Smart Investing

Thinking about investing?

Investing in stocks and bonds is one way to increase your wealth over the long haul. Unfortunately, it is also a way of losing a lot of money in a hurry. Want to take $10,000 and turn it into $5,000? Try investing in stocks. You might just watch your money disappear.

Here are some things to consider BEFORE ever buying a stock:

    1. Do you have an emergency fund? This is a fund of money sitting in a bank account. How big should this fund be? About enough to live on for eight months. That may seem like a lot of money, but it is important to have. Then if worse comes to worst, you will have a cushion of cash to fall back on.
    2. Do you have credit card debt? You are probably paying a lot of interest on this, so the best policy is to pay this off. Don’t even think about investing until it is paid up.
    3. How is your employment situation? Are you and/or your partner situated in secure employment? If your employment is shaky, it is not the right time to invest.
    4. Are you prepared to spend time to learn about investing? Read The Battle for Investment Survival by Gerald M. Loeb; and also Beating the Street by Peter Lynch. Subscribe to Money Magazine and watch Suze Orman on TV. You need to be somewhat prepared before you invest your money. You will also have to spend time every day after you invest tracking your purchases. Learning about investing and following your investments should be considered a life-long part-time job.

OK. Let’s assume you have all of the above items under control. What next? Open an account with a large mutual fund company such as Fidelity or T.Rowe Price. Put some cash into this account and add to it regularly. If you’re lucky you have an employment-based 401(k) retirement account with an employer match. Or you may be able to have money deducted from your paycheck and deposited directly into such an account. Pick out which of their mutual funds you would like to buy, something that specializes in the so-called Large Cap or Blue Chip Stocks (the stocks of large, well-known companies.) One example would be T. Rowe Price Blue Chip Fund. Now you can follow this mutual fund daily and learn how it reacts to events.

Finally, you can make a purchase. Start with a small amount of this fund and follow it every day. Read the prospectus to learn more about your fund. Resist the urge to buy and sell. You will surely guess wrong and end up losing money. Just buy and hold. If it is working out well, buy a little more every three months, adding to your position. Over time, the stocks should go up as our nation gets richer.

As this is being written, many investors like dividend bearing stocks, so maybe you could buy a small amount of a mutual fund that specializes in such stocks, such as Vanguard Dividend Growth Fund. Buy and hold.

If conditions warrant, sell a fund, but have a good reason. As the years go by, you might add several more mutual funds as you gain more knowledge.

After you have made a thorough study, you might even buy shares in an individual stock. But be careful, they can lose money fast if you don’t pay attention.

Some people prefer to turn their investment accounts over to an investment company to manage. Picking the right company is an incredibly important decision, so ask a lot of questions. Make sure they are insured against fraud. My advice is to select a “fee only” company. They will charge you a flat fee to manage the account, usually a percentage of your balance. Look for conservative, safe investments. Don’t plan on making a lot of money fast. That mind-set is a good way to end up losing. Instead, aim for a steady increase over time.

Be Upfront About Money Before Marriage

You’d like to think that love conquers all, and sometimes it does. However, the sad fact is that money problems are often the undoing of many relationships. Even if the couple has sufficient money, differences in how each person feels about saving and spending can put a strain on a marriage. It is extremely important that some basic financial issues are discussed before the wedding. If they aren’t dealt with ahead of time, they will only become bigger issues as the years pass. Here are some suggestions for couples to discuss before tying the knot.

  1. Do either of you have debt? How much? Are you paying it off regularly?
  2. Do each of you know the income of the other?
  3. Are you going to pool your money? If not, who will be responsible for what?
  4. Is either of you looking for a change of jobs which might involve relocation?
  5. Will one of you be returning to school?
  6. Do either of you have a poor credit score?
  7. Who will be responsible for paying the bills and balancing the checkbook each month?
  8. Who will be be in charge of savings and investing?
  9. Do you have differences in spending habits? If one is a saver and the other a spender, you may have to learn to compromise.

Keep Track of Your Finances

One way to keep a handle on your financial situation is to make an annual balance sheet. It may sound complicated, but it is really just a list of all your financial assets and debts. If you make one every year and track your progress (or lack of progress) over the years, then you will be in a better position to understand your finances. You may be surprised by the results, and knowledge is power. After it is all done, be sure to share it with your partner so your situation is in the open.

Your assets (the things you own) should include all bank accounts, stocks, IRA’s, 401k’s, etc. Anything that has actual cash value. Do include your home equity – the value of your home minus the amount you owe on it. Don’t include physical property such as cars, clothes, collections, etc.

Liabilities are your debts. Do include credit card and consumer loans.

The only hard part is collecting all the information, and that gets easier the more you do it. The actual balance sheet can be just a list of assets with their value, a list of liabilities with their value, and your net worth (assets minus liabilities). Or you can follow the sample that I have provided here.

The numbers in parentheses are negative. This is bad. The key to having a positive net worth is getting rid of the debts. Then gradually add to the savings, and you will be on the way to wealth.

Family Investment Decisions

Do you know where your money is invested and how much it is earning? In many families, it is still common to find that the husband pays the bills and keeps track of the money coming in and going out. When the husband dies, is incapacitated or there is a divorce, the wife is clueless about finances. If you are a woman, and that sounds like you, now is the time to educate yourself. The same goes for the husband if the roles are reversed.

An ideal marriage involves making financial decisions together. If one partner is better at investing and enjoys it more, that’s fine, let them do it. But make sure that you know what those investments are, and where the information about them is located. In addition, check on them at least quarterly to see if there have been, or need to be any changes. Take advantage of opportunities to learn about investing, so that you will be able to make informed decisions if the need arises.

Tax Savings With IRAs

Everyone is looking for tax savings at this time of year. One of the best things you can do is contribute to an IRA. It might reduce your taxes this year, and the money will grow tax free. There is still time to do it and have it apply to the 2010 tax year. You and your spouse can each contribute up to $5,000 a year ($6,000 if you are 50 or older). This amount may be less if you are already investing in a 401K at your workplace.

If you are a retiree, but have part-time employment, you can continue to contribute to an IRA up until the age of 70, although the amount is dependent upon your earnings. It’s an easy way to save money if you don’t need the cash right away. If it turns out that you do need the money, you have the option of beginning withdrawals from your IRA at age 59½.

What is best for you is an individual matter, but for most people, a traditional IRA works better than a Roth IRA. With a traditional IRA, your money is deducted from your income and deposited tax free. You pay taxes on it when you begin withdrawing it. At that time, since you would no longer be employed, you would probably be in a lower tax bracket. With a Roth IRA, you pay taxes now, the money grows tax sheltered, and you withdraw it tax free.

Buy Mutual Funds with Low Expense Ratios

What is an Expense Ratio? An “expense ratio” is how much a mutual fund charges you to manage your money. Funds with low expense ratios charge about 0.3% per year. Funds with high expense ratios charge 2% per year – or more!

How They Invest. Low-expense funds, such as Vanguard, usually buy and hold a “basket” of stocks that represent a certain segment of the market. Mutual funds with high expense ratios trade stocks constantly, buying the ones they think will increase in value.

Random Chance. So mutual funds with high expense ratios must generate a higher rate of return, right? Actually, no. Studies have shown that mutual fund managers perform no better than random chance. And all that buying and selling means that taxes are higher. Not to mention the fees. So, in actuality high-expense funds perform much, much, worse.

Think it doesn’t matter? Consider this:

$100,000 invested for 20 years – 10% return
Fund w/ Low Expense Ratio (0.3%) Fund w/ High Expense Ratio (2.0%)
$636,990 $466,096

Over 20 years, the difference is 37%. With taxes, it is even more! So, before you buy a mutual fund, know the expense ratio. It really matters.

Not convinced? I highly recommend reading A Random Walk Down Wall Street. And if you’re looking for a good place to find low-expense funds, I personally use and recommend Vanguard Mutual Funds, which have very low expense ratios.

What is the Best Way to Increase My Savings?

The best way to save money is to control your spending. It is the hardest thing for many people to do, but it is really the only way to get ahead. If you make $50,000 after taxes, try living on only $40,000 and put the rest into a savings account at your bank. As your money builds up, resist the temptation to spend. Look upon that savings account as a nest egg for the future, not as a pile of money to spend. Pretty soon you will be earning interest on your interest and you might enjoy watching your savings grow. Better yet, have some of the money deducted from your paycheck and directly deposited into a tax sheltered retirement plan such as an IRA or 401k.

The important thing here is to limit your spending.

What Should I Invest In?

There is no pat answer to this question. It is a high individual choice and will be different for every person. Some investments are volital (they go up and down a lot) and some are not; some investments are risky and some are safe; some people won’t need their money for a long time, but some will need it before then; some people are old, but some are young; some people are willing to spend a lot of time managing their investments and some aren’t; some people are good at investing and some aren’t. Where do you fit into all this?

Take a moderate approach. Let’s say you are a young and have finally come up with some surplus money with which to invest. First open a money market account at your bank and put the money in there to use as an emergency fund if you really need it. After you have set aside a reasonable emergency fund (maybe a month’s salary), try buying some bank certificates of deposit, something safe and easy. Just sit back and watch your money grow. Buy the CD’s for different lengths of time so that they don’t all come due at once.

Some people never get past investing in bank CD’s and this is fine. If you don’t have the interest or time to put into studying investing, or don’t have much tolerance for risk, then bank CD’s will continue to grow and multiply. You will be getting interest on your interest, and with time it will grow into a nice nest egg.

Most advisers would suggest that you move into buying stocks at some point. The quickest and easiest way to do this is to purchase no-load mutual funds. They charge no up-front sales fee, so all your money goes to work for you. The mutual fund buys stocks for all its customers and you own a portion of this big pot. You will actually own a small amount of many different stocks. Try signing up with a large mutual fund company such as Fidelity or T. Rowe Price. First, just buy a mutual fund that specializes in the big companies, the so-called large cap or blue chip stocks. You should regard your mutual fund as a long-term investment. Just buy a small number of shares and plan to hold it a long time – years or decades. Then you can add to this investment as time goes by.

Mutual funds may specialize in a certain type of stock or bond, so you may want to branch out into other kinds of funds such as foreign stocks, small companies, government bond funds, etc. By spreading out your money over several different kinds of investments you are getting diversification which protects you a little more. Some people are always buying and selling mutual funds, others just buy and hold. This is an individual choice, but most experts suggest the buy-and-hold method as the best way to come out ahead over time.

After you’ve invested for a long time you should own numerous bank CD’s and a diversified group of mutual funds. If some of these are held inside an IRA or other retirement plan, all the better.

Some people may choose to invest in individual stocks. It takes time to research and manage your stocks, but it might pay off for you if you are lucky and skillful. The person who invested in Cisco Systems in 1994 probably had no idea the stock would increase 20-fold over the next six years. If he sold out then he did well. Shortly after that, the stock took a big hit in the tech-wreck and lost most of its value. If you don’t have to stomach for such ups and downs, just stay away from individual stocks. Be prepared to put a lot of time into evaluating and monitoring your stocks.

If you really want to get involved, there is always real estate. It takes expertise and effort to make money with this investment, but fortunes have been made there.

Some people like to have a small amount of money invested in gold coins sitting in their safe deposit box. They don’t pay dividends and may go down in value, but will never totally lose their value.

Is Gold a Good Investment?

In my opinion, gold is not a good investment, but it does have its uses. Generally, the price of gold muddles along at a fairly steady price with occasional spikes up and down. For example, gold cost about $200 an ounce in 1975. In 1980 there was a big spike and the price rose to about $850, but quickly sank to about $400. It stayed at about $400 with minor fluctuations for the next 20 years, and now we have another spike. Will the price continue to go up or will it come back to earth? Only time will tell.

So, if you had bought gold in 1975 and held it for 30 years you would have doubled your money – not even enough to keep up with inflation. If you bought in 1985 and held for 20 years you would have broken even. If you bought in 2005 and sold in 2010, you would have made a very good return on your investment. If you buy gold this year, who knows? Of course, all these dollar amounts represent less purchasing power due to inflation. If you break even over 20 years, you are really a big loser because of inflation.

Gold is getting a lot of attention and hype now because of the spike in price. Most of the people who recommend gold as an investment are the ones selling it. The more they sell, the more they make, so of course, they recommend gold. Remember, gold doesn’t pay a dividend, and it can be stolen or lost. When you buy gold you might have to pay more than the spot gold price and also sales tax.

So, if your goal is to buy gold, hold it for a while and then sell, this is a very risky proposition. How can you tell if the price is low enough to buy or high enough to sell? I can’t tell the future, can you?

Uses of gold investment: Protection: Some people buy gold as a means of protecting themselves against the uncertainties of the future, things like market declines, growing national debt, currency failure, inflation, war and revolutions. It is unlikely that gold will ever lose all its value. Throughout history, gold has been valuable, and that will probably never change. So, if there is a revolution and you have to leave the country, then your paper money won’t be much good, but gold coins will be as they say, “good as gold.” For example, when the boat people of Vietnam wanted to leave their country and sail someplace safer, it was gold that would get them where thy wanted to go not Vietnamese currency. When Germany suffered hyper-inflation after World War I, the Germany currency was worth very little, but the people who had gold could use it to get food and other goods. This is why some people feel they should have a certain number of gold coins – to protect themselves if worse comes to worse.

Diversification: Many people don’t like to put all their eggs in one basket. They like to diversify their wealth, to spread it over several different kinds of investments, possibly including gold.

Speculation: If you can see into the future or if you have good reason to believe that gold will go up in value, maybe you will take a gamble and buy some gold with the idea of reselling after the price is higher. Don’t be surprised if you lose.

Personal enjoyment: In addition to the monetary value of gold, some people get enjoyment out of owning gold jewelry and coins. They like to wear the jewelry and they also know that the gold content will hold value over time. Some people like to collect gold coins and may also hope that the coins will appreciate because of their value as coinage in addition to the gold content. Some people like to get a bunch of gold coins and run them through their fingers.

An idea: Look into buying stock in gold mining companies. Aren’t they in a position to profit from the spike in gold prices?

How Do I Invest in Mutual Funds?

The easiest way to invest in stocks is to buy a no-load mutual fund from a big company such as Fidelity or T. Rowe Price. There are hundreds of companies that sell mutual funds, but I would stick with a major company. Get a no load fund. This means that they don’t charge you a sales fee up front. A mutual fund owns many stocks, and you will own a little bit of the mutual fund. So actually, your investment is spread over a lot of different stocks which lowers the risk. Once you select the mutual fund you wish to invest in, you will have to call them or go online and fill out some forms. Try to select a company that answers the telephone.

Mutual funds come in many different flavors depending on the kind of stocks you want to own. Some funds buy stocks from a certain country or geographic region. Other funds buy stocks from certain economic sectors such as manufacturing, pharmaceuticals, precious metals, technology, etc. Other funds will buy any stocks. You might want to start with a fund that buys stock in big companies (such as T. Rowe Price Blue Chip Growth Fund) for starters and then branch out into different types of funds as you gain experience.

The good thing about mutual funds is that you don’t have to go to the trouble of researching and buying individual stocks. There is a fund manager who does that for you. You should monitor the funds results to make sure the manager is doing his job, and be aware that owning a mutual fund may have a tax liability each year.