31
Mar
Posted in Investing 101 by Roger, the Amateur Financier |
(Hey kids! And teenagers, adults, cats who fell asleep on top of the keyboard and anyone else who might be out there reading this; guess what time it is! That’s right, it’s Investing 101 Time! This week, we’ll cover the wonderful, wacky world of ETFs!)
Q: Alright, so what is an ETF?
A: Exchange Traded Funds, more commonly known as ETFs, are similar to mutual funds in that they are investments that hold stake in numerous other investments. ETFs are created by buying a large amount of stocks (or bonds, real estate, commodities, or other investments), usually following the allocation of a particular market index, and putting them into a trust. Shares of the trust are created, typically in lots of 50,000 (called creation units) and each share represents a stake in ownership of the trust (similar to the way that shares of stock represent ownership of a company).
Q: Why buy an ETF, then? Why not just buy the underlying securities?
A: Because there can be hundreds, if not thousands, of securities in a particular index. To buy all the stocks represented in the S&P 500, you’re have to purchase 500 stocks, each of which will generate a commission at your brokerage. Buying an ETF enables you diversify your holdings instantly, owning numerous securities with one fell swoop, cutting down your costs.
Q: Wait, I thought that mutual funds diversified your holdings. Which is it, mutual funds or ETFs?
A: Both, actually. ETFs are closely related to mutual funds, especially index funds, which follow the same allocation as popular indexes. Both investment choices allow you to diversify your holdings with a single investment. Most ETFs invest in the same indexes as index funds, allowing you to choose which type of investment is more appropriate for you. The prime difference is how they are acquired (ETF shares are purchased through a brokerage, while mutual fund shares are bought from mutual fund companies) and how they are priced (ETFs are priced based on the last traded value, while mutual funds are priced based on the value of the underlying funds).
Q: Are there any particular advantages to using ETFs rather than mutual funds?
A: First, ETFs tend to have a very low expense ratio, even lower than the comparable index mutual funds. Second, ETFs trade throughout the day, allowing you to purchase or sell them instantly (which might be a disadvantage in some people’s eyes). Third, it’s possible to use ETFs to invest in certain sectors of the broader economy, since you can buy an ETF that is invested in, say, financial stocks when you think they’re about to increase in value, and then sell it easily when you think that sector has peaked.
Furthermore, you can do some more complex investing maneveurs with ETFs that are impossible with index funds, like shorting them (that is, borrowing shares from other investors, selling them, and then buying them back at lower prices, hopefully) or using options (specialized investment derivatives, allowing you to set particular prices at which you can sell your holdings or buy other assets). If you’re an active investor, having these possibilities make ETFs a great trading vehicle.
Q: I’ve done enough of these to know what’s next; what are the downsides to ETF investing?
A: I’m glad you asked. One big downside is that since you purchase them through brokerages, you need to pay commissions whenever you buy or sell your ETFs shares. This will cut into your profits, especially if you trade ETF shares regularly. Further, there is a spread between the bid (the amount a buyer pays) and the ask (the amount a seller receives), which means even if you find a broker that offers you commission-free trades, there’s a hidden cost to your purchases and sales. For these reasons, if you buy and sell ETF shares throughout the day, you can end up losing more money than simply putting your money into a mutual fund, where the ability to trade shares is much lower (and the temptation is that much less).
Q: Which should I choose, mutual funds or ETFs?
A: It depends on your goals, investment style, and schedule. If you are investing frequently, especially in small amounts, mutual funds are probably better for your needs. The lower expense ratios of ETFs will make little difference if you’re paying 5% of your investment money towards commisions to buy the ETF shares.
On the other hand, if your investments tend to be seldom, in large amounts, ETFs are likely to be better. If you’re investing $10,000 once a year, the expense ratio is going to take a bigger chunk of your money than a small commission fee when you buy the ETF.
Q: Is there any way to actually figure that out?
A: There is. Just consider this equation:
Real Return = (Money Invested – Commission) * (Rate of Return – Expense Ratio)
The term in the first set of parantheses tells us the amount of money we actually have working for us in our investments. The second term shows the real rate of return, taking into account the expenses for the fund when calculating the rate of return. You can use this equation to figure out what will be the less expensive investment, or to work out which type of investment will lead to a greater value years from now (which I would hope is more important to you).
If you don’t feel like setting up a spreadsheet, (and if you’re not a geek like me, you might not want to do so), there are tools out there that allow you to figure out the better investment online. I like Vanguard’s cost comparison tool, both because I like Vanguard in general, and because it’s an interesting tool. Seeing how your investment patterns and expenses can influence the better investment choice can be informative, and sometimes surprising.
That’s all the time we have for this edition of Investing 101; hopefully ETFs are now more than a random set of letters to you now, and you feel better about how to go about investing in them.
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30
Mar
Posted in Uncategorized by Roger, the Amateur Financier |
Some comments that My Life ROI made on my last Thoughtful Thursday post got me thinking about pet ownership. ROI has argued that owning a dog has many financial benefits, including health advantages, socialization, and security. (Although, as I noted in my response to his post, a yappy little poodle is unlikely to scare off any potential robbers.) On the other hand, Free Money Finance, for one, has been decidedly negative about pet ownership, noting the yearly and one-time costs associated with owning a pet.
My view? I think both views, while valid, miss the point. The main benefits of pet ownership are psychological; if you are someone who loves pets, there’s little chance you’ll be satisfied without owning a pet. It’s a quality of life issue, first and foremost. You need to look at your interests, and if owning a pet is something you want in life, you will just need to integrate pet-ownership into your other household expenses. Going broke in order to own a dog won’t be good for either of you. (And if you don’t have your finances properly in order, you might find yourself facing some hard choices if your financial situation worsens.)
But as with most things in life, it’s not an all or nothing proposition; if you treat pet ownership like any other ongoing expense (similar to car ownership), plan ahead, and budget for your cuddly puppy or adorable kitty (or other non-exotic pet), you’ll be able to handle anything that owning a pet can throw at you. Some things to consider:
1) Know the costs of your pet before you adopt it. The Society for the Prevention of Cruelty to Animals (SPCA) lists the costs of owning several common pets. There are ways to cut down on some of the expenses (for example, by getting the equipment you need to care for them second-hand), but some expenses like food are inevitable. If you can’t afford the costs of the pet, you need to (a) cut other household expenses, (b) find ways to earn more income, or (c) consider a cheaper pet (or even no pet, at least until your finances improve).
2) Set money aside for emergencies. Even if you know how much your pet will cost each year on average, there can be problems and unexpected events that exceed the normal pet budget. Having an ample emergency fund, enough to cover expenses for you, your family, AND you pet, is invaluable. (And can help you avoid situations where you have to put your pet down because you can’t afford to care for him or her.)
3) Be aware of your life situation, and have a back up plan. Life happens, as we know; you need to know how likely it is that you will be unable to care for your pet through its whole life. If you have a puppy, it’s possible that it will live another fifteen years, or longer; for cats, the maximum life is even longer. Are you going to be able and willing to care for your pet more than a decade from now?
If not, or if you are not sure what the future will hold that far in advance, you need to have a back up plan for your pets. You could arrange for a relative to take your pet or make sure that your local shelter will be able to care for your animal if you cannot do so yourself. As with any life-altering change, adopting an animal should not be undertaken lightly; you need to provide for your pet should something happen.
4) Adopt an older pet. There are multiple benefits to having an older pet. You usually find pets that are well trained, friendly, and have all their shots, cutting down on out-of-pocket expenses to get them ready to live with you. You can also get the mental boost of helping organizations like the Humane Society and ASPCA to adopt animals that might be put down or spend the rest of their life in a kennel. Older animals are also less likely to be hyperactive, which can be an advantage if you are a more sedate person by nature.
Follow these suggestions, and you should be able to integrate owning a pet into your financial plans without a problem.
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29
Mar
Posted in PF Spotlight by Roger, the Amateur Financier |
Another week is upon us, and with it comes another PF Spotlight. This week’s feature goes to Lazy Man and Money. Let’s be honest, it’s a cool blog name, and he usually has good commentary; what more do you want from a PF blog? That said, he’s one of the moderators of the Money Blog Network and works a ‘regular’ job on top of his blogging, so he’s hardly lazy; false advertising, anyone?
Ah, I kid, I kid. He’s really a great blogger. Some of the most interesting posts he’s put up recently:
Money’s Seven New Rules of Financial Success (Part 1) and (Part 2) – Lazy Man covers an article in the most recent article of Money regarding the ‘new’ rules of money (which you can read here). Lazy Man’s conclusions pretty much line up with mine; the new rules aren’t so new, at least if you’ve been reading up on personal finance. Still, it’s good to get reminders about these rules every now and again, especially now, when there’s so much talk of ‘everything changing’.
Dog Costs for the First Month – A post covering some of the costs that arise when adopting a puppy. A good list to consider before purchasing a dog. Not having had a dog since I was quite young (and not paying for that dog myself, obviously), I wasn’t aware how expensive a dog, even a rescue dog, could be. An eye-opening post for us non-pet owners.
Leaving Full-Time Blogging - Lazy Man is probably unique in having left his previous job for full-time blogging, and then having gone back to work. (Crazy, I know, but to each their own.) He notes that he’s spending more money, and also becoming more efficient, as he tries to keep up with his blog, his job, and his new dog.
Giving a Lasting Gift to a Baby…(But Not the Parents) – An interesting post; Lazy Man discusses how to give a financial gift to a child that the parents will not be able to access (in this case, because they aren’t good with money). One good idea that came up was to open a 529 in the child’s name and donate to it every year. This works pretty well for a relative, but not so well for the child of a friend; the original questioner wanted a one-time gift that would still be available to the child regardless of how his friendship with the parents proceeded.
Lazy Man’s favorite suggestion is to give the parents a book on managing money, with an IOU promising to contribute a match to a 529 plan when they open one up. Not a bad idea, but you have to be aware of how the parents will react to that kind of gift; if they’d be insulted by a gift encouraging them to be more financially responsible, it could do more harm than good. If that’s the case, you might need to find an alternative gift idea.
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28
Mar
Posted in Weekly update by Roger, the Amateur Financier |
I’m feeling rather manly. As I write this, I’ve just completed constructing a salad table for my girlfriend and her mother. My girlfriend got the idea from Martha Stewart, and I, um, ‘volunteered’ to help her out.
A salad table, for those who don’t know, is a wooden frame (similar to a table) with compartments lined with mesh underneath. The mesh keeps the soil in the compartments from falling out, while allowing water to pass through. This makes it ideal for growing plants, particularly vegetables, in situations where you don’t have much access to soil.
If you do build a salad table, I suggest you stick with the directions as given, and use screws. I built my table using nails, and it seems somewhat unsteady. It’s still stable enough to use, but screws would make it more secure.
Even with that caveat, I do feel proud of my accomplishment. It’s nice to able to make something with my own hands, and to have that item be put to good use. I’m especially glad, as I had never heard of a salad table before, so it’s been a learning experience all around.
Onto my finances:
Offline Savings
PNC (Checking Account) $ 100 -$1229
Susquehanna (CD) $ 2542 +$0
Online Savings
ING Direct (Checking) $ 55 +$0
ING Direct (Savings) $ 1118 -$220
ING Direct (Orange CD) $ 1016 +$0
HSBC Direct (Savings) $ 23 +$0
Smarty Pig (Savings) $ 1398 +$450
Total Savings $ 6252 -$1900
Investments
Vanguard (Roth IRA) $ 6935 +$281
- Small Cap Index (NAESX) $ 3470 +$144
- High Dividend Yield (VHDYX) $ 2917 +$121
- Foreign Total Market (VGTSX) $ 547 +$15
Share builder (ETFs) $ 2948 +$177
- Total US Market (TMW) $ 960 +$55
- Extended Market (VXF) $ 811 +$55
- Total Foreign (VEU) $ 575 +$25
- Small Cap Value (VBR) $ 277 +$21
- Emerging Markets (VWO) $ 324 +$20
Other Investments
Lending Club $47 +$47
Vanguard (Money Market) $ 901 +$0
Total Investments $ 10831 +$1406
Total Assets $ 17,083 -$494
Debts
MasterCard (JCPenney) ($ 28 ) +$0
American Express ($ 813) +$161
Student Loans ($ 11,882) -$8
Total Debts ($ 12,723) -$169
Net Worth $ 4360 -$663
I shifted the organization of my investments and savings around. I’ve also added the funds I’ve had in Lending Club to my investment list. This arrangement more accurately reflects how I actually view my accounts, and should help me to monitor things more readily. There’ll be more changes next month, as I’m closing out my two CDs and reinvesting the money.
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