The Three Investments Every New Investor Should Have


There are a lot of investment choices.  There are stocks, bonds, REITs, Options, Warrants, and convertibles.  Then there are funds that buy and sell these different investments for you, which would make things simpler, except that there are many different funds out there.  In fact, there are actually more mutual funds buying and selling individual stocks than there are individual stocks.  So, how do you choose?

The good news is, there are really only a few things that you should invest your money in.  Once you know these few investments, you can cut through all of the noise and make a wise choice of where to place your money.  I would say that there are three investments you really should make before you get near retirement.  Ignore the rest.  Here are the three:

1.  Total Stock Market Index Mutual Fund

This investment does what it says – it buys stocks in the total US stock market.  Buying just this one mutual fund will mean that you are diversified over the whole stock market.  You’ll want this because it eliminates the risk of picking a bad stock or a bad sector.  It is possible that one company could go out-of-business and you’d lose your whole investment if you try to pick a stock.  But what are the chances that every company in the US stock market will be wiped out?  If that happened, you wouldn’t be too worried about your portfolio.  You would be worried about finding enough ammo to keep the wandering bands of marauders at bay.

You need to have stocks when you are investing for a long time since they are the only investment that will grow over time.  This means that you will make real money, even when inflation is taken into account.  Put your money in the bank for 30 years and you’ll find that you’ll be able to buy maybe 75% of the stuff you could have bought with the money when you put it in.  Put your money in the stock market for the same period of time, and you’ll be able to buy about eight times as much stuff.

You buy an index fund because they are cheap.  The fees are really low, often below 0.25% of the amount of money in your account each year.  If you go out and buy a managed mutual fund where someone, or a team of someones, buys and sells stocks for you, you’ll pay 1% or more per year.  Given that most managers match the indexes at best over long periods of time, you’ll probably make a lower return in a managed fund than an index fund.  So, go for the index.

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2.  A Corporate Bond Index Fund

A bond is a loan to a company.  In exchange for the loan, they pay you interest payments twice a year for a period of time.  At the end of the period, they pay you your money back.  Bonds are good because they give you steady income that quiets down the gyrations caused by a stocks.  If you have an all-stock portfolio, you might be up 30% one year, but then down 30% the next.  Over time you’ll make about 7% after inflation, but it is a wild ride in the mean time.  Add 20-30% bonds, and you’ll see lower swings since the bonds will always be there, paying out interest, which helps offset the swings in stock prices.

You don’t want to have all bonds.  That is even more risky than having a mix of bonds and stocks.  You also don’t want to hold a lot of bonds for thirty years or longer since the returns you’ll get will be lower than they will be from stocks.  Over shorter periods of time, however, bonds will sometimes outperform stocks, particularly if there is a big downswing like we saw in 2008 and early 2009.  In that period, while stocks lost 40%, bonds actually went up a few percent.  They did a lot worse than stocks in late 2009 and 2010 as the markets recovered, but people who were holding bonds during 2008 and 2009 felt a lot better than those holding stocks.  Again, buy an index fund that holds a lot of different types of bonds for low cost and diversification.

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3.  An International Stock Fund

US stocks are often the place to be since the economy is stable and often growing, but it is not always the best place.  You’ll always want to have some of your money in whatever segment of the market is doing the best at any given time.  You should therefore put some of your money, maybe 20-25%, into an international stock fund.  Here you want to look for inexpensive index funds that invest all over the world, rather than picking a niche fund that invests only in Asia, for example.

So there you have it.  A total stock market fund, a bond fund, and an international fund.  Find cheap index funds, send in a check, and never look back.  Happy investing!

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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.

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.

What Factors to Use When Picking Stocks


jehericotopfalls

Stock picking is an art form that requires experience and an inherent feel for which companies will do well, but there are many factors that can be used to screen stocks and narrow the choice down to a few. Today I thought I’d discuss my method of picking stocks.  I’ll start my listing the factors I look at, and then discuss some of the factors in detail.

The theme of this blog is serious long-term growth, not trading stocks or making small profits then selling.  We’re looking for stocks that will grow over the next several years, not just short-term fads.  I’ve found it is easier to spot long-term trends than predict what the market will do over any short stretch.  In fact, the long-term trends are often pretty clear – it is surprising that more people don’t seem to look for them.  Here are the factors I look at, relatively in order of importance:

  1. The long-term price trend
  2. Earnings growth rate
  3. Dividend growth rate
  4. Return on Equity
  5. Debt
  6. Cash flow
  7. The business type/strategy

Let’s go through each of these factors in detail.
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The long-term price trend

The first thing I tend to look at, which is an obvious but an often over-looked trait, is the price of the stock itself.  As said above, the market price will tend to follow the fair value, just as a paper boat floating downstream in a turbulent river will tend to move at the average velocity of the stream, although there may be many changes in velocity if observed for only a short period of time.  If a company is increasing share holder value, making the company’s stock more valuable, this will be reflected int he price of the stock eventually.

When looking for candidates, I will flip though several stocks looking at the 5-10 year price history (High-Low-Open-Close charts or candlesticks, preferably) and look for those that I could set a ruler on and draw a relatively flat line.  This can be done in a chart book (Dailygraphs, for example), in a publication like Valueline, or, less easily, on the web at Yahoo or another site.  The issue with doing this online is that you often need to provide the symbol for the company, so you can’t easily flip through a set of price graphs, and you obviously won’t look at the charts of companies of which you have not heard.

Also, I try to avoid companies that are increasing very rapidly in price.  While these companies are the lifeblood of the momentum investor, which is also a perfectly valid investment method, these companies tend to fizzle out and fall back down to earth, producing a bell-shaped curve (see Krispy Kreme for an example).  In a later post I’ll go into the two main investment philosophies, momentum and value, and provide some tricks for those wanting to do momentum investing.

An example of a company with this type of price trend is Aflac (AFL).  While there are some deviations, over the period growth is relatively steady, so the people running the company obviously know how to grow the business.  As long as they don’t change what they do, and the business climate is such that what they have done will continue to work, and the company has not grown as big as it can following that business model, then I would expect this trend to continue.
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Earnings growth rate

A second factor I look at when picking stocks is the earnings growth rate.  As said previously, we’re looking for stocks that have shown persistent growth and that we expect to continue to grow over the next several years.  As also said, a stock price will tend to grow along with the underlying value of the company. Why is this true?  To understand the reason, we need to look at the reason people buy stocks and other securities.   This is a little complicated, so please bear with me.

The value of an investment depends upon the rate of return and the risk of the investment.  In general the greater the risk, the greater the investment return required by investors.  For example, a bank account carries very little risk, and therefore people will put money in the bank even when they receive very little interest in return.  The interest rate paid by banks is based on the rate at which banks can loan out the money and the rates at which the bank can borrow money.  Because the risk on commercial bonds is greater than for a bank account since companies tend to default on bonds more often than banks default on deposits, and because banks are insured by the Federal Government against default, the interest rate paid by bonds will be higher than bank account interest.  Note also that if the interest rate that banks goes up, the price of commercial bonds will drop so that their effective yield increases (a bond pays a fixed amount, so if the price of the bonds drops the effective interest rate increases).  This is because investors need the bond to pay a certain percentage more than the bank in order for them to take on the additional risk.

Stocks also pay “interest,” although in the case of stocks the payout comes in the form dividends — current and expected future dividends — rather than interest.  When a company is new, it pays little if any dividend as it retains capital in order to grow the company, but as it matures it begins to pay a larger and larger share of profits out as dividends until the company becomes fully mature and pays most profits out as dividends.  The fair value of a stock is based upon what individuals expect to be the future dividend of the stock, the degree of certainty that individuals believe that the future dividends can be predicted, and the perceived risk of investing in the company (the perceived likelihood that the company will cease to exist).  Because the dividend is related directly to the earnings of the company, the larger the company’s earnings, the larger the future dividend.

Now, investing in stocks is more risky than investing in a bank account, so investors will require that the rate of return from an investment in a company is several percent higher than what they could receive from a bank.  If not, why take the added risk?  The rate of return when the company is mature and paying dividends will be the dividend amount per share divided by the price of a share of stock (the yield).  So, the price of a company’s stock will grow if earnings increase since they then would be able to pay a bigger dividend.  This price will increase as long as the yield is sufficiently greater than what can be earned in the bank.

So, if earnings are increasing by 10% per year, say, all other things being equal (bank rates remain the same), then the fair value of the company will grow by about 10% per year, so the price of the stock should also grow by about 10% per year, over the long-haul.  In general I look for earnings growth rates of 10-30%.  Less than this will not be worth the additional risk of owning stock, more than this is unsustainable, and will usually result in the shares being overpriced.

Care should also be taken not to buy a company that has had good earnings growth but now earnings will be slowing.  An example of this is Freddie Mac in the mid 90’s.  Up to that point, FRE’s earnings grew reliably.  In the mid-nineties, however, the opportunities for making good mortgages began to decline, and so earnings growth rate began to decline.  This caused the stock to stagnate for many years.  Because investors pay more for a stock with a high earnings growth rate than one with a low growth rate, the relative price of the stock (reflected in the price/earnings ratio) will also tend to contract as the rate of growth in earnings slows.

Dividend growth rate

Continuing on with what I look for when picking a stock, we turn to a factor closely related to the earnings growth rate, dividend growth rate.  As I said during the post on earnings growth, the fair value of a stock is based in part on the return people expect to get from the stock relative to what they can get from the bank, bonds, and other sources.  While people will buy stocks early on expecting to make most of their profits from capital gains (when the stock goes up in price and they sell the shares), as a stock matures and stops growing rapidly investors who are looking for a steady return will start buying the stock.  They will buy primarily based on the dividend rate.

Because people will be willing to pay more for the stock if the dividend is higher than what they can get from other investments of equal risk, a stock will tend to go up if the dividend is increasing.  If it is increasing very rapidly, because earnings are increasing rapidly, people may actually bid the price up to the point where the yield drops below equilibrium because they are buying the stock based on future dividends, not current dividends.  The price of the stock will also go up if interest rates are falling (because bank interest rates will also be falling), and vice-versa.  The rate of taxes on dividends relative to those on capital gains will also have an effect.  If the Bush tax cuts expire as is expected and dividend tax rates return to 20%. more investors will start buying stocks with small dividends, opting instead for price appreciation, so that they can delay paying taxes.

I therefore look for stocks that have a steady dividend growth rate of at least 10%, if the stock is fairly mature, since I can then expect to get both a good dividend and a growth in price of at least 10% over the long-term.  Care must be taken to ensure that earnings are also growing at a steady rate or the company won’t be able to continue to raise the dividend.

Return on Equity

Continuing the traits I look for when picking stocks, one that I took from Warren Buffett’s playbook is Return on Equity (ROE).  ROE is a measure of how well a company is run.  Basically it is the amount of earnings that a company makes on the money that it has.  (For a more detailed description, along with some formulas for its calculation, see: http://beginnersinvest.about.com/od/incomestatementanalysis/a/understanding-return-on-equity.htm ).

I tend to look for companies with ROE of around 15-25%.  It is also important to compare the ROE of the company against that of its peers in the industry, since this will indicate how well it is run compared to its competitors.  Note that some industries, such as retail, tend to have larger ROE’s than other industries, so ruling out a company simply based on ROE of less than 15% would not be advisable.

Debt

The next trait I look for when picking stocks is debt.  Here, opinions differ on whether debt is good or bad for a stock.  If a company takes on debt, they can fund more rapid expansions, buyout competitors or businesses that bring them into new markets or that they can use to fill a gap in their company, and take advantage of other like opportunities.  Just as with personal debt, however, it always costs more for a business to buy things using debt since they must then pay not only for the item they are acquiring, but also the interest.

I find that the types of companies I want to own generally have little if any debt.  Ideally a company will be making enough of a profit from its business and have managers who manage the business well, allowing them to make needed purchases without going into debt.  Often when you find stocks with the type of price movement I favor — steady increases in price — you’ll also find a balance sheet free of debt.  A free balance sheet also allows the company to take on debt if needed for an opportunity if needed.  Once a company is laden with debt, it becomes far less nimble.

Note, however, that some types of businesses, banks for example, will generally have more debt because they are in the business of borrowing money, loaning it out to others, and then making money on the difference between the interest they can charge and what they must pay.  I would therefore not rule out a company entirely just because they have debt.  I would compare their debt load with those of their competitors, however.

Cash flow

elated to a low amount of debt or an entirely clean balance sheet is the 6th trait, a good solid cash flow.  Cash flow is the amount of money the company has coming in from their business.  A company with a good cash flow has more than enough funds for day-to-day operations, and can use their cash flow to pay for expansions, research, and other opportunities.  An ideal company would be one that has a large cash flow from a solid business line that allows them to develop other business lines.  For example, a software company that creates a software package that everyone buys, such that they make far more from the software than they need to spend on marketing and support, can then take the extra profits and use the money to develop other software packages or even move into other business lines.  They take far less risk than a company that does not have the cash flow because they do not need to borrow to do development.  If the new business line fails, they simply close it down and move on.  They do not have a huge debt hole to dig out of.

One unusual example of this is McDonald’s.  While one may think of their business being burgers, they have actually amassed a large real estate portfolio.  Using profits from one restaurant, they earn enough cash to buy a second restaurant.  This continues until they have acquired all kinds of properties.  As the cities grow around them selling their burgers and fries, the value of their land increases.  Later, if the business at the restaurant begins to slow, they can sell the land for a nice profit and acquire more restaurants elsewhere.


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The business type/strategy

The final trait I look at when picking a stock is the type of business and general traits, demographics, market conditions, etc….  This might seem like the first thing to look at, but I generally find it is easier to look for stocks with the other traits of which I spoke and then look at the business and decide if I think they will be able to continue to grow.  The trouble with going the other direction is that a company may have a good business and the climate is right, but the company is run poorly so even though they may sell a lot of products all of the money goes out the door.

As a side note, Warren Buffett has said that he will not invest in a company unless he fully understands the business.  He therefore has been reluctant to invest in technology companies, instead buying insurance companies, retailers, and the like.

When I’m looking at a business, I look to see if they have a product/business line that will continue to be needed and profitable in the future.  For example, at the present time Baby Boomers are getting towards their 60’s, a time at which they will start needing hip and knee replacements, giving up some hobbies and turning to others, and so on.  Harley Davidson has been an excellent company for the last several years, during the time that the Boomers were making a large disposable income and buying Harleys for rides on the weekends.  These folks have already bought their bikes and all of the gear, and are now starting to look at retirement (many shocked to see that they don’t have as much to show for their years of high income as they would like).  I therefore would be reluctant to buy Harley Davidson, even though they’ve had a great run, because I can’t see at this time where they have a good opportunity for growth.  Perhaps they will find a market I’m not aware of, however, and prove me wrong.  At that point I may buy in again.

Got a question or comment about personal finance or investing?  Please leave a comment.

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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.

Could You Become a Billionaire like Trump?


jehericotopfalls

Funny thing.  Pretty much since I started working a real job, paid off my car, and decided that I would never have a car payment again (or a credit card interest payment, ever), I started projecting how much our net worth would be at different stages of our lives.  I had always assumed that I would work until I was about 70, and that long work career, combined with regular investing and living a comfortable but financially responsible lifestyle that grew with time but always allowed a substantial majority of the income from our investments to compound, caused me to project that we would have no issues with money by the time we retired.  Despite a terrible ten years or so in the stock market after I first made those projections (right before the dot-com bubble burst, the housing bubble burst, and then the multiple years of slow growth ensued), we are tracking well with my original projections.  Depending on the rate of return I assume over the next 25 years, I think we’ll end up somewhere between maybe four times and fifteen times what I would consider the bare minimum needed for our minimum income needs in retirement.  Probably closer to the former, but if the stock market does great and we see returns at the top of the possible range, the latter.

But then I started playing around on the Vanguard website the other night.  They have a neat tool that runs a whole series of Monte Carlo simulations for you.  (In a Monte Carlo simulation, you run a whole series of calculations to determine the range of possibilities of where you could end up.)  These simulations take a mix of cash, stocks, and bonds and run simulations based on random but historically accurate returns for each of these categories and project where you’ll be twenty, thirty, or forty years out after retirement under different market conditions.  The purpose of the simulator is to show how much income you’ll be able to spend and have a good chance of making it all the way through retirement without running out.  For example, if you expect to have $1 M at retirement and pick a portfolio of 50% bonds, 40% stocks, and 10% cash, you may find that you’ll make it through a retirement of 30 years without running out of money maybe 70% of the time.  It is also meant to show the advantages of adding bonds and cash to your portfolio since your risk of running out of money will generally go way up if you stay in all stocks and spend a healthy amount of cash each year if you start with a modest nest egg at retirement.

If you start with substantially more than you need, and plan to spend an amount that is very modest compared with the size of the portfolio (less than 1% per year, for example), a funny thing happens.  Even in the all stock portfolio, your chances of making it all the way through a 30 year retirement without running out of money can become almost certain.  Even in the worst of circumstances where the stock market does terrible a lot of the time, you can still expect to die with a few hundred thousand dollars net worth because you started out so far ahead of the game.

                       

What is really odd, however, are the best scenarios – the ones where the economy does really well, like it did back in the 1980’s and 1990’s, and everything just works out really well.  In that case, because you’re entirely invested in stocks, you can see your net worth grow from the simply comfortably wealthy into the leagues of unreal wealth – $100 M, $300 M, even the ultimate level, a billion dollars!   Imagine joining that elite circle with Warren Buffett, Donald Trump, and Bill Gates.  OK – so I still wouldn’t be quite at their level, and they still wouldn’t return my calls.  And they would be like trillionaires by then.  And they’d all be dead by then.  And I’d be the next day.  But still!

Standing where I am today, that hardly seems possible.  But then again, starting out with a couple of thousand dollars in an emergency fund when we were in our twenties, I could not image being where I am twenty years later even though the math said it would happen if the economy continued to perform as it had for the last couple of hundred years.  The power of compounding at stock market returns, which can average anywhere between about ten and twenty percent annualized over a given fifteen-year period, does not stop just because you’re retired.  That thirty year period between retirement and death is no different from the one between twenty-five and fifty-five, provided you don’t withdraw funds too rapidly and allow your investments to continue to grow.

So will we die as billionaires in fifty-five years?  Probably not.  But we’ll probably leave a significant inheritance and make a sizable donation to some cause unless the markets do really badly between now and then.  Historically badly.  Still, it shows the advantage of working to retire with more than just the bare minimum, since then you can let your money continue to grow in the stock market rather than needing to convert it all to cash and bonds, or worse – give it to some insurance company to get an annuity.  So here’s to all the potential future billionaires out there who just look like middle-class workers with older cars right now.

Got a question or comment about personal finance or investing?  Please leave a comment.

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.

How Do I Determine My Rate-of-Return?


jehericotopfalls

Let’s say that you’re invested in a mutual fund and you think you’re doing pretty well, but you’re just not sure.  One of the best way to see how you are doing is to calculate your annualized rate of return (let’s call this ARR for short) and then compare your results to other investments.    You ARR is the interest rate at which you would need to invest your money at in a bank account to end up with the same amount of money at the end as you did in your mutual fund.  This allows you to compare how you’re doing versus just putting the money in a bank CD, for example.  It also allows you to compare different mutual funds.

At this point I could give the formula for calculating ARR, but instead, let’s just use some of the tools already available to us from the net.  On the right sidebar in the blogroll is a link to an Investment Calculator.  Use that link or just click here.  You should end up with a screen that looks like this, from the Dave Ramsey website:

invcalcblank

Now let’s say that you started out ten years ago with $1,000 in a mutual fund and have been contributing $200 per month ever since.   Let’s say that you now have about $41,000 in the account.   Do the following:

  1.  Put $1,000 in the starting balance box, 5% in the annual return box (this is the ARR), $200 in the monthly contribution box, and 10 years in the remaining two boxes.
  2. Press “show results.”  This will then show the amount your investment would be worth after 10 years.
  3. Adjust the annual rate of return up if the total number is too low.  Adjust it down if it is too high.  In our example, we’re too low, so let’s adjust it up a bit.
  4. The final result for our example is shown below.  I found that with an ARR of about 8.5%, I ended up with $40,892, which is close enough to $41,000 for our purposes.

invcalc8pers

So now that we know we made about 8.5% ARR for the period, which is quite a bit better than we would have done in a bank CD.  For comparison, where would we have ended up if we had put the money in a bank CD making 1% interest?  Change the ARR on the investment calculator to 1% and see the results.  I now see that I’ll end up with only about $26,000, so the higher rate of return definitely helped me out (to the tune of about $15,000).

A word of caution here.  While it is valid to determine a ARR for a portfolio of stocks or a mutual fund over a long period of time, like five to ten years, a mutual fund does not behave like a bank CD and pay steady returns.  Instead, it may go up 30% one year, then down 15% the next.  You cannot plug in 8.5% into the calculator now and try to predict where your fund will be three years from now or even five years.  If you want to predict, you can do things like project out ten or twenty years and assume ARR limits of maybe 8% to 12% and get a rough idea of the range of portfolio values you might see for the mutual fund.  You can use this as a guide to see if you need to be saving more to reach your goals or get an idea of when you might become a millionaire, but realize that your actual returns might be a little above or below that range.  Stocks are unpredictable.

Finally, I now know that I’ve made an 8.5% ARR for the period of Jan 2007 to Jan 2017, but how did my fund do versus “the market?”  Well, a good benchmark to use is the S&P500, which is an index of the 500 largest companies in the US markets and gives you a sense of where most of the money invested in the market did for the period.  You can get the returns for the S&P500 index over any period of time through this calculator here.  If I plug-in the start and end dates of Jan 2007 to Jan 2017 with this calculator, I find that the S&P500 had an ARR of about 4.8% over the period without reinvesting dividends, and 6.9% if dividends were reinvested.  Since my fund made 8.5%, it did pretty well for the period.

Got a question or comment about personal finance or investing?  Please leave a comment.

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.

Will the Republican Party Be Changed this Time?


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I was eight years-old when Ronald Reagan was first elected.  Like Donald Trump, he was an outsider, elected after years of a dismal economy under a President who tried Liberal policy after Liberal policy to fix it, only making.  Like with Donald Trump’s predecessor, many of the actions Reagan’s predecessor was taking were probably keeping the economy in the doldrums.

The effect of President Reagan’s presidency on my generation was enormous.  We saw that the Conservative, free-market principles, really worked.  If you cut taxes, the economy would surge as people worked more.  There were jobs everywhere because light regulations allowed businesses to do productive things instead of fill out reams of paperwork and businesses actually wanted to be located in the US.  We learned that if you gave people the freedom to take care of themselves, they mostly would.

Then came George H.W. Bush.  America returned from an outsider to a party insider.  We then started seeing typical Republican actions – talking about free markets and lower regulations, but not really fighting to reduce regulations and government influence in the markets.  He even reluctantly went along with the Democratic Congress and raised taxes after his famous, “Read my lips” statement in the debate.

Under President Clinton we of course saw taxes raised a great deal and all sorts of new regulations come into play.  We saw something interesting under Clinton, however, largely due to the push from Newt Gingrich and the Republican Congress elected under the Contract with America pledge.  We saw a requirement that those on welfare, who were able, go back to work.  I remember hearing stories of women who had gone into the workforce after knowing only welfare saying that they had dignity for the first time in their lives.  The other thing that was striking was something I didn’t realize until Bill Clinton mentioned it in a speech he was giving at the 2008 Democratic Convention for Barack Obama – that everyone was working in the late 1990s, and the economy was on fire.  I came to realize that a side effect of getting everyone to work is that you have a lot more things being produced, meaning there is more wealth to go around.

With the second George Bush, again we saw the typical Republican talk about free-enterprise but no a lot of fight for free markets.  We even saw regulation of the light bulb – phasing out twenty-five cent incandescent bulbs for $3 CFLs and $10 LEDs.  When the mortgage meltdown came in the end of 2008, rather than seeing the government simply support the money markets and protecting depositors as they could have done, we saw the government bailing out the large banks and insurance companies.  The people who made the bad mistakes kept their companies and their jobs, while the taxpayer was left holding the bag.  This was clearly crony capitalism, not free-enterprise.

Now, like Reagan, we have an outsider.  In fact, Donald Trump is even more of an outsider than Reagan since Ronald Reagan was at least Governor of California before he became President of the United States.  Trump has never held an ected office or even been an officer in the military – a first for America.  Donald Trump talks about using free enterprise principles – low taxes, reducing regulation, reducing the cost to repatriate money from overseas — to help those in America who have been exploited by the Democrats and ignored by the Republicans.  Hopefully he will do as he promises and the Republicans in the House and Senate won’t block him.  And, hopefully,  Republicans will see the support he has gotten despite not being the most elegant speaker or tactful politician and realize that really using free-enterprise principles is the path to a strong economy.  And that is the path to keeping the Presidency.

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

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.

Teaching Personal Finance in School


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A dyed red-haired rapper criticizes the public education system in a viral YouTube video, “Don’t Stay in School“.  Looking back at my education, I remember learning the capitals of the states for no apparent reason.  Other than watching Jeopardy, I’ve never used this information.  Now my children are also learning the capitols, again for no reason.  With search engines this information is even more useless than when I was in school.

If we replace the teaching of useless and pointless things like this, or maybe the learning of the three types of rocks (igneous, sedimentary, and metamorphic), we would have time to teach children a lot of really important things for their lives like personal finance.  Much of the information about personal finance that keeps people from making bad decisions was not taught to their parents, which is one reason we see so many people buying new cars every three years or running up debt on 19% interest credit cards.  Here are some lessons that should be taught in schools instead of, say, the types of clouds.

The rule of 72.  If you take 72 and divide by an interest rate, that will tell you how long it will take an investment to double at that rate.  For example, if you put your money into a CD paying 4% interest, you will double your money about every 72/4 = 15.5 years.  Double that rate to 8% by investing in bonds and you’ll double your money about every 72/8 = nine years.  You get a better return because you’re taking on a little more risk since the bond issuer could default.  Go into stocks, which have a variable return, but one that averages around 12% annualized if you hold them for at least 20 years and you will double your money every six years or so.  If you invest your money for 30 years, $1000 will turn into $4,000 in bank CDs, $8,000 in bonds, and $32,000 in stocks.  That’s something worth learning.

The rule of 72 works the other way as well.  If you are taking out a home mortgage at 8%, you will pay in interest about every nine years about the amount of principle that is not paid off during that time. Because you pay back very little of the principle during the first two-thirds of a mortgage, if you have a $200,000 30-year mortgage, you’ll pay about $160,000 in interest during the first nine years and still owe about $180,000 on the loan, as if your payments just vanished.  Over the life of the loan, you’ll pay about $530,000 for that $200,000 mortgage.  If you use the rule of 72 and assume you’ll owe about the full loan value for the first 18 years and then a little over half of the mortgage value for the last twelve years or so, you would estimate paying $200,000 for the first and second nine-year period, then a little of $100,000 for the last 12 year period, which is pretty close to the $530,000 paid.  If you get a 15-year loan instead, you could estimate about $200,000 for the first nine years and then a bit more than $100,000 for the next six years.  The true amount you’d pay would be about $344,000 – fairly close to your estimate of a bit more than $300,000.

Note if you keep a credit card balance and are paying 15% interest, the rule of 72 tells you that you’ll be paying the full value of the balance in interest every five years.  If you keep a $10,000 balance on your cards, you’ll be paying $10,000 every five years or about $2,000 per year in interest.  That is a paycheck or two for many people, meaning you’re working a month of your life per year just to pay interest on your credit cards.  Maybe if people learned this in school, they would be more leery of whipping out the plastic for a vacation.

The power of extra payments.  And speaking of home mortgages, here’s a little trick that is not taught in school that would be very valuable.  If you look at your mortgage pay-off plan, you can determine how many payments you could remove from the loan by making an extra payment.  For example, in year one of a 30-year loan on $200,000 at 4% interest, you’ll be paying about $3,500 in principle and $8,000 in interest.  Monthly this is about $300 in principle and $670 in interest each month, for a payment of about $970 per month.  If you paid an extra $300 in a month (the amount of the principle paid each month), you would be eliminating one mortgage payment, saving yourself $970.  Pay an extra payment, and you’re eliminating about three payments, or $3,000.  If you make an extra payment during the last year of the loan, you’d only be saving about $60 since at that point your payments are going mainly to principle.  By looking at the amount of principle you are paying off each month, you can see how powerful making extra payments is.  Early in the loan (and the higher the interest rate you’re paying), extra payments are very powerful and well worth the money.  Later on, not so much.  Maybe if people knew this, they would try to hit the loans hard during the first several years and save hundreds of thousands of dollars.  People often get serious about paying off their loan at the end, but by that point, most of the damage has been done any you might be better off to invest the money.

Small amounts add up.  Let’s say you run by Starbucks every working morning and drop $6 on a sugary coffee drink.  If instead you made a cup of coffee at home for essentially free (compared to $6 per cup) and invested the money, you would be investing about $150 per month or $1,800 per year.  Invested in mutual funds, making 10% annualized over 30 years, you’ll have about $330,000.  That is enough to send a child or two (or three) to college.  So, just by changing your morning routine and making expensive coffee drinks an occasional luxury rather than a daily routine, you can pay for college.  Imagine how different things would be if almost everyone did this.

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

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.

Financial Options for Paying for Retirement


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So perhaps you’ve been saving and investing for years, and now retirement is in your sights.  The question now is, “How do I use the money in my retirement accounts and other savings to pay for things in retirement?”  Today I thought I’d discuss some considerations and ideas.

How much income can I receive each month?

The first consideration is how much spending money will you have in retirement.   This information might also point to the need for a part-time job or other source of income in retirement.  A fairly good rule-of thumb is that you can withdraw about 3-4% of your net worth per year from your retirement account without the value declining in value in real-dollar terms.  (Here “real dollar” means dollars adjusted for inflation so that you’ll have the same amount of spending power as the years go on.)  If you withdraw more than this, you will be spending your portfolio over time and eventually run out of money, assuming you live long enough.

For example, let’s say you have a portfolio (401k, IRA, savings, etc…) totaling $750,000.   You would be able to spend about 0.03*750,000 =  $22,500 per year without seeing the value of the portfolio decline and be able to leave your heirs about the same amount of money when you died.  Monthly this would be about $1875.  If you were just paying for a family of two, had the house paid off, drove old cars, and didn’t do much, this might be sufficient.  If you wanted a bit more of a lifestyle, you might need to work a part-time job to help with expenses.  You could also consider options such as selling your home and downsizing to increase the investment portion of your net worth.  If you pulled out $40,000 per year, the value would decline over time, meaning you might run into an issue in your 80’s or 90’s.

How can I generate the income I need?

The second aspect is how you use the money in your portfolio to generate the cash needed to pay for living expenses.  Here there are basically three options:  1)  Invest a portion of the portfolio in income producing assets to generate regular payment, 2) Sell some assets each year to raise cash, and 3) Buy an annuity to pay the income you need.  Let’s look at each of those options.

1.  Invest a portion of the portfolio in income-producing assets to generate income.

This is the traditional way of generating income for expenses.  It works well in times when interest rates are fairly high (not the current period).  Many people simply invested in bank CDs to generate income, but while the dollar value of bank CDs remains constant, value will be lost to inflation each year, plus the rate of return will always be lower than other options like bonds, real estate, and dividend-paying stocks.  You can choose this option if interest rates are sufficiently high to generate the income you’ll need and you’ll have enough left over to invest in growth assets like stocks to prevent inflation from reducing your rate-of-return in the future.

Typically the percentage of income investments when you retire should be around 50%, so if you can generate enough income from bonds and dividend-paying stocks using about half of your portfolio or less, while investing the remainder in growth stocks that will increase in value with time. this could be a good option.  Note that as you age, you would shift a greater percentage of your assets to income assets to increase the amount of income you receive each month to account for inflation.  When you were 80, you might be 70-80% in bonds and 20% in growth stocks.  You could buy individual. stocks and bonds, but it is usually easier to buy an income fund.  Also note that the higher the return you’re receiving, the higher the risk you’re taking.  It is generally a good idea to spread the risk out between safer, lower paying bonds and more risky, higher paying bonds.

2.   Sell some assets each year to raise cash.

The first strategy is probably best if you have just enough money to generate income for retirement.  If you have more than enough, you might still put a portion in bonds to help smooth out the volatility (having about 20% in bonds will greatly reduce the price level of value fluctuations in your portfolio without greatly affecting your total return), but plan on selling assets each year to raise cash for expenses.  Because growth stocks will provide greater returns than bonds and income stocks over long periods of time, this will provide more money to use in retirement and/or pass on to the next generation.  There will be volatility, however, so you need to have enough of a cushion to weather most market downturns that may occur.  This means you really should have at least twice the portfolio value required to generate the income level you really need since a 50% decline in stocks over a short period is not common, but it does happen once-in-a-while.

Part of using this strategy involves using cash to provide the money you need during the years when the market declines and you need to wait for the market to recover before selling more shares.  Since the market usually recovers within a year or less (although there are exceptions like the Great Depression), having a cash cushion will usually provide the time you need to avoid selling shares too cheaply and locking in losses.  Since having a loss over a five-year period is almost unheard of, having between three and five years’ worth of cash is a conservative strategy.  (Note “cash” here means bank CDs and money market funds – not $100’s in your mattress.)

If using this strategy, some level of opportunism should be used.  If there are years when the markets do really well, use the opportunity to raise some cash.  In years when the markets decline, maybe wait to sell unless your cash drops below some threshold, for example, 2 years’ worth of expenses.

3.  Buy and Annuity to provide a monthly payment.

When you buy an annuity, an insurance company invests your money and pays you a guaranteed amount per month for the rest of your life (or some other period depending on the terms of the annuity).  Because the insurance company wants to make money, they will always pay you less than the amount you could have received if you had just invested it yourself using strategies 1 or 2 above.  The difference is that the rate-of-return each year would vary if you invested yourself, where it would be guaranteed (provided the insurance company didn’t default) with the annuity.  The insurance company would get variable returns by investing your money, but make a higher return overall, where you would get a lower, but fixed (guaranteed) return.

Clearly, annuities have drawbacks.  The income they pay is often fixed in dollar terms, so your buying power may decline over the years due to inflation.  If you die young, your money may be gone so you may not have anything to leave heirs.  As stated above, you will not, on average, do as well with an annuity as you will do investing yourself (assuming you invest appropriately).  The exception may be if you live a really long time, but for everyone who lives exceptionally long, someone dies exceptionally early.

If you do choose to buy an annuity, avoid the fancy annuities that promise things like additional returns based on the market performance or other bells and whistles.  Just buy a simple annuity that pays a fixed amount (perhaps indexed to inflation), either immediately or at a certain age (if you’re worried about running out of money late in life) .    If you want to also get some market returns, hold back some cash and invest it yourself outside of the annuity.

Note finally that there is no reason to just choose one of these strategies.  You can mix and match them.  You could buy bonds and income stocks to generate some income, but also sell some stocks to raise cash to supplement what the bonds were paying, particularly in times like now when bonds aren’t paying much.   You could also buy an annuity to pay for something critical like food and basic necessities, then use bonds and growth stock sales to pay for luxuries like travel and home improvements.

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

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.

Time to Buy Energy?


IMG_0123There are two fundamental strategies to stock selection – growth and value.  With growth you try to find the stocks in companies that are expanding and will continue to do so for many years.  You profit when the company grows and their share price increases along with the growth.  Eventually they’ll also pay a dividend that will increase in value each year, providing income maybe ten to twenty years down the road.

The second type of investing, value investing, involves picking stocks that are beaten down in value, and therefore are cheap compared to where they should be in price.  Generally the best thing to do is to find industries that are out-of-favor and select stocks within that industry, rather than buying individual stocks that are having issues.  If a whole industry is declining, good and bad stocks will all decline in price.  When the industry recovers, so will most of the stocks within that industry.  In fact, the companies that emerge will do better than they were doing during the last boom time since the weaker companies will have vanished, leaving market share for the survivors to grab up.

If an individual stock is falling because of issues at the company, however, there may be systematic issues with the company.  Many of these companies will take years to recover, and may disappear entirely.  One example in my portfolio where this happened was with Pacific Sunwear, which I had bought at $20 per share, then again at $2 per share once the price had dropped, thinking that they were cheap enough to be worth taking the risk  and waiting for a recovery.  In that case they over-expanded and the taste for their products turned.  Since that point the whole company has filed for bankruptcy.  The company had systematic issues that didn’t disappear with a turn in the economy.

Right now an interesting place to be from a value investing standpoint is energy.  I held a few oil and gas companies just when the energy market peaked about a year ago, leading to some big losses.  I mistakenly decided that I wanted a hedge against inflation and energy seem like a good inflation hedge, so I bought in, right near the top.  The price of oil then dropped through the floor, taking many of my investments down 80% or more.

I sold many of the companies I had purchased, such as Oasis Petroleum and Ensco PLC, since I didn’t see them coming back for a long time.   Others, however, like Greenbriar and Cameco, still seemed like good places to be as a long-term investment.   Greenbriar makes rail cars and was doing well during the oil boom because of all the oil that is shipped by rail.  They also have business beyond oil, however, so they should do well in any booming economy where a lot of things are being shipped.  I therefore bought more shares after the fall and plan to sit on them for several years, waiting for the recovery.

Cameco is the world’s largest uranium producer.  They were hurt both by low oil prices and by the Japanese nuclear accident.  Nuclear power, however, is the only currently viable energy source that doesn’t produce carbon dioxide, and with many countries imposing carbon taxes and other measures to reduce CO2 production, nuclear may become much more popular.  I therefore bought more shares of Cameco after the fall.

These are not short-term position.   It takes time for industries to recover.  Over long periods of time, however, mixing in a few value positions with growth positions can pay off well.  We’ll see what happens for me with these two positions.

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

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.

Year-End Financial Forget-Me-Nots


BikeThe new year is of course a time of resolutions and soul-searching.  People see the coming of a new year as a time to change and make themselves better.  People resolve to lose weight, pay off debt, or maybe spend more time with friends.  If you haven’t been doing so already, hopefully one of your resolutions will be to start and keep a budget.  In our house we didn’t do so well in that department this year – only getting a yearly budget together and then a couple of monthly budgets along the way.  After years of saving and investing our finances can take a little abuse, but still I don’t like the feeling of not having control over how we’re spending our money.  I want to know if we buy this doodad, or go on this trip or that, that we’ll still have the money to put away for college and retirement during the year.  I also don’t want to see our account balances declining because we’re spending more than we’re making, so getting back on course with a good budget will be one of my resolutions this year.

 There are a lot of things to do before the new year, however, that you don’t want to forget during all of the holiday madness.  Probably the thing to do is to get these things out-of-the-way in October before the holiday madness really begins, but if you haven’t done these things already, maybe take a little time between Christmas and New Years to get them done and start the next year out right.

1.  Take some losses.  If you have sold some stocks at a profit and had a lot of capital gains in the stock market this year, now is the time to sell some of the losers remaining in your portfolio to offset those gains and reduce your taxes.  You can also deduct up to $3,000 in losses against regular income. (Always check on things like this.  I’m not a tax guy, plus tax rules change all of the time.)   Note that you can’t buy back a stock you sold at a loss for thirty days after the sale, and you can’t buy the same stock less than 30 days before you sell at a loss or the transaction will be called a wash sale and will not be deductible.  The IRS doesn’t want you to take a loss when you really stay in the same position.

Also, note that your investment strategy is a lot more important than saving on taxes, so only sell stocks you were planning to unload anyway.  Don’t sell some stocks you really like but that have just dropped a bit since you bought them just to take the loss, because chances are you’ll never buy them back even though you think you will.  A small move in the price of a stock will make up for a lot of taxes that you pay.  If you would buy the stock again today, don’t sell.  Again, back earlier in the year you could also have bought more shares, waited 30 days, and then sold the shares on which you had the loss, but you might then have a large position than you want.  You could also sell now and hold onto  the cash for thirty days so that you could buy the shares back later, but you run the risk of missing a big move up in the mean time.  Really, it’s best to sell because you no longer want the shares, but think about the timing to take advantage of tax rules rather  than to let tax rules drive your investing.

2.  Pull together a yearly budget for 2017.  Get together with your spouse and talk about the new year.   Talk about how much you want to spend on vacations and luxuries during the year.  If your car is ready for a trade, talk about where the money will come from for that.  Also, talk about the things you want to start putting money away for like home repairs and the next car, then put it in the budget so it actually happens.

3. Start an IRA.     OK, you really don’t need to do this before January 1st because you can make contributions for 2016 through April 15th, but if you go ahead and get the account open, maybe you can contribute some year-end bonus money and get the account funded rather than waiting until April when you may be low on cash.  You can also then save up quickly and make a 2017 contribution early rather than waiting until April 15th of 2018.  The longer you have the money invested,  the more time it has to grow, so it is better to invest early in the year than to wait until the last-minute to make next year’s contribution.  Also, use this time when you are home from work for a few days to actually get an IRA open and choose your investments so that you don’t miss another year.

4. Start an educational IRA.  If you have kids at home, you should start up an educational IRA and start putting money away for college yesterday.  They will be heading out the door to campus before you know it.  As with an IRA, you actually have until April 15th to make a contribution for 2016 (see rules here), but with college such a short time away, any extra time you can give your investments to grow is really golden.  If you start putting away money early and often, you can let the markets help pay some of the costs.

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

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.