Invest Your Money?

Sometimes investment concepts appear to be simple; yet most people fail to meet their retirement goals because they miss the basics. These two simple investment concepts are extremely basic; yet if you fail either one you will probably fall short of meeting your retirement needs.

Invest Your Money

You must invest your money. There is a difference between saving and investing. Many investors don’t invest their money because they don’t get started. The odds are very small that you will be able to save enough money to meet your retirement goals. This is especially true today.

In a time period the Federal Reserve is keeping interest rates near zero, you must invest your money or its purchasing power will erode and you will go backwards instead making progress toward your goals. After taxes and inflation your money will buy less and less every year. Over a period of a couple of decades you can easily lose one-half of your purchasing power.

Learn all you can about asset allocation and diversification. These are the foundations of sound investing. Everything else is of secondary importance. Get started today!

Don’t Lose Your Money

Once people move from saving to investing they don’t pay attention to the most important rule: Don’t Lose Your Money! Most people invest too aggressively. The old rules, including buy and hold and a fixed asset allocation, are prescriptions for wealth destruction. Pay attention to valuations and don’t let the culture influence your investment decisions. Use resources, such as this blog, to learn about risk management.

Because of the laws of compounding, it is more important that you don’t lose your money than it is to invest too aggressively and lose a substantial part of your portfolio.  If you lose 50% of your portfolio it takes a 100% gain to get back to breakeven. If you only lose 10% of your portfolio it takes an 11% gain to breakeven. This makes risk management the single most important concept in portfolio management.

The Proper Balance

The AAAMP Blog offers a wide variety of resources for investment education. If you are a novice investor you may want to start with our Investing For Dummies page. This page will provide resources to broaden your investment knowledge and examine sound investment principles and strategies that will help you achieve your investment goals. It comes down to a balance. You must invest your money; but employ a risk management plan so you don’t lose your money.

 

Stock Market Terms

Investors who understand stock market trading execution terms increase their ability to make efficient transactions.  Being a smart investor means understanding trading terminology and use the tools that best fit your needs for executing transactions and risk management.

The following trading terms are common and available on most, if not all, trading platforms and accounts, including online trading.

Bid Price

This is the price a buyer(s) is currently willing to pay for a security. There is a bid size attached to the bid which is the number of shares the investor(s) are currently willing to buy at that price.

Ask Price

The price a seller(s) is currently willing to offer or sell a security. There is an ask size attached to the order(s) which is the number of shares the investor(s) are currently willing to sell at that price.

Bid/Ask Spread

The difference between the bid and ask price. In efficient markets with high volume the spread should be very small. In thinly traded markets the bid/ask spread could be very large; in which case investors should beware of being ripped off. Question buying any investment with a large bid/ask spread.

Market Order

A market order will be executed at whatever price is available when the order is executed. Market orders have first priority; they will be filled (executed) before other types of orders. Market orders guarantee execution and carry little risk in securities that are traded heavily on major stock exchanges. Market orders may be dangerous in thinly traded securities where the bid/ask spread could be large.

Limit Order

A limit order guarantees a certain price (or better), but does not guarantee execution. A limit order will not be executed unless the limit price stipulated (or better) becomes available.

A buy limit order can only be executed at or below the limit price. A sell limit order can only be executed at or above the limit price.

Stop Order

A stop order is an order that sets a price level, which if reached, will trigger a market order for execution. A stop order, also known as a stop loss order, is a risk management trading tool.

A sell stop order would be placed below the current price. For example, you buy XYZ Inc. at 100 and place a sell stop order at 90. If XYZ trades at 90 or below, your order will become a market order and it will be filled at the price available at that time.

A buy stop order would be place above the current price. For example, you are short (see below) XYZ Inc. at 100 and place a buy stop order at 110. If XYZ trades at 100 or above, your order will become a market order and it will be filled at the price available at that time.

Stop Limit Order

A stop limit order is a combination of the stop order and limit order. The stop limit order sets a specific stop price, which if reached, will trigger a limit order for execution. This allows the investor to control the execution price but carries the risk that the order will not be executed because the limit price is not available.

A sell stop limit order would be place below the current price. For example, you buy XYZ Inc. at 110 and place a sell stop limit order at 90. If XYZ Inc. trades at 90 (or below) your stock will be sold only if a price of 90 (or better) becomes available.

A buy stop limit order would be placed above the current price. For example, you are short XYZ Inc. at 100 and place a buy limit order at 110. If XYZ trades at 110 then it will trigger a limit order in which your shares will be sold if and when a price of 110 or better becomes available. 

Duration Orders

In addition to the above an investor can stipulate conditions on the duration of the order. Unless stipulated the Day Order is the default duration.

Day Order – If the order is not filled during the trading day it will be cancelled.

Good Until Cancelled (GTC) – The order will be open for execution until the investor cancels.

Fill or Kill (FOK) – If the entire order cannot be filled immediately, it is cancelled.

Fill and Kill (FAK) – Similar to FOK except it can be partially filled. Any parts not filled immediately are cancelled.

Cancel or Change Orders

Allows a trader to cancel or change current open orders.

Understanding Trading Execution Terminology

Now that you understand trading execution terms; you are able to use the tools available to you as an investor. Use them to make efficient transactions and apply risk management strategies to your stock market trading orders.

Related Reading: Online Investing For Dummies 

Weekend Reading

The market typically looks ahead about 6 – 9 months. We have a year-end train wreck ahead of us regardless of the election results in November. Current legislation has all the Bush tax cuts expiring, the payroll holiday ending, new taxes and regulations for Obamacare kicking in, etc. Tough choices will either be made (causing great short term pain); or they will be ignored, and bond markets around the world will punish us; just as they are currently doing in Europe.

Here is Weekend Reading  from shortest to longest (sort of J):

Is Gold Really An Inflation Hedge? – Capital Speculator  

Another Month, Another rise In The Conference Board’s Leading Indicator – Capital Spectator  

Home Builder Sentiment at Nearly 5-Year High – Real Time Economics

Lower Correlations Don’t Mean That Active Managers Deserve Your Investment – Symmetric Information

Individual Investing Can Be Tough – The Aleph Blog

There Has Never Been a Better Time to be an Individual Investor – Abnormal Returns

Peak Everything – Why Everything Costs More – Yahoo! Finance

Great charts and explanation of how Obama’s Budget Proposal Will Drive Fewer Companies to Pay Dividends – World Beta Blog

Face The Music: Road Back To Prosperity Is Through Shared Sacrifice, Not Government Stimulus; Case Against Fractional Reserve Lending – Mish’s Global Economic Trend Analysis

 

Carnivals I’ve Participated In:

Carnival of Passive Investing –  (AAAMP Blog article is one of Editors Picks!)   

Carnival of Personal Finance #348, The Grammy Award Edition

 

Related Reading: Weekend Reading – Finance & Investing Links

Value Stock Picks

Federal Reserve money creation and signs of economic recovery are leading me to think about investing during increasing inflation. This may mean increasing my position in small cap value stocks. Investment management requires being forward looking and anticipating where potential rewards are greater than the risk being assumed. I have been overweight in dividend paying blue-chip stocks for several years. These stocks have become very popular and no longer the bargains they were in 2008-09.

Small Cap Value Investing

Small cap value stocks are fertile ground to find undervalued stocks. This category is not well covered by analysts and individual investors who either lack the time or skills to properly research individual companies. Therefore many “gems” are not discovered, or at least are not subject to the hype and inevitable collapses suffered by many promoted stocks. During rising inflation small cap companies have the ability to adapt quicker than larger companies.

What is the best way to invest in small cap stocks? Recent circumstances have caused me to change my mind when answering this question. Until recently I believed that ETFs were the best investment vehicle. But the facts have changed; and adapting is part of successful investing.

In a post last week I laid out Why Value Investors Should Avoid Most Value ETFs and Mutual Funds. Most value funds are loaded with high risk financial service stocks. It’s unacceptable for me to have more than 20% of my ETF (many value ETFs have more than 20% in financial services) in stocks I wouldn’t even think about owning right now.

Therefore I think individual value stock picks are the best way to invest in small cap stocks. Even though I am portfolio manager of the Arbor Asset Allocation Model Portfolio (AAAMP); I don’t have the time to do the deep research required for small cap investing. Therefore I rely on a service to provide me the initial research for stock picks I may want to include in the AAAMP.

Value Stock Guide Review

If you can benefit from a small cap value stock picking service I suggest you consider Shailesh Kumar’s Value Stock Guide. His service provides his best small cap value stock picks as he shares his personal transactions with subscribers.

Other than receiving his Value Stock Guide I have no business dealings with Mr. Kumar. In other words, I’m not being paid for this post or receive any kind of compensation for referrals. The AAAMP Blog is about sharing with you the most effective ways to manage your own money.

Investors interested in small cap value investing should consider avoiding value etfs and mutual funds and instead pick individual stocks. It may be advantageous to find a deep value investing research service for initial ideas on small cap value stock picks for your portfolio.

Happy Valentine’s Day

In our uncertain and turbulent world we need days such as Valentine’s Day to concentrate on our loved ones. I want to thank the following carnival participants for sharing their wisdom with us. I hope you enjoy and learn something from these posts:

Economics and Politics

Investor Junkie submitted Capitalism is NOT a Zero Sum Game! Capitalism is about expanding the economic pie, not trying to divide a static pie equally.

Portfolio Management

Miss T at Prairie Eco Thrifter presents Bond Laddering for Retirement. Bonds are called fixed income securities for a reason. They give you the ability to manage your cash flows. You can create a bond ladder using coupon bonds that will pay quarterly, monthly, or even weekly. It all comes down to creating your desired cash flow with the proper bonds. 

Kanwai Sarai at Simply Investing gives us What are Dividends? Why Should You Care? Investing with a focus on companies that have a strong record of producing consistent dividends has many advantages over other, more risky styles of investing.

Risk Management

Doctor Stock at Invest In the Markets presents How to Develop an Exit Strategy Before Entering a Trade. How to develop an exit strategy before you enter a trade on the Dow, Nasdaq, S&P, or any other stock exchange, is one of the most important steps to making money in the stock market. Failing to plan an exit strategy before you enter a trade can lead to clinging to a falling stock…and losing significant amounts of your wealth capital.

Value Investing Strategies

Rob Bennett at Out Of Your Rut writes If Valuations Matter It Must Be Possible to Profit From This Reality. Why do investors believe that valuations matter but that having valuations on their side does not help you win at the game of investing?

Specific Investment Ideas

Mich at Beating The Index submitted How to Invest in Oil to Maximize Profits and Minimize Risks. Let’s face it, the era for cheap oil is behind us, oil has become more expensive to find and to extract from the ground, which requires sustained high oil prices to ensure future supply. A look at ways to invest in oil.  

Investment Planning Strategies

Glen Craig at Free From Broke submitted Cost Basis Reporting – How it Affects Your Taxes. Cost basis reporting is an important concept to understand when you are selling investments as it can affect what you pay in taxes. See how new rules can change your filing.

Rob Kuban at One Money Design presents What Christians Should Keep in Mind While Planning for Retirement [Christian Financial Alliance]. What is one thing a Christian should keep in mind while thinking about/planning for retirement? Consider the advice from Christian financial bloggers.

Jason Van Steenwyk at MoneyCrashers gives us Index Funds vs. Managed Mutual Funds. One of the great debates in the investment world centers on whether mutual fund managers, in the aggregate, add any value for investors.

Marissa at Thirty Six Months presents How to Use a Mock Investment Portfolio. One of the best ways to start feeling comfortable with investing is by using a mock investment portfolio.

Boomer at Boomer and Echo gives us How to Set Up a DRIP. A DRIP, or dividend reinvestment plan, is a great way to build up your investment portfolio, especially when you are just starting out.

Jim at Bargaineering gives us Basic Rules to Make Your Portfolio More Tax Efficient. It’s important to keep taxes in mind when investing; specifically, making the right types of investments in each account to maximize tax efficiency.

Barbara Friedberg at Barbara Friedberg Personal Finance submitted Don’t Spend Your Dividends. Don’t get me wrong; dividends are fine, but just because a stock pays a hefty dividend, does not mean it is a great investment. And the dividends the stock throws off are not “free money”.

Teacher Man at My University Money submitted Should You Invest In Individual Stocks?   What’s that? You’re a 34 year old who works a blue collar job, without any post-secondary education, and you’re student loan free? Well, in my defense, I’ve never met you. The good news is most of you will be able to relate to this post, no matter your age, education level, or indebtedness. We’re going to talk about investing.

From the AAAMP Blog I have added Making Probability Theory Practical For Investment. Understanding investment probability theory will help investors avoid short term prognosticators and concentrate on a long term investment plan.

Invest in Brazil?

Brazil has the seventh largest economy in the world and the fifth largest as measured by land mass. With a population of 193 million and a 2 trillion dollar economy, it is a political and economic leader in Latin America. However, social and economic problems have kept it from being an effective global power. In the future, economic growth may drastically change the role of Brazil in our world.

Why Invest in Brazil

The booming global demand for commodities, particularly energy and agriculture, is a major proponent of a robust Brazilian economy. Brazil is now a global power in natural resources and agriculture; two of my top global investment trends that I expect to enjoy strategic advantages for decades to come.

Brazilian exports are booming; and include aircraft, electrical equipment, automobiles, ethanol, textiles, footwear, iron ore, steel, coffee, orange juice, soybeans, and beef. It can meet growing demand for its’ products with an ample and efficient work force at competitive prices. Billions of dollars in infrastructure investment is currently benefiting the country as they prepare to host both the 2014 World Cup and the 2016 Olympics.

Brazil has been increasing its’ presence in international financial and commodities markets and is perfectly situated to take advantage of global growth trends. Many financial experts include Brazil in their risk on risk off trading. This means Brazil is considered a major player in world growth. Therefore, when investors want to invest in global growth, they should have Brazil as a part of their asset allocation.

Invest in Brazil Stocks with ETFs

Investing in Brazil Stocks through ETFs is how most investors should invest in Brazil. Since diversification is always paramount to reduce risk; an Exchange Traded Fund (ETF) is the most cost effective means to invest in Brazil. Here are ETFs traded in the United States:

Brazil ETFs based on Market Capitalization:

Ishares MSCI Brazil Fund ETF (EWZ)

Global X Brazil Mid Cap ETF (BRAZ)

Market Vectors Brazil Small-Cap (BRF)

MSCI Brazil Small-Cap Index Fund (EWZS)

 

Brazil Sector ETFs –

EGS INDXX Brazil Infrastructure ETF (BRXX)

Global X Brazil Consumer ETF (BRAQ)

Global X Financials ETF (BRAF)

 

Brazil Leveraged ETFs -

ProShares Ultra MSCI Brazil ETF (UBR)

ProShares Ultra Short MSCI Brazil ETF (BZQ)

 

Investing in Brazil

Brazil is well positioned to participate in global growth trends. Investors who want to participate in growth of the Brazilian economy can invest in Brazil stocks through a variety of Brazil ETFs.

(Disclosure: The Arbor Asset Allocation Model Portfolio (AAAMP) has a 1.3% position in BRF and 1.2% position in EWZ; no positions in BRAZ, EWZS, BRXX, BRAQ, BRAF, UBR, or BZQ on 2/12/12.)

 

Weekend Reading

Despite last week’s slight increase in employment; other factors should cause investors to be cautious. Insider selling, enthusiastic retail stock buyers, collapsing global trade, and high event risk are all factors that should affect portfolio asset allocations.

Here is Weekend Reading sorted from shortest to longest:

The Designated Driver – Investing is a game of probabilities. – Capital Observer

Indicators may signal why the market is Stubborn Like Ox – Capital Observer

Anyone thinking about investing in Penny Stocks should read Do Penny Mining Stocks Count as Investments? – Canadian Capitalist

We’re Officially in a Stock Picker’s Market – Wall Street Daily

Petroleum 3-Month Rolling Average Turns Sharply Lower; Negative Shipping Rates; Collapse in Global Trade – Mish’s Global Economic Trend Analysis

What Christians Should Keep In Mind While Planning For Retirement – One Money Design

Warren Buffett: Why Stocks Beat Gold and Bonds – CNN Money

What is Deflation – Definition, Causes, & Effects – Money Crashers

 

Carnivals I’ve Participated In:

Carnival of Financial Planning – Personal Finance Edition #223

Carnival of Wealth, Ronald Reagan’s 101st Birthday Edition

Carnival of Financial Camaraderie #19 – The Super Edition

Totally Money Carnival – Super Bowl Edition     

 

Related Reading: Weekend Reading Archives

Bank Stocks

Bank stocks are no longer investments for “widows and orphans”, but are instead, high risk investments with erratic dividends. Their volatility and undependable dividend payouts are symptoms of long term problems for the banking system.

In our last post we looked at why investors should Avoid Value ETFs and Mutual Funds. I pointed out that value ETFs and mutual funds are loaded with financial services stocks that used to be safe dividend paying stocks but are now high risk investments.

Bank stocks are large percentages of many value stock portfolios; and are being considered for purchase by individual investors because they can be bought for a fraction of the price they traded for a few years ago. I have avoided bank stocks for many years and, after careful examination, will not be adding any now either. Here is my analysis.

We know that most bank stocks have been volatile and poor investments the last few years. I’m not saying these investments won’t have periods in which they do well. If a stock falls from $50 to $2 and then rises to $4; I realize if you buy at $2 you have a 100% gain. My point is you need to realize what you are buying. Are you looking for a trading opportunity or a long term investment? While banks stocks used to provide security, dividend income, and moderate consistent growth; there are plenty of reasons to believe those days are over.

Long Term Problems for Bank Stocks

Let’s look at the long term problems of the banking system that make bank stocks high risk investments for the foreseeable future:

Political Risks – Everyone hates the banks right now

Failing Mortgages – Still millions of underwater mortgages on the books (and more coming!).

Deflation – Housing prices are still falling!

 

Litigation and Settlement costs over mortgage putbacks.

Regulatory reforms adding costs and making loans harder to make.

Exposure to Europe.

Lack of Transparency – What exposure do they have to derivatives?

When Interest Rates Rise – Banks are getting a free bailout from the Federal Reserve artificially holding down rates. What happens when rates rise?

Balance Sheets need improvement as requirements for additional capital make lending harder and less profitable.

Lack of Credit Growth – Banks have thrived for decades on ever expanding credit. Credit is shrinking now.

Does This Mean You Shouldn’t Buy Bank Stocks?

The point of this post is not to keep you from buying bank stocks. Everyone has their own personal risk parameters. There may be a price where it’s worth the risk to own a particular stock. The point of this article is that bank stocks are a completely different investment from what they were in the past. They are no longer steady dividend investments for “widows and orphans”.

Bank stocks are high risk investments with erratic dividends because the banking system environment has changed. Be sure you understand the risks, and possible rewards, before making an investment.

 

Avoid Value ETFs and Mutual Funds

Investors, especially value investors, should avoid most value ETFs and mutual funds because they are over weighted in high risk investments. As a value investor I am always looking for stocks that sell at low prices compared to their potential cash flow and risks associated with the underlying company. What was value and low risk in the past is not necessarily value and low risk today.

Most Value ETFs and Mutual Funds Are Loaded With Financial Services Stocks

Financial services, and particularly Bank Stocks, used to be the investment choice for “widows and orphans”. In other words they have been, in the past, considered safe dividend paying stocks with low volatility. The world has changed and these stocks are now investments with huge risks and considerable volatility.

So now value funds that used to have steady low volatility dividend paying stocks now own risky high volatility stocks with erratic dividend payouts. The question is: Are you getting what you intended when you buy these funds?

The percentage concentration of financial stocks in value funds is not insignificant. Many of these funds have considerable exposure to financial stocks.

Examples of Percentages of ETF Portfolios in Financial Services

iShares S&P500 Value Index Fund (IVE)              22.6%

iShares S&P500 Growth Index Fund (IVW)            3.8%

iShares Russell 2000 Value Index Fund (IWN)      23.0%

iShares Russell 2000 Growth Index Fund (IWO )    2.9%

As an investor interested in Value Investing Strategies; it is important to not get caught up in labels, but understand what you are buying. Sometimes investments are not what you think they are; so do your homework. An ETF or mutual fund investment labeled “growth” may have more value or less risk than an investment labeled “value”.

Many value investing funds have heavy exposure to financial service stocks which used to be stable dividend companies but are now volatile stocks with erratic dividends. Value investors should consider investing in individual undervalued stocks; but avoid value ETFs and Mutual Funds, until the environment for financial service stocks has changed.

Related Reading: Investment Portfolio Management

(Disclosure: The Arbor Asset Allocation Model Portfolio (AAAMP) is 2.5% long iShares Russell 2000 Growth (IWO) on 2/7/2012)