The first few lines of a recent blog post at Sound Mind Investing said:

After falling roughly 18% in two weeks (and scaring many investors half to death), the stock market bottomed August 8th at just under 1120. Since then, it has bounced back and forth between 1120 (white line) and 1220 (red line)…

For between 3 – 4 years, I’ve been a subscriber of the Sound Mind Investing Newsletter.  It is my ‘go to’ source for all things investing.

Actually, it is one of my few current sources for investing related information.  I do enjoy reading blog posts from the Oblivious Investor as well.

See, I have a confession to make.  I’m a driven, focused, and tenacious person.  While that can be a very good thing, it can also be a very bad thing.  Sometimes my one track mind tendencies make it hard for me to focus on multiple things at a time.

A few years ago, I was at an emotionally unhealthy (which ultimately becomes a spiritually unhealthy) place with my investments. As the children’s song says, I got all wrapped up, tied up, and tangled up – in my investments.

However, I decided that I needed something more productive to do with my time, and it was time to practice truly passive investing.  When I talk about passive investing, I’m not talking about investing in index funds vs mutual funds. I’m talking about a kind of investing that allows you to continue in bliss when the world is apparently falling apart.  I’m talking about the kind of investing that allows you to focus your time and energy on other more important things in life.*

*By the way, I’m thankful for Sound Mind Investing and the folks who do dedicate their time to studying these types of things.  However, I think they do all that work so the rest of us can glean from their advice and experience without investing untold hours following the market.

However, this week (not trying to brag), I realized I’ve made the necessary changes because when the SMI blog post pointed out that the market has fallen roughly 18% in two weeks, I had no idea.  The corollary blessing is that I missed out on getting scared half to death.

The Key to True Passive and Worry Free Investing

Tip #1: Turn off the news when they start talking about the stock market.

Alright.  I undoubtedly have a strong advantage because I have no TV.  But seriously, why do you need to know what the stock market does every day?  I honestly couldn’t tell you what the S&P 500 is doing.  That might make you think I’m a bad investor, but following the market doesn’t improve or reduce returns.

I liken following the investing news to a day at the lake.  If you sit in a boat and drop rocks into the lak,e you’ll see, recognize, and notice every change.  However, if you were to stand at the shore, you’d miss out on inconsequential ripples.  You can’t even see the impact of little things.  However, anything big that happens will be visible on the shore.

I want my investing to be like that.  I don’t want to see little ripples in the market.  If something major happens, I can see that and decide if I should make appropriate adjustments.

You must find a way to filter out useless, daily, and overwhelming information about the market.  Instead, develop a system where you can identify trends and movements, and then only exert any emotional energy when necessary.

Tip #2: Stop tracking your investment gains and losses.

Most people like to see what is happening with their investments, so they buy personal finance software that allows them to track the gains and losses.  I switched to Moneydance a couple of years ago, and I didn’t even link the software to my investment accounts.  When it’s time to do the budget, I do just that – without getting distracted by what might be happening with the stock market.

If I think it is important to see what’s happening with my investments, I just sign into my accounts online and see the gains and losses there.

Tip #3: Consistently do what you’ve decided to do.

It may be possible to make more money in the market when you closely follow the ebbs and flows.  It may be possible to pull funds out at the right time and to buy at the right time.

However, a much healthier approach is to simply do what is right for you when it’s right.  Yes, you’ll need to decide how much money to put into certain fund types, but once you’ve made your decision, stick with it.  Constant second guessing and trying to avoid the impact of the market is a ludicrous and time consuming effort.

Do the right thing – even when the market is telling you it’s wrong.

Tip #4: Make sure you’re putting something into retirement.

I don’t think avoidance is the solution.

The biggest contributing factor when it comes to saving for retirement is consistency.  In fact, I think the thing that most dramatically impacts your investment returns is how much you put into the market. 

In our family, it’s around the first of the month.  Money is taken out of our bank account.  Some purchases are made automatically, and with others, I initiate the trade.  Either way, we put in more money without trying to analyze what the market is doing.

When the market is high or low, money is still invested.

Tip #5: Remember that security is not found in money.

I understand fear.  I understand fret.  I understand worry.

But, why put your money in investments that bring all those things?

If you aren’t comfortable with the stock market, don’t use it as an investment vehicle.  Life is too short for money worries to dictate your security.  I currently invest in the stock market and have for nearly 15 years.  However, I’m not going to allow a down day, year, or decade to create anxiety in my life.  If I’ve done what is responsible (put money in the market) in a responsible way (with some research), then my best option is to trust.

I don’t trust that God will make my stock go up.  That’s nothing God has promised me.  I don’t trust that God will give me supernatural investing wisdom.

I simply trust that God will be there regardless of how things turn out.  I trust that life can be good with God even if things fall apart.

I gotta tell you. I’m enjoying my passive investing strategy.  I’m glad to know that while most investors are sweating bullets, I’m ignorantly doing ministry and spending time with my family.  I’m glad to know that the market can drop 18% in two weeks, and I have no clue about it.

I wouldn’t trade it for the world.

What do you do to keep your investing as a truly passive activity?  How do you involve yourself in the investing process without getting overly involved?

To leave a comment or easily share the article with your Facebook or Twitter friends click here -> Mastering the Art of True Passive Investing | A Guide for Worry Free Investing

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I recently introduced you to the importance of asset allocation.  In order to help you determine the right asset allocation, I figured I’d spend a few moments introducing the different types or categories of stocks and the general trademarks that represent each type.

The best primer book on this topic is The Sound Mind Investing Handbook by Austin Pryor.  My comments on the book exactly mirror those of Mary Hunt who says, “Everything I know about investing I learned from Austin Pryor.”

Ditto.

Small Companies Vs. Large Companies

In one corner, we have Wal-mart. (Ever hear of them?  I think I may have seen one before.)  In the other corner, we have Ralph’s Revolutionary Raft Corporation.

Wanna guess which is the small company and which is the large?

Now, the biggest question is which type of company provides more opportunity for returns, and which provides more opportunities for losses?

Wal-mart is a big company. They are more stable and consistent.  It doesn’t mean that they can’t, won’t and don’t lose money.  It simply means they are more established, and thus, more predictable.

Ralph, on the other hand, could easily triple or quadruple his sales (and stock value) if everything goes right.  However, he could go all in and bust too.

A mutual fund company or index fund that owned lots of Wal-mart type companies would be categorized as a Large Cap or Large Company.  On the other hand, a mutual fund company or index fund that was more interested in Ralph’s Revolutionary Rafts would be categorized as Small Cap or a Small Company.

What if they own both?

Typically, they would be called mid-cap or would be identified by whatever is the bigger focus.

For those of you who are more familiar with Dave Ramsey lingo, Large Cap is what he calls Growth and Income Funds or Blue Chip Funds.

Growth Vs. Value

Going one step further, different mutual fund managers have different strategies. (You won’t get into this type of distinction with index funds as index funds will own both growth and value companies.)

The value managers look for companies whose shares are selling below what they are ‘worth’.  The management team will determine what represents a value and then buy up shares at a discounted price.

Growth managers look for companies with a solid track record and good potential for growth.  They are willing to buy stocks at top dollar because the company has been, and is expected to perform well into the future.

Once again, some managers do both, so this may be identified as a ‘blend’ fund.

International Funds

International funds try to identify growing markets and economies outside of the USA.  They also attempt to take advantage of currency difference to maximize their returns.

In this final category you must remember that you can have each of the above types of companies with the only constraint that they will focus their investing outside of the United States.

Thus, you could invest in an international small growth stock or an international large value international fund.

What’s the difference between global and international?

Global funds are given more flexibility to invest both in the US and outside of the US, whereas international funds primarily invest only outside the US.

Sector Funds

Sector funds only invest in one part of a given economy.  They might focus on automobiles, medical care, precious metals …  Thus, these types of mutual funds or ETFs would only buy stocks that belong within the specified sector of the economy.

One could categorize the risk levels as follows:

1. Large Value (least risk)
2. Large Growth
3. Small Value
4. Small Growth
5. International Funds
6. Sector Funds (greatest risk)

For those of you who are currently investing, your homework is to be sure that the index funds or mutual funds that you own represent your current risk level.  If not, it’s time to adjust your holdings.

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I get questions.

I get questions about the Bible and money, questions about debt, and questions about investing.

Did you know that the questions you ask don’t necessarily get you to the solution you need?  If you ask the wrong question, you’ll get the wrong piece of advice.

We tend to think the most important investing questions are:

1. How much should I be saving for retirement?
2. Should I invest in a 401k, Roth, or Traditional IRA?
3. What stock broker should I use?
4. Which company is best – Vanguard, Fidelity, or …
5. Should I invest in mutual funds or index funds?

Yet, none of these are the most important question.

The most important question you must answer is: what should my asset allocation be?

What is Asset Allocation?

Asset allocation is the art (not science) of deciding how you’re going to split up your investment pie.

You can see two sample asset allocations below (neither are recommended for anyone – just an illustration):

In this case, the Friendly Fellow on the left has a more conservative asset allocation than the Young Wippersnapper on the right.  This means Friendly has less potential for losses and less potential for gains.  Wippersnapper has more potential for gains and more potential for losses.

However, how they decide to cut the pie allowing some pieces to be bigger and others to be smaller will have the biggest impact on their investing.  Neither can surpass 100%, but they can mix and match investment types and categories as they wish.

In order of conservative to aggressive assets, I’d categorize them as:

1. Bonds (most conservative)
2. Large Cap
3. Small Cap
4. Foreign stocks
5. Precious metals
6. FOREX Trading (most aggressive)

Note: Not everyone would agree with the listing of how I order the risk you take with each investment.  Also, the large and small caps are often known by different names and can also be broken down further into growth funds and value funds.

Why Asset Allocation is So Important?

1.  Asset allocation significantly impacts your returns.

I’ve heard a lot of people struggling trying to choose the right mutual fund from the right company.  Let’s say you have a similar asset allocation; one person is at brokerage Y and the other at brokerage Z.  Those two people can expect relatively similar returns.  However, two people could both be at the exact same brokerage with one person in 100% large cap and the other 100% foreign, and they’d see very, very different returns.

2.  Asset allocation impacts your emotions.

If you are young and willing to invest more aggressively, then your losses might not be as troublesome to you.  However, if you’re 65, you don’t want the potential worry of losing a large part of the money you’ve invested.  At this point, your strategy has switched from growth to preservation.  Your conservative place in life must be reflected in the types of holdings you have.

Lessons from 2008-2009

I remember when the stock market started dropping and the reporters were reporting that many retirees were worried because they had lost half of their retirement.  From that statement (assuming it is true), we could conclude that many retirees had their asset allocation wrong (or they had a target retirement fund that had it wrong).  If you’re getting close to retirement and still have 100% stock holding, you’re in a riskier position.  However, the older you get, the more bonds you should add to your portfolio.

I say all this to say that now is a great time to ask yourself – is my asset allocation right for me?

You may need some help in answering that question.

Unfortunately, I’m not the right person to answer that because I don’t know your personal situation.  I’d also avoid anyone (as Dave Ramsey promotes) who says you should have 25%, 25%, 25%, and 25% in certain stocks.  The reason is because a 20 year old and a 60 year old should not have the same asset allocation.

Partly because of my personality and mostly because of my age, I’ve never been interested in bonds.  Instead, I own 100% stocks.

Here’s a general introduction to our asset allocation (not as a suggestion):

80% is currently invested according to Sound Mind Investing suggested asset allocation for someone who is in 100% stocks.  If you are a subscriber you can access that information in the January 2011 edition.  I do own stocks in the following categories: small growth, small value, large growth, large value, and foreign.

10% is given to a more aggressive investing strategy by Sound Mind Investing called the Sector Rotation.  Basically, rather than investing across different sectors, it focuses on investing in one sector at a time.  It might be real-estate, technology, or oil and gas.  Never all of them at the same time, just one sector of the economy – as long as it continues to perform well.

10% (this is my favorite 10%) is the wild, follow my gut, blank check, executive, and fancy foot work investments.  My wife has a agreed to let me use 10% of our investments to follow my own whims.  Since we’re young, we can afford to be involved in some investments that a little riskier.

Moral of the story:  Your asset allocation must be your allocation.  It must be catered towards your knowledge, your investment strategy, your age, and your risk level.  You.

And remember, however you decide to set your asset allocation is the most important investing decision you’ll make.

Do you think there is an investment decision that is more important than asset allocation?

To leave a comment or easily share the article with your Facebook or Twitter friends click here -> Asset Allocation is the Biggest Investment Decision You’ll Ever Make

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If you were to jump into a Canadian lake in January, I bet you’d feel some sort of shock to your system.

If you’ve never done much investing, you’ll feel a similar shock when you start to sort through all the investing options.

In fact, beginning investors often use phrases like -  overwhelmed, so many choices, and I don’t know what to do.

Don’t expect me to tell you what to do, but I do plan to help you understand some important terms and investment vehicles so you can continue investing with confidence.

These three important terms are index funds, mutual funds, and ETFs.

In addition to this guide I suggest the beginner’s guide for newbie investors.

A Basic Primer on the Stock Market

When you buy a stock, you are buying a part of a company.  When that company succeeds, your stock value increases.  When things are waning, your stock value will likely decrease.

Index funds, mutual funds, and ETFs are all ways to own stocks (or even bonds, but we won’t focus on that now).

You can, if you’d like, buy a stock for a select company.  Personally, I’ve used ShareBuilder when making those types of transactions (they even give you $50 when you sign up).

However, buying single stocks can be dangerous because you are not diversified.  This means all your eggs are in one basket, and if your stock goes down, so does all your investment.

Thus, index funds, mutual funds, and ETFs are all common ways to diversity your investment.  You buy shares for each of these types of investments from a broker.  Due to low prices I recommend online stock brokers if you are doing your own investing.  Remember, you can often get bonus goodies when signing up for a new online brokerage account.  A current example is the free Dell 24” monitor at OptionsHouse.

Now, let’s learn a little more about …

Index Funds, Mutual Funds, and ETFs

The Index Fund

The goal of an index fund is to own all or most of the stocks represented by a certain part of the stock market.

Take the S&P 500 Index Fund as an example.

The S&P 500 represents the largest 500 publically traded companies.  If you have $1,000 to invest, it wouldn’t be prudent (due to buying and selling costs) to buy shares for all of those 500 companies.  However, if you were to buy a S&P 500 index fund, in that single transaction you would actually be buying stocks for those 500 companies.

Consider the fruit basket, as an example.  You could go the the grocery store and buy an apple, an orange, a banana, and a grapefruit.  Imagine that you would be forced to pay for each of those fruits separately.  That would be annoying, right?  However, you could buy a basket that has an apple, an orange, a banana, and a grapefruit, and checkout once for all of those items.

That’s what you do when you buy an index fund.  You buy a little bit of all of the companies represented by the company.

Now, you need to remember that index funds track different indexes.  Some will track big companies and some small.  Some will buy international companies.

Since index funds own a little of all stocks in the index, their goal is not to beat the market, but simply to average returns consistent with the market.

A hallmark of index funds is very low operating costs so more of your money is in the market.

Recommended: A Low-Cost, Diversified Investment Portfolio with Only Three Funds

The Mutual Fund

The goal of the mutual fund is to own only the best performing stocks because they want to beat the market.

Consider the fruit illustration once again.  In this case, let’s say a shopper has heard that grapefruit are in low supply.  She decides to buy extra grapefruit because she thinks they will be more expensive the next week.  She doesn’t get a little of everything – she just picks the winners (or what she thinks will win).

When you buy a mutual fund, the fund manager will use the money you invest to buy what he, she, or they think will be the winning stocks.  If they are right, your investments go up.  If they are wrong then your investments will go down.

See also: Important Mutual Fund Tax and Capital Gains Facts Every Investor Must Know

The ETF

Now we meet the latest rock star in the investing world.

An ETF can have a strategy like a mutual fund (actively managed fund) or an index fund (passively managed fund).

The biggest difference about these little guys is that they are the easiest to buy and sell.  Many brokerages will allow you to buy them free of charge, and they can be bought or sold at any time of the day.

ETFs are the absolute best for those with a very small starting investment.  With $100 (or less), you can get started buying ETFs.  Many index funds require that you have anywhere from $1,000 to $2,500 to start in a single index fund. Thus, with $1,000 you can get much more diversity with ETFs than you can with index funds.

Which is the best way to invest?

I’ve previously compared index funds to mutual funds.

Here’s a list of questions and answers suggested in this Christianpf article (written by a guy named Craig Ford – sound familiar?):

• Do you like to do a lot of investment research and analysis?  The stronger you answer no, the better an index fund becomes.
• Do you need a fund that, for tax reasons, has less buying and selling (short term gains)?  The stronger the yes, the better an index fund becomes.
• Do you have a lot of money to start investing?  The less money you have, the more you should look at ETFs.  This is especially true if you use something like Charles Schwab that offers fee free ETFs.
• Do you like a more aggressive investing strategy?  The stronger the yes answer, the more you should look at mutual funds.
• Do you know a lot about investing?  The less you know about investing, the safer you will be using index funds until you have a chance to learn how to start investing.
• What investing strategy do you use?  Do you buy funds once a year, do you dollar cost average, or do you use a value averaging investment strategy?  The more frequently you trade, the more you should look at ETFs as they typically have the lowest trading fees.  Check with your broker for the exact fees.

At least now you should know the difference between your investing options so you can proceed with confidence.

To leave a comment or easily share the article with your Facebook or Twitter friends click here -> The Ultimate Beginner’s Guide to Index Funds, Mutual Funds, and ETFs

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Several months ago, I introduced you to some of the best online discount brokers for investing.  When I wrote that post, the cheapest option was OptionsHouse.  Nothing has changed in the price comparison as it is still the cheapest way to buy and sell stocks.  It is only $3.95 per trade.

The big change is that you can now get …

Free Dell Monitor with a New OptionsHouse Account

• Fund your account with $5,000 to $99,999 and you can get a 24” Dell monitor – use promo code DELL24 when you fill in your paperwork.
• Fund your account with $100,000 to $249,999 and you can get a 27” Dell monitor – use promo code DELL27 when you fill in your paperwork.
• Fund your account with $250,000 or more and you can get a 30” Dell monitor – use promo code DELL30 when you fill in your paperwork.

You can view all terms and conditions here, but here are a few highlights:

1. Dell monitor promotion applies only to newly funded OptionsHouse customers who initially fund their account within 60 days of completing the application.
2. Limit one monitor per funded account holder, please.
3. This promotion may not be combined with other offers and additional restrictions may apply.

I don’t see any indication that there are any number of trades required, and it doesn’t say how long you must keep the funds at OptionsHouse. 

Also, I’m assuming that this is a limited time offer that won’t be around forever. 

About the 24” Dell Monitor:

The new Dell™ ST2420L 24" widescreen full HD monitor with LED delivers true cinematic picture quality with a 16:9 aspect ratio and excellent color contrast (estimated dynamic contrast ratio of 8,000,000:1).

Cinematic picture quality with 1920×1080 full HD resolution and fast response time of 5ms

• Energy-efficient performance and ENERGY STAR 5.0 compliance
• Easily connects to desktops, laptops and gaming consoles
• Elegantly designed with a slim depth and stylish look

The Dell website is currently pricing the 24” monitor at $219.00.

If you’ve never done this type of promotion before, you should know that it is possible that you will get a 1099 for the value of the monitor.  That means you may need to pay taxes on the value of the monitor.

Summary: Open a new account at OptionsHouse and fund it with $5,000, and you can get a 24” Dell HD monitor for free – click here.

*I am an OptionsHouse affiliate, so I will get a payment if you sign up.

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If you asked me for advice to start investing, I’d first have to tell you that I legally cannot give specific investing and accounting advice.  Then I’d tell you that both index funds and mutual funds are better ways to invest than single stocks.  Then you might ask me which is better: mutual funds or index funds*?  Here’s what I’d say …

*For clarification in this post, I’ll be discussing actively managed mutual funds and passive index funds.

What is an active mutual fund?

A mutual fund is a collection of funds from various individuals who have like-minded investing plans.  Typically, a person will send her money to invest in a specific mutual fund.  That mutual fund is overseen by a manager and a team of people who make the best decisions on how to use the money available to them.  It’s just like you have a professional making all your decisions.  They pick stocks and bonds that they think will beat the market average.

A mutual fund overseeing body will have a meeting where a bunch of geeks share reports and analysis.  These experts will burn the midnight oil fighting about which are the best stocks to buy based on the likelihood that they will perform better than most other stocks.

Fund management is limited to the descriptions laid out in a document called a prospectus.  Mutual fund #1 might focus on buying stocks from smaller companies.  Mutual fund #2 might focus on buying stocks from big companies.  You would purchase mutual funds from the company that had the best fees and management style according to your investing principles.

What is a passive index fund?

Similar to mutual funds, an index fund is a collection of funds from various individuals with like-minded investing plans.  However, index funds don’t ever try and beat the market.  Proponents of index funds believe that being average is better than taking a big swing and ending up behind average.

As an example, if you buy $100 of an S&P 500 index fund, what you are doing is buying a very small piece of stock from the 500 largest companies.  If those stocks collectively go up, so does your index fund.  If they collectively go down, so does your index fund.  The simple reason is you own equal shares of all the stocks that are part of the index.

While there is a flurry of activity in the active mutual fund camp, in the index fund war room all you’ll hear is crickets.  All the decisions have already been made.

Hey Hal, “did you use that $100,000 to buy $200 worth of stock at each the 500 companies that are part of the S&P 500?”

Yup.

Alright then.  Let’s call it a day.

Which is better?  Index Funds or Passive Funds?

Reasons to Consider a Mutual Fund Investing Instead of an Index Fund

Have the Potential to Earn More Profit

The index fund industry will tell you flat out that their only goal is to stay even with the market.

However, there are some of us that tend to think average is not good enough.  I was never satisfied finishing 20th place in a race of 40!  I’m not sure the reality will turn out as planned, but mutual fund investors do undoubtedly have more potential to earn more profit.  Ultimately, the question is: do they do it?

Reasons to Consider an Index Fund Investing Instead of a Mutual Fund

Less Operating Fees and Expenses

Remember that big team of smart people who is making decisions about your money.  They don’t do it for free. You pay a part of every dollar you invest to support your team of experts.

With a mutual fund you can expect to pay an ongoing fee of anywhere between 1%-3% of the money you invest.

Index Funds, on the other hand, typically cost less than .10%.  That’s because a computer automatically knows what to do, and there are no decisions to be made.

Fewer Investing Decisions

When I was investing in mutual funds through a financial advisor, at least once a year it would be time to add something to my portfolio for the sake of diversity.  I’d get a hit list of 3-5 mutual funds to consider.  Then I’d have to act like I had an idea how to choose which one is better, and then tell ‘my’ financial guy which mutual fund I wanted to buy.

With index fund investing, once you decide on your allocation (how much you want in each type of index fund), then you have fewer decisions along the way.

Tax Efficient

If taxes are a big consideration for you, an index fund might serve you better.  With a mutual fund, stocks are always being bought and sold.  For that reason, you can have capital gains even if you haven’t sold a mutual fund.  However, with index funds, the investments stay invested so you don’t have capital gains until you sell.  Here’s a primer on mutual fund tax implications.

More Diversification Options With Less Cash

If you have $1,000 to invest, you might be able to buy one mutual fund.  However, if you by ETF index funds, you can own 4-10 different types of index funds.

So, I’m Obviously an Index Fund Guy, Right?

Well … Kind of. Sort of.  If you asked me which I’d recommend to you, I’d probably say index funds.  They offer a solid way to invest, and I think a person will likely do less damage with index fund investing than with mutual fund investing.  If I say mutual funds and the thing blows up in your face, then I feel bad.  At least with index funds I know you won’t do worse than the market.

When I first started investing, I was buying mutual funds with a 5% front end load.  Without a doubt, I can say that was a dumb choice.

But, to be honest, the majority of my personal investments are in mutual funds.  I follow the upgrading strategy and sector rotation through Sound Mind Investing.  That’s because I’m young (tell that to my back), and feel like I’m willing to lag the market for a few years if the door is open for my investments to outperform the market.

That said, I do think it is time to start putting a portion of my retirement money in some index funds just as a way to diversity our holdings.

If index fund investing appeals to you because you are looking for a simple way to invest, you might consider Betterment.com.  I was just introduced to these folks recently, and they help you set up an automatic withdrawal and then purchase a batch of index funds on your behalf.  Yes, there are minimal fees involved with this (less than the mutual fund route), but if you want the easiest way to start investing in a healthy way, this could be a viable option for you.

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Just because you have money in the stock market, that doesn’t make you an investor as defined by Benjamin Graham. Graham made an important distinction between an investor and a speculator. In a prior post, we looked at the traits of an actual investor.

Basically, an investor looks for safety of principal and an adequate return. A speculator in everybody else.

Although speculating isn’t illegal, there are some dangers that you should be aware of. For instance:

• You may be speculating, but you think you’re actually investing.
• You may speculate seriously rather than as a hobby.
• You may speculate with more money than you can afford to lose.

Here are three of the speculative strategies that people have used in the past, along with their results. They’re here to serve as warnings of the potential pitfalls.

The January Effect

The refers to the tendency for small stocks to produce big gains at the beginning of the year. Studies in the 1980′s showed that if you bought stocks in the latter half of December and held them until January, you’d beat the market by 5 to 10%.

What caused the great return? Many investors sell their underperforming stocks late in the year to create a loss that can cut their tax bill. At the same time, money managers want to maintain their outperformance by refusing to buy a poor stock.

These factors make small stocks a temporary bargain. When the selling stops in January, they bounce back and produce a quick gain. From 1990 to 2001, if you followed the January Effect, you would’ve beaten the market by 5.8%.

However, as more people learned of and implemented this method, they became less of a bargain, which led to lower returns. Furthermore, since the cost of buying such stocks added up to about 8% of your investment, this cost immediately canceled out any gain you had to begin with.

Doing What Works

Money manager James O’Shaughnessy wrote a book called What Works on Wall Street. In it, he claimed that from 1954 to 1994, you could’ve grown $10,000 into more than $8,000,000 using the following investing method:

• Buy the 50 stocks with the highest one-year returns, five straight years of increased earnings, and a price less than 1.5 times its revenues.

Based on this strategy, he launched four mutual funds. Unfortunately, the strategy stopped working after he publicized it. Two of the funds were so bad that they shut down completely in 2000. On top of this, the S&P 500 outperformed all his funds almost nonstop for the four years between 1996 and 2000.

The Foolish Four

The Motley Fool claimed that you could beat the market by spending just 15 minutes a year planning your investments. Here were the steps they suggested:

1. Take the five stocks in the DJIA with the lowest prices and highest dividend yields.
2. Ignore the one with the lowest price.
3. Put 40% of your money in the stock with the second-lowest price.
4. Put 20% in the three remaining stocks.
5. After one year, sort the DJIA the same way and repeat steps 1 through 4.
6. Repeat till you’re rich.

Over a 25-year period, they claimed that this technique could beat the market by over 10% each year. How did it actually do? Poorly. In 2000, the Foolish Four lost 14%, while the DJIA lost just under 5%.

Moral of the Story

Speculating strategies for better performance nearly always lead to diminishing returns. If the formula is based on random luck, then time will show that it made no sense to begin with. And even if the formula actually worked in the past, publicizing the formula usually decreases its effectiveness in the future.

So if you do want to speculate, set aside a tiny portion of your money in a separate fund, and never mix your speculative and investment pursuits.

Do you speculate in the market? If so, how much?

Photo by Katrina.Tuliao

To leave a comment or easily share the article with your Facebook or Twitter friends click here -> Stock Speculating Strategies You Should Avoid

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When considering investing in stocks, there is a lot that we must learn. First we must determine whether we have the time/knowledge to choose our own investments or if we should take a more passive route (hiring a broker, passive index investing, choosing age-related mutual funds, etc). Then we must figure out our investing temperament and risk tolerance,  decide on an length of time to stay invested, and then develop a strategy for evaluating the performance of our investments.

What Investing in Stocks Represents

However, before we begin to wrap our heads around all of those topics, we must understand the most basic truth of investing in stocks. When you purchase stock, you are buying a share of the ownership of a company. In fact, this is why it is referred to as purchasing “stock” or “a share” of a particular company.

When a company needs to raise money, they have two main options from which to choose. First, they can issue debt – selling bonds and notes on the open market, or borrowing directly through banks and other institutions. They also have the option of selling equity (ownership) to raise money. This is where the stock market comes in to play.

When a company chooses to sell equity, it is referred to as a Public Offering – an Initial Public Offering (IPO) is the name for the first time a company sells shares to the public; while a Secondary Offering refers to a company that has already conducted an IPO, but still needs to raise more money at some point in the future. The primary owners usually maintain majority ownership in the company (holding on to at least 51% of the shares of stock).

Once an IPO takes place, the shares of stock are now sold and traded on the secondary market. This means that you and I can buy and sell tiny pieces of ownership of any publicaly-traded company via the “stock market”!

Investing in Stocks as an Owner

Because you now see yourself as the owner of a company, who has all of the rights of stock ownership, you will begin to approach investing in stocks much differently.

Understanding this truth should change how we evaluate investing opportunities. Instead of looking at the price of a share of stock as a random number, you will now understand that price to be the cost of owning one share of that particular company.

Instead of gambling with your money trying to guess which way a random number will jump over the next few weeks, you will now try to decide what the value of a company will be over time, and if the current stock price reflects that.

This means that you must evaluate the value of the company whose stock you are thinking of buying. You will not only look at their current products, competitors, and industry, but you will also look at their future prospects to determine the company’s value.

Yahoo Finance has a wealth of pertinent information (news, historical price information, analyst opinions, reports, financial metrics and ratios, etc) about most companies, so you don’t have to do all of that research alone.

If after your evaluation you determine that you would be willing to pay $50 for a share of stock (for example), and the stock is currently trading for $45, then buy it (assuming that it met all of your other qualifications listed in the first paragraph)! If it is trading for more than what you determine to be a fair value, then pass it by (or short it)! Pretty simple.

Remember that the current price of any investment vehicle should be the present value of all future earnings. So just be sure that you are investing in stocks because they present value of their future earnings is less than the current price. Yes, I know that I just said that the two should be equal, but we live in an imperfect world with irrational people (which is why being a contrarian is often very profitable); so take advantage of true value when you see it!

If you can understand this fact, then you will automatically be ahead of most investors out there!

photo by Alan Cleaver

To leave a comment or easily share the article with your Facebook or Twitter friends click here -> What it Really Means When You Buy Stock

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When it comes to building wealth through investments, I can think of few people who are better than Warren Buffet. After all, I don’t think you become the third wealthiest person in the world by accident. You need to know what you’re doing – and Warren knows how to invest.

Have you ever wondered where he learned his craft? If so, one of the people who had the greatest influence on his life was Benjamin Graham. Luckily for us, Graham wrote several books on investing, including The Intelligent Investor. Warren thinks so highly of this book that he says its “By far the best book on investing ever written.”

Since Warren is a man who I respect when it comes to knowing how to invest, I bought the book in order to learn how to be a better investor. In my journey here are the things I’ve learned.

1. You don’t need a high IQ to be an intelligent investor. This should give all of us hope! What’s more important is to have the discipline to keep your emotions under control. Following certain principles and attitudes is more important than the ability to analyze stocks.
2. Know the difference between an investor and a speculator. Speculators trade in and out of the market, trying to determine the right time to buy and sell. Be an investor. In your desire to create wealth, look to gather little by little.
3. Determine whether you’re a defensive or enterprising investor. You’re defensive if you want to avoid serious losses. You want freedom from major effort and the need to make frequent decisions. On the other hand, you’re enterprising if you’re willing to put in extra time and care into the selection of investments. Enterprising investors need to treat their investments like a side-business. In order to profit from stock-market folly, they need to bring extra effort and intellect.
4. Dollar-cost average. This investing principle teaches us to purchase strong stocks on a regular basis, through thick and thin. Graham mentions that in the 20 years from 1929 to 1948, if you only invested $15 dollars every month, you would’ve ended up with about $8,500! The nice thing about this is that you’d only be contributing $3,600 of your own money. You’d be earning a bit over 8% returns, and would have more than doubled your money.
5. Understand how the stock and bond markets performed in the past. You’re likely to meet similar conditions in the future. Bull and bear markets are a regular occurrence in the stock market. In 1987, US stocks had their worst 1-day fall in history. And after a great bull market in the late 1990′s, a tough bear market started in early 2000.
6. Be wary of technical approach, the dow theory, and other gimmicks.
7. Don’t be cocky. People once thought stocks could be bought at any time, and any price. They believed that profit was a sure thing, and that any losses would be recovered by a rise in the market to higher levels.
8. Don’t put much faith in over-optimistic forecasts and assurances from “experts.”
9. A lack of enthusiasm. In most areas of life, enthusiasm is helpful in trying to achieve a goal. But when investing to build wealth, over enthusiasm can lead to your downfall.

Have you read The Intelligent Investor? Do you try to follow some of the principles mentioned above?

To leave a comment or easily share the article with your Facebook or Twitter friends click here -> Nine Traits of an Intelligent Investor

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Don’t quote me on this (my memory is not what it once was), but I think it was two years ago this month that I signed up for a 30 day free trial at Sound Mind Investing (SMI).

I thought I knew about investing, but when I started reading the three years of archived newsletters, I realized my investing knowledge was really superficial.  Among other things, I didn’t have a good grasp on what an Index fund was or the difference between small cap and large cap company.  While I’m not an investing expert or guru, I can confidently say that SMI has given me enough investing knowledge to feel confident addressing the investing topic on this site.

But, I digress.

Sound Mind Investing is once again offering a 30-day free web membership for new members.

Here’s what SMI says about their web membership:

That’s right, for 30 days, they can test all the great features you’ve come to know and love — Editor’s Weblog, 401(k) Fund Tracker, Sector Rotation (and all the other Advanced Strategies), the Message Boards, the market-pounding Upgrading Strategy, article archives, and so on. And they can do this at NO COST, with NO STRINGS attached.

Just a few week ago some folks were asking me some investing related questions (what an exciting Thanksgiving topic, eh?).  I told them they should check out Sound Mind Investing – not because I completely endorse all their strategies, but because if you read some of the back issues and you keep up with the newsletters, you’ll have a clue about investing.  It’s better to learn about investing than spend your life relying on someone to tell you what to think.

So, if you want to try Sound Mind Investing, this is the time.  I have a review of Sound Mind Investing in case you are interested.

Check out their free trial offer today – click here.

* Affiliate Disclosure – I am a SMI affiliate.  This means two things: (1) I receive free copies of the newsletter, and (2) I get a small commission if someone becomes a paid subscriber.  However, I told friends about SMI before I was an affiliate because I truly like their product.

To leave a comment or easily share the article with your Facebook or Twitter friends click here -> Tis’ the Season to Check Out Sound Mind Investing [Limited Time Offer]

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