The Regular Guy's Guide to Saving and Investing

Basics Part 2

noreply@blogger.com (Ken) — Thu, 12 Apr 2012 00:43:00 +0000

Some people wonder about how you make money on stocks. There are basically two ways.

The first is rise in share value. Let's pretend that you bought 100 shares of a Wizzy Cola Inc. for $10 per share in 2011. You hold onto Wizzy stock for a long time because it is doing well. Let's say that you haven't bought any new shares in Wizzy over the next five years, but the value of Wizzy Cola is now $15 per share. You originally spent $1000.00 (100 shares at $10 per share), but now your shares are worth $1500 (a $500 dollar profit.) If you hold onto Wizzy, then you have an unrealized gain of $500. It is unrealized because you haven't actually sold the stock and received the $500 in profit. Once you sell the stock, it becomes a realized gain. This is when the tax man comes knocking.

The second way to earn money on a stock is through a dividend. Some companies (usually older, or more established companies) pass out a certain amount of money per share to shareholders (usually quarterly, or every three months). This can be based on profits, but is usually fairly constant.

For example, Wizzy Cola Inc., declares a dividend in March of 5 cents per share. If you own 100 shares of Wizzy, you receive $5. Then in June, Wizzy declares a dividend of 5 cents per share. Again, you receive $5 dollars. In September, Wizzy (after a great summer) declares a dividend of 7 cents per share. Now, you receive $7.00. At the end of the year, Wizzy declares a dividend 5 cents per share. You receive $5 dollars.

During the year, you have received $22 dollars in dividends on your 100 shares. You can elect to receive this as a payment, or more wisely, use it to buy more shares. This is one way to build up your share balance.

For example, you own 100 shares of Wizzy, which you bought at $10 per share in January. In March, Wizzy shares are still worth $10 per share, so with your dividend, you buy 1/2 of a share ($5 worth). In June, Wizzy shares are worth $15, so you buy 1/3 of a share with your dividend. In September, Wizzy is worth $14 per share, so you buy 1/2 share with your dividend (of $7), and in December, Wizzy is $15 again, so you buy 1/3 of a share with your dividend.

Throughout the year you have purchased (1/2 +1/3+1/2+1/3) or 1.667 (one and two-thirds) new shares with your dividends. You now own 101.667 shares of Wizzy. Wizzy is now worth $15 per share. The total value of the Wizzy shares you own is now $1525.01, up from $1000 when you purchased it in the beginning of the year. If you sell your stock at $15 per share, then you would end up with $1525.01, raking in a $525.01 profit.

More in the next segment. Please comment or email me.

Stock Basics

noreply@blogger.com (Ken) — Thu, 12 Apr 2012 00:42:00 +0000

When you are a kid, someone (a parent, grandparent, aunt) assists you in opening your first savings account. You are convinced to place your communion money, or allowance, or whatever you have managed to scrape together and not spend into a savings account and marvel at the accrual of compound interest. Someone pays you just to hold your money. Now, of course, fees chew up more than the pittance banks hand out in interest, and savings accounts often become losing investments. Even if they don't have fees, the sub-par interest rates (currently below 1% for most banks) don't even keep pace with inflation.

So you look for somewhere else to park your money. Somewhere that you hope will provide returns that are better than inflation.

Many people look to stocks for this. "Stock" basically refers to part ownership of a company. Stock is usually divided into "shares" or pieces of the company. Now a company can have billions of pieces or "shares" available, making it theoretically possible for a company to have billions of owners. Usually, though, you buy a certain number of shares based on how much money you have, how much you want to buy etc.

Now, you don't actually go in and run the company day-to-day, as you would if you owned a computer repair shop or a small business. For most of us, this is because someone like Bill Gates owns many more shares than we do (and usually owns more "powerful" shares, but we won't go into that), and so he or people that he votes for will run the company. So you and Bill Gates are now partners, but it is not an equal partnership. Bill Gates will have a lot of say over what happens in Microsoft. Depending on how many (or few) shares you own, you will have little or no say. You will trust that Bill or his appointees will do what's right to make the company more valuable (thus potentially increasing your share price) and thus hopefully making you richer. So at this point, it may come down to trust, especially if you are new to investing. You trust that Bill will want to get rich, and that he will want to see Microsoft grow and succeed, and this is probably true.

So, if you bought stock, congratulations! You are now part owner of a very large, famous, wealthy company with probably little or no say in how the company is run, but hopefully it will make you money! More on stocks in the next post.

Please feel free to comment below or e-mail me.

Time to Save

noreply@blogger.com (Ken) — Tue, 18 Oct 2011 23:25:00 +0000

During such "dire" economic times, it is essential to save as much as you can. There are instruments that are relatively safe for such a time, including savings accounts, although the returns will be minimal. You could try bonds, or even dip into stock mutual funds, since prices are fairly low.

Now is a good time to feed your funds, especially for the long term. It is difficult to overcome the mental blocks when the markets are turbulent, but it is essential to remember that buying when stocks are low will most likely lead to more profits.

Should I Hire an Financial Advisor?

noreply@blogger.com (Ken) — Wed, 29 Jun 2011 08:45:00 +0000

The short answer- it depends. Some people feel more comfortable with a financial advisor- someone to guide them through the murky waters of investment. Others prefer to take a bit of time and discover how to invest on their own.

I personally don't like the idea, for personal reasons. When I left college many years ago, I took a job with a company as an investment advisor. Our goal was to make ourselves rich- not you. We made money every time you bought or sold mutual funds, stocks or other investment instruments, so our goal would've been to get you to buy and sell as often as possible. Yes, your success was beneficial to us, but not our primary goal.

When it comes to my future, I prefer someone who has my best interest in mind. This is where a seeming conflict of interest arises. A friend of my father, who used Edward Jones as his financial advisor, was advised to dump much of his holdings during the stock market downturn in 2008. He lost a lot of money, and won't recover, even though stock prices did. Now, you can find anecdotal evidence either way, but you must be wary of anyone who makes money off of your transactions.

If you feel that you need a financial advisor, look for someone who charges a flat fee, versus a transaction based fee. Ask around and find someone with a good reputation. Don't be afraid to dump them if you don't feel comfortable- it is your future at stake.

I would suggest finding financial literacy courses at your local community college instead. Once you get the basics of investing under your belt, you will probably have enough confidence to invest on your own. Remember, just because someone became licensed to buy and sell investment products, doesn't mean they are gurus when it comes to how the market will perform. A little research will put you on par with them.

Getting Started- When to Pick What?

noreply@blogger.com (Ken) — Sun, 19 Jun 2011 01:18:00 +0000

In the previous post, I discussed four basic types of mutual funds. There are many variations on these, but we will stick to looking at these four basic types. The next question is: which one do I pick?

Well, there is no easy answer to that. If you assessed your comfort level for risk, then you may already have excluded certain types of funds as either too cautious or too risky. Here are some guidelines when looking at the various funds.

Money markets- You might want to keep your money here when you need it to remain liquid. This can be a good place to hold money before investing it, or prior to needing it. For example, maybe you need money for a down payment on a house and moved money from another mutual fund into your money market, because you knew you would probably need it in the next 6 months. Leaving it in more risky investments could cost you thousands of dollars since you would need to sell it at closing.

Income funds- These funds are good for people who are nearing retirement and expect to start drawing on their money. These funds tend to be less volatile, and so you won't generally lose your money if there are bad market fluctuations right when you are about to or have retired. As you approach retirement, say a couple of years before, you may start moving some money from a stock fund into an income fund. A downside to income funds is that they produce income, often as realized gains through dividends. You will have to pay taxes on these gains annually.

Balanced funds- These funds support the risk averse who have considerable amounts of time before they may need the money (college, retirement etc.) but don't want to let it all ride in a stock fund. You may also want to use it as an intermediate fund prior to needing it, while you have 5 or more years before needing the money.

Stock funds- These funds are for those who believe greater risk leads to opportunities for greater reward. These funds have been traditionally good for those who are just starting to invest, or who know they probably won't need the money for many years (at least 7 years, maybe more). If you are 30, you probably want to invest in a stock fund. Sure, you can put some in other types of funds for a down payment on a new home, but you have plenty of time to grow your money.

Which one you pick is up to you. You may want to have two, three, four or more funds. I have a stock fund and an income fund (which has been giving much better interest than a savings account. I also have a savings account. These are my current funds (not including IRA's and retirement funds). What you do is up to you. Let me know what your opinions on this matter are. I look forward to hearing them.

Getting Started- Different Types of Mutual Funds

noreply@blogger.com (Ken) — Mon, 13 Jun 2011 23:24:00 +0000

As mentioned previously, mutual funds are tools that try to spread risk through diversification. Mutual funds purchase shares in many different instruments in order to try to protect against big losses. You can still lose money in mutual funds, but they tend to be less risky than individual stocks.

Some basic types of mutual funds, in order of perceived risk (from low to higher) are listed below:

Money market funds- I discussed these previously. Basically they are safer investments that do not generally lose money. They tend to get a bit more interest than your typical savings account. Your initial investment will not decrease.

Bond/Income Funds- Companies, governments etc. issue bonds to raise money. Basically when you buy bonds, you are lending money to an entity. They agree to pay you back at a specified interest rate. Bond prices vary for a lot of reasons, which I won't go into now, but tend to be less volatile than stocks. While you hold the bond, you collect interest. This is why they are called income funds. You are paid the interest, which many choose to reinvest, or, if in retirement, use as income. A widely used measure of bond performance is the Barclay's Capital Aggregate Bond (BCAG) index, which measures the performance of a variety of investment grade bonds, to give investors an idea of returns on bond funds. The BCAG has shown average annual returns of 5.57% over the past ten years.

An example: If you put $1000 in a savings account and let it grow for 10 years at 1% interest, after 10 years you would have $1104.62. If you put $1000 in a bond fund that matched the BCAG with an average return of 5.57%, and you reinvested the interest from the bonds (bought more of the fund), you would have about $1720.00 after 10 years.

Balanced Funds- These funds tend to mix bonds with stocks purchases in some ratio based on level of risk desired. They may be 60% stock and 40% bond. They tend to be less volatile than straight stock funds because of the presence of bonds, but may not produce the same rewards over the long term.

Stock Funds- These funds invest only in stocks. They can invest in U.S. stocks or foreign stocks. They can invest across many sectors or limit themselves to one or a few, (like healthcare). You put money in stock funds for the long haul. These tend to fluctuate, but have historically outperformed other types of funds. Standard and Poor's 500 (S&P 500) measures a collection of stocks across the board, and is a widely used index to measure performance. If you look at 1 year growth- its average annual growth is over 15%, if you look at 10 years, its average annual growth is around 3.3% (due in a large part to the beating the stock market took in 2008), and if you look at the life of the S&P 500, its average annual return is 8.7%

This is a basic overview of types of funds in which you can invest. I will discuss choosing mutual funds in a future post

Beginner’s Guide to Getting Started- Where to start investing

noreply@blogger.com (Ken) — Thu, 09 Jun 2011 00:59:00 +0000

You now have a place to park your money. From here, you can invest, or hold, access cash or save when you are not comfortable. Now it is time to look at other investment options.

I will discuss mutual funds first. Mutual funds come in many forms. Basically, when you buy shares in a mutual fund, you are buying into a pool of possibly thousands of other investors and billions of dollars’ worth of securities, stocks, bonds- whatever the fund purchases. For the purposes of this post, I will focus on a mutual fund that buys stocks.

The mutual fund company pools this money, and buys many different stocks. Your mutual fund may own parts of 100’s of stocks. The perceived benefit of this is diversification. Some investors, especially those that do not spend their lives researching different companies, like diversification. It operates under the premise that if a few stocks do poorly, you won’t lose everything. If a well-managed mutual fund goes under, it means that thousands of companies have gone under, the economy as we know it is gone, and you need to move to your underground shelter with your canned food and weapons cache. So for many investors, diversification seems to reduce risk.

For example, if you have $1000 to spend, you could buy 100 shares of Wizzy Cola, or 100 shares of Livewell Mutual Fund. Livewell invests in over 100 stocks, including Wizzy. Unfortunately for Wizzy, their new CEO is caught with his hand in the till, profits are down, and 50 people got salmonella after a party where only Wizzy was served. Unfortunately for you as a stock holder, Wizzy stocks drop 30% and will seem to keep falling. If you own only Wizzy stock and you try to sell out because it seems like the company is going under, you are out $300 and more. If you own Livewell, their mutual fund only had 1% of its money invested in Wizzy, so the dent in your investment is much lower. Your “share” of Wizzy may have been $10 within the mutual fund. And unbeknownst to you, Crazy Cola sales skyrocketed in the wake of Wizzy’s misfortune, and their market share was set to increase, vaulting their stock prices, so their gains (as part of Livewell’s fund) offset your Wizzy losses.

In conclusion, many investors see diversification, and thus mutual funds, as good instruments to invest. Their risk is spread over hundreds of companies rather than in one or two. It is the old ‘don’t put all your apples in one basket’ approach.

In future posts, we will discuss different types of mutual funds, and what to look for when choosing a mutual fund.

Beginner's Guide to Getting Started- Finding a Parking Lot for Your Money

noreply@blogger.com (Ken) — Sat, 04 Jun 2011 02:39:00 +0000

At this point, you may have figured out what type of investor or saver you want to be. I would say that personally, I am a cautious to moderate risk taker, when it comes to saving. But when I started, I was extremely cautious. This worked for me because at the time, bank interest rates actually produced interest, and I wasn’t very knowledgeable about different investment products. It is fine to start out as cautious as you like, as long as you use the time to learn more about different savings and investment options.

Some investments for the most cautious include a savings account, certificates of deposit, interest bearing checking accounts, money-market accounts and United States savings bonds. These are places to park your savings when caution is needed or desired. Some reasons you may put your money here are:

You are learning about different higher risk investments and savings instruments

You are cautious

You think you will need money in the short term (tomorrow to 3 years)

These instruments are considered low risk because you rarely if ever lose money on them. You may not gain a lot, but you don’t lose, generally. Bank deposits are usually insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000, so if the bank goes under, you can recover up to that amount. You can check out www.fdic.gov for more information about coverage. This coverage would apply to checking, savings and certificate of deposit accounts at insured banks. Money market accounts aren’t insured, but tend not to lose money, so many people use these to gain a slightly higher interest rate than a standard savings account. You can generally link these to checking accounts or make instant transfers to checking accounts and access your money at any time.

These types of accounts become your 'parking lot'- the place where you hold money before you invest, when you need it, and after you sell out investments.

Beginner’s Guide to Getting Started- Setting Up a Portfolio

noreply@blogger.com (Ken) — Mon, 30 May 2011 23:11:00 +0000

People who invest tend to set up portfolios. These are just collections of stocks and/or other investment instruments. Your portfolio is up to you. If you want to own one stock, then that is your portfolio. If you want to own five stocks, three bonds, a mutual fund and a money-market account, that is also up to you.

People usually set up portfolios depending on their goals. You may want to retire in 20 years, so you will establish a portfolio that fits that goal. You may want income from stocks now, so you would set up your portfolio to match that goal. You may be wildly conservative, or just wild. It depends on you.

So how do you choose investment instruments? Well, looking back to previous blogs, you can glean a general understanding of the potential risks and rewards involved in different investment instruments. Savings accounts at banks seem to offer the least risk and least reward, while stocks and other instruments increase both the potential risks and rewards. You should think about, along with your goals, the amount of risk with which you are comfortable. This will help you determine which types of instruments are right for you.

Along with your goals, it is important to discern your time frame. I like investing over the long term, so volatility doesn’t necessarily bother me. If you are looking to make a killing in a few years in order to put a down payment on a house, then you will need to take on greater risks.

In summary, a good way to start is to:

1. Establish your goals (retirement, get rich, send kids to college, extra money in case something comes up)

2. Establish your time frame (I need it NOW!, I’ve got 3-5 years, looking at 10+ years, I’ve got all the time in the world)

3. Be honest with yourself about the level of risk you are willing to take. (safe, medium, no pain no gain

Any social, moral or ethical dilemmas you may or may not have with certain companies or entities

Once you have your list, you can look at ways to start targeting these goals.

More on stocks for beginners...

noreply@blogger.com (Ken) — Thu, 26 May 2011 00:22:00 +0000

Stocks are one of the most common investments that small investors own. You can buy individual stocks in companies. Companies that issue stock that you can buy are called public companies. They usually trade shares on any one of a variety of stock exchanges. You may have heard of the New York Stock Exchange, the NASDAQ exchange, or various foreign counterparts. The exchanges work as middle-men between the buyers and the sellers. Prices that you see on stock tickers, (the scrolling numbers at the bottom of your TV screen) indicate what price the stock last traded for.

Basically, if you want to buy a stock, you will go through a broker (human or computer). Many brokers are now online, through sites such as E*Trade, Charles Schwab, and ScottTrade. You basically set up an account, wire them money or send a check, place an order with them, and they facilitate the stock purchase for you.

For example, you use one of the ubiquitous on-line trading websites, such as E*Trade or ScottTrade. You want to buy $1000 dollars-worth of Wizzy stock, our favorite cola. Your broker (the site) places the order when the stock price is $10.00 per share. Your site now has an account for you that indicates how many shares of stock you own in Wizzy ($1000-transaction fee)/$10= numbers of shares you now own. Some of these sites charge a flat fee, around $7-$10 dollars per trade, so you would have to factor that in.

Of course, you can use actual human brokers as well. I will get into that later.

Savings and investing- Part 2-Risk expanded- Basics about equities

noreply@blogger.com (Ken) — Sat, 21 May 2011 16:04:00 +0000

In the previous post, I discussed various “low-risk” savings and investment instruments. I placed low-risk in quotes because each person’s assessment of risk is different. I will discuss this in future posts. This post will talk more about other types of savings and investments, particularly equities.

You may hear talk about options, futures, derivatives, short-selling and all of this mumbo jumbo that may intimidate you. As a long term investor, I would like to take a step back and focus on more basic forms of investments. I discussed stocks in previous posts, and will continue to focus on them now as part of my discussion on equities.

Equity basically refers to part ownership, usually in stock shares, of a company. If you own shares in a company, you have equity. Equity basically gives you some rights to vote (based on how much of the company you own) in areas such as board elections, but mostly refers to your piece of a company. Your fortunes will rise and fall with the stock price and dividends you receive. In my previous posts, you can look up an example of how basically stocks work.

Generally, there are two types of stock shares- common stock and preferred stock.

Common stock comprises the types of shares people usually buy on the stock market, or as part of a mutual fund (more on that later). Common stocks are equity (ownership) in the company. They tend to carry voting rights, with regard to company policies, stock splits and board member elections. In the event of liquidation or bankruptcy, common stock holders come after creditors, bond holders and preferred stock holders. There is generally no fixed dividend for common stock holders. Over the long term, they tend to perform better (or worse) than preferred shares.

Preferred stock shares, tend to have “preference” over common stocks when it comes to receiving dividends (pay the preferred shares first) and when it comes to liquidation (in case the company sells or goes out of business). They may have a fixed dividend as well, unlike common stocks. Preferred shares tend not to carry voting rights, unlike common shares. In some cases, they can also be converted to common stock shares. There are many types of preferred stocks, and I won’t go into the “what and why”. If you are truly interested, there is plenty of information on the internet, or you can send me an email.

Which is better? It depends who you ask or what your needs are. And I will discuss “needs” in a future blog.

So why not save all of my money in low risk investments? (Part 1 continued)

noreply@blogger.com (Ken) — Wed, 18 May 2011 23:51:00 +0000

It sounds appealing. No one wants to lose money. With many investment vehicles, you run a risk of losing money. So why wouldn’t you stuff it all in the bank?

Well, the first reason is inflation. Do you recall hearing grandpa say “A dollar doesn’t buy what it used to…” or some similar nostalgic rant? One dollar 20 years from now won’t buy what one dollar buys today. Inflation is basically the record of rising prices for goods that people generally use. The U.S. Bureau of Labor Statistics (BLS) created a Consumer Price Index to monitor the purchasing value of a dollar. They created “a basket of goods and services” that they feel most consumers use, and measure prices for items in the “basket”. These include food prices, housing, electricity and transportation. There are subsets within each of these major groups, but you get the idea. Occasionally the add or subtract items from the “basket”. Inflation generally measures the overall percent increase in the CPI.

You may hear that inflation in 2010 was approximately 1.4% based on the CPI. What this means is that the average cost of what you could buy (based on the CPI “basket”) for $1.00 on January 1, 2010 would cost you close to $1.02 at the end of that year. Currently (at time of posting), it would cost you close to $1.05.

Here is an example. If you put $1000 in a savings account in 2001, you would need to average about 2.4% interest per year in order to keep pace with inflation (before taxes). Depending on your tax bracket, (since you are taxed on interest earned), you would actually need to earn more. About 10 years ago, interest rates on savings accounts fell below 2%, and have hovered there ever since.

The second reason is that, even without inflation, you probably want more money, not the same amount. We will discuss more in the next post about how to potentially make this happen.

Savings and Investing- relatively low risk investments

noreply@blogger.com (Ken) — Wed, 18 May 2011 00:48:00 +0000

There are various ways to save and invest. Each has its own level of risks and rewards. I will discuss the various types here based on perceived level of risk from least to greatest

1. Stuffing money under your mattress, in a sock, in a box buried in your yard- This may be a way to guarantee that you don't lose any money (barring a fire, theft or treasure hunting pirates), but it also guarantees that you don't make any money. Whatever money you put in, you get out.

2. Bank accounts- We all remember the glory days when bank accounts actually gave out interest. When I was a kid, bank accounts gave out around 5% or so, so when you owned a savings account as a child, it actually made sense. Now, you are lucky if you can squeeze out anything above 1%. Let's say you put the $1000 you had into a savings account at 1% interest. Your interest compounds daily. At the end of the year, you will have $1010.05, for a profit of $10.05. Not very much for a full year's work, but more than the mattress pays.

3. Certificate of Deposit (CD)- Consider these to be longer term savings accounts. You can "buy" a CD for a period of time, possibly 30 days, 3 months, 6 months or one year. You are promising to save your money in the CD for that period of time. You cannot withdraw it without incurring some kind of penalty (like losing all interest). CDs usually then offer a slightly, and I mean slightly, higher rate of return than a savings account. You might earn an extra 1/4 or 1/2 percent. You have to consider if it is worth locking up your money for that long of a period of time for such a small reward.

4. Money markets- Without going into a tremendous amount of details, these are relatively safe, short term monetary instruments, usually traded between banks. They can yield a little bit more than savings accounts, and tend to be low risk. It is rare to lose money in a money market account (although, like savings accounts, they rarely keep pace with inflation, so your money is worth less in the future). If you are getting 1% with a savings account, you might get 1.5% or 1.6% or close to that with a money market. Slightly better, but not by much.

These are just some of what are considered "low risk" investments (depending on your feelings about inflation). I will talk more about this in future posts.

Please email or comment, I would love to hear from you.