High Frequency Trading is Here to Stay

While opponents of high speed traders won’t like to hear it, I think the practice is here to stay. As each year passes, there are more and more high frequency trading firms starting up. A sign that these firms aren’t going anywhere is the fact that they have begun to form their own trade associations. Sure, you could say that the pragmatism behind that belief is a little off, but I am convinced that there is too much money involved in the game of high frequency trading to see its growth slow down or taper off now.

As it stands now, high frequency trading is largely unregulated and unless Congress passes sweeping legislation, which is unlikely to happen given its performance during past opportunities to enact regulation upon the stock market or financial dealings, there is nothing impeding the growth of high frequency trading. The drastic increase in political donations points to the fact that high frequency traders are growing in number and are concerned over possible legislative efforts to mitigate their algorithmic trading.

Do We Benefit From High Frequency Trading?

As with any controversial issue there are multiple sides to it. The high frequency trading firms will argue that they are bringing liquidity to the market that benefits the mom and pop investor. They will also argue that this increased liquidity brings about lower pricing for the retail investor that we all get to benefit from.

The critics, on the other hand, will argue that these firms are harming the common investor through their practices. These firms use their algorithms to take advantage of very small price movements within the stock market that are not readily available to investors like you and me. I don’t know that I would say that one side is entirely wrong or entirely right, but this issue is one that does warrant measured consideration.

That said, we have already seen impact, on some level, with high frequency trading from the Facebook IPO debacle, to the Knight Capital fiasco, to the April 22 Fake Tweet Flash Crash, to the Flash Crash several years ago. All those events were related to high frequency trading at some level and had the potential to trigger a much bigger black swan event. With this knowledge of how high speed traders have impacted the stock market as a whole one has to question if they do benefit us and I would say it’s not really at the level the high frequency trading firms would necessarily say.

Is More Regulation the Answer?

The knee jerk reaction to seeing how these firms have increased in number, in addition to the number of problematic events, has led some to believe that regulation is the answer to the problem. I am not one to typically champion increased regulation, though the events of the past do make me wonder if they are called for here.

While there are circuit breakers in place in the event of a quick and massive sell off, there still is a lack of new regulations in place to police the practices of high frequency trading firms. As one who tends to think that getting the government involved generally makes problems worse, I do believe we need to have a national conversation about this topic. We do not want to restrict a free market, but we also do not want to allow things to run roughshod without a certain amount of restraint. The fact that numerous westernized countries have certain regulations in place or are at the very least seriously looking at them does cause me to wonder if we should be doing the same in relation to our high frequency trading issue here in the States.

Should We All Just Throw Up Our Hands?

Now that I have gone on ad nauseam about the issue of high frequency trading, one has to ask what should we do now. Should we throw our hands in the air, take our ball home and stop investing in the stock market? Not at all!

I understand the hesitancy to be comfortable with the market in light of something like this, but I ask you where else will you go to build your wealth? Where else will you go to help further your retirement planning? You could take your money and run and put it into something “safer” like CD’s or certain bonds, but how will that help you reach your goal of accumulating and building wealth as most are earning very little interest overall?

What this issue causes me to see is the increased importance of being mindful of what is going on in the stock market and avoiding an extreme version of setting and forgetting and hoping that your investments will do well. While the growth and expansion of these trading tactics can cause many to fret their financial investment opportunities away, the more concerning thing to me is giving up on investing in the stock market altogether and risk missing out on potential solid gains that would be a boon to your portfolio as a whole. In my opinion, we investors are often a bigger threat to the performance of our investment portfolios than any market force, such as high frequency trading, could ever be.

What’s your take on high frequency trading? Do you think it is here to stay and are you taking actions in your portfolio because of it?

Political Contributions, High Frequency Trading and You is a post from: The College Investor. Please check out the site at http://thecollegeinvestor.com or follow him on Twitter @CollegeInvestin. Thanks!

There’s no shortage of people who attempt to do it, though. In truth, when the market is expensive, so too are individual stocks. So, naturally, one would like to buy when the market is cheap and sell when the market is expensive, whether you’re holding indexes or buying individual equities.

Top Down Valuation Metrics

Recently, I’ve heard a lot about the Shiller PE ratio, a backwards looking ratio built on top of a normal price-to-earnings ratio. The Shiller PE is cyclically-adjusted. It uses 10 years of past earnings, adjusts for inflation, and then divides the 10-year average earnings by stock prices to come to a simple ratio.

The Shiller PE is naturally more conservative than other valuation metrics. In using a 10-year average, it automatically adjusts for booms and busts, as they tend to happen every few years. The last 10 years would include low earnings from 2003, higher boom earnings from 2005-2007, and then depressed earnings from 2008-2010.

The Schiller CAPE ratio would tell you to buy when stocks trade for below the median cyclically-adjusted earnings and slow your purchases, or sell, when stocks trade above the median.

Right now, the CAPE as reported by Multpl.com is 19.35, well above the 14.51 median.

CAPE has some weaknesses. It doesn’t take interest rates into consideration, only a proxy for interest rates – inflation. The historical median of 14.51x cyclically-adjusted earnings happened in periods where interest rates were higher, so naturally earnings multiples were lower. Now, with interest rates at historic lows, earnings multiples should be higher.

What’s Buffett Say?

Warren Buffett may be all about the qualities of individual companies, but he also looks at top down valuations when making purchases on the open market.

His favorite ratio is the market cap of all American equities relative to the gross domestic product (all economic output) of the United States. Currently, the total market cap to GDP ratio tells us that the markets are slightly overvalued.

Interestingly, the ratio is back to its 2007 peak, but still much lower than its dot com bubble high.

There are some obvious weaknesses to this valuation metric. The companies that make up the total market cap of the US markets do business all around the world. Also, it excludes the valuation of private companies, which make up a substantial share of American GDP. In the last decade, acquisitions and take private transactions have taken hundreds of companies off the public markets. These companies are thus excluded from total stock market capitalization.

Finally, it does not adjust for interest rates or alternative investments. If the only alternative is to earn 3-5% by locking up your investment capital for 20 years in corporate or US Treasury debt, paying a higher price for a business isn’t such a terrible alternative.

Using Top Down Ratios as a Guide

Top down investment ratios are best used as a guide than a rulebook. If you look at either the Shiller PE or the total market cap to GDP, you find that stocks are only slightly pricier than historical levels. In a low interest rate environment, one could reasonably call that “fairly-valued.” Investors should expect long term rewards in stocks at or slightly below the long-term averages going forward.

These two metrics are perhaps best used to find places to buy more rather than to sell. Total market cap to GDP is much better at finding tops and bottoms than the Schiller PE ratio, which would have indicated that stocks were extraordinarily overpriced in January 2009. Since then, the stock markets have more than doubled. Buffett’s total market cap to GDP would have told you to be a heavy buyer of stocks during the financial crisis.

All in, no valuation metric is perfect. Markets are at the whim of participants, people who were willing to purchase dot com stocks for triple digit earnings multiples and sell high-quality blue chip stocks for single digit earnings multiples in 2009. But one should keep an eye on top down valuation measures, if for no other reason than to confirm an investment idea that already makes sense to you – long or short.

What are your thoughts on these top down approaches?

Two Ratios for Top Down Market Valuation is a post from: The College Investor. Please check out the site at http://thecollegeinvestor.com or follow him on Twitter @CollegeInvestin. Thanks!

One of the most popular misconceptions about student loan debt is that it is “good debt”.  Though it’s true that going into debt to pay for school is probably a better idea than going into debt to pay for a big screen TV, in the end both debts have to be paid back.  Debt is debt, no matter what you call it.

For students getting ready to go to school this fall, acquiring a student loan has arguably never been easier.  Numerous banks, credit card companies, and financial institutions offer instant approval over the Internet or by phone.  Speaking from personal experience, when I was funding my education, my thought progression went as follows: the school I am attending costs X dollars, I am Y dollars short, I will get a loan for Y dollars.

Things like interest rate and repayment terms took a back seat to speed and efficiency.  In my case I decided I needed a loan for $6,000.  I went to my bank’s website, entered in my information, and I was instantly approved.  Some schools make it even easier – sign a Master Promissory Note once when you’re a freshman (that takes 5 minutes), and they’ll instantly approve your loan for each quarter until you graduate – no thinking at all.

I never for a second considered whether or not I could afford the debt I was getting into.  The goal of this article is to illustrate the things each college student and cosigner need to consider before they apply for student loans.

Student Loans Compared to Other Forms of Debt

Student loans are a unique form of debt unlike all others.  The most important difference between student loan debt and most others is that student loan debt can almost never be discharged through bankruptcy.  For the 18 year old who is about to enter college, bankruptcy is probably the furthest thing from their mind.  However, it is a critical consideration, because anyone who is about to sign for a student loan needs to understand that no matter what they do, that debt will follow them.  If you don’t pay your student loan bills, you go into default, your lender can garnish your wages and you are powerless to stop it.  Just remember the story about the lady who was getting her Social Security garnished to pay her student loans.

ALL borrowers, no matter how confident they are in their job prospects, need to understand this dynamic.  First of all, if you are borrowing on a loan with almost no bankruptcy protection, you should make sure you are getting a lower interest rate.  The lender is taking less of a risk, and that should be reflected in the terms of your agreement.  Secondly, because the lenders know they can always collect on these loans, they have no incentive to work with you to assist repayment.  Compare this to a credit card company.  If you owe $20,000 and tell your credit card company you are struggling with payments and are considering bankruptcy, they will go to great effort to see to it that they collect as much as possible from you.  A student loan company has no incentive to do so; they know they are getting their money from you.

Therefore, we are left with one undeniable fact: If you borrow a student loan, you better be certain you can pay it back.  The collateral of the student loan is YOU – your ability to repay it in the future based on your income.

Can I Afford My Student Loan?

In order to fully understand whether or not you can afford a student loan, you need to know your loans interest rate, origination fees, and when you will start paying it back.  For the sake of example, lets assume you have some scholarships, a bit of help from home, and because you were smart enough to go to a state school, you only need to borrow 10k a year.  Guess how much a month that will cost you when you graduate?

In order to get that 10k for your first year, lets say you are able to find a loan with an interest rate of 5% and a loan origination fee of 2%.  Some will find these numbers high, others low, but they are definitely reasonable and they make the math a bit easier.  If you borrow that 10k, it immediately becomes $10,200.00 due to the origination fee.  Because you are in college, you likely won’t be able to make payments on the loan so the interest will continue to grow.  Assuming it compounds monthly, if you take out a loan for $10,000 your freshman year, it will have grown to $12,453.13 four years later.  The exact same loan from your sophomore year will have a balance of $11,847.02, the 10k loan from your junior year will have grown to $11,270.40, and your most recent 10k loan will already have a balance of $10,721.85.  Meaning if you take out only 10k a year for four years, by the time you graduate you will owe a total of $46,292.40.

On the standard 10-year repayment plan you will have to pay $491.00 per month.  That means even if you find a good job paying 60k a year, nearly 10% of your income will be going to student loans for the next decade.  What will you do if you can find a job at that level of income?

The point of this exercise is not alert you to be ready to pay $500 a month when you graduate, nor is it to scare people out of going to college.  Instead, the point is for everyone who is considering student loans to go through and do the math.  Put together a plan A, a plan B, and a plan C.  Compare this math to what it would be if you just paid the interest on your loans while you are in school.  Investigate the repayment plans that your lender may be offering.  The federal government has a great variety of repayment plans and even some forgiveness programs, but the low undergraduate loan limits mean people will often have to resort to private loans.

A Checklist Before You Apply for Student Loans

Here is a checklist for responsible student loan borrowing:

1. Determine how much money you already owe, and how much you will need for each remaining year of college
2. Find out your student loan interest rate and how often it compounds
3. Add any origination fees
4. Calculate the total debt you expect to have when you graduate
5. Review the available payment plans
6. Estimate conservatively how much you expect to be making when you graduate
7. Ask yourself honestly if this is something you can afford

The price of college has never been higher.  Americans owe over 1.1 trillion dollars in student loan debt.  For the amount you are borrowing, you could probably buy a nice car or even a house.  With this kind of money changing hands, be smart about your research.  Before you sign your name on the dotted line, know exactly what you are getting yourself into.

This is a guest post by Michael Lux, from The Student Loan Sherpa.  After being utterly disappointed with the lack of helpful information available regarding student loans, he created his site. Michael now spends his spare time trying to keep his lenders happy and helping others satisfy their student loan overlords.

Things to Consider Before You Apply for Student Loans is a post from: The College Investor. Please check out the site at http://thecollegeinvestor.com or follow him on Twitter @CollegeInvestin. Thanks!

I could fill a book with nuggets of wisdom I’ve picked up in the nine years I’ve been out of college (first, where on earth did I put my gosh darn dentures?). But there’s one piece of financial advice that would have made a huge difference in my life.

I thought I’d share that with you, the most important piece of financial advice for college graduates:

Stay Out of Credit Card Debt, No Matter What

Here’s how my post-college life started. Graduating cum laude in 2004 with a degree in politics and a relevant job in my field upon graduation set me up for success. Many of my classmates didn’t have any jobs lined up, and the economy, which was so strong when we started college in 2000, was not looking good. But that didn’t matter to me. No. The 22-year-old version of myself was unstoppable. I was excited, and I got to work on a campaign. Looking back, I never could have kept up that pace of working 100 hours a week, walking door-to-door, asking voters for their support in November. But I thought I could propel myself toward a more lucrative, more powerful political job in Washington, DC.

The Conversation I Wished I’d Had

Let’s say someone older, and wiser, took me aside. Not my dad, because what 22-year-old listens to their dad? Definitely not the ones who know everything and feel that every good thing can come their way. Let’s say a professor took me aside. “Kathleen, there’s something you should know,” she’d say, and I’d be all ears.

“You have a good head on your shoulders, an amazing work ethic, and the drive to do anything you want. The problem you have is your optimism gets in the way of reality sometimes. So, here’s what I’d like you to promise. Wait until you earn a paycheck or two before you spend it. Bills will come with regularity, and so too will your paychecks. But never, I repeat, never ever, use your credit card to pay for something you can’t afford.”

I didn’t have that conversation. Nobody told me not to view credit card limits as a challenge.  To pretend that my credit cards were like debit cards. To shred those “convenience checks” instead of filling one out and helping a friend of a friend invest in his business to the tune of $20,000. My optimism believed that friend of a friend when he said that I’d get the money back before interest started accruing.

Everyone’s get-into-debt story is different, but so many start right after college, when you spend more money than you earn. Sometimes it’s little by little. Sometimes it’s a huge amount. I think part of the reason it happens is because when you get that first job offer, you don’t really understand that $40,000 in salary is really more like $33,000 after taxes. You can get mad at the taxes all you want. But if you get into credit card debt, you’re the one who has to pull yourself out. No one else.

If you can manage to keep ahead of your credit cards in your early years, you will be one step ahead of everyone else. You can work toward paying off your student loans, start saving for a down payment, and yes, even drink until last call every once in a while.

But no matter what, make sure you are always paying off your credit cards.

Own your finances. Do not let the credit card companies own you.

What financial advice for college graduates would you give?

The Most Important Piece of Financial Advice for College Graduates is a post from: The College Investor. Please check out the site at http://thecollegeinvestor.com or follow him on Twitter @CollegeInvestin. Thanks!

Purchase a Share of Common Stock

This is the most common way to own a company. While it doesn’t feel much like ownership, you do in fact have ownership of the company and have rights to understand the company’s strategy and decision making. So how much of the company do you actually own by purchasing shares in the general stock market? Well, it all depends on how many shares you buy. If a company has issued 100,000 shares and you own 100, you essentially own 0.1% of the company.

Become an Angel Investor

A pimple-faced kid walked around the neighborhood, asking friends and acquaintances if they’d like to invest in his company. He spoke some geeky gibberish about software and user interfaces, but it didn’t make much sense to you, so you politely turned him down and closed the door. Little did you know that this opportunity could have made you millions. That kid that was just at your door was Bill Gates! Just think, what if you were able to provide him some start-up capital in exchange for 10% ownership of the company? What would that be worth today? At Microsoft’s peak, it was worth over $600 billion. You, as a 10% owner could currently be worth $60 billion. Not too shabby huh?

Well this is obviously easier said than done. First of all, you have to have some serious money stashed away, and second, you need to have some connections to the newest up-and-comers (because chances are that these opportunities aren’t just going to fall into your lap). If you truly do find some talent that shows some promise, don’t be afraid to invest. Sure, you might lose everything, but you also might find the next Bill Gates.

Buy Preferred Shares

Buying preferred shares is yet another way to own a portion of a company. Those that purchase preferred shares often think of their investment as they would if they owned common shares. However, in the event of a liquidation, those that have preferred shares will be the first to receive any kind of payment (if there is any money left). This is an obvious advantage, but it also comes with its disadvantages, such as having to give up your voting rights.

Buy Stock Options

Instead of just buying shares the old fashioned way (through common or preferred shares), you could purchase stock options, which, quite obviously by the name, gives you the option to buy the stock. But, how exactly does this work? There are many different types of options, but for the sake of this example, let’s use a call option. If a stock price is currently $40 and you believe that it’s going to increase in value and rise to $50 per share, you’d buy a call option. If, in fact, the stock price does rise to $50, you now have the option to purchase the share for $40 and could effectively turn around and sell it (if you wanted) for $50. But, if you felt like the price would continue to rise, you could keep it and own a portion of the company for a little longer.  A lot of people look to boost their returns by buying stock options.

Buy a Stock Warrant

Many of you may not have ever heard of a stock warrant, but they are almost the exact same thing as an option. Using the example from above, if you thought a stock price was going to rise from $40 to $50, you could buy a warrant that would allow you to buy your shares after the stock price had risen. You’d pay the $40 after the stock went up and own the shares for $50. But, here’s the real difference. Rather than purchasing the shares from another investor, you would actually receive the shares from the actual company. Typically, a company does this if they’re looking to increase their cash reserves. Since they directly offer the shares to you, the investor, the money that is used to make the purchase goes directly back to them.

So What’s Your Choice?

I currently own my own business, meaning I actually started a business from scratch. Let me tell you that it is a ton of work! But, I have total control over all of my operations. If I want to sit back and do a little less work this month, I have that option. Sure, I make less money, but I don’t have any investors to worry about because I’m not incorporated (yet). On the other hand, since my business is completely my own, I have the ability to ramp up my efforts as well and hopefully make some additional money. With greater control though, comes more responsibility.

Many people like to have a little less influence on their business. For instance, some people really like the idea of investing in real estate, but do they go out and buy a quad-plex and rent out each room personally? Most likely no. What do they do instead? They invest in real estate in the market! They can diversify their investments more effectively and they have far less responsibility, while still capitalizing on the growth of that market sector.

So what is your choice? Do you prefer to start an actual company on your own? Or do you like the idea of a more hands-off approach? If you’d rather invest your money in the hands-off approach, then which of the choice above would you most prefer? Any reason why you’d choose one over the other?

Beyond Stock: Creative Ways to Own a Company is a post from: The College Investor. Please check out the site at http://thecollegeinvestor.com or follow him on Twitter @CollegeInvestin. Thanks!