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Posts from the ‘Intermediate’ Category

25
Feb

Securities Investing: Keep it Simple

I’ve recently been looking at my stock portfolio.  I’m going to be back to work soon and I want to get a jump on what I want to buy when my full income kicks back in.  I’ve also been paying attention to the personal finance blogosphere again.  Nothing much has changed.  People who are talking about stock investing are really just talking about gambling or they’re talking gibberish.  So I thought I’d share a few details about my portfolio.

I started my portfolio around April 2010.  I spread $5,000 over six different stocks and have been making regular buys up until my layoff last December.  As of yesterday (Feb 24, 2012) I am approximately 13.5% up with an approximate 7.4% annualized rate of return on 10 individual stocks.  In an insanely volatile year for the market, I still managed to make a few bucks.  How did I do it?

I kept it simple.  I don’t get into options trading.  I don’t do forex trading.  I don’t do arbitrage.  I don’t do derivatives.  I don’t day trade.  I don’t speculate.  I don’t do any of the things that are really just gambling on the market.  I keep my risks low by being a strict value investor.

As a value investor, I follow the axiom of “Buy great companies at attractive prices.”  Of course, the trick is figuring out what a great company is and then what an attractive price is.

Figuring out the greatness of a company generally has a qualitative and quantitative component.  The quantitative component is the answer to the question, “Does the company make money consistently?”  The qualitative component is whether the company has an enduring competitive advantage.  When both of these components are affirmative, you’ve found a great company.

That leaves the question of what an attractive price is.  First, you need to find the intrinsic value of the company.  Once you’ve figured that out, you can figure out what discount you are comfortable with.  I generally require at least a 30% discount against intrinsic value.

In my opinion, this is the minimum amount of research you need to do when selecting individual securities.  If you aren’t willing to do this, you should just stick to index funds.

If you are willing to do that kind of research, take a look at the books listed in the Amazon affiliate box to your right.  Those are the foundational books I built my investment strategies around.

Thanks for reading.

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12
May

The Rule of Seventy-Two and You

Hey guys, how’s it goin’?

When a person is just starting out with investing, they may be wondering if the risk is worth it.  After all, they can get a high-interest (relatively) bank account at some online bank like ING Direct or a CD at their bank.  Sure, their money may not make the same returns, but it’s a lot safer.  If they have no risk tolerance, they will want to put their money in the most risk-averse vehicles and call it a life.  Of course, as the saying goes, “No guts, no glory.”

For the sake of argument, let’s look at the difference between the returns on no-risk instruments and more traditional, risky investments.  Let’s start by taking a look at something called the Rule of 72.  The Rule of 72 is a way to approximate how many years it will take to double your money.  It’s a simple formula:  72/(rate*100).

Let’s take a look at just how much you’re missing by staying in a low interest vehicle.

  • Scenario 1:  My portfolio is making an annualized return of 10.43%.  Using the Rule of 72, it will take 6.9 years to double my money. 72/(0.1043*100) = ~6.9
  • Scenario 2: I take my current portfolio and invest it into a 1 year cd at a rate of 3.25%.  Using the Rule of 72, it will take 22 years to double my money.  72/(0.325*100) = ~22
  • Scenario 3:  I take my current portfolio and put it into an ING Direct savings account at a rate of 1%.  Using the rule of 72, it will take 72 years to double my money.  72/(.01*100)  = ~72.

While I would like to live forever, I obviously won’t.  At 72 years, the best I can hope for is to leave my money to someone else to enjoy.  Even at 22 years, that leaves me with little time to enjoy the fruits of my labor.  While I may not be able to live high on the hog in twenty years with a 6.9 year doubling period, that’s still a pretty good chunk of change to help pay for things when I’m old.

If you want to be even marginally financially independent, saving is not enough.  You still need to save a significant amount every year, but you also need to find ways to make that money work for you and maximize returns.  For most people, that means investing.

If you found this post useful or know someone who can benefit from it, go ahead and pass it on.  Follow me on twitter, fan me on Facebook, sign up for the RSS feed.  Thanks.

Until next time, keep on saving!

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9
May

Personal Finance Milestones, Part II

Hey guys, how’s it goin’?

Last post, I talked about dealing with long-term financial goals by creating short-term milestones.  Today, I’m going to go through an example of creating a schedule of milestones.

I have about six and a half years left on my student loan payments.  I took out slightly more than $30,000 in student loans to finish my CS degree.  After three and a half years of repayment, I’ve chipped the loans down to $21,650.  I’ve made a great deal of progress, but I don’t need to tell you that a lot of things can change in six and half years.  You can lose your job, you can get really sick, you can get divorced, any number of things can happen to throw your life into a downward spiral.  One of the best ways to manage these kinds of events is to make sure you don’t have a lot of financial obligations. To reduce risk, I want to pay it off early.  Where do I start?

  1. Make a goal. First, I need to decide on a reasonable time frame.  While I make a good wage, I don’t make nearly enough to pay the debt off outright.  I put a sizable hunk of my income into retirement and other investing.  I also have to consider the money it costs to live a reasonable lifestyle.  While I could put every spare cent into paying off my debt at the cost of the small luxuries that help keep me sane, that’s not much of a life.  After everything has been factored in, four years is a reasonable time frame for paying off this debt.
  2. Make a plan. To pay off my student loans in four years, I need to find my minimum payment.  A good mortgage calculator can do this, but I prefer to do the math myself (with Excel. Thank you, Mr. Chou.)  To pay off the loans in four years (48 payments), I need to make a minimum payment of $451.00 per month.
  3. Write it down. Now I have a preliminary milestone, “Pay $451.00 per month toward my student loans.”

Now I have a set of monthly milestones.  Are they sufficient to stay on track?  Yes.  If I set up automatic payments and make sure the money is always in my bill account I won’t have to worry about it again.  Are these good milestones?  Not really.

  • Is this series of milestones small?  Yes.  But they can be much smaller.
  • Do the milestones have a deadline?  No, not really.  A deadline is usually associated with an actual date.
  • Is the series of milestones specific?  Yes.  But they can be more specific.
  • Do the milestones move me closer to my goal?  No.  The way it’s written now, there’s no indication that these payments will ever end.

Not bad for a first pass at a set of milestones.  They can be greatly improved, though.  What can I do to make them better?

  1. Refine my goal. My student loan total is made up of three different accounts:  $2,575 @ 5% ($43/mo.), $3,415 @ 3% ($86/mo.), and $15,650 @ 4.3% ($232/mo.)  Combined, my minimum payment is $361/mo.  To meet my schedule, I need to pay an extra $90/mo.
  2. Refine my plan. What I want to do is pay off the highest interest rate first, so I’ll assign that extra money to the 5% loan.
  3. Write it down. Now I have a refined payment schedule: $133/mo, $86/mo, and $232/mo.  I also have a new set of milestones.  “Pay $133/mo to Loan 1.  Pay $86/mo to Loan 2.  Pay $232/mo to Loan 3.”

That’s better, but are they good enough?

  • Is this series of milestones small?  Yes.  As opposed to the previous milestones, these are broken out into the individual loans.  Going smaller won’t add value.
  • Do the milestones have a deadline?  Still no deadline beyond the “per month” statement.
  • Is the series of milestones specific?  Yes.  You can’t get much more specific.  Or can you?
  • Do the milestones move me closer to my goal?  No.  There’s still no indication that these payments will ever end.

Looks like another revision is in order.

  1. Refine my goal. I know the overall monthly payment to meet my goal.  I don’t need to do much beyond this.
  2. Refine my plan. What happens when I pay off Loan 1?  To make the goal, I’ll need to push that extra money into one of the other loans.  That needs to be reflected in the milestones.  To do this, I’ll need to put together an amortization schedule in excel.  According to that, I’ll have Loan 1 paid off in 21 payments (02/13), Loan 2 paid off in 30 payments (11/13), and Loan 3 paid off in 48 payments (5/15).
  3. Write it down. With the payment schedule more refined, I now have a new set of milestones.  “Pay off Loan 1 by 2/13.  Pay off Loan 2 by 11/13.  Pay off Loan 3 by 5/15.”

We’ve moved a little bit further down the road.  Are we done?

  • Is this series of milestones small?  No.  By introducing the amortization table, we’ve re-introduced the long-range problem.  Remember, the point of milestones is to create short term goals to accomplish long term goals.
  • Do the milestones have a deadline?  Yes.  Our milestones have deadlines now.  But since the deadlines are so far away, they aren’t much use.
  • Is the series of milestones specific?  No.  We actually can get much more specific.
  • Do the milestones move me closer to my goal?  No.  Even though we’ve introduced the snowballed payment schedule, they still need to be phrased correctly.

One last revision.

  1. Refine my goal. The overall goal is pretty well defined at this point.
  2. Refine my plan. We have a complete plan to accomplish the long term goal.  By creating the amortization schedule, we now have a framework to set up the milestones.  Using the amortization schedule, we can set up a schedule.  For the sake of brevity, I’ll set up a quarterly milestone schedule.
  3. Write it down. Now that I have a quarterly milestone schedule, I need to write it down.  What I don’t want to do is continue saying things like “Pay $133/mo.”  A better phrasing is “Pay Loan 1 down to $2,200 by 8/11.”  Using the amortization schedule, I make a list of balances by quarter until I’ve paid off the loans.  When I’ve paid off one loan, I adjust the schedule moving the money to the next loan, then on to the third loan until it’s all paid off.

It looks like we’re done.  Let’s check.

  • Is this series of milestones small?  Yes.  For brevity, I set them to quarterly milestones.  But with the amortization schedules in hand, I can set them to monthly.
  • Do the milestones have a deadline?  Yes.  By using the amortization schedules, I’ve set up a series of concrete dates.
  • Is the series of milestones specific?  Yes.  By tying the dollar amounts to the schedule, we’ve gotten as specific as we need to be.
  • Do the milestones move me closer to my goal?  Yes.  Now that we’ve phrased them to reflect the amount outstanding rather than the payments, we’re showing progress against the overall goal.

It looks like there is a lot of work up front.  But once you’ve got your milestone schedule set up, you won’t have to do much more with it.  Mostly, just checking them off as they pass.  Another benefit to milestones is flexibility.  If something happens that throws you off schedule, like a month or two of bad spending decisions, you’ll know exactly how to get back on track.

If you found this or any of my other posts useful, or know someone who can make use of it, pass it on.  Like us on Facebook, follow us on Twitter, sign up for the rss feed.  Thanks.

Until next time, keep on saving!

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4
May

Personal Finance Milestones, Part I

Hey guys, how’s it goin’?

As a software engineer, I work on projects that are rarely as straightforward as the toy programs I made in college.  The stuff I work on is not just internally complex, it’s part of a web of complex interactions with the outside world.  A good sized project can take five years to go from planning to delivery and seem impossibly daunting when they first ramp up.

Same thing with pulling yourself out of a financial hole.  Saving money and getting out of debt can seem every bit as daunting as the most complex software projects.  It’s hard to keep the end goal in sight when that goal is realistically years away.  Repaying your credit card can seem like a Sisyphean Task when you look at your monthly statements.  It’s hard to stay motivated when you are making little apparent progress.  How do you stay on track when your goal is not even in sight yet?  By concentrating on the stuff that is in sight.

In Software Development, companies use the idea of milestones to keep a project on track.  These are smaller tasks that have been broken out of larger tasks.  They give the engineers a concrete, achievable goal that when finished, has moved the overall task forward.  It also gives you a framework to recover when you’ve fallen behind.

What makes a good milestone?

  1. Milestones are small. The best milestone can be met with the least amount of steps.  It’s one thing to say, “I want to save $10,000.00 by the end of the year.”  It’s quite another to say, “I want to reduce my spending by $350 and save $500 out of my paycheck this month.”
  2. Milestones have a deadline. To keep you moving forward, a milestone needs a time limit.  Like in the previous example, there’s a big difference between the end of the year and two weeks from now.  Hitting milestones on time gives you a sense of momentum toward your overall goal.
  3. Milestones are specific. A milestone is not ambiguous.  Don’t say, “I want to have a 10% down payment on a car by the end of the month.”  Instead, say, “I want to have $1,750 by the end of the month.”
  4. Milestones move you closer to bigger goals. A good milestone points toward the overall goal.  If you want to save $10,000 dollars by the end of the year, create your milestones so you show progress.  “Save $850.00 this month,” is not as good as, “Have $3,400 in my savings account at the end of the month.”

Setting up a series of milestones is an effective way to meet your long-term financial goals.  They help you maintain a sense of progress that can keep you motivated when your goals are still some ways off.  They help you track where you are in relation to where you want to be and make it easier to correct your course when necessary.  In my next installment I’ll walk you through an example of my own personal milestones.

Until next time, keep on saving!

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15
Apr

Get Ready, Get Set, Wait For It, Wait For It, INVEST!

Hey guys, how’s it goin’?

So you’ve got your emergency fund, you’ve paid off all of your debt (or a significant portion), you’ve made arrangements to pay your bills on time, every month, you’ve contributed as much as you can to your retirement accounts, and you are putting away a little bit of money every paycheck as pure savings.  You know you want to get in on that sweet stock market income, but you’re not sure what to do.

1.)  Read.  Read a lot.  Start with the Intelligent Investor by Benjamin Graham (psst, check out the Amazon widget in the sidebar.)  This is about as close as it comes to a holy book of investing.  Anyone who makes a lot of money in the markets will tell you that this book is the starting point.  If they don’t, get an autograph, because you are speaking to one of the luckiest people in the world.  This book will get you in the right frame of mind and give you all the knowledge you need to start investing.  It’s also a doorstop book and densely written.  If you can get through it, chances are you have the right temperament to invest.

2.)  See number 1.

I’m being dead serious.  Investing is not something to be entered into lightly.

Baseball is the only field of endeavor where a man can succeed three times out of ten and be considered a good performer.” — Ted Williams

Swap baseball with investing and you’re not too far off the mark.

There is an entire industry dedicated to picking stocks.  These are folks whose full time job it is to pick stocks.  They have the luxury of large pools of capital, research assistants, expense accounts, every resource you can imagine and the best of them can’t beat the market half the time.  Sure, there’s an occasional superstar like Bogle and Buffett.  But those guys are extreme outliers who will be the first to admit that their skills didn’t come easy.  They succeed because they work their butts off every day.

Until you’ve done your research and have come to a good understanding of how the market works, you don’t have any business picking stocks.

Now, that doesn’t mean you shouldn’t invest.  It means you need to gear your approach to appropriate investment vehicles.  If you don’t know how the markets work and/or you don’t have the time to spend researching individual stocks, then investing in individual stocks is the wrong strategy for you.  The good news is there are right strategies.

While you’re doing your homework, you can put your money into an index fund.  The same basic rules for retirement investing apply to regular investing.  Pick a fund with a low expense ratio (less than 0.5%) and start making regular buys.  Be careful that you don’t spend too much on trading fees (I never spend more than 2% of the buy on trading fees.)  Don’t get nervous.  Just keep pushing ahead.  There will be bad times, there will be good times.  The key is to not lose your head and let it ride.

By the time you’ve thoroughly absorbed the Intelligent Investor (psst.  See the Amazon widget in the sidebar,) you’ll have what you need to start investing in individual stocks.

Until next time, keep on saving!

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30
Mar

Savings vs. Debt Reduction. By the Numbers

Hey guys, how’s it goin’?

In my last post, I talked about what you have to do to get out from under credit card debt.  It can take a long time to do and you may be raring to start growing your savings.  Today I want to talk about the age-old question, “Is it smarter to pay off my bills before saving or investing?”

In general, you will end up making more by paying off your debts before saving.  Shoveling every spare dime into retiring your debt will free up more money faster.  Allow me to illustrate:

Assumptions:

  • A $50,000.00 loan, compounded monthly at 8.5% over 10 years.
  • An annualized return on investment of 4.5% compounded quarterly.

I used Excel to calculate a payment of $619.93/month and set up an amortization schedule.  I’ll show you three scenarios.

Scenario 1:  Pay off the loan per the amortization schedule and invest $100/month.

  • Loan paid off on schedule (120 payments)
  • Total Interest Paid on the Loan = $24,391.41
  • Total Return on Investment = $2,299.24
  • Net Interest Paid = $22,092.17

Scenario 2:  Pay off the loan plus $100.  When the loan is retired, invest the total payment amount for the balance of the term ($719.93)

  • Loan paid off two years early (96 payments)
  • Total interest paid on the loan = $19,064.32
  • Total return on investment = $642.95
  • Net Interest Paid = $18,421.37

Scenario 3:  Pay off the loan plus $50 and invest $50 per month.  When the loan is paid off, invest the total payment amount for the balance of the term ($719.93)

  • Loan paid off 14 months early (106 payments)
  • Total interest paid on loan = $21,389.62
  • Total return on investment = $1,023.45
  • Net Interest Paid = $20,366.17   (*edited to remove rogue minus sign)

The best strategy is to retire your debt as quickly as possible as long as you keep saving and investing the money after the debt is paid off.

Caveats:

  • If you don’t have an emergency fund, you’ll have to sacrifice those possible gains to build one.  An emergency fund is a crucial component of paying off your debt.  If you don’t have the cushion of an emergency fund to fall back on, you’ll just be forced to go back into debt when your car breaks down or your roof has a leak.  If I’ve said it once, I’ve said it a thousand times.  There are few things more frustrating and demotivational as taking one step forward and then two steps back.  While you can still pay off extra, you should be putting some money in an emergency fund at the same time.
  • If the interest on your debt is significantly less than what you would reasonably expect to get from investments, then use the money to invest.  For instance, the interest on my student loan payment is less than 4%.  My investments are returning around 5%.  Of course, that’s after years of reading and studying value investing before I invested my first dollar.  And I could easily lose money next year.  It’s not easy to maintain good returns year after year and it’s best you don’t try until you’ve read up on the subject extensively.  This is a very risky strategy if you know what you’re doing.  If you don’t, it borders on disastrous.

Hope you found this post useful.

Until next time, keep on saving!

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