The Amateur Financier

I’m a mood that combines playfulness with nostalgia.  I think it’s because I’m currently back home and have a job interview today, so I’m both happy and thinking about my past.  I’ve been thinking a bit lately about some of the stories and fables I was told as a child.

So today, let’s have some fun with some of the most famous of Aesop’s fables, and see how we can apply the lessons found within to our personal finance situations.  After all, these are stories that I (like many of you, I’m sure) have heard since I was young.  Let’s go on a trip down memory lane and see what we can learn about money management from good old Aesop.

1) Fable Name: The Ant and the Grasshopper

Short and Sweet Summary: There was once an ant and a grasshopper.  (Good start, no?)  The grasshopper laughed, frolicked and played the days away, while the ant diligently spent his time during summer and fall gathering up extra food.  The grasshopper laughed at all this effort; why gather food when there was such an abundance all around them?  When winter came, though, the grasshopper found himself out of food while the ant had plenty, and the grasshopper comes to realize the folly of his short-sighted ways.

A hardworking ant, possibly working hard

(Depending on what version you read and the particular message the author is trying to push, the final fate of the grasshopper and the ant (or ants, in some versions) can vary.  In the most traditional versions, the grasshopper dies from starvation.  Since this doesn’t make the most child-friendly ending, in many cases he gets food from the ant, usually in exchange for providing some service or at least promising not to be as lazy in the future.  There are also plenty of more politicized versions, having the grasshopper suing the ant and taking his hard-earned food (to send up socialist/communist worldviews) or attacking the ant for being so stingy (to attack those who hoard wealth).  For our purposes, we can end the story once the grasshopper realizes the error of his ways.)

General Moral: Prepare today for lean times tomorrow.  Also, if an ant and a grasshopper both offer you financial advice, go with the ant.

Financial Moral: Pretty much the same as the general moral; be sure to stock up on money (or other supplies, etc.) while you have the opportunity, particularly if you know the lean times will be coming.  Replace ‘winter’ with retirement, ‘food’ with money, and ‘ant’ with anyone who didn’t get a trust fund for their 16th birthday, and you have a pretty good plan for saving for your golden years in our ‘fund your own retirement’ economy.

2) Fable Name: The Tortoise and the Hare

Short and Sweet Summary: A tortoise and a hare have a race because the hare was talking smack about the tortoise’s mama (or possibly just called the tortoise slow).  During the race, the hare takes an early lead, getting so far ahead that he decides to take a nap (or goes off to play keno, depending on the version of the tale).  While the hare is distracted, the tortoise slowly but steadily catches up, and then overtakes him.  By the time the hare wakes up (or gets kicked out the of the casino due to his bad credit), there’s no way for him to beat the tortoise.  Victory to the slow guy with the shell!

General Moral: Slow and steady wins the race, OR don’t take a nap until you finish the darn race.

Financial Moral: Pretty much the same as the general moral (the one about slow and steady winning in the end, not the napping one).  A decent to good financial plan, implemented over the course of a lifetime, will be much more effective at boosting your net worth than a great financial plan you only follow off and on.  (Note: you should not take the lesson that betting on a long shot in a race is a good way to improve your financial security; they’re long shots for a reason, and no every gamble will pay off in the end.)

3) Fable Name: The Dog and the Bone (noticing a pattern to these names yet?)

Short and Sweet Summary: A dog goes walking alone with a bone in his mouth.  He looks down into a still pool of water, and sees another dog looking back at him, also with a bone in his mouth.  Getting greedy as he looks at the other dog’s bone, and thinking that the other dog looks like a bit of a push over, our first dog opens his yap and barks at the second dog.  His bone drops into the water, disappearing under the waves, leaving the dog (and his reflection) without any bones at all.

Pictured: Dog; Not Shown: Lost Bone

General Moral: If you get greedy, you risk what you already have.  Also, mirrors can steal your soul (or at least, confuse you, if you happen to be a dog).

Financial Moral: Let’s quote another source of great wisdom, Warren Buffet: ‘Rule #1: Never lose money.  Rule #2: Never forget Rule #1.’  As with bones, so it is with money; it’s much easier to keep what you already have then it is to earn more.  If you get greedy and try for excessive gains, you can end up losing what you already have.  (Add in the number of scams and other simply fraudulent ways people will try to get your money, and the importance of keeping what you have comes into sharp relief.)  Invest smartly and don’t try to shoot for the moon with your returns, and you’ll have a much better shot at growing your wealth and adding to your supply of bones (or cash, if you prefer that type of thing).

4) Fable Name: The Goose that Laid the Golden Eggs (just like that, the pattern is gone)

Short and Sweet Summary: A farmer and his wife (I picture them as Ma and Pa Kent from the Superman comics, but I’m pretty sure that’s not what Aesop intended) discover that they have a goose who lays golden eggs.  After a few days of enjoying the bounty this goose puts out, they get impatient, and slaughter the goose to get all the golden eggs at once.  Alas, once the goose is dead, they find no golden eggs inside, and realize that they’ve just killed a source of great wealth.

General Moral: Greed and impatience destroy wealth.  Also, geese aren’t filled with all the eggs they’ll ever lay (at least, not in fully developed form).

Financial Moral: As usual, the general moral can be pretty easily applied to the personal finance; get greedy and it’ll backfire on you.  This is most apparent when looking at your nest egg (an apt term for a waterfowl based fable); if you start with a small, safe withdraw rate when you retire, your nest egg will have the chance to grow, continuing to generate more money (golden eggs) for your spending pleasure.  Pull out too much of your money in the first few years, and watch as your nest egg quickly withers away, and you spend your retirement years desperately searching for more money (or a goose that lays golden eggs).

Alright, that’s enough nostalgia for one day; hopefully, there’s plenty of stories mentioned here that spark a few memories of your own childhood, and maybe, just maybe, remind you of a

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There’s always a lot of questions when it comes to investing.  It’s hard to figure out everything you need to do.  How can you keep everything straight?

Well of course, you can use the classic rubric of 5 W’s (and that one H; there’s always one black sheep in every group).  If you can answer a few simple questions about investing, you can give yourself a guide to the financial world, as well as understand why you’re bothering with all this investment stuff at all.

Who should invest? The short answer is, just about everyone.  If you have enough money to meet your needs, you probably should be putting some money aside for your long term goals, such as retirement and major future purchases.  (What constitutes meeting your needs?  At bare minimum, earning an amount equal to the poverty line, although personally I’d be inclined to say that you shouldn’t worry too much about investing unless you’re making twice the poverty level.  Even that’s only about $20,000 for a single person and $30,000 for a couple; particularly in high cost of living areas, it could be hard to find money for investments in your budget.)

How much should I invest? That’s a tricky one; the minimum level most investing advisers suggest is 10% of your gross salary, although there’s plenty of mitigating factors that will push that up or down.  If you are barely earning more than the poverty line (or especially if you are below it), investing any amount should be the last goal you attempt to achieve.  On the other hand, if you are earning a good income, much more than you need for your immediate requirements, then putting much more than 10% into your investments will speed your progress to your investing goals.  In short, invest as much as you are able.

What should I invest in? There’s a number of possible investments to choose, perhaps too many if you’re just getting started at figuring out your money situation.  I suggested a variety of methods a few weeks ago, ranging from target date funds to index funds to individuals stocks.  Depending on your particular goals and desire to learn more about investing, you could choose any of these methods and still succeed.  My suggestion: stick with target-date or index funds unless you like investing enough to do a LOT of research.

Where should these investments be held? At a reputable mutual fund company (or discount brokerage, if you choose to go the individual stock route), preferably in a tax-advantaged retirement account.  Personally, I’m a fan of the Vanguard mutual fund family, although Fidelity and T. Rowe Price are also highly regarded.  At to which type of retirement account, either a Roth or traditional account, while either one can be good, the best one will depend on what the future holds (in terms of tax rates).

When should you start? As soon as possible.  The advantages of starting your investing early is that you’ll have more time for your investments to grow.  Compound interest is one of the most powerful forces in the universe, but it does require one thing to work properly: time for the investment to grow.  The longer you enable to your money to stay invested and grow, the less you’ll need to put into your investment account to reach your goal, whether that’s retirement or another long-term goal.

Why invest at all? The simplest reason is this: if you want to fund your retirement purely by saving, you’ll need to put aside a huge amount of money.  If you work for forty years, and think that you may live for forty years in retirement (a reasonable assumption, given the high and rising life expectancies in the Western World), you’ll need to save half your salary each year just meet your goal.  (Actually, unless you are saving in TIPS or another inflation adjusted vehicle, you’ll need to save even more to counteract the effect of inflation.  But saving half your salary is daunting enough already.)  By investing, you can greatly increase how quickly your money will grow, and thus decrease the amount of money you personally need to take out of your paycheck.

There you go, some of the most basic questions about investing asked and answered, so you don’t have to!

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If you’re a typical student, there’s a lot you still have to learn about investing.  Actually, if you’re a typical high school or college student, there’s a lot you still have to learn about most things in life, but investing is a big one.  There’s very little formal education you will receive about investing (or any other money management skills, for that matter), and many things that need to be learned.

I’m not saying all this to discourage you, but rather to point out the task you face.  If you’ve stumbled across The Amateur Financier, chances are that you’ve at least begun to seek out personal finance information on your own, which is an excellent start.  To help you get a good start to your financial future, here are some tips straight from Roger:

1) Start Investing Now – Being a young whippersnapper does have its advantages every now and then.  If you’re young, there’s lots of time for your investments to grow.  I touched on this last week; the longer you invest, the more your money will grow, and less you need to invest in order to reach your goal.  Start while you are in college (or even better, during high school, although you might need to use a custodial account under your parent’s name to do so) and even small amounts can turn into a decent retirement fund.

2) Get Good Grades – Particularly for you high school students, getting good grades should be task #1.  Good grades open the doors to more impressive colleges, and make it easier to get scholarships or other aid packages once you get into school.  Even if you don’t want to go onto college (if you want to join the armed services or start your own business, for example), making sure you get everything you can out of your education will help you to get a leg up in life, if only by expanding your personal level of knowledge.

3) Expand Your Experiences – It’s easy to get locked into a particular way of thinking or doing things, particularly if it’s a way that’s always worked for you.  But when you’re young and have relatively few obligations to fulfill (such as a family or a job), that’s the perfect time to do things that you’ll be unable to do in the future.  Take some classes outside your major, try a few part-time jobs to learn what you like to do, even try starting a small business in your free time (blogging is pretty fun, for one); it’s an excellent time for you to explore your options.  Speaking of which…

4) Take Some Big, Foolish Risks… -Speaking of experiences, youth is the perfect time to do stupid things.  Not just things like drinking until you pass out at a college party, but also things like trading stocks, making highly speculative investments, or generally doing everything that most investment financial guides tell you to avoid.  As mentioned before, when you’re young, time is on your side; even if you end up penniless at thirty because of some bad investment decisions, you’ll still have decades to recover before you need to rely on your savings for your living expenses, plenty of time to recover.  (Actually, if you find yourself with a net worth of exactly $0 at age thirty, you’ll be doing better than many people who are loaded up with debt at that age; that’s an accomplishment itself.)

5) …But Don’t Be Too Stupid – There’s a difference between taking on risk, even incredibly high risk, and being stupid with your money.  Day-trading stocks is highly risky and potentially hazardous to your wealth, but giving your name and identifying information to someone offering you Nigerian prince money is just plain stupid.  Even while you are taking risks, including potentially big risks, be careful with your financial information and don’t do anything that could seriously impair your wealth in the future.

6) Always Read The Amateur Financier – Alright, alright, this one is a little tongue in cheek.  But continuing to read and build your knowledge about money management throughout your life is an important step to controlling your finances.  Thanks to the Internet, it’s as easy as turning on your computer and looking through all the resources you have available online.  Some worthwhile first stops include Morningstar, Investopedia, and Vanguard, all of which have excellent resources for investors who are just learning the ropes.

There you go, hypothetical high school or college student to whom I’m directing this post, several things you can do to get your finances off to a good start.  Enjoy the head start on financial wellness!

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When it comes to investing in stocks for capital gains, there are two different approaches that can be taken in order to ensure that your stocks increase their worth: growth investing and value investing.  (There are other rationales for investing, such as investing for dividends, but for now let’s stick with growth and value investing.)  These two methods represent two different ways of viewing stocks and trying to profit from them.  So, what sort of considerations do you have to make when considering which method to use when choosing your investments?

Investing Rationales

Growth Rationale – The growth investor is looking for companies that growing their business (which you probably guessed).  These could be small, upstart companies that have a great deal of potential, or large companies that continue to expand into new areas and increase their business at a much faster rate than their rivals.  If stock investing were horse racing (a reasonably apt metaphor), growth stocks would be those that are the reigning champions or the quickly rising upstarts.  The growth investing model essentially involves trying to find some of the fastest expanding companies, and tethering your fortunes to their growth.

Horse Racing - An Ideal Stock Metaphor

Value Rationale – Value investing, on the other hand, focuses on finding stocks that have been knocked below the true value of their respective companies, then buying and waiting for the broader market to recognize their worth.  As with growth investing, these companies can be either large or small, and the reasons they are currently undervalued can be diverse: bad news that took the stock prize below a reasonable level, a run of bad luck that decreased the company’s perceived value, or even a broader economic storm that dragged everything down at once (like we’ve just experienced).  To go back to our horse racing metaphor, value stocks would be akin to the strong finisher who’s failed to win the past several races and wound up as the long shot.

Why Does This Matter?

The difference between growth and value might seem academic, and in a way, it is.  There are those people who have argued that assigning stocks to the ‘growth’ or ‘value’ columns have nothing to do with the actual value of the companies, but instead such dividers display their own ignorance.  (’Those people’ in this case include Warren Buffet, as you can see at the bottom of this linked page, so perhaps they have a point.)  On the other hand, when looking at the performance of broad segments of the US economy, it appears that the value investing style has beat out the growth style in the past.

The results, if you are a mutual fund investor (particularly a passive indexer like me),  is that your portfolio should attempt to lean more towards value and less towards growth in terms of your funds’ orientation.  This does not mean that every value stock will outperform every growth stock; on the contrary, because the faster increase in value of growth stocks is sometimes deserved, the top performers in the growth category can and will outperform the best of the value classification.  Rather, it means that taken as a whole, stocks that are categorized as value will outperform those in the growth column over time.  Unless you fancy being a stock picker (and make a good job of it, as well), sticking to a portfolio that leans toward value stocks will lead to a much richer future for you and yours.

I hope you enjoyed this rather brief introduction to value and growth stocks, as well as the difference between the two.  Good luck with your investing, whichever option you decide to choose.

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Two trends that seem to be everywhere now are going green and cutting down on your expenses.  Both are rather similar in concept; by cutting back now, we can ensure a better future for ourselves (or our children).  You have to have an eye towards life yet to come in order to be motivated to save money or the Earth.

They also require some sacrifice on our part.  It’s more fun to party, buy expensive things  that will just sit on the shelf, and to just throw away anything we don’t need than to worry about the costs to our pocketbook and planet.  How can we overcome our less caring nature and start to focus on the future?

First, know yourself and your motivations.  It’s easier to commit to a plan to ‘green up’ your life or to get your finances in order if there’s some strong rationale you have to do so.  You might look to your faith for reasons to protect God’s creation or to not be a borrower.  If your family feels strongly about having financial security or saving nature, you can turn to them for support on your decision.  One big motivator for many parents is protecting and providing for their children’s future; these could be all the motivation you need to save money and the planet.

Once you have your motivation, start small.  Don’t try to cut your expenses or your emissions to the bone in the first month; much like trying to go on a crash diet, you’re going to feel deprived if you change too much at once.  Instead, trying making a few changes at first, to feel out where you can make cuts without too much trouble.  Cutting down on eating out, using less electricity or decreasing your driving won’t be enough to save the planet (or your financial future) all on its own, but will be easier to handle at first, and will give you encouragement to take on bigger reductions in the future.

Since we’re trying to do two things at once, it’s good to find ways we can work on both goals simultaneously.  If you can find methods that will be good for the environment and save you money, you can kill two birds with one stone, improving two areas of your life at once.  In addition to the already mentioned areas, you can also purchase energy efficient appliances or make an effort to drive no faster than the speed limit; both methods will help to reduce your expenses and carbon emissions over the long term.

Of course, there are situations where saving money comes at the price of increasing pollution, or where the environmentally best solution costs more money.  Buying organic food, for example, can be significantly more expensive than traditionally grown food, while decreasing the impact on the environment.  On the other side of the coin, shopping at a ‘big box’ department store can cut your expenses significantly, but the environmental impact of shipping the items around the planet is substantial.

For these circumstances, the only thing you can do is try to do the best you can, according to which principle you value more highly.  If you are a die hard environmentalist, you’re obviously going to make different trade-offs between cost and environmental principles than someone who wants more than anything to live frugally.  This goes back to our first point; if you don’t think about what you are really want to accomplish, your values, and your priorities, you’ll end up facing situations where you have to choose between the two without the guidance of a prior decision.

Follow these simple steps, and you’ll be able to go green and keep yourself on the right path financially.

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As we reach the middle of our series on investment scams, we’re going to take a little break from the world of liars, cheats and thieves, and take a look at some ways to protect yourself in general.  If you take the following steps, you’ll be much less likely to be targeted by scammers or to fall for the numerous scams that exist out there in the world of finance.  Here are a few tips that will help you to spot, identify, and avoid many of the scams out there, even for scams that haven’t yet been conceived:

1) Educate Yourself: Knowledge is power, and when you’re looking at investments, knowledge is also money.  If you understand a variety of investments (at least in principle, if not all the gory details involved), you’ll have a much easier time recognizing the bullshit investment pitches you will encounter during the course of your life.  If you know that stocks typically return about 10% a years (during the good years of the twentieth century, at least; many rather clever people maintain that the returns in the future will be going lower), it’ll be easier to call bull pocky on claims about miracle investments that can return 20% each month.

2) Be Leary of Everyone’s Advice, Even Friends and Relatives: No, I’m not accusing your cousin who keeps talking about her ‘hot stock investments’ of trying to scam you.  But, there are any number of reasons why their advice might not be in your best interest; from not fully understanding their investments to being victims of scams themselves, your friends and family might be making suggestions that are not in your best interest.  If you do get any hot tips, you can give them all due consideration, due thorough research, and decide whether it’s a legitimate opportunity or a scam; and if it is a scam, be sure to let your tipster know, so they can get out of it themselves.

3) Research, Research, Research: If you don’t understand an investment class, grab a book, check some websites, and do research to learn what’s going on.  If you hear a hot tip, be sure to hit the books before you put down money.  When you are trying to decide to what investment choice to make, what do you think you should do?  That’s right, research; don’t put any money into something you don’t understand, and if you don’t understand an investment, be sure to break out the books and start to do research.

Some good places to start your research include the Security and Exchange Commission (SEC), which monitors publicly traded companies and the Better Business Bureau.  There’s plenty of good information out there; it just takes some work to find it and sort out the good from the bad.

If you follow these steps, you’ll find yourself in much better shape when you next confront a possible scam.  Build a broad financial education, be leery when your acquaintances offer investment suggestions, and do plenty of research BEFORE putting any money down; stick to a cautious approach, and your investment career will be all the better for you.

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Yesterday, I had a horrible, horrible drive home from work.  Two of my wheels went flat, and it took the bulk of the day to get them fixed.  Luckily, since I’m working the night shift now, I had the time to get towed (to two different repair shops), have the wheels replaced, and have the hub of one wheel fixed (at a third shop I only reached thanks to my emergency spare).  Unluckily, because I had to run around repeatedly in order to accomplish all of this, I only got about three hours of sleep before I needed to go into the work that night.

Still, even though I had little sleep (and even less time to catch up on my blog writing and reading), it did inspire some thoughts for me.  The biggest one is to be prepared for trouble whenever you go out driving.  Although I was on the road for less than an hour, going a route I practically know by heart,  I still ended up having to stop.  If you aren’t prepared for such an eventuality, it could end up costing you in terms of time, money, and even safety.  With that in mind, here are some points of advice for anyone who drives regularly, as well as my grade in each of them.

Car Maintenance Tips

1) Keep your car in good shape: The more preventative maintenance you do, the less likely you will find yourself standing by the side of the road, calling desperately for help, trying to find someone who can give you a ride.  If you make sure you have fresh oil, plenty of fluid in your radiator, good tires with a nice tread, and no problems with the frame, you’re going to have much less trouble with your car during your drives.
My Grade: B – I do try to keep my car in good working order, but sometimes I let things get a little backed up and my tires get a bit bald or my fluid levels get too low.  After this event, though, I’m going to make much more effort to be up on these preventative maintenance tasks in the future.

2) Know thy car and how to repair it: Let’s face it, no matter how well we try to care for our ride and how much we try to keep it working, accidents happen.  A tire blows, the engine overheats, the radiator blows; when we drive, any number of things can occur that can stop us in our tracks.  Being able to determine the cause of your problems, and fix the most common minor ones, is a valuable skill for anyone who spends time behind the wheel.
My Grade: C – I can change my tires, check my fluids, and keep my car moving in most circumstances, but if anything happens to the engine or to the exhibition catacomb, it helps me way beyond my ken.  Luckily, that’s fairly rare.

3) Have the Appropriate Materials Needed: When you have car trouble, it’s likely due to problems with your tires or the engine.  Now carrying a complete engine and four spare tires is not the sort of thing most of us can (or will) do.  But if you make an effort to have some repair and replacement materials on hand, you’ll be that much closer to being able to fix your car problems yourself.  Being sure to have everything you could need (especially if you are going to be far from stores or other resources) is vital for the prepared traveler.
My Grade: D – I’ll be the first to admit, I don’t usually have enough car repair items in stock.  I have an emergency spare tire, a jack, and a wrench, but that’s it; no extra oil, no spark plugs, no jumper cables, no equipment of any kind to help if something other than a tire gives way on me.  For that matter, I only have the one emergency (non-full-sized) spare, so if two or more of my tires go, that’s all she wrote.

4) Stay Calm: If you do find yourself in a situation where your car is no longer functioning and you can’t repair it, don’t panic.  Stay calm, focus on contacting someone who can help (either a family member or, more likely, the nearest repair person), let your boss or whoever you were driving towards know the situation, and wait until the calvary shows up.  Yes, having your car break down is a pain, but if you keep focused, you can easily get through it without a problem.
My Grade: B – I’m pretty good at not panicking under pressure, and it has helped whenever I’ve had car trouble.  I could be better (less cursing my luck when these things happen, for example), but I’m not too bad.

5) Have a Cell Phone Handy: In these days, when everyone and their kids have their own phones, finding a working public phone is all but impossible.  If you are out driving, be sure that you or one of your passengers is carrying a charged cell phone, so you have some way to contact help should you need it.
My Grade: F – I carry a cell phone everywhere I go.  Unfortunately, it’s getting kind of old, and it no longer holds much of a charge.  In the case of this incident, I ended up having to go inside the nearest gas station and use their phone (the pay phone out front was out of order).  Being able to get help on your own is vital to your safety, so be sure to be more prepared than me.

6) Join AAA – The American Automobile Assocation provides any number of services to its members, offering towing to stranded vehicles and sending repairmen who can perform simple maintenance on your vehicle.  Plus, you can frequently get discounts at various retailers by presenting your card, potentially enabling it to pay for itself.
My Grade: A – I am a proud, card-carrying (literally) member of AAA, and have been since I first started to drive.  They’ve helped me out a pinch many times (more than I would care to admit, honestly), and are more than worth the cost.  If you are a US citizen who drives a car and aren’t a member, I strongly, strongly recommend you change that fact immediately.

There you have it, six pieces of advice from me to you that should make your driving life a lot smoother.  Farewell, and happy travels!

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(Once again, when it’s Tuesday, that means it is Investing 101 day!  We’re running out of individual investment vehicles to cover, so we’re going to start covering some broader investment concepts.  Today, that means asset allocation, a concept that comes up repeatedly in discussions of investing and personal finance.)

Q: What is Asset Allocation?

A: In general, asset allocation refers to how you have your money distributed among different investments.  The point of asset allocation is to view your portfolio holistically, ensuring that you aren’t taking more risk than you want, or less risk than you need, with the money and resources you have available.

Q: What’s the perfect asset allocation, then?

A: There’s no way I can answer that; no one single perfect asset allocation exists.  It’s a bit like individual investment choices; some people prefer investing in stocks, others in real estate, still others in mutual funds.  Each option could be equally effective at building wealth, it’s simply a matter of personal preference and individual needs with the investment that will dictate the best one for each person.  Similarly, the best asset allocation for you will depend on a number of personal factors.

Q: Alright, how do I determine the best asset allocation for me?

A: There are a few important factors to consider to determine how to build your asset allocation.  The first step is to consider what goal(s) you’re investing to meet.  The big one for most people is retirement, of course; besides being one of the most expensive events in your life, it’s also one of the few you can’t take out a loan to finance.  You might also find yourself investing for college (for yourself or your children) or investing in order to buy a house.  For the purpose of keeping track of your progress, it might be best to think of each of these goals as a separate portfolio, even if in practice they are co-mingled.

Second, know how long you have until you need the money.  The less time you have available to make up any shortfalls, the more conservative you’ll have to be with your investments.  In general, the advice is that any money you’ll need within five to ten years (depending on the source of the advice) should not be invested in the stock market or similar risky ventures.  (As an aside: for goals where you’ll need the money all at once, this means you should be completely invested in bonds, bond funds or cash equivalents five to ten years before the event.  For goals that occur over the space of years or decades, like retirement, you can (and should) remain invested in stocks or other growth investments at the start of your retirement, to maximize the growth of your money and help make sure it lasts through your whole retirement.)

The third consideration is how much growth you need.  If you can save enough money to meet the goal through your own efforts, you can focus on keeping that money safe rather than growing it, by putting it aside in a savings account or other secure cash equivalent.  You won’t see much return, but the money you save will be safe and secure for when you need it.  If you need a great deal of growth (for a huge event such as retirement), you’ll have to put your money into riskier but higher average growth investments like stocks.  (Of course, you still need to balance your need for growth of your money with your time frame; if you try to make up for a short time frame by investing in highly risky ventures, you put yourself at risk of losing even more money and falling even further behind in meeting your goal.  If you have limited time, you should try to boost your savings to make up the difference, not upping your investment risk.)

A fourth consideration is your own tolerance for risk.  Depending on how well you can stomach the ups and downs of the market, you can tweak your portfolio to be slightly less risky or slightly more risky (with a higher average return).  Note that I say tweak; you shouldn’t take a huge amount of risk if you only have a few years left to make up your losses, regardless of how ‘risk-tolerant’ you are, nor should you hide from any risk if you have a long investment horizon and a large amount of money that you need to gain through investing.  While much is made about risk tolerance, ultimately it has to take a back seat to more practical concerns of time and needed growth.  At most, you could shift ten to twenty percent of your portfolio to a more or less risky investment according to your tolerance; that should moderate your returns while still allowing a reasonable level of growth.

Q: Whoa, that’s a lot to think about; care to run through an example asset allocation?

A: Sure, here’s an example of an investment portfolio for retirement, showing how to start, how to shift the investment over time, and where to end up:

1. Start with stock mutual funds, approximately one-third in a total foreign fund and the rest in a total US stock fund.  (Consider adding more funds to cover other investment classes, like REITs or commodities, but don’t worry about getting too complex.)  Rebalance whenever the ratio gets too far from your desired allocation.  (A five percent threshold before selling off part of the portfolio will keep you from constantly buying and selling within your portfolio.)
2. About twenty-five years before your intended retirement, switch ten percent of your portfolio over to a bond mutual fund, either a total bond market or total short term bond fund.  Keep the same proportion of US and foreign funds in your stock allocation.  (Ideally, make the switch within a retirement account to avoid paying any capital gains taxes on the growth of your stock funds.)  Rebalance between the three funds as needed, ideally by directing new investment money towards the laggards in your portfolio.
3. Every five years, continue to build up the bond portion of your portfolio, ten percent each time.  In this way, you’ll slowly scale back on the risk that a bad stock market will deplete your retirement reserves.  Continue to rebalance if your actual allocation gets too far out of proportion.
4. At ten years to go, start putting the new bond money into a TIPS fund, to provide you with an inflation hedge.  With ten years until retirement, you should have 40% in US stocks, 20% in foreign stocks, 30% in bonds and 10% in TIPS.  Have I mentioned that you should rebalance your portfolio if it gets too far from this allocation?
5. With five years to go before retirement, ensure that your cash reserves equal three to four years worth of expenses, to give you a buffer if your investments decrease in value.  Add more TIPS to your portfolio, giving you a final portfolio allocation of 33% US stocks, 17% foreign stocks, 30% bonds, and 20% TIPS.  Rebalance when needed.
6. At retirement, start to live off your cash reserves (as well as any pensions, Social Security payments, or annuities you happen to have).  Put the dividends from your investments into your cash accounts, and when selling your investments (if the dividend income is not enough to meet your needs), try to maintain the same asset allocation you had before you retired (in that way, you’ll automatically be rebalancing your portfolio as you progress).  With a large enough investment portfolio, this method should enable you to live quite well in retirement.

Q: Wow, that’s kind of complicated.  Is this the only asset allocation I should use?

A: Far from it.  This is just a simple, off the cuff allocation progression.  With some effort and a little research, you can probably come up with an even better investment plan of your own, or at least tweak this one enough to meet your personal needs.  It does illustrate some key points about your own asset allocation plan, though.  First, when you have plenty of time to invest, you should invest agressively, using a lot of stocks and other growth investments.  Second, when you are approaching your goal, you should scale down your risk, starting to focus more on preserving what you’ve gained rather than gaining still more.  Lastly, there should be a ‘flight path’, a slow, gradual progression from agressive to safe investments, which you follow over the course of your investment career.

There you have it, some basics on creating an asset allocation and altering it over the course of a lifetime.  Hopefully, these tips will help you as you begin your own investing career.  Good luck, and happy investing!

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The internet is a glorious and wonderful tool, and not just for finding naughty pictures.  You can also find information about stocks, if you are so inclined.  In fact, you can probably find much more information than you would ever need, to say nothing of pitches, scams, and other assorted chicanery.  The best way to defend yourself: learn how to read through financial data.

To help you out, let’s have a little crash course in understanding online stock listings.  For our lesson, let’s use Buffalo Wild Wings (BWLD) as our example stock, since they make some tasty wings.  We’ll look at listings from Google, Yahoo, and Microsoft, as three of the major sources of financial information in the world.  There are, of course, any number of other sites that provide this information, such as the Motley Fool and stockbroker sites like Sharebuilder, but the information is essentially the same on any (reputable) site you could name.  So, as follows, here are Google’s, Yahoo’s, and Microsoft’s listings, respectively, for BWLD on the evening of August 6, 2009:

Quite a lot of information, hunh?  Luckily, most of the information is the same no matter where you look.  I’ve gone ahead and lettered some of the important information given on each picture, to make it easier (I hope) to find this information on each one.  Let’s break down some of the most salient points:

A: Closing Price – The last price the stock traded at during the normal trading hours of the day, it’s how much the stock is worth, until trading starts up again.  Useful in figuring out the value of your stock holdings.  (Well.. there are some exceptions, as we’ll see in a few moments.)

B: Price Change – How much the stock price changed during the day, expressed in points and percentages.  Gives a quick view of how much the stock price shifted during the day.

C: After Hours – Data on the price change and new price of the stock as a result of trading after the market closes.  After hours trading tends to be rather sparse (Microsoft shows an after-hours volume of 2177 shares traded), but will shift the value of the stock from the close on one day to the open on the next.  My advice: don’t bother with after hours trading if you don’t know what you’re doing; and if you’re getting your info from a blog, chances are you still have quite a bit to learn.

D: Price Chart – Shows how the price shifted throughout the day.  If you’re a technical investor, this could be all the information you need (or want); if not, it’s just a plot of the background noise you encounter every day in your investing.

E: Open Price – The price the stock started trading at during the day in question, helpful if you want to know how the price has shifted during the day.

F: Daily Range – The highs and lows of the stock price during the day.  A larger than normal range could be a sign of more volatility in the stock price, possibly as a result of some unexpected news about the underlying company.

G: 52 Week Range – Similar to the daily range, this gives you some idea of where the stock has traded over the past year.  A value that goes above the high or below the low could indicate some big news about the stock itself, or possibly a broad economic trend (as occurred last year with the market meltdown.

H: Daily Volume/Average Volume – Shows the number of shares traded during the day as compared with the average.  As with large price shifts, higher than normal trading volumes indicate something has changed regarding the stock.

I: Market Cap – The size of the company as determined by the value of its assets.  Knowing the market cap can help you to figure out where a stock falls on the scale of small-cap to large-cap, which helps when creating an asset allocation of determining how the stock will perform under various conditions.

J: P/E – The price to earnings ratio.  As I’ve previously mentioned, the P/E ratio is one way to determine the expensiveness of a stock; high values mean that a stock is more expensive than one with low values.  Although, you need to look at comparable stocks to determine what constitutes a ‘high’ value for a particular class of stocks.

K: Dividend – The quarterly payments per share of stock, as well as the dividend yield (the annual payout divided by the current stock price).  Useful to know if you are investing for dividends (if so, you should look elsewhere; BWLD doesn’t pay any dividends, which is often the case for smaller, newer stocks).

L: EPS – Earnings per share, the value of the company’s net profits divided by the outstanding shares.  If you want to know how much of the company’s income belongs to you, the shareholder, just multiply this value by the number of shares you hold.  Obviously, higher values are better.

There is, of course, quite a bit more information that is available on each of these websites, but this is a good start.  Enjoy the stock researching goodness!

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As a consequence of the recent downturn in the stock market, one investing philosophy that has made a remarkable recovery is dividend investing.  Rather than investing purely for capital appreciation (or the growth in stock prices over time), you invest to get paid a regular, quarterly dividend from your stocks.  Besides the appeal of getting paid just for holding the stock, dividend payments also have the ability to grow extremely fast, thanks to a combination of compound interest and dividend growth.

In a normal compounding situation, like earning interest at a bank, the interest earned the first year can then be redeposited so it earns money the second year, and so on.  As a result, the longer time frame we consider for compounding to work its magic, the more
interest we earn.  If we start with a $10,000 deposit in an account that yields 5% at a fixed rate (perhaps a CD), the first year it will earn $500 in interest (5% of $10,000).  The second year, though, it’ll earn $525, as both the original $10,000 and the $500 in interest from the first year will generate interest, assuming the interest was reinvested.  After twenty years, the account will be earning about $1250 in interest, more than double the original interest rate, and in forty years, it generate roughly $3350 per year.  (Of course, with the ravages of inflation being what they are, the ‘real’ value of those payments will be much less; approximately $625 and $837, respectively.  Still more than you were originally collecting even after accounting for inflation, but not much of a gain for forty years.)

So far, so good.  But dividends have an advantage that bank accounts do not: they tend to increase over time.  Let’s look at a situation where we start with an investment of $10,000 in dividend paying stocks, again producing a starting yield of 5% on our invested money.  This time, though, let’s add in a yearly dividend increase of 5%, as well.  For the first year, our results are identical: we get $500 in dividend payments.  But, with year two, we end up getting about $551 in dividends; not only do we have a higher basis (since we reinvested our dividends, giving us $10,500 to start the year), but our dividend has increased by 5%, as well, raising the amount we earn from each stock that we own.  Skipping ahead, as with our simple compounding example, and after twenty years, it’s reasonable to expect a yearly dividend in the neighborhood of $3200 per year, and at forty years, about $22,500 per year, more than double your initial investment.  (Again, inflation will erode the value of these payout amounts; the equivalent present values of these payouts are $1600 and $5625, respectively.)

As they say on infomercials, ‘But wait, that’s not all!’  Remember that stocks, unlike a savings account, can also have capital appreciation.  In fact, because the company is steadily increasing the dividend payout, the stock will likely increase at least as much as the dividend rises.  This should make sense; if the stock price remained the same as the dividend increased, then after fifteen years, the stock would be yielding 10%.  After thirty years, the yield would be 20%, and by the end of our forty year period, the stock would be giving dividends equal to 33.5% of its price, more than one-third.  Before it gets to any of those points, though, the rising dividend will encourage more investors to buy the stock, driving up the price and decreasing the yield, as yield equals the dividend divided by the stock price.  Not withstanding the regular ups and downs of the stock market, the price of the stock will stay at an appropriate level according to the changes made to the dividend, with investors boosting or dragging down the yield as they buy and sell.

To show you just how these processes work, as well as where I got my numbers, have a look at a table showing the growth of money in one hypothetical dividend paying stock:

Here, we started with 1000 shares of stocks trading at $10 per share (because it made the math easy).  The stocks have a 5% yield at the time of purchase (or $0.50 per $10 share) which grows by 5% each year.  The dividends are calculated from the dividend yield and the number of shares, and then the dividends are reinvested at the going price per share.  (We’re assuming the stock will rise in value as fast as the yield increases, but no faster, just to make our math simpler.)  The stock value then represents the capital gains from the stock as well as the value of reinvested dividends.

What do we see in this table?  Well, the dividend per share and the number of shares both increased 6.7 times their starting values, the former from the company’s dividend increases and the latter from reinvested dividends.  (The fact that this value is nearly identical is purely a function of how I did the calculations and by no means indicates that this is a regular occurrence in real life.)  What’s more striking is that because the dividend depends on both the yield and the number of shares held, it has gone up more than 44 times the original value we were earning (6.7 squared is 44.89, which, if we multiply by our starting dividend of $500, gives a final expected dividend of around $22,477).  Similarly, the value of our holding is (at least in theory) worth more than forty times our initial investment.

And THAT, my friends, is the power of compounding dividends; with a relatively small initial investment and plenty of time, we can easily build a rather sizable sources of regular income.

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