Hope to Prosper » Investing

How to Save a Million Dollars on a Modest Income

Bret — Sat, 24 Mar 2012 22:51:58 +0000

Last week I got an interesting comment from Kurt @ Money Counselor recommending a less stressful way to invest. He recommended investing in TIPS and iBonds. It made me wonder if I was being too aggressive with my portfolio, taking unnecessary risks. Should I endure the ups-and-downs of the stock market or find more conservative investments? Here is why I invest the way I do.

My Million Dollar Dream

Image by Eperales

I’ve had a written goal to become a millionaire since 1992. That was 20 years ago and I’m still a long way off. But, I have made a lot of progress. At my current rate of savings and return, I estimate I will have around $1.6 million saved for retirement in 20 years. Of course, $1.6 million will only be worth around $888 thousand of today’s dollars in 2032. But, it’s close enough to a million to make me happy and I should be able to live on it.

One important factor in reaching my million dollar retirement goal is that I must get at least a 4% average annual return from my investments. It will take a 7.2% return to reach the projected $1.6 million. If I average 2% return for the next 20 years, I would only end up with $817 thousand dollars. That’s still nothing to sneeze at, but it’s shy of a million, especially after inflation. This is why I invest primarily in stocks and mutual funds, to obtain the higher yield.

Check Out: Why I Invest in Mutual Funds

It’s Within Your Reach

I believe one of the biggest reasons there aren’t more millionaires is because most people think it’s impossible. Whenever I talk to people about saving and investing, they don’t think they could save up a million dollars. In their mind, millionaires are high income people and that leaves them out. They don’t realize how much money grows over a long period of time at a decent rate of return. They don’t realize how little money it takes with the right savings plan.

Monthly Savings Required to Become a Millionare

Rate	10 Years	20 Years	30 Years	40 Years	50 Years
10%	$4,882	$1,317	$442	$158	$58
8%	$5,466	$1,698	$671	$286	$126
6%	$6,102	$2,164	$996	$502	$264
4%	$6,791	$2,726	$1,441	$846	$524
2%	$7,535	$3,392	$2,030	$1,362	$971
0%	$8,333	$4,166	$2,778	$2,083	$1,667

Source: TimeValue.com

Start Saving Now

The single most important thing anyone can do for their financial future is to start saving as soon as they start working. Even saving a very small amount from each paycheck in your 20s makes a huge difference over the course of a career. Waiting just five or ten years could mean you will have to save twice as much to accumulate the same amount. I began saving and investing when I was 21 years old, even though it was just $25 per month to start. If I had of waited until I could afford to save, I wouldn’t have my house or my million dollar dream.

Don’t despair if you are getting up there in years and haven’t started saving yet. It’s way better to retire with a couple thousand dollars than to retire broke. Plus, when you get in the habit of saving, you are living on less than you earn. That means you will be able to live on a lower income more comfortably in retirement. There really is no excuse to not save at least some portion of your income, whether you aspire to be a millionaire or not.

Be an Owner, Not a Loaner

It’s easy to see how some people become millionaires on a modest income. They own businesses, properties and equity investments. They are rarely the people who work for a paycheck and then put some away in a savings account. You can become a millionaire that way, but it’s a long and drawn out process. It’s much more profitable to own equity investments, than to loan your money to a bank and let them make all of the profit. Owning stocks and real estate come with some big risks. But, they also offer greater rewards. People need those higher yields from equities to power their portfolio over the million mark.

CDs, savings accounts and treasury bonds are yielding less than the current rate of inflation right now. It’s what I call a guaranteed money loser. Even though they yield a small profit, you would be losing purchasing power, every month. These kinds of investments are fine for preserving capital, but they aren’t suitable for accumulating wealth. Unless you are nearing retirement or will need the money within a few years, being too conservative with your investments can cost you a lot of money.

It’s very difficult to save up a million dollars in TIPS, CDs or savings accounts.

The Bottom Line

The bottom line is that it’s not that hard to save up a million dollars. In fact, that’s how most people become millionaires. The people who run into millions rarely hang onto it. Have faith; see yourself as a millionaire and you will likely become one.

“The amount of money you have has got nothing to do with what you earn. People earning a million dollars a year can have no money and people earning $35,000 a year can be quite well off. It’s not what you earn, it’s what you spend.”

Paul Clitheroe – Australian Financial Analyst

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The Stock Market makes a Comeback

Bret — Sun, 18 Mar 2012 16:35:16 +0000

Back in 2010, I bet Len Penzo and Financial Samurai each dinner the Dow Jones Industrial Average would finish the year above 13,000. It was a very aggressive prediction on my part and it cost me a couple of dinners. This week, the Dow finally crossed the magical 13K mark and is holding steady. More impressive, the S&P 500 closed above 1,400 for the first time since 2008 and the NASDAQ composite closed above 3,000 for the first time since 2000.

What does this all of this mean for investors?

Happy Days are Here Again

Image by Jason Rogers

For millions of people who remained invested during the 2008 crash, this means our investments are finally back near where they should be. Sure, we have lost four years, but at least the value has returned to our portfolios. In my case, I kept investing the entire time, so I dollar-cost-averaged my way to a tidy little profit. It’s also a little vindication for having faith in the market while others were bailing out with huge losses. It was hard for me to even watch the news in those days.

There is Nowhere Else to Go

One important factor propping up the stock market is the lack of other investment opportunities. Deposit investments, such as CDs and Money Markets, often yield below the rate of inflation. Treasuries and other bonds are so low, they could devalue significantly when interest rates rise. Gold and other precious metals are very high by historical standards. Right now, stocks are one of the best bets for investors looking for returns. This has a lot of income investors chasing dividend stocks.

Is the Bubble about to Burst?

Although investors seem to be getting nervous at these higher levels, the market is in pretty good shape. Unlike the bubble markets before 2000 and 2008, stocks have reasonable values based on their earnings. The P/E ratio of the S&P composite is right now around 21%, compared to the historical average of around 15. So, it’s little higher than normal, but nowhere near the P/E bubble territory above 44 in 2000. If earnings keep growing at their current rate, the stock prices will be justified. If not, you can count on a correction. But, there is no bubble waiting to pop.

The Bottom Line

The bottom line is that you need a plan and some discipline to invest in the stock market. If you can’t hold tight when your portfolio drops 20% you should probably leave your money safely in the bank.

“It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”

George Soros – Billionaire Investor

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3 Reasons to Control your own Assets

Bret — Sun, 11 Mar 2012 07:39:00 +0000

I read a couple of interesting financial articles this week, which the news media mostly ignored. The common theme was that investors were bilked, scammed and even murdered by unscrupulous money managers. Although most advisers are honest, hard-working professionals, these types of stories are becoming way too common to ignore. Relinquishing control of your assets can be fatal.

1. Theft is Common

Courtesy of Santa Monica P.D.

Daniel Becerril II was arrested last week as a suspect in the stabbing death of Alexander Merman, a Santa Monica elementary school teacher. While investigating the homicide, which occurred in 2008, police discovered the financial advisor owed Mr. Merman a quarter million dollars. They also discovered $300,000 was missing from Merman’s accounts and deposited into accounts belonging to Becerril and his firm. There are dozens of other victims in this case and potentially millions in fraud, including a lady who was evicted from her own house, after it was illegally resold by Becerril and his associates.

Although they rarely lead to murder, theft of customer deposits by financial firms happens way too often. In my opinion, customer deposits should be guaranteed by regulators, just as they are in banks. But, they aren’t. FINRA (Financial Industry Regulatory Authority) has a stated mission of Investor Protection and Market Integrity. They have regulations against improper use of customers’ securities or funds. But, they don’t require their members to be bonded or audited. Customers who are defrauded rarely recover their deposits.

Never count on the integrity of a money manager.

2. Disclosure is Opaque

Allen Stanford was convicted of fraud Tuesday in a $7 Billion Ponzi scheme. Most of Stanford’s depositors haven’t received any of their investments back. There is some money in offshore accounts that may be recovered. But, most of the money was spent on Stanford’s lavish lifestyle. It’s amazing how he was able to convince depositors for so long that their money was safely invested, while he was using their deposits like a personal ATM. It helps to have your own bank in Antigua. It also helps to print up your own fake statements. I’m sure they were filled with colorful charts and projections.

Even when firms report deposits and earnings accurately, the disclosure requirements are often inadequate. Hedge funds and private equity firms have just recently been required to report to depositors by the recent Dodd-Frank law. The SEC quickly relaxed those requirements so that medium-sized funds only have to report annually and small firms aren’t required to report at all. These requirements don’t take effect until March 30, 2012, so existing investors have been in the dark.

Never trust reports or statements, unless they are audited.

3. Oversight is Lacking

MF Global plans bonuses for three of the executives who ran the company during its collapse. The former chief executive Jon Corzine hasn’t been charged despite the fact that $1.6 Billion was improperly removed from customer’s accounts prior to the bankruptcy. Corzine claims he never gave anyone authorization to commingle depositor’s funds, but it’s hard for me to believe the CEO wouldn’t be aware of transactions this large. Just prior to the collapse, Corzine was shopping for a chateau in France. A Chicago grand jury is investigating and may finally bring charges against MF Global executives. Much of the depositor’s money is still missing.

In the case of massive fraud, such as Stanford, Madoff and Corzine, regulators have usually received tip-offs or complaints and failed to protect depositors. The SEC received five separate credible complaints against Bernie Madoff and they investigated four times prior to the collapse. But, they never audited his books to ensure depositor’s funds were safe. They simply walked away, even though they discovered inconsistencies.

Never believe regulators will safeguard your investments.

The Bottom Line

The bottom line is that it’s risky turning your money over to a firm or an individual who isn’t audited regularly. Even the big firms who are audited have been known to misuse funds. The safest policy is to pay an advisor for financial advice and deposit money in your own investment accounts that are audited or insured.

“In limited professions there’s boundless theft.”

William Shakespeare – English Poet & Author

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2012 looks like a Good Year for the Stock Market

Bret — Fri, 13 Jan 2012 08:13:08 +0000

The future of 2012 may be ominous based on the Mayan calendar, but it doesn’t look like the world is going to end on the stock market. In fact, it looks like 2012 could be a pretty good year for investors. It’s easy to be optimistic when thinking about a brand new year. But, I have my reasons for being confident.

First Five Trading Days

Image by Fisherman's Daughter

One of my favorite stock market indicators is the First Five Trading Days. Historically, if the stock market goes up for the first five trading days, there is a 69% chance the stock market will be up for the entire year. The more positive the first five days are, the more likely it will be a good year. For 2012, the first five trading days were definitely positive.

Dow +1.43%
NASDAQ +2.65%
S&P 500 +1.82%

Stock market indicators shouldn’t always be relied upon, because they seem to fail investors at the worst possible time. Many feel the First Five indicator is hyped more by brokers than is justified by the returns. But, a solid start to a new year is always welcome, especially after the lackluster performance from last year.

The Economy is Improving

I wouldn’t say the economy is great, especially for the working class, but it is definitely getting better. The stubborn unemployment rate is slowly dropping and consumer optimism is starting to return. Retail sales are up slightly, especially for automobiles. There is a lot of pent up demand from consumers who have tightened their belts for the past couple of years. Their cars, computers and appliances are starting to wear out and need replacement.

The bad news for the markets is that profits are shrinking as companies are forced to hire and inflation is taking a bite out of their bottom lines. They had a field day during the recession with drastic layoffs and squeezing the remaining employees for maximum productivity. But, the tide is starting to turn and opportunities are opening up for skilled employees. Wages will start to rise.

It’s an Election Year

Election years have had a very positive correlation to the stock market. Looking at the last 21 election years since 1928, all but three have been positive for the S&P 500. Of course, one of those three election years was 2008 and we all know how badly that turned out. The average S&P return during these past 21 election years is around 11.8%, which I would gladly take this year.

This election year is about a lot more than just a quick pop in the S&P 500. It’s about the future direction of our country and our economy. Do we continue to slide into debt while special interests loot our treasury? Or, do we return to the economic powerhouse that has led the world for the past century? Only time will tell.

The Bottom Line

The bottom line is that past performance isn’t a guarantee of future results. We are still living in troubled times, considering the shaky state of our financial system and the massive federal deficit. But, unless there is a major financial meltdown of some kind, 2012 should be a pretty good year.

“Cheers to a new year and another chance for us to get it right.”

Oprah Winfrey – American Talk Show Host

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Where Would You Invest a Million Dollars?

Bret — Fri, 09 Dec 2011 06:08:06 +0000

Since 1992, I have had a goal of becoming a millionaire. I am on track to reach my goal before retirement age, but the stock market certainly hasn’t been cooperating lately. Even if I do save up a million dollars, I don’t think the return from those investments are going to yield the lifestyle I envisioned back in the ’90s. So, I am reaching out to bloggers and readers to ask, where would you invest a million dollars? Here is what I see happening with investments.

The Stock Market is Rigged

Image by Unlisted Sightings

The stock market is definitely rigged. I have said it here before on this blog and I will say it again. Between the super-fast trading networks, dark pools, rampant insider trading and the massive amount of leverage from derivatives, the markets are being manipulated and small investors are getting taken. It doesn’t matter whether you have a 401K, mutual funds or a brokerage account, you don’t get a fair shot.

The big boys are getting away with murder and regulators can’t seem to reel them in. Even worse, there is so much corruption and influence peddling between Wall Street and Washington, people are literally buying outcomes in the market. Congress is along for the ride, trading on privileged information that isn’t available to the public. They are creating laws and making policy decisions on the companies they own stock in.

Check out what’s happening in the financial news right now.

Members of Congress are accused of insider trading, yet they seem to be immune to action from the SEC. Meanwhile, others go to jail for this.
MF Global collapsed in October with former U.S. Senator Jon Corzine at the helm. Investors may have lost between $600 million and $1.2 billion.
Citigroup’s proposed $285 million settlement with the SEC was rejected by a judge for being too lenient. Investors lost over $700 million on the deal.
J.P. Morgan was recently fined 33 million pounds for not properly separating an average of $8.6 billion of their client’s funds from their own.

Sources: Business Week, USA Today, Huffington Post

Housing is Still Overvalued

Real estate is traditionally a good hedge against inflation and a great place to generate income. But, it’s still overvalued where I live and likely to drop some more. I base my guesstimate on the fact that real wages have stagnated and it’s way cheaper to rent in many areas. It’s virtually impossible to buy a property here and rent it out for even close to break-even. I could buy somewhere with lower housing costs, but I don’t want the hassle and expense of being a long-distance landlord. I would give my left eye to have a nice little triplex at the beach, but it’s an expensive proposition.

Other problems with real estate are that it is highly leveraged and illiquid. It requires a big down-payment, a lot of debt and massive liability. If the tenants stop paying or they trash the place, you are out a lot of money. If someone gets hurt on your property, you are getting sued. The laws in my state are very lenient on deadbeat tenants. Besides, my goal is to work less and enjoy life more. Investment properties are a lot of work.

Precious Metals are Sky High

I will be the first to admit that I completely missed the boat on gold, silver and other precious metals. I have seen them do so poorly during my lifetime that I wrote them off as horrible investments. I was very wrong, at least for the past couple of years. Precious metals have outpaced most other investments, by a long-shot. The truth is that precious metals have done so well mostly because currencies have done so poorly. If you compare gold prices to the true U.S. rate of inflation (based on the 1990 CPI), it hasn’t really gained at all.

The past means little to an investor. It’s the future that really matters. What are the future prospects for precious metals? Will the favorable trends continue for precious metals? Or, will they crash and languish for decades, like they did in the ’80s? Only time will tell. I’m not so sure I want to bet a big portion of my future on shiny metals. I would prefer an investment that actually provides a return based on income. Precious metals are only a store of value.

Bonds & CDs have Low Yields

I have shied away from bonds because the interest rates are artificially low. So, the yields on bonds are artificially low, especially considering the risk. If the interest rates shoot up for any reason, it would greatly devalue most bonds. People think it won’t happen, but it just happened in Italy and it could easily happen here. That’s a lot of reasons not to like bonds. Even the Bond King, Bill Gross from Pimco, is bearish on bonds right now. They aren’t the safe haven for investors they once were.

Deposit investments, such as Money Markets and CDs, have horrible rates of returns. So do U.S. Treasury bonds. It’s almost as if they know investors have nowhere else to go and they are taking advantage. For me, any investment that yields less than the true rate of inflation is a guaranteed money loser. And, the risk is higher than people think. Banks weren’t far from a massive collapse in 2008 and they aren’t that healthy now. The U.S. government is in even worse shape and it deserved to be downgraded by S&P.

The Bottom Line

The bottom line is that there aren’t many attractive investment opportunities right now. There is a minefield of risks and a dismal return. If anyone knows of a sound investment please let me know, because I don’t see any.

“The investor of today does not profit from yesterday’s growth.”

Warren Buffett – Billionaire Investor

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How Has Buy-and-Hold Survived So Long?

Guest — Fri, 09 Sep 2011 14:48:25 +0000

The following is a guest post from Rob Bennett of A Rich Life. Rob is a tireless critic of Buy and Hold investing. Instead, he recommends Valuation Informed Index investing. If you lost a bunch of money in the market, you should read this post.

I’m not a Buy-and-Holder. I believe that Yale Economics Professor Robert Shiller’s research has shown Buy-and-Hold to be a gravely flawed strategy and that Valuation-Informed Indexing (which teaches that investors must change their stock allocations in response to big valuation swings) is far more sensible and effective approach.

Shiller published his research showing that valuations affect long-term returns in 1981. The obvious question is — What took so long? Why is it that it is only in recent years that large numbers of investors have begun to wonder if Buy-and-Hold is dead?

I can offer six explanations.

1) The implications of Shiller’s research are so far reaching that even his supporters do not yet fully appreciate them.

Shiller showed that valuations affect long-term returns. To know what affects returns is to know what causes them.

What Shiller really showed is that overvaluation causes poor returns. His research is showing us for the first time in history how stock investing really works. Valuations are key.

Once we learn how stock investing really works, we become able to avoid the risks of stock investing. For those who understand Shiller’s research, stocks are a significantly less risky asset class than they are for all others.

This is of course wonderful news. But it is not news that is easy to accept. Most advances in knowledge are
achieved in small steps. The Shiller Revolution represents a huge leap forward. It is taking us some time to absorb how much we have learned.

2) In practical terms, Buy-and-Hold caused no problems for 15 years after Shiller published his research.

Buy-and-Hold never “worked” in an intellectual sense. It is rooted in a false premise (Buy-and-Hold assumes the efficient market theorized by University of Chicago Economics Professor Eugene
Fama).

Still, in a practical sense, Buy-and-Hold worked just fine from 1981, when Shiller published his
groundbreaking research, until 1996, when stocks prices first rose to insanely dangerous levels. Both Buy-and-and-Holders and Valuation-Informed Indexers go with high stock allocations at times when prices are reasonable. So Buy-and-Holders were adopting proper stock allocations for the wrong theoretical reasons for those 15 years. It was a case of “no harm, no foul.”

3) The extent of the problem with Buy-and-Hold did not become apparent until the 2008 crash.

Shiller predicted in Federal Reserve testimony delivered in 1996 that those going with high stock allocations at the prices that applied at the time would live to regret it within 10 years or so.
We know today that he was right. Those who went with far safer asset classes (TIPS, IBonds or CDs) are now ahead of those who invested in stocks at the time.

But Shiller’s prediction was not proven correct in the eyes of many until prices crashed in late 2008. Stocks started performing poorly in 2000. But the losses suffered by stock investors were not big enough to impress those who believed in Buy-and-Hold until the crash hit.

4) An entire industry has been built up to promote Buy-and-Hold.

It’s wonderful news that we now know how to invest in a way far more effective than the way advocated by
Buy-and-Hold enthusiasts. Making the transition to Valuation-Informed Indexing is not a simple business, however.

There are now thousands of books promoting Buy-and-Hold. There are hundreds of calculators promoting
Buy-and-Hold. There are thousands of experts who made their reputations promoting Buy-and-Hold. In short, there are lots of powerful people and institutions with a strong financial interest in promoting the failed strategy rather than its replacement.

5) Most investors are emotionally invested in Buy-and-Hold.

What the research says will win the day in the long run. But we humans are not entirely rational creatures. We allow our emotions to influence what research we are willing to consider.

Millions of people have staked their retirements on Buy-and-Hold and told friends or co-workers or neighbors about it. These millions of people very, very much do not want to acknowledge the flaws in the Buy-and-Hold Model regardless of how exciting an approach Valuation-Informed Indexing might appear to be according to the research.

6) We have so far only seen a small portion of the damage that Buy-and-Hold will likely do to us.

This is the fourth time in U.S. history that Buy-and-Hold strategies have become popular. On the earlier three occasions, we ended up with stock prices at one-half of fair value. The inevitable return to fair value prices always causes an economic collapse and the economic collapse always causes prices to fall far below fair value.

That’s a price drop of 60 percent from where we stand today. After that price drop, we will likely be in living in the Second Great Depression and no one will be singing the praises of Buy-and-Hold anymore. Until we get there, it will remain possible for many to keep their hopes in Buy-and-Hold alive.

The question is not — Is Buy-and-Hold dead? Buy-and-Hold has been dead intellectually for three decades. The question is — When are enough of us going to acknowledge what the research says and begin making the changes we need to get our economy and our retirement portfolios back on track?

Rob Bennett believes that IBonds are a greatly under-appreciated asset class. His bio is here.

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4 Important Lessons on Investing

Bret — Sat, 02 Jul 2011 20:54:49 +0000

MySpace, king of the social networks just a few short years ago, sold for a paltry $35 million this week. News Corp. bought MySpace for $580 million in 2005, which pencils out to a 94% loss. There have been a number of recent blog posts debating the market value of Twitter and Facebook. I believe they are worth way less than current estimates, because members could leave at any time, taking the revenue with them. The recent fire-sale of MySpace clearly illustrates this problem. I won’t invest in Facebook, Twitter or most other online businesses and here are 4 important reasons why.

1. Earnings = Value

Image by Bitterjug

Warren Buffett says he likes to invest in companies that have a “moat” around them. In other words, he likes to invest in companies that have an insurmountable competitive advantage. The reason this is so important is because investors can count on the future earnings. Companies with no competitive advantage may see their earnings disappear suddenly and the market value will disappear with it Even worse are companies with no earnings. There were a lot of companies like this during the dotcom era and most of them are long gone, along with the investor’s money.

Example: Google created the first search engine that returned relevant search results. Anyone who has used an older search engine like Alta Vista understands how much better Google is. Anyone who hasn’t takes their amazing technology for granted. But, that’s not the reason Google’s stock soared while the other search engines went out of business. Google figured out how to earn revenue from their search engine, without selling out their users. Their Adsense and Adwords campaigns changed the game of paid search forever. By using a fremium revenue model, with clearly identified free and paid search results, they make billions. And, their huge earnings justify their huge market cap.

2. Customers = Revenue

I rarely invest in social networks or other online businesses. The reason is that online businesses can be quickly replicated and displaced. There are no factories, patents, products or infrastructure to protect earnings and retain customers. Online customers are fickle and highly price conscious. Dozens of competitors are only a click away. Customers are the lifeblood of a business, because they generate the revenue. Without their customers, all a company has left are expenses. Some companies, such as banks and telecom providers are often abusive to customers. This is dangerous for investors, because customers will defect as soon as new technologies or competitors are available.

Example: Blockbuster recently filed for bankruptcy after dominating the video rental business for more than a decade. There are many reasons for their spectacular downfall, including the inability to adopt new technology, such as video streaming. But, their rapid decline seems to have started with the immensely unpopular late fees. Customers felt they were being taken advantage of by Blockbuster, who used the high late fees to pad their bottom line. As soon as more consumer-friendly options appeared, such as Netflix and Red Box, customers abandoned Blockbuster in droves.

3. Trendy = Treacherous

Corporate conglomerates are about as boring as a box of rocks. But, when you invest in one, you aren’t investing in pet rocks. Flashy, hot and trendy companies are exciting to invest in. But, they are also very risky for the bottom line. They often disappear as quickly as they came. Think about all of the hot companies from 10 years ago. How many are still in business? Of those, how many are still worth a fraction of what they once were? Not many. Using social networks as an example, think about AOL, Geocities, Friendster and MySpace. Who will still be on Facebook and Twitter in the future? Other types of companies to watch out for are retail, clothing and restaurants. Customer tastes change quickly.

Example: General Electric (GE) was founded in 1890 by Tomas Edison. It is the only company remaining from the original 12 Dow Jones Industrial companies. Although it was originally founded as an electric company, most of its revenue now comes from its financial and media empires. It is also involved in aviation, locomotives, appliances, oil & gas, nuclear power and renewable energy. Profits for GE in 2010 were $14.2 billion on revenues of $150 billion. They have $79 billion in cash and are ranked by Forbes as the second largest company in the world.

4. Premium = Profits

The absolute worst thing any company can possibly be is the lowest cost provider. Margins are razor thin, which increases the risk of going out of business. Customers have no loyalty and products have no particular appeal. Investors should avoid low-margin companies and instead invest in companies with premium products or services. These companies have a loyal base of customers and products that are unique or innovative. Customers will happily pay a premium and the earnings and stock prices reflect this.

Example: Apple Inc. recently became the largest technology company by market capitalization in the world. There is no big secret to their success. Their products are slick, reliable, popular and often technologically superior to others. Users are fiercely loyal and competitors are envious. Their products are expensive and their gross margins are high. But, the products continue to sell and their stock price continues to rise.

The Bottom Line

The bottom line is that stock market investing is risky enough without buying flash-in-the-pan companies. By investing in companies with stable earnings, premium products and loyal customers, you will avoid losing your shirt on the next MySpace.

“Never invest in a business you cannot understand.”

Warren Buffett – Billionaire Value Investor

Lessons from the Iraqi Dinar Scam

Bret — Sun, 19 Dec 2010 01:20:21 +0000

This week, one of my coworkers came into my office all excited and gave me an investment tip. I’ve gotten used to receiving tips, because everyone knows I invest and I love to talk about investing. Today’s tip was something unusual and unfamiliar to me, investing in the Iraqi Dinar. According to my friend, I can buy Iraqi Dinar for pennies each and they will be worth a couple dollars each, as soon as the UN recognizes the Iraqi currency.

If it Sounds too Good to be True, it Probably Is

: Image by Leonardo DaSilva

I admit I was intrigued by this opportunity to make some money and I jumped right into research mode. The first thing that came up was a ton of Google hits for Iraqi Dinar Scam. Luckily for me, there were a dozen red flags that warned me to avoid this scam. My friend wasn’t so lucky, since he already invested in the Dinar and it could turn into a total loss.

Many of the people on the forums complaining about this scam had paid many times what the Dinar were worth and they weren’t aware that Dinar are only redeemable in Iraq. If the Iraqi Dinar is ever accepted back into the global monetary system, they will likely be re-issued, making the existing notes worthless.

The Smell Test

There have always been fraud and scams, as long as there have been people to swindle. Since the age of the Internet and email, it has become possible to scam thousands of people all around the world, from anywhere on the planet. It’s more important than ever to check the fundamentals of any opportunity, before you invest your money.

Taking investment advice from a friend or associate can be a costly mistake, since they may be just one step above you in a scam or a Ponzi scheme. Or, they may not understand the fundamental risk and value of an investment, causing them to overestimate what its worth. Before you act on someone’s advice, always verify the investment’s fundamentals for yourself.

Den of Thieves

Wall Street has become a rigged casino, with investment banks and hedge funds looking out for themselves, instead of their customers. Often, they are betting against their own customers and profiting from the bad positions they have recommend to them. Insider trading is rampant and the SEC only catches a fraction of the people and companies engaging in fraud.

Even your friendly neighborhood investment advisor has to earn a living by recommending fee-laden products. And, sometimes they have been known to skip town with their client’s assets. Investment advisors can be a valuable resource, but you must verify they have your best interests in mind.

The Bottom Line

The bottom line is investing has become a minefield of shaky investments and conflicts of interest. Don’t wander in without first looking where you are about to step. After all, the first rule of investing is to not lose money.

“Beware of false knowledge; it is more dangerous than ignorance.”

George Bernard Shaw – Irish Playwright

Year End Stock Market Strategies

Bret — Sun, 12 Dec 2010 00:02:26 +0000

It’s the most wonderful time of the year, especially for investors in the stock market. Between the January Effect, the Santa Claus Rally and mutual fund distributions, my portfolio usually takes a nice jump at year end. I consider it my personal bonus for sweating out an up and down market and I look forward to it every year. So far, I haven’t been disappointed.

Don’t Miss the Profits

Image by Kevin Hutchinson

Last year, I wrote a post called How to Profit from the January Effect. It was an informative post, but I published it in January, after the January Effect had largely run its course. This year, I wanted to give everyone a heads up, so they can position themselves to profit. Since the Dow was up almost 400 points last week, it’s possible the January effect started early this year.

The January Effect is caused by investors who sell at the end of the year for tax purposes and then buy again in January. This causes a surge in the prices of small-cap stocks, which may lift the broader market. It is also possible this surge is helped by year-end bonuses, some of which is invested in the market. Like the Christmas shopping season, the January Effect seems to start earlier every year. I believe it’s already well under way this year and it will continue for a couple more weeks.

How you Can Profit

Since the January effect benefits small cap stocks more than blue chips, you may want to shift some of your investments. If you are going to make a year-end IRA contribution or stash away some of that Christmas bonus, consider small cap stocks or mutual funds. Between the January effect and the economic recovery, I believe small cap stocks will outperform the broader markets and that is where I’ve chosen to invest.

If you have some cash on the sidelines, now is generally a great time to invest it. In a good year, you can often make a better return in December in stocks than you would if you left your money sitting in bonds or a savings account for the entire year.

Finishing the Year

Investing is a lot like sports. You can stumble though the first three quarters and still win the game at the buzzer. Finishing strong is a critical strategy for success in any competition, especially investing. Just a few extra percentage points per year can double your total return over time.

Last year’s Santa Clause Rally yielded a 7.5% gain for the Russell 2000 index, which is a pretty good year for most types of investments. This year, the Russell 2000 index is already up 4.6%, since the beginning of December and it’s up 22% since a low in September.

The Bottom Line

The bottom line is that the January Effect has happened in 13 of the last 16 years. That’s about as close as you can get to a sure thing in the stock market these days. When it comes to easy money, I always take advantage.

“The key to making money in stocks is not to get scared out of them.”

Peter Lynch - Former Manager of Fidelity Magellan Fund

The Economic Crisis is the Best Thing that Ever Happened to Us

Guest — Thu, 21 Oct 2010 07:10:54 +0000

This is a guest post by Rob Bennett. Rob often writes on behavioral finance on the Passion Saving blog. You can learn more about Rob’s background on his bio page.

You get fired.

You’re feeling very, very, very down. And scared about the future.

What do your friends tell you?

They tell you that someday you will look back at the firing as having been a good thing.

It doesn’t seem possible at the time that that could turn out to be true. It’s just nice people saying a nice thing. But you know what? I have heard lots of real-life stories in which it did indeed turn out to be true. I have had this happen in my own life.

People who get fired are usually not dumb people or lazy people or bad people. But there’s usually a reason why they got fired. There was a mismatch between what they were good at and what their employer needed from them. For any of dozens of possible reasons, both the employer and the employee put off dealing with the problem until the effects of the mismatch became so painful that a firing was the only way to force a change.

That’s what is going on with this economic crisis. It is a terribly painful thing for just about all of us. But I believe that there is going to come a day when we are all going to look back at it as the best thing that ever happened to us. I believe that there is today a mismatch between how we think stocks work and how stocks really do work that must be addressed and that the mismatch has been ignored for so long that a point was reached at which an economic crisis was the only way to force a change.

I am the world’s leading critic of Buy-and-Hold Investing. Buy-and-Hold teaches investors that it is okay (or even a good idea!) not to change their stock allocations when stock prices rise to insanely dangerous levels (as they did in the late 1990s). I want to see Buy-and-Hold supplanted by Valuation-Informed Indexing, a strategy that posits that investors must change their stock allocations if they are to have any hope whatsoever of keeping their risk profiles roughly constant.

Bret (the owner of this blog) was kind enough to link to an article of mine not too long ago. Along with his link he quite properly put forward words expressing his skepticism as to whether most investors would be able to follow a strategy in which they must lower their stock allocation when prices are moving quickly up and increase their stock allocation when prices are going quickly down. Bret observed: ”It’s easier to pry a pit bull off your ankle than it is to get someone to sell a stock after it has gone up 80 percent.”

He’s right. Our natural inclination is to buy stocks when prices are going up and to sell stocks when prices are going down. So how do I expect to get this Valuation-Informed Indexing thing off the ground?

Our natural inclination is wrong. It is rooted in emotion, not reason. It’s a mathematical reality that stocks are more risky when prices are high than they are when prices are moderate or low; there has never once been a long-lasting stock crash that started from a time when prices were reasonable and there has never once been a time when prices were at the levels we saw from 1996 through 2008 when prices did not crash hard. So we know intellectually how to avoid most of the risk of stock investing — pay attention to valuations when setting our stock allocation. We just don’t do it. Because our emotions pull us in the other direction.

It is the job of our investing strategies to protect us from self-destructive emotional inclinations. An investing expert that teaches that it is “okay” to stay at the same stock allocation after valuations rise dramatically is to my mind akin to a doctor that tells his patients that it is okay to eat six pieces of chocolate cake each night because he knows that doing that will make him popular. It is sometimes the job of an expert to tell his clients and listeners and readers things they very much do not want to hear but very much need to hear.

It’s never been done that way. I hear that comeback all the time.

My response is to point out that things change. There has never before been millions of middle-class people invested in stocks to finance their retirements. What worked in earlier days does not work in a day in which a stock crash causes millions to become afraid to spend money and thereby craters the entire economy. The stock market and the economy are now connected. We are going to have to start giving better investing advice if we are to realistically expect our economy someday to become a fully functioning one once again.

We can prevent stock crashes. If we impress on investors that stocks offer a poor long-term value proposition when they are overpriced, people will learn to sell at the first sign of significant overvaluation. Which will bring prices down. Which will cure the overvaluation problem. Market prices are self-correcting once investors understand that the first rule of long-term investing is to never, never, never give thought to staying at the same stock allocation at all times,.

We’ve “known” all this for a long time. The academic research showing that valuations affect long-term returns was published in 1981. For 30 years, we have been pretending that we didn’t know what anyone following the literature did know. Because we are humans. Because we let our emotions overrule our intellect. Because we don’t like change.

We all messed up. We have all been fired.

Lucky us! We are through this painful experience now being presented with an opportunity to move on to something a lot better!

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