looking for a little protection.  Understand, however, that any hedging strategy you employ will reduce gains in the future.

In speaking about hedging we’ll assume that the investor is primarily long to start with, meaning that the investor will make money if the stocks he/she owns go up in price.  (When you buy a stock, bond, or mutual fund, you are “long.”  When you sell short or buy an option that goes up in price when a stock goes down, you’re “short.”)  Most people are long most of the time and this makes sense because the market’s long-term tendency is always up.  Being short for a long period of time would be like entering a turbulent river and expecting to travel mostly upstream.  Hedging a short position can also be done just by doing the compliment of the trades I describe.  For example, buying a call option instead of a put option.  (If you are not familiar with options, check out Options Trading: QuickStart Guide – The Simplified Beginner’s Guide To Options Trading or a similar book.)

One often associates hedging with risk, largely because of the term, “hedge fund” applied to the high risk/high return funds purchased by wealthy individuals.  These funds get their names because they can take long or short positions, but often these funds are not hedging.  Instead they are using large amounts of leverage to make large gains from relatively small movements in the markets.  This causes a substantial risk of losing money.  True hedging actually reduces risk.

To hedge is to take up positions that are designed to offset long positions, such that the investor will be less susceptible to losses due to falls in the market.  For those who play roulette, you would be hedging a bet of $100 on red by putting $50 on black as well.  You would be reducing the amount you would win if red were rolled since you would lose the bet on black, but you would also be reducing your loss should black be rolled since your small win on the black bet would reduce the loss on the red bet.   If an investor is perfectly hedged, he/she will not lose money no matter what the market does.  But by taking up these positions, one also limits or eliminates the possibility for making gains while the hedges are in effect.  The following are ways to hedge a long position:

Selling shares of the same stock short-  This is also called “selling short-against-the-box” and forms a perfect hedge provided that equal numbers of the shares are sold short as are held.  No matter the movements in the stock, no money will be gained or lost.  (Note that if the stock price goes up an investor would need to add cash to the account or pay margin fees, since this would result in  negative cash balances in the account).  Selling short-against-the-box has little purpose other than delaying gains from one year into the next for taxes.

Selling shares of other complimentary companies short-  In this strategy, the investor sells short shares of a company that he/she expects to decline if shares of the company he/she owns fall in price.  For example, if he owns McDonald’s, he might sell shares of Wendy’s short, figuring that is the market turns against fast food companies shares of both companies will fall.

Buying put options- A put option is a legal contract by which someone agrees to buy shares of a stock for a predefined price before a certain date.  This can be though of as an insurance contract on the shares of the stock.  In exchange for this agreement the owner of the shares gives the seller (called the writer) of the put a certain amount of money, called the “premium”.  For example, a put option for selling 100 shares of XYZ stock at 50, good for three months, might cost $300 when the price of XYZ was at $51 per share.

Writing covered calls on the stock–  Here a contract is written that allows another individual to purchase your shares for a fixed price.  This limits the amount the investor can make on the shares (since if they go up above the agreed to sales price they will be purchased for the sales price) but reduces losses somewhat if the shares decline in price due to the premium collected.

Buying short ETFs– This involves buying short exchange traded funds (ETF).  These are financial instruments that are designed to go in the opposite direction of a particular market segment or index.  For example, an owner of several mining companies might buy a short basic materials ETF as a hedge against a fall in commodities prices or a slowdown in goods production.

Selling a portion of the position The simplest way to guard against losses in a position is to simply sell some or all off the position, and is probably the best thing to do if you really need the money in the short-term since it is the most cost-effective way to be safe.  This, of course, reduces the possibility of future gains, however.

If you’re interested in individual stock buying and this strategy, I go into far more detail in my book, SmallIvy Book of Investing: Book1: Investing to Grow Wealthy.  Check it out at the link below if interested.

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.

The Stock Price is All About the Dividend (Even When They Don’t Pay One)


A couple of years ago I got into a lengthy discussion of stock pricing with a reader.  Unfortunately the exchange ended up being by email (I’d much rather readers post comments to the blog – I get so few of them).  I contended that stocks are priced based on the dividend they pay, or actually, based on the potential future dividend.  The reader basically said that I was incorrect and that stocks are based on a lot of factors, the dividend being a very minor one.  (In actuality, we’re both right, and I’ll explain why in a minute).  In any case, he cited Apple as a company that would never pay a dividend; therefore, the idea that it was priced based on potential future dividends was ludicrous.  A few days after our debate, Apple announced that it would start paying a quarterly dividend of about 2%.

How is he right?  Stock pricing isn’t like pricing at the supermarket.  You don’t walk in, pick up an item from the shelf and see a price sticker on it.  (Yes, I know that we’ve gone to bar codes now, and the price (might) be on the shelf, but bear with me – I’m from the 80’s.)  Prices fluctuate constantly and for a wide variety of reasons.  Some people look at earnings and decide what a stock should be worth.  Some look at how likely it is for the stock to have an earnings surprise and bid the stock up accordingly.  Some people sell shares and don’t care what the price is because they have a large profit and just want to unload it, or they need to pay for their daughter’s wedding.  Some people see a stock go up or down in price, and buy or sell it because it went up or down in price.  They figure that if the price is going up, they’ll be able to sell it at a higher price.

Very few of these people are probably thinking about the dividend that the stock is paying.  Heck, a lot of these stocks may not even have a dividend.  So I must be wrong, right?

Well, even though all of these people don’t know it, they are basing the price they pay on the projected future dividend.  Note that the “projected future” part is very important.  Note also that there are fluctuations int he price – the dividend just sets the price range.

 

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You see, the amount that people are willing to pay for a stock depends on its potential future return.  This return must be enough to justify the risk that is being taken on.  If one can get a 5% return from a bank CD, one wouldn’t even think about buying a stock unless one thought a 8% return or greater was possible.  Why trade a certain return of 5% for a possible return of 6%?  You wouldn’t.  You would drop the price you were willing to pay for the stock until the potential return was at least 8%.

Also, the more uncertain the return, the greater the return must be.  If you are buying shares of McDonalds, for example, you can assume that the amount of traffic at their restaurants won’t change by that much during any given year.  It isn’t like everyone is going to swear off Big Macs at once.  You can therefore predict with reasonable certainty how much the company will earn during the next year (or the next five years), and therefore you know about what the price will be.  (Here you’re also assuming that the price to earnings ratio will remain about the same, which isn’t too bad an assumption.)

On the other hand, if you are buying shares of a silicon chip maker like Cypress Semiconductor, the future becomes far less certain.  You don’t know if research and development won’t pan out, or the Koreans will dump a bunch of cheap chips on the market, or what.   You also don’t know if interest in electronics will remain, or if manufacturers will choose Cypress chips or one from their rivals.  Because they are somewhat of a commodity, the fortunes of a company can be pinned to a few cents savings per chip made.  Because of this uncertainty, shares of Cypress are priced cheaply relative to shares of a company like McDonalds.  Note that the PE ratio for Cypress is 17.5, while that for McDonalds is about 18.5.  People are willing to pay a little more for more certain earnings.

But wait, that’s earnings, and I was talking about dividends, right?  Well, let’s say that a company never, ever paid a dividend.  What return would a shareholder receive?  Another way to look at it is, what value would the company be to the shareholder if he never received any share of the profits?  True the company might be making a lot of money, but the investor would never see a cent of that.  Without a dividend, there is no return to the shareholder.  He would not even see capital gains because no one would be foolish enough to buy the shares from him. (OK, someone would be, but that’s beside the point).

 

 

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So, when people are buying stocks, they are trying to figure out what the future dividend will be, and what their return would be based on that dividend, and then pricing the share price accordingly.  Granted, this is a Ouija board-type of pricing where people may not even know they are pricing it based on the dividend, but they really are.  The reason that people pay more for shares with growing earnings is that if the earnings of the company are higher, they will be able to pay a bigger dividend.  Many who price stocks based on earnings forget this fact, but that is what they are doing (that is why earnings matter at all).  It is kind of like how the main reason people paint houses is because if they don’t the wood will rot, but they are probably thinking more about how the house looks than wood rot when they decide it’s time to paint again.

Note also that the piddling 2% Apple is paying may seem small, but if you bought the shares back a year ago when the price was half of what it is now, you would now be receiving a 4% dividend on your investment.  If you continue to hold the stock and the dividend continues to increase, you effective yield will continue to climb.  You might be making 8%, 12%, or 20% in five years.

So, dividends do matter, even if many people have forgotten that fact.  When it comes to pricing, it’s all about the dividend.

Join the conversation and help make this blog more exciting!  Please leave a comment.  Also, if you have an investing question, email  vtsioriginal@yahoo.com or leave the question in a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

It’s not the individual choices – It’s the habits


 

I’m still making my way through Darren Hardy’s The Compound Effect.  One of the things I’m beginning to understand is that it isn’t the individual choices we make that set our destiny so much as the habits we form.  For example, right now I’m trying to lose the 50 pounds or so I gained back after dropping the same weight several years ago.  The last time I lost weight it was because I had changed my habits.  I regained it when I changed them back.

You see, back in my mid-thirties I realized that I was going to die young if I didn’t lose some weight and start exercising.  I started jogging about 3/4 of a mile in the morning, then walking back.  This continued three mornings per week for about three or four weeks (and I hated starting every time, but was always glad when I had finished my jog), at which point I was able to jog all the way out and back, running 1 1/2 miles per morning.  After this I would walk around the block (another 1/2 mile or so),  After a month or two of doing this, I started running around the block instead of walking after going out and back, increasing my total to about 2 miles.  Finally, after doing this for several months, I increased the distance I went out, upping my run to about 2.25 to 2.5 miles.  At that point I decided the run was far enough and running farther would just wear out my body.  I was able to run 5K’s and actually registered a time in the mid 20-minute range.

The Compound Effect

I also changed how I ate.  Instead of cleaning the plate when I went out to eat, I would eat about half and then save the other half for lunch.  I found that the whole meal would be about 1500 calories, so eating a half portion was about right.  At home, I would leave one thing off, like the side of corn or maybe the potatoes.  At Mexican restaurants I would just have a few chips rather than finishing the bowl and asking for a second or a third.  One thing I noticed was that when you’re out, many of the things you do centers around food:  stopping for ice cream, pie and coffee, or just a sugary coffee drink.  I found other things to do that didn’t involve eating.

As a result I went from a high of about 248 down all the way to about 215 pounds.  My pulse had dropped to about 50 beats per minute, to the level where they would need to take a couple of readings and get one over 50 before they would let me give blood.  I had a lot more energy, my blood pressure was lower, and generally I was in good shape.

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Then life started to get in the way.  While I was exercising regularly, I often didn’t really want to get up and go out into the cold to jog since it was hard to get going to the point where I fell into a rhythm.  (After I would started, however, I discovered that actually the best temperature was about 35 degrees or so since I could wear a sweatshirt and cap and not get sweaty about half way through, so I preferred cold mornings to one that was in the 60’s or 70’s.)  When I reached about 39, however, I started getting heel spurs which would cause my feet to ache if I tried to walk after sitting for a while.  Jogging would cause the condition to worsen for several days after.  As a result, I stopped jogging as much, then finally quit entirely.  I changed my habit of exercising.

I also found myself eating more full meals when I went out to eat.  I also started getting soft drinks again in restaurants (I went to water before).  Worst of all, I started doing more business trips and vacations, where I would be eating out every meal and having a big breakfast at the hotel.  (I normally didn’t eat breakfast, so that added another 50 to 800 calories onto my diet each day.)  I went back to 220, then 230, then into the 240’s.  Finally, after a few holidays and trips, I found myself in the 250’s, higher than I had ever been.

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From reading The Compound Effect, I realized that what got me into such great shape was that I changed my habits.  It wasn’t the first day I went jogging or the choice of having water at lunch instead of a Coke one day that made me lose weight and get into shape, it was the habit of doing those things.   Likewise, changing habits back to eating full meals out and drinking a soft drink more often than not when we went to a fast food chain caused me to go right back to where I had been and then some.  Once again looking at an early fifties heart attack, I’ve changed back, cutting my meals and counting calories to stay below 2000 per day.  As a result, I’m down to 242 again.  I plan to stay with this, and start jogging again after I lose another five pounds or so (so that it isn’t as hard on my heels) and keep those habits this time.

So what does this have to do with personal finance?  Well, just like with losing weight and getting healthy, putting yourself onto a firm financial footing doesn’t mean doing one thing and then going about your life.  If you stick $100 into five shares of Intel Corp today and never do anything else, you won’t retire a multimillionaire.  But if you put away $100 every week or two and invest regularly, you’ll find yourself in 20 or 30 years financially independent.  It isn’t the individual choices – it’s the habits that make the difference.

So what are your habits?  Are they good, taking you where you want to go, or bad, holding you back and making you unhealthy or poor?

Join the conversation and help make this blog more exciting!  Please leave a comment.  Also, if you have an investing question, email  vtsioriginal@yahoo.com or leave the question in a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Bulls Make Money, Bears Make Money, Pigs get Slaughtered


The title of today’s post is an old Wall Street axiom related to asset allocation and greed.  It means that people who buy stocks (bulls) and those who sell stocks short (bears) can both make money.  There are times when each of these strategies are effective.  Those who hold for too long, or put too much in any one stocks, however, eventually get slaughtered.  It is important to remember that no stock will go up, or down, forever and one must always be wary of the possibility of sudden movements the other way.

As long-time readers of this blog will note, I tend to favor less diversification than is the standard.  Many money managers will advocate investing in hundreds of stocks, saying most investors should not even buy single stocks because they can’t get enough diversification unless they have millions of dollars.  The trouble with that philosophy is that 1)while it is true this provides downside risk, it also limits one to just making the market averages or less after fees, 2)one has little control over taxes because the taking of capital gains is up to the whims of the mutual fund managers, and 3)it leaves one subject to the little games that the mutual fund managers play, like buying the hot stocks just before reporting holdings to look like they were in the best companies all along.

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There is nothing wrong with holding some mutual funds.  If one has quite a bit of money mutual funds provide good insurance against sharp declines that single stocks endure.  If one only has a few thousand dollars to invest, however, it makes little sense to spread that money out over 100 or 1000 stocks.  The advantage of being able to double or triple that $3000 in a year or two outweighs the risk of losing $1500 or $2000, or even the whole amount due to a missed earnings report or a scandal at the company.  Note also that investing over the long-horizon of years also reduces risk because over time most good companies will grow in price even though they may decline in any period of weeks or months.

Here again, though, one does not want to be piggish and face the slaughter.  For this reason my strategy is to concentrate in a few, great stocks, adding money all of the time to my investments, but when a position gets to be so large that I would not want to risk that amount, I pare it down and invest some of the funds in another stock.  This is true even if I think that the company has great prospects and will continue growing indefinitely.  I could be wrong and I don’t want to give back all of the gains I have made should the stock turn against me.  One strategy is even to sell enough to recover all of the money that had been invested.  Additional shares can then continue to be sold as the stock makes new highs.  In that way most of the profits made are secured as the stock rises should the stock turn around and fall.  It also gives a psychological boost to know you will make a profit no matter what, allowing one to “let the rest ride” with confidence.

As a portfolio grows from a few thousand dollars into hundreds of thousands, mutual funds should be purchased to lock in gains and provide security through diversification.  A portion of the portfolio remains concentrated in individual stocks with good prospects, however, but not so much so as to risk a loss that one cannot sustain.

Learn how to use mutual funds from the founder of Vanguard:

Join the conversation and help make this blog more exciting!  Please leave a comment.  Also, if you have an investing question, email  vtsioriginal@yahoo.com or leave the question in a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

401K Changes that Would Work


IMG_0120401k plans are better than traditional pensions and way better than Social Security, if they are used correctly.  The issue is that they are not used correctly.  People are too timid and leave all of their money in the money market or treasury fund their entire careers, missing out of the growth they could have had if they had invested.  They don’t enter the plan until they are in their forties or fifties, or contribute far too little.  They are too aggressive when they are nearing retirement, usually because they are trying to make up time, and see a market crash wipe out half of their portfolio value right when they were ready to head out-the-door.  They borrow against their 401k plan, or take the money out entirely, and lose the effects of compounding.

These issues could be easily solved.  The reason they occur is the rules behind 401k plans that allow or even encourage behaviors that are destructive to the employees retirement.  People have no choice in the amount they contribute to Social Security or pension plans.  The employer or the government dictates how much of the employee’s pay is contributed and how much they provide.  And at least with Social Security, you have no choice but to participate.  You are enrolled whether you like it or not.  Employees can choose not to enter the pension plan at some companies, but most realize that they should and they do enroll.  Likewise, you can’t borrow against your pension plan or Social Security or take it out early.  In the case of pension plans, they are invested in a mix of stocks and income investments in a manner that is appropriate for the goals of the plan and the payouts that must be made.

The sad part is, if people were to put all of the money they are putting into Social Security (about 13% of their paycheck) into a 401k plan and invested it properly, everyone who worked their whole life would be set for retirement.  There would be no issue paying for living expenses and medical bills.  The senior discount would vanish since most seniors would be multi-millionaires.  Unfortunately, people don’t think about their futures and plan.  They either see the big pile of cash they’ll need to build up to have  comfortable retirement as being either too difficult to achieve or retirement too far out in the future, so they sabotage themselves.  Much as I hate to see central government planing and control, some regulation is needed to nudge people in the right direction.  Unlike Social Security, where the government has proven that they’ll just squander any money given to them, however, government involvement should only extend to preventing people from drawing the money out to soon, not enrolling at all or not contributing enough,  or investing the money in a way that is too timid early or too aggressive late.  Here are some regulations that would make 401k plans the path to comfortable retirement for all:

1.  Required enrollment.

Employees should be required to contribute at least 5% of their pay to a 401k plan to ensure they’re putting enough away for at least a basic retirement.  While I hate to force people to do anything, it is for the good of society to not have a group of destitute retirees.  As an incentive to contribute more, the rules could eliminate the need to make a Social Security contribution if at least 10% of an employee’s paycheck is being contributed to a 401k, between the employee’s contribution and the employer’s.

2.  Forbid withdrawals until age 62, then limit withdrawals until age 70.

There is no good reason for people to be pulling their retirement savings out early, and again, doing so subjects society to the burden of carrying a lot of destitute old people.  No withdrawals should be allowed until the employee has reached at least the age of 62 (which also encourages people to work longer and reduce the number of years they’ll need to be supporting themselves with their savings).  To prevent people from pulling all of the money out at age 62 and blowing it, they should only be able to pull out a portion, like 5%, each year until they are age 70.  Hopefully by that point they will have learned that it is a good thing to take the money out slowly since then the account has the ability to recover and generate more money and they’ll continue that behavior from then into old age.

3.  Eliminate borrowing of funds.

Just as funds should not be withdrawn, they should not be borrowed.  If people want to pay down credit cards, start a business, or upgrade their home, they should find the money elsewhere than their retirement savings.  People shouldn’t live beyond their means at the expense of their retirement funds.

4.  Remove the money market option for those under age 58.

There is zero reason for anyone to have a dime in a money market fund within a 401k account until they are getting close to using the money.  Removing this option would force employees to invest the money, which would allow the money to grow and prevent inflation from reducing their spending power in retirement.

5.  Require a professional money management option.

Most people know little about investing.  An option where a professional money manager just invests the money for employees should be included.  This would be similar to a traditional pension plan, except the money manager could invest for groups of employees separated into different age brackets instead of investing everything as one big account.  Because there would just be a few, large accounts (maybe three), instead of a lot of little accounts to manage, and because the manager would be investing in mutual funds instead of individual stocks, the cost would not be very much.

6.  Limit the contribution of company stock by employers.

Some employers like to issue company stock as their contribution instead of giving cash because cash is more precious.  This puts an employee in a risky position since he/she then has a big position in one company – their employer’s.  They could both lose a job and see their 401k decimated should the company misread market conditions.   A reasonable limit, such as 1% of salary, should be placed on the amount of company stock that can be issued by a company for a 401k contribution.  Alternatively, require a company match at least 5% of salary with cash before issuing stock so that the employee at least has 10% of his/her salary going into the 401k in a diversified manner before concentrating in company stock.  Employees should also be able to sell shares that a company distributes to them immediately and shift the money into mutual funds where it will be appropriately diversified.

7.  Require low-cost index fund options in each plan.

Research has shown that low-cost, passive funds will beat out high cost, actively managed funds over time.  Unfortunately, some employers only have high cost funds available.  Every 401k plan should at least have the choice of a large cap, small cap, international, and bond index fund in their investment mix.

8.  Auto-enroll employees in a target date retirement fund.

Even when they do enroll (usually through automated enrollment), many employees tend to wait to get into their 401k plans and make their investment choices, sometimes for years.  Currently, many 401k plans auto-enroll employees in a money market fund, meaning they are losing money to inflation until they shift the money somewhere better.  Instead, they should be auti enrolled in a target date retirement fund so that at least they’ll have a reasonably good investment plan until they get the time and motivation to take a little more active role.

To ask a question, email  vtsioriginal@yahoo.com or leave the question in a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing

Is a Roth 401k Better than a Traditional 401k?


IMG_0120We’ve all heard the conventional wisdom.  If you have an old, stodgy traditional IRA you should convert to a snazzy new Roth IRA.  There is now even a new Roth 401k.  Sure, you’ll need to pay all of the taxes since the money was initially invested tax-deferred and the conversion requires that the taxes be paid immediately.  For an account of $100,000 this could mean a tax bill of $20,000 or more.  But it will be worth it in the long-term, right?

Well, maybe.  It is true in general that if you are investing for a long time before retirement, the mathematics show that a Roth IRA , where after-tax funds grow tax-free, will do better than investing in a traditional IRA where funds are not taxed until withdrawn from the account at retirement.  This is true even if you invest the tax savings (the money that would have gone to taxes) in a taxable investment account rather than spend it.  This is because the large amount of growth in the IRA will not be taxed, so when you are withdrawing your millions later, because you paid the taxes on the thousands you put into it now, you will end up with more money.

But those making the above calculations leave out some important factors.  First of all, they assume that you are investing for a long time period, such that the money you put into the Roth IRA will have years to grow, compounding ad nosiuem such that the amount gained from interest and capital gains will far exceed the funds deposited.  If you are putting funds into an IRA for a shorter period of time — 10 years before retirement, for example — it may be better to put the funds into a traditional IRA.  This is because the money has little time to grow (15 years or so), and if your withdrawals are small enough, you may be in a higher tax bracket when you are making the money than when you are withdrawing it.  It may therefore make sense to make tax-free Roth IRA contributions early in one’s career when in a lower tax bracket and with many years before retirement, and then make increased tax-deferred contributions into a 401K or Traditional IRA when near retirement.

The second big factor that is left out of the calculation is politics and all of the things that can happen in thirty or forty years.  Because the rules can be changed at any time at the whim of the legislature, your calculations may be meaningless.  This is particularly true with the current demographics.  We have a large percentage of the population who have saved nothing for retirement, and a few people who have saved a great deal through IRAs and Roth IRAs.  This has led to a situation where some individuals have millions of dollars, and others have almost nothing (or negative balances, in some case).

Given that the nothing-savers far outnumber the big savers, it could be very popular to establish some sort of wealth tax (as the inheritance tax is already) or change the rules on the Roth IRA withdrawals, charging a “distribution fee” or some other form of tax.  After all, “how is it fair that some people have lots of money, and others have none”, the thinking will go.  Even if the rules are not changed, the taxes on dividends and interest as funds from the Roth IRA are pulled out and put into fixed-income securities could rise to high levels as governments try to balance their books.

Another possibility is that the income tax could be abolished or radically changed.  For example, the Fair Tax idea has been around for years.  In this scheme, income taxes would be eliminated entirely and replaced with a national sales tax.  To make things “fair” each individual would receive a prefund (beginning of the year refund) such that those who make little would pay essentially nothing in taxes, while the larger spenders would pay more.  If such a tax scheme were enacted, the Roth IRA tax-free growth would evaporate.  There has also been talk about eliminating the income tax and replacing it with a Value Added Tax (VAT), which is similar to a sales tax.  Here again, the Roth tax-free growth would be eliminated.

The bottom line is to not get too enamored with mathematical calculations when it comes to finances.  One must always remember that the rules can change and the risk of rules changes affecting results, particularly when large time periods are involved, must be taken into consideration.  As the old saying goes, a bird in the hand is worth two in the bush, and perhaps sometimes it is better to save the taxes now than save the taxes later.  So go ahead and save up for retirement, putting away at least 10-15%, but think about spreading it out between tax-deferred and tax-free growth, just to play both sides of the table.  Also, think long and hard before converting a traditional IRA to a Roth IRA, particularly if it is a large account.  In particular, if you do not have the funds available to pay the taxes without touching the balances of the IRA, it may not be worth it.

To ask a question, email  vtsioriginal@yahoo.com or leave the question in a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing

Best Single-Stock Investing Posts


The Small Investor Blog is a big place with a lot of good information.  The trouble is, it can be hard to find the information you want since there are a lot of posts.  This is the first in a series of posts designed to lead you to what I consider to be the best posts on a given topic.

This first series is a group of posts related to single stock investing.  These are for those who want to buy and sell single stocks and want to learn how to do it.  If you want to find the best posts I’ve written on single-stock investing, here’s a list of my favorites:

Why buy individual stocks?

Before you think about single stock investing, get your accounts in order.

Become an investor, not a speculator.  Here’s the difference.

Common mistakes you should avoid.

How many shares should you buy?

How many different stocks should you buy?

Learning the different types of stock orders.

Learn which stocks to choose.

Learn about value investing.

Learn about momentum investing.

Learn to catch a falling knife.

You can beat the markets.  Here’s how.

Saving and Investing for Retirement Starting at Age 45


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Here’s a neat trick to determine how much money you’ll have in 20 years if you invest it in diversified, low-cost stock mutual funds: Take the amount that you are investing per month and multiply by 1000.  For example, if you are investing $100 per month, in 20 years you’ll have about $100,000.  Increase your investment to $500 per month and you’ll have $500,000.  Want to have a million dollars in 20 years?  Put away $1000 per month.

This calculation assumes that you’ll get a return of about 12% annualized from the stock market which only occurs if you invest for many years.  Stock market returns over short periods of time are very unpredictable.  Invest for one year or even five years and you might get 1% or you might get 20% annualized per year.  You might even get -40% as we did back in 2008.  Look at long-term averages, however — those of ten to twenty years — and you’ll see that stock returns fall into the 12-15% range.  It is possible that things will change in the future if the economy stops growing as it has in the past, probably due to something like a massive disaster or changes to the regulatory environment, but using 12% isn’t a bad rule-of-thumb.

To retire comfortably and not need to worry about outliving your money, you’ll want to have about $2.25 M in your portfolio.  That will provide $250,000 to pay for healthcare expenses and another $2 M to generate money to live on.  $2 M in investments would allow you to withdraw about $60,000 per year without seeing the value of your portfolio decline substantially.   This means you’ll still have about $2 M when you die to pass on, so you could take out a little more but then you run the risk of running out of money should you live for a long time.

Generating $2.25 M by the time that you reach 65 if you start from age 45 would mean putting away $2250 per month or about $27,000 per year.  For most people, this would be difficult to do unless they radically changed their lifestyles.  Note also that this calculation assumes you stay fully invested in stocks as you approach retirement.  While the long-term average return is around 12%, there are years with large negative returns.  If you’re fully invested at 64, you’re running the risk of suffering a large loss right before you’re ready to retire and needing to wait another three to five years for your portfolio to recover.  Many people learned this lesson the hard way in 2008 who had to delay their retirement until 2012 or even 2015.

Ways to generate income to invest

One possibility for generating enough money for retirement investing if only one spouse has been working is to have the second spouse return to the workforce after the kids are out of the house, or at least old enough to not require as much attention during the day, then invest most or all of the new income.  If the second spouse’s income is directed entirely to retirement savings, it might be possible to amass enough even with only 20 years to go.

Another possibility is to plan to work another five years and retire at age 70.  You could then reach $2.25 M with a monthly investment of about $1250, or a yearly contribution of $15,000.  If you were to pay off your cars and hold them for several years, trading them in for quality used cars when the time came, you could free up $1250 per month to put towards retirement.

Places to Invest

When saving for retirement starting relatively late, probably the best first choice if it is available is to use your employer’s 401K plan.  Because many employers match at least a portion of your contributions, you may not need to put away the full amount each month.  Investing at least enough in the 401k to get the full employer match is a good first step.

A second place to invest is in a private IRA account.  Here there are two choices, unless you have too large an income to be allowed to use both choices (and if that’s the case, just cut your spending and invest directly in index mutual funds).  The first choice is a standard IRA, where you will be able to deduct your contributions now, but need to pay taxes on the money you withdraw just like regular income.  The second choice is to invest in a Roth IRA, where you won’t get to deduct your contributions so you’ll need to pay taxes on the money earned now, but you’ll get to withdraw the money tax-free in the future.

If you’re struggling to be able to invest enough money, using the traditional IRA will allow you to cut your tax bill, leaving more money to invest.  For example, if you’re in the 25% tax bracket and put $4000 into an IRA, you’ll cut your taxes by about $1000, meaning you’ll only need to come up with $3000.  If you can afford to pay the taxes, you’ll probably end up better in the long run by investing in the Roth since you’ll never need to pay taxes on the earnings on the money you invest.  In either case, spend some time doing some calculations with both options and check with a CPA to verify that you won’t get snared in some tax trap like the alternative minimum tax.  Often a couple of hundred dollars spent on a CPA can save you thousands of dollars in taxes later.

Got something to add?  Got and investing question? Please  leave in a comment or send it to vtsioriginal@yahoo.com.

Follow on Twitter to get news about new articles. @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.

The Opportunity of Bear Markets


Space CapsulePeople are funny when it comes to investing.  If they were to go into a store and see a rack of slacks half off the normal price, they would pick of two or three pairs because it was such a great deal.  If they look at their stock portfolio and see that some of the stocks they own are down 50%, they pull their money out to wait for things to settle down.

Really, most of the time is only a decent time to invest.  During these times stocks may still have a ways to go before the next decline, but you might only be able to eek out a 10-20% gain during the year.  Right after a good bear market, however, great stocks may be down 50-70% or more.  That provides what could be the buying opportunity of the decade since those stocks may go up 400% over the next year or so.  Just take a look at the crash of 2008 and see how many stocks went from single digits to $40 per share or more.  During a bear market things are on sale.

Unfortunately, while the sales manager at the department store may be scared when she needs to discount the slacks 50% to get customers in the store, people don’t feel fear and pain when they see slacks on sale.  They may regret buying a pair a few weeks earlier for twice as much, and some of the more opportunistic individuals may actually bring the other pair back and then buy a new pair to get the discount, but seeing the slacks on sale doesn’t make them scared to buy another pair.  They know what the fair price for a pair of slacks is and are able to judge if something is a bargain.

Stocks really act the same way.  They have a fair price based upon the value of their business and their potential to generate earnings in the future, but they may trade at a substantial discount to that price at times.  Other times they may trade at a huge surplus to the fair price.

One stock picking strategy that is based on looking at stocks that are at a discount is called value investing.  A value investor will only buy stocks if they are cheap compared to value that he calculates.  He will then hold the stock until it goes up in price to the point where it is well above its fair value, making it overvalued.

There are mutual funds that use a value investing strategy.  Generally they will have the name “value” in their description.  You can also look at the prospectus, which normally has a diagram that shows if a fund is value oriented or growth oriented.  In the past value funds have outperformed growth funds over long periods of time.  They have not done so well in the past ten to fifteen years, but they will probably outperform again in the future.

So maybe consider adding a value fund to your portfolio.  Also realize that market downturns actually create great opportunities to see rapid gains.  Sure the stocks that you already own will decline in price, but if you can find some more money to invest you’ll end up far ahead once stocks recover.  Market declines tend to take good stocks down in price with bad ones.  The bad ones go bankrupt and disappear, but the good ones emerge stronger than ever with fewer competitors.  Don’t sell in a bear market.  If you’ll need the money in the near future, you should sell while things still look bright before the decline starts.  If you don’t, have confidence that things will recover – the long-term direction of the market is always up.

Got something to add?  Got an investing question? Please  leave in a comment or send it to vtsioriginal@yahoo.com.

Follow on Twitter to get news about new articles. @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.