The Amateur Financier

(It’s another Tuesday here at the Amateur Financier, and that means one thing: Yep, it’s another thrilling round of Investing 101.  Today, following our recent trend into considering more complex investments, we’re going to look at the futures market, and determine how these futures could help your financial future.)

Q: So what are futures, anyway?

A: When talking about futures, you’re really discussing futures contracts, agreements where you set the price for a commodity or financial products (stocks, bonds, Treasuries, or any number of other investments) at some point in the future.  Let’s say you’re an oil producer, and are afraid that continuing financial shakiness world-wide might lead to falling oil prices.  You can sell a futures contract locking in the current price of oil for the shipment you will produce for September delivery.  This way, you can be certain of the price that will get for your product when it becomes available.  The buyer of the contract also gets the certainty of knowing exactly much the oil will cost.

Q: Sounds pretty good; but why is there such a large market for futures?

A: Well, let’s take a closer look at some possibilities for what can happen between now (June) and September for our example.  If prices fall, as you (the oil producer) expect, then you win; having sold the contract, you locked in your profits, and ensured you will get the desired amount of profit for your oil.  The holder of your contract, on the other hand, loses; he or she has an obligation to purchase your oil at the higher price.  If the holder tries to sell the contract, he or she would have to sell for less than the face value of the contract, to make it attractive to the purchaser.

But, that doesn’t have to be the case.  If oil prices rises, then you, as the contract writer, would have to deliver the oil at lower prices than the current market value.  In this case, the contract holder would win, and could profit in one of two ways: first, he or she could take delivery of your oil at less than market value, pocketing the difference between the amount he or she actually paid and the current cost of that oil.  Or, second, the contract could sell on the futures exchanges for more than the initial cost.

Because of the possibility that the contracts become more valuable, an extensive secondary market in futures has arisen, allowing you to buy or sell contracts, even if you have no intention of taking delivery of the underlying product.  Most people investing in future contracts, especially for raw materials, do so with the intention of making a profit by reselling the contract later, rather than getting the underlying product.

Q: So, why would I want to invest in future contracts?

A: There are several reasons to consider investing in futures.  First, if by chance you are a manufacturer or user of various industrial or agricultural raw materials, it can make sense to lock in your prices to guarantee your future profits or expenses.  This way, you can ensure your future profits and more easily plan out your financial future.

Or you could use futures as a means of speculation, similar to options.  In this way, you can benefit from the increased leverage offered by futures, allowing you to make bigger profits than by holding the underlying assets.  It’s another way to take advantage of leverage, if you so desire.

Q: Sounds good!  Any last comments?

A: As with any form of speculation, you need to be extraordinarily careful about how much you invest in the futures market.  Make sure you know exactly what you are doing before you invest any real money, and only make futures contracts a small part of your portfolio.  Unless you have need for a particular commodity for your business and are using the futures contracts to lock in the future costs, chances are that you don’t REALLY need to invest in futures, and should treat your future contracts very carefully.

That’s all for this week; hopefully, you’ve appreciated this introduction to futures contracts, and have an easier time understanding what futures investing is all about.

While watching a local news station, I came across a pretty interesting concept: an ID Score, which attempts to quantify your risk of having your identity stolen or your personal information misused.  The goal, as noted on the main site, is to give you an idea of how much you have to worry about having your identity stolen.  It’s a laudable goal, and the information provided about how to protect your identity is helpful and proper (although, the link provided to the FTC’s identity theft guide is probably the most helpful of all).

I do have a problem with My ID Score, though: when I attempted to get my ID score, I discovered that they would need my Social Security number to verify my identity.  Although the first page I came to claimed that giving my Social Security number was optional, attempting to get a score without giving it led to a page saying that my identity could not be verified with the information given, and that providing my SSN would help with identification.

This set off some pretty big warning signals in my head; one of the first pieces of advice on protecting your identity given out by almost every source is to not give out your Social Security number to any person or organization you don’t fully understand, especially online.  Given this, it seems rather ironic that a group promising to help you protect your security would want you to give out this sensitive info.  Add in the fact that this ID Score is still a new concept (unlike, say, a credit score) and not currently used by any groups to determine whether to give you money or hire you for a job, and the risk did not seem worth it.

As a result, I didn’t go through with getting my ID Score; instead, I’m simply going to go about protecting my credit on my own.  In addition to not giving out my Social Security number or other sensitive information in most cases, I’m always sure to check my credit reports regularly (I actually signed up to get my credit score monitored at MyFICO.com, but that’s something rather different), shred all my important personal documents, and closely watch my credit card statements for unusual activity.  I’ve considered getting a credit freeze, as well, although I’m not sure if that will provide a good level of protection for the inconvenience it would cause over the next few years as I potentially go back to school or buy a house.

So, I have to ask, has anyone tried to get their ID scores yet?  Do you have any good alternatives to this service that don’t require giving out personal information?  Are there any big ways to protect yourself from identity theft that I’ve missed?

As a personal financial blogger and wannabe money nerd, I do my best to stay up to date with the financial media.  I flip to CNBC when I have some spare time, I try to read personal finance books, and I subscribe to three different personal finance/investing magazines.  These three magazines, Money, SmartMoney, and Kiplinger’s, are among the biggest names in personal finance media, and their influence leads to ripples almost everywhere.  (Among other things, I’ve previously been inspired to write blog entries off of information I’ve read in these magazines.)

I’ve been subscribing to all three of these magazines for at least three months, and have developed some thoughts on each of them.  I actually have taken to viewing each magazine sort of like a person, with their own talents, focuses, and personality.  Here’s how I view each one:

Money: I see money as a middle-aged, single woman with kids (a bit like my aunt, who actually introduced me to the magazine).  There’s not much of a focus on investing in Money, and when the subject does arise, the advice given is almost the same: invest in mutual funds, not individual stocks, choose index funds whenever possible, and dollar cost average your way into the investment using regularly contributions.

This advice doesn’t take up all the space in Money, though, which also covers topics like best ways to improve your house, tips on getting a new job (the July edition had a ten page special on makeovers for three eager job seekers), and how to talk to your kids about money.  In fact, helping your kids to get a better financial start is one of the most frequently reccurring topics covered by Money.  It also has a tendency to get deeper into the morals and ethics of money decisions than either of the other two magazines.  This last issue, for example, there’s an article about trying to do the right thing (financially) during a recession, from how to decide who to fire to what to do about friends who cause you to spend more of your money.

Overall, I think Money is my favorite of these magazines, but it might be a little broad for some people.  It provides good, solid advice, but don’t expect too much in the way of analysis of individual companies, for example.

SmartMoney: SmartMoney makes me think of the young, eager stockbroker characters you sometimes see on television and in the movies. It focuses primarily on stocks (as you might have assumed from something billed as ‘The Wall Street Journal Magazine’). One pretty typical feature is ‘Buy-Sell-Hold’, which looks at three stocks in the same field (for July, it was energy stocks) and lists one worth buying, one that should be sold, and one that can be held (for now). It does provide a great deal of good background information into the companies it covers, very much a value based investing approach.  On occasions where mutual funds are mentioned, they typically tend to be actively managed, rather than the index funds preferred by Money.

But SmartMoney isn’t just about stock picking.  They also do quite a bit of work looking into broader economic conditions and attempt to provide advice about what the market will likely do in the future.  It, more than either of the other two magazines, has been stressing the possibility of inflation as a result of the government spending to fight the recession, and giving recommendations to fight it, like investing in TIPS and commodities. Not bad advice, by any stretch.

I like the advice that SmartMoney gives, and especially the sharp contrast it offers compared to Money, but it’s not really the best for me. If you’re a more active investor, someone looking for deeper commentary about the companies you are considering, then SmartMoney would be a good choice for you.

Kiplinger’s Personal Finance : Kiplinger’s is choke-full of information on almost every page. The density of the information is impressive, but can make it a bit hard to read and digest everything. Kiplinger’s is very fond of recommending both stocks and mutual funds, in rather impressive numbers. Overall, it reminds me of the overly brainy kid in class, who would study up on everything and throw himself into every assignment.

Kiplinger’s also has a tendency to get into more complex investment strategies than either of the other two.  In one article in the July issue, it brought up the idea of buying put options (which allow you to sell your stock at a set price) as a way of hedging against falling prices.  The plan they suggest is pretty straight forward, as options trades go, but still a bit more tricky than the average person would care to try.

If you like your magazines heavy on the research and numbers and light on commentary, Kiplinger’s might be for you.  Some of the strategies and investment it discusses go beyond my comfort level, but the overall level of scholarship impresses me.  (It also seems to have fewer ads than either of the other two, which might be one reason it seems so packed with information.)

There you have it, my thumbnail reviews of three popular investment magazines. I hope, if you are trying to figure out which one to subscribe to, that this article has helped you learn more about each one.

If you haven’t been completely obvious to the financial news this week (or to news in general), then you’re likely aware that on Wednesday, President Obama made an announcement about some rather sweeping changes to the nation’s financial system.  If you feel like reading up on the full list of proposals, you can read the government’s (88-page!) white paper on the subject, assuming you have the time and willingness.  If not, read on, for I shall give you a thumbnail sketch of some of the biggest points.  (With assistance from BusinessWeek)

First Proposal: Creating a Consumer Financial Protection Agency, in charge of regulating consumer financial products (credit cards, mortgages, bank accounts, etc.) with the goal of standardizing the products offered and increasing disclosure to consumers.

Pro: More disclosure from financial firms; easier comparison of financial products from diverse companies due to government standards; and an overall safer financial system.

Con: Stifled creativity on the part of financial firms when creating new products; and more difficulty for individual firms to make their products stand out.

My Take: In theory, I like the idea of a broader, overarching agency monitoring financial markets the same way that the FDA and other agencies monitor our food supplies.  In practice, I’m sure it’s going to take quite a bit of fine-tuning to adequately protect financial product consumers while allowing banks and other agencies to make a decent profit.  Given the current state of the economy and the regulatory system, I think it might be best to opt for regulation, even at the risk of over-regulation, and back off from there.

Second Proposal: Require that banks and mortgage companies that originate mortgages and other loans keep at least 5% of the assets should they securitize the loan (they’d have to ‘keep some skin in the game’).

Pro: Lenders are less likely to push risky loans when they could face financial consequences if the loan defaults; and it puts a de facto cap on the amount of leverage lenders can utilize (at twenty times the organization’s lending capital).

Con: Won’t neccessarily prevent excessive risk taking by lenders.

My Take: This proposal should do well in decreasing the number of lenders who take on great amounts of excess risk; suddenly, giving mortgages to dozens of subprime borrowers starts to seem like a bad idea if their defaults will have a direct negative influence on your bottom line.  The percent the originators are required to keep seems a bit low to me, but I suppose limiting their ability to sell loans and lend again too much would result in far fewer loans being issued, even to qualified applicants.  Five percent (and the twenty times leverage it potentially offers) seems like a good compromise.

Third Proposal: Appointing the Fed (that is, the Federal Reserve) to regulate systemic risk in the financial markets, backed by a council of other regulators chaired by the Treasury,.

Pro: Provides increased power to regulate the economy as a whole; allows the Fed to take the lead in decreasing systemic risks posed by events in the financial markets

Con: The Fed could end up being too powerful; worries that the Fed will fail to provide adequate oversight.

My Take: While it seems like a good idea to assign one organization to take point in providing regulation to the market, there are legitimate concerns about leaving that job in the hands of the Fed, especially as there is no direct Congressional oversight.  The key will be finding a compromise that minimizes the number of worried parties; the Obama proposal, for example, attempts to add more oversight to the Fed by giving some oversight of their actions to the Treasury.

Fourth Proposal: Adding increased oversight and funding requirements for derivatives trading.

Pro: Decrease the risk level in a fairly risky financial sector; add disclosure and standardization to credit default swaps and other complex derivatives.

Con: Push back from derivatives traders who are used to an environment of secrecy; difficulty in regulating the sometimes highly individualized trades.

My Take: This one is a tricky one, but necessary if we’re going to avoid a repeat of the last year.  Getting derivatives trades out into the open, ensuring that the traders have enough capital to back their trades, and understanding the level of risk involved is the only way to allow this trades to continue while preventing future financial collapses.

All of these proposals, of course, still need to be debated and approved; for the most part, though, I think they are a definite step in the right direction, and a good way to push the financial system back on track.