The Amateur Financier

When we last saw our intrepid hero, he was minutes away from completing an investment in Lending Club.  Unfortunately, he was stopped at the gate, unable to buy Notes (the name for the Lending Club investments, parts of loans to other people) directly from Lending Club as a result of living in the state of Pennsylvania.  What will our intrepid hero do now?

Luckily, Lending Club offers a second method of acquiring Notes, purchasing them off the original investors on a secondary market at the Note Trading Platform.   (I still haven’t heard a good reason why I can buy second-hand Notes, but not new Notes.  But, that’s an issue for a different blog entry.)  Since I still had the (free) $50 from the Lending Club promotion, I decided to check it out:

Foliofn Trading Platform

The trading desk did not look much different from the mutual fund sites I’ve used to seeing.  You can go in, click on individual notes and see the status of the loan repayment. You can see the starting price for the Notes, the current selling prices, and the expected yield on the Note, if held to maturity.  You can also see if the borrower’s credit score has changed during loan period or whether he/she/they are late on any payments.

In a way, it’s similar to how the stock market really works.  After the initial public offering (akin here to the creation of Notes and purchase through the main Lending Club system), the price that a stock can be sold for is determined by an number of factors affecting the business and the broader economy.  Good information leads to high prices, bad news drives prices downward.

With some browsing, I settled on a C1 grade note yielding 11.78% and an E1 note yielding 15.68%:

My C1 Note

My E1 Note

The combination of these two Notes should give me a decent yield, but not have too much risk of default.  If these investments go well, I’ll probably be adding more money to my Lending Club accounts.  If not, I’ll just have to write off the $50 as a learning experience (and take some solace in that it wasn’t actually my money).

I’ll have to give regular updates on the progress of my Notes, and when I’ve seen how this investment with Lending Club pans out, I’ll have to give it my final review.

When it rains, it pours, I suppose.  I wrote my article about serving on consistory at my church yesterday, where I stressed the need for volunteers and money in order to keep the church running, especially in light of the recent economic downturn. On the very same day, Wisebread put up an article by Catherine Schaffer about Nine Charities that Deserve Your Money.  And down at number 8, you have local churches and charities.  I suppose that great minds think alike.

Catherine’s proposition is simple: if we need to put more money into the economy (as just about every commentator says we should), our focus should be on the people who can really benefit from that money.  I agree completely; I’m going to look seriously into these charities, and see what I can do to help.  (Some, like Habitat for Humanity, might be better served with donations of time rather than money; luckily, I have more than a little bit of time on my hands.)

Some of the other thoughts I’ve mulling lately:

Writer’s Coin is at WiseBread – The title pretty much sums it up, but I’ll elaborate anyway: the blogger behind Writer’s Coin, WC Porter, is now publishing articles on the popular PF site, WiseBread.  (Yup, the same WiseBread from which I pulled the first article; it’s a big, popular PF website.)  Anyway, go and support him!

Buying a Dog Saved Me Money – My Life ROI makes some financial arguments for dog ownership, starting with exercise benefits and ending with security.  I don’t think his arguments are applicable for all dogs; trying using a tea cup poodle for security purposes, and you better hope the burglar laughs himself to death at Muffin’s yapping barks.  But his main points are valid; dogs and other pets have numerous advantages, most of which are not limited to finances.

Money May Satisfy But Does Not Bring Happiness – An interesting post by Mr. ToughMoneyLove, detailing a study noting the effects of increased income on happiness (the positive feeling, as measured moment to moment) and satisfaction (how fulfilled you feel in life overall).  The study noted that money was more closely correlated with satisfaction than with happiness.  One possible reason: lower income people had more leisure time.  My inferred conclusion: giving up a few hours of overtime to relax or otherwise do something for yourself might lower your satisfaction, but could make you happier.

What You Don’t Know About Renter’s Insurance – Stephanie of Poorer Than You covers some of the finer points of renter’s insurance.  I’ve never had to rent a place of my own (one of the positives of ‘boomeranging’ on my mother and living in her basement, I suppose), but when I do, I’ll be sure to look into renter’s insurance.  It sounds cheap, easy, and highly advantageous should something unfortunate occur (which is, of course, the whole reason to have insurance).

Paying Less for Prescriptions: Generics and Assistance – On a sadder note, we have a story about a woman who stopped taking her medications and ended up dying of a stroke.  Mrs. Micah then lists a few recommendations to avoid finding yourself in this sort of situation, including buying generics and signing up for a prescription drug plan.  Hopefully, we stop a repeat of this incident; some tragedies can be avoided.

One of the ways I volunteer my time is to serve on my church’s consistory.  It’s essentially the Board of Directors, making decisions about budgets, hiring, and strategic planning.  If it happens in the church, we need to approve it, determine how to implement it, and get regular reports on the progress that’s made to complete it.

It’s an interesting view into running the church, getting to see behind the scenes.  I’ve learned many things about the expenses associated with even a small church. One of the most important, if somewhat disillusioning, things I’ve learned it that money really does make the world go round.  It’s nice to think that our churchs, mosques and synagogues are immune from the money-grubbing ways of the outside world.  Unfortunately, that’s not the case.  My church (and yours, if you are a church going person) has all the expenses of any other business, including salaries, building maintenance, and administrative expenses.  If these things aren’t all paid, the church will fail to run, and might even fall into bankruptcy.

Furthermore, our church holds several investments, of which I was not even aware before joining the consistory.  We have three mutual funds from Vanguard, which fell in value along with the rest of the market over the past year.  These falling investments have put pressure on our finances, along with every other organization with exposure to the stock market.

Another lesson is that, as the number of volunteers decrease, the number of paid positions we need to fill increases.  We’ve had to add at least two positions in the course of my one year tenure on the consistory, each requiring a salary to get the needed work done.  As more work goes undone by volunteers, more employees are added, leading the remaining volunteers to feel as if they should be receiving a salary as well.  And the cycle continues, with an ever larger portion of our work being done by paid professionals.

One particularly sharp lesson is that when the broader economy goes sour, the ripples can spread further than you’d initially believe.  In part because of the economic downturn, the attendance at our church has been down and the offerings decreasing.  Combined with the aforementioned investment declines and increasing number of staff members, and we’re finding ourselves in a financial crunch.

All of these have helped to put our church in a bad way financially.  We are considering cutting down our giving to other churches and charities, looking at what functions we can do without, and even debating whether we should merge with our neighbors.  In any case, there’s no chance that we’ll be able to continue the same way we’ve been going so far.  In many ways, it’s much the same situation many individuals find themselves in currently, debating what needs to be removed from the budget in order to make ends meet.

I’m not writing this to bring anyone down, merely to describe some of the things I’ve learned as a volunteer with my church.  It’s given me a valuable look at how the church is run, enabling me to have a better understanding of the money, time and effort needed to run a sizable organization.  It’s been an enlightening experience, one I’d highly recommend to anyone who’d like to help their community and gain some first hand knowledge at how an organization like this functions.

(Welcome back!  I hope you are ready for some learning, as we are going to cover the wonderful world of mutual funds.  Hold onto your hats, it’s going to be a wacky ride.)

Q: What are mutual funds?

A: Mutual funds are companies that buy a variety of other investments, such as stocks, bonds, and REITs.  Shares of the mutual funds are then sold to investors, who then can participate in the gains or losses of the investments.  The mutual funds charge some expenses to the investors, covering the costs of maintaining the funds and employing the fund managers.

Q: Alright, sounds reasonable.  Why should I invest in mutual funds, though?

A: The primary reason to invest in mutual funds is for diversification.  Each mutual fund holds dozens, hundreds, or even thousands of individual investments.  Buying shares of a mutual fund allows the investor to own a tiny amount of each of those investments, limiting the damage that a single bad investment choice can cause.

Another advantage of mutual funds is that fund companies will allow you to regularly invest new money into the mutual fund without paying commissions.  This includes reinvesting dividends or capital gains distributions automatically, if you choose to do so.  By investing in mutual funds, you could save the money that would be spent reinvesting these funds in stocks or bonds.

Q: I’m sold.  What types of mutual funds are there?

A: There are thousands of mutual funds, covering just about every investment type in existence.  Just within the stock funds, for example, you have foreign and domestic funds.  The domestic funds are further divided up into growth (companies that are expected to grow faster than most companies), value (stocks that sell for  less than their intrinsic worth), and blend (a mixture of these styles) funds.  And these funds are divided even futher, into large, mid, and small sized company funds, dependent on the overall net worth of the company.  These divisions are expressly shown in a style box, such as the one below, where each small square represents a different type of fund (with some even covering more than one box):

An example style box

And there are still other distinctions; some funds invest in particular sectors in the broader market (such as technology or utility stocks), others invest for dividend yield, and still others invest according to principles of social responsibility.  And that’s just domestic stock funds; there are other distinctions for foreign funds and bonds…

Q: Alright, alright, I get it; there are lots of different funds.  Are there any important distinctions?

A: All the distinctions are important.

Q: *Threatening Stare*

A: Alright, one particularly important distinction is the difference between index funds and actively managed funds.  Index funds follow various indexes (like the S&P 500, the Russell 2000, the Wilshire 5000), holding all the stocks in the index (or sometimes a smaller, representative sample).  Actively managed funds have managers running things, choosing which investments to buy and sell.

Q: Ooo, that sounds good.  What could go wrong with having professionals choose my investments?

A: Oh, yes, that… Well, while active management can beat the indexes (in theory), in practice, most actively managed funds keep pace with their respective indexes, at best.  When you take into account the higher expenses charged by active funds (typically above 1% of the assets being managed compared to 0.2-0.4% for index funds), they usually end up lagging behind the comparative index.  A good primer on the difference can be heard on the Vanguard website.

Q: That’s no good.  So, it’s better to stick with index funds?

A: Generally, yes.  While there can be actively managed funds that outperform the appropriate index over a long period of time, it will take time and research to find them.  Furthermore, there will be changes, whether in the management or in the broader economy; active managers that do well in good economic situations may crash during bad times, or vice versa.

For the most part, having most (or all) of your mutual fund money in index funds will serve you well.  Adding actively managed funds only after much research, a thorough understanding of how the fund manager will use your money, and a reasonable expectation of how much more money you will earn from taking an active approach is a smart approach.

Q: I get you.  How should I invest my money in mutual funds, then?

A: That’s the $64,000 question; there are almost as many different ideas of how to invest in funds as there are commentators making the recommendations.  In short, a lot of different ideas are being bounced around.  There are a few generally agreed upon principles:

1) When you are young, you should own mostly stock funds, gradually adding bond funds and even cash to the portfolio as you get older.

2) You should have exposure to foreign markets as well as domestic stocks, to help diversify your holdings even further.

3) Narrower types of funds, such as sector-specific funds, should be used sparingly in your portfolio.  Most of your holding should be broad, total-market  funds, whether in domestic stocks, foreign stocks, or bonds.

I go more in depth about one method of creating a portfolio from stock and bond index funds in my second investment pyramid post.

Q: Any shortcuts to all that investment work?

A: Most fund companies now offer target-date funds.  These are funds of funds, mutual funds that invest in a variety of other mutual funds.  They are designed to start out fairly agressive (mostly stocks) and gradually shift into more bonds and cash as the funds get closer to the target date.  By picking a fund with a target date near the time you intend to retire, you can have an investment that does all the rebalancing and reinvestment work for you over the course of your life.

Target date funds aren’t perfect, though.  They charge additional fees on top of the fees for the underlying mutual funds, increasing the expenses.  They also take a ‘one size fits all’ approach, without regards to individual differences in goals or investment needs.  If you do decide to take this route, do some research, and make sure your chosen target date fund will meet your needs, now and in the future.

That wraps our look at mutual funds in all their glory and splendor.  I hope it helped you to get a feel for this investment and how to take advantage of it.