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If the broker-dealer cannot, or chooses not to, execute the trade internally, they must attempt to execute the trade with another broker-dealer. This often means accessing the security on OTC Markets Group’s OTC Dealer application and ascertaining whether the order is marketable. Marketable orders are orders where the price specified can immediately be executed in the market. Market Orders are, by definition, marketable. Limit Orders are marketable if the limit price is better than or equal to the bid price (for sell orders) or ask price.
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Finding Your Investing Comfort Zone
To participate in the financial markets , both short-term traders and longer-term investors need to be comfortable about their holdings and their specific portfolios. In other words, if a certain position leaves you with a sense of uneasiness or the inability to sleep at night, it is not for you! Knowing the boundaries of your personal comfort zone makes it easier to maintain a portfolio that contains only suitable positions. So how do you find and establish these boundaries? Read on to find out.
Why Should I Be Comfortable?
Establishing a comfort zone is particularly important for a number of reasons:
• An uncomfortable trader or investor may allow emotions to take control of trading decisions.
•
Those who are too complacent may ignore risk.
• Determining a comfort zone helps you avoid borderline trades that usually turn out poorly.
• It helps you recognize when risk has increased.
• It encourages you to take profits when very little profit potential remains.
• It minimizes the possibility that youll be forced to make difficult decisions under pressure. Being comfortable with your positions means that high pressure situations should occur rarely.Settling Into Your Comfort Zone
Being in the comfort zone means owning a portfolio that contains only suitable, well-researched and understandable holdings.
Arriving at this type of portfolio involves going over your holdings yearly and deciding whether the reasons that you bought the stock still apply. For the stocks that dont make the cut, sell those positions, even if it results in a loss. Technically, the loss has already occurred and, except for tax reasons, turning it from a paper loss to one that is realized makes no difference. Once youve done this, you can put your money to work where you believe it will increase in value.
When choosing new stocks for you portfolio, remember that not every investment tip is a winner. In fact, its best to ignore all tips and conduct your own research.
Long-Term Investor or Trader?
Despite the inconsistency of the markets, the vast majority of investors choose to adopt a long-only approach by purchasing stocks, bonds, real estate, collectibles, etc. If you have good stock and investment selection skills, this method will do well over time. If you dont, and prefer to manage your own portfolio, different skills are required. For example, it may be worthwhile to learn how options work and how you can use them to hedge risk in stock portfolios .
At the same time, long-term investors must understand when a position is no longer suitable, either because it has run up in price very quickly, or the company is not expected to perform well in the future. You should work hard at mastering this skill - the time to recognize that some positions are too risky to hold is before disaster strikes.
The way you decide to invest in the market will determine your comfort zone. Day traders hold positions for a very short time. Swing traders hold longer, but by no means do they attempt to make long-term trades. And then there are the investors who have no specified holding period - and for many, that means they expect to hold for years. Which category you fall into will affect your comfort zone. For example, the day trader doesnt worry about sleeping well because positions are not held overnight, and the long-term investor is less concerned with timing. The one characteristic these trades should have in common is suitability for the investor, who must find both the risk and reward potential of any position acceptable.
Becoming a full-time trader is a goal for many individual investors, who see it as a glamorous road to riches, but these perceptions are false. As with any other profession, it takes education, practice, skill and discipline to succeed. In the same way that not everyone can become a professional athlete or movie star, the simple truth is that not everyone can be a full-time trader. Keep this in mind when thinking about your comfort zone - if you dont succeed in making profits as a trader, you probably wont be very comfortable.
Trading Within a Comfort Zone
Both long-term investors and traders must make important decisions. Among the questions to consider are:
• Is this a good entry point?
•
Is this an appropriate time to invest?
• Is the security fairly priced?
• How much profit do I expect to earn?
• How much capital is at risk?
• Is it possible this trade can result in a margin call?
• Whats the probability of earning a profit?Summary
Its important to invest or trade so that you are comfortable with the nature of your holdings - and thats especially true when it comes to understanding both risk and reward. Once you find your comfort zone, staying within it will help you make better investment decisions. If a security doesnt fall within the parameters of your comfort zone, its not a good investment for you.
Once broker-dealers accept an offer to trade through OTC Link or through another means of communication, they must report, clear, and settle the trade. Part of this process is the confirmation of the trade with the investor; however, the trade will not be complete until final settlement (the delivery of funds by the buyer and securities by the seller), which, for equity securities is generally three business days after the trade date (T 3).
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The Lowdown On Index Funds
Index funds have provided investors with a return that is directly linked to individual markets while charging minimal amounts for expenses. Despite their benefits, not everyone seems to know exactly what index funds are and how they compare to the many other funds offered by different companies.
Active and Passive Management
Before we get into the details of index funds, its important to understand the two different styles of mutual-fund management: passive and active.
Most mutual funds fit under the active management category. Active management involves the art of stock picking and market timing. This means the fund manager will put his/her skills to the test trying to pick securities that will perform better than the market. Because actively managed funds require more hands-on research and because they experience a higher volume of trading, their expenses are higher.
Passively managed funds, on the other hand, do not attempt to beat the market. A passive strategy instead seeks to match the risk and return of the stock market or a segment of it. You can think of passive management as the buy-and-hold approach to money management.
What Is an Index Fund?
An index fund is passive management in action: it is a mutual fund that attempts to mimic the performance of a particular index. For instance, a fund that tracks the S
Many OTC securities are relatively illiquid, or "thinly traded," which tends to increase price volatility. Illiquid securities are often difficult for investors to buy or sell without dramatically affecting the quoted price. In some cases, the liquidation of a position in an OTC security may not be possible within a reasonable period of time.
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Gold Or Oil: Which Is The Hotter Investment?
Financial innovators have issued a wide variety of financial instruments over the last decade, giving investors exposure to many asset classes that were unavailable in past years. These instruments include ones leveraged to the price of oil and gold, two of the more popular areas for investors. However, this freedom to invest is not without risk, and those interested in exposure here should research carefully before jumping in. (Gold is a very useful investment during periods of instability and high inflation. Check out Why Gold Matters.)
Gold and Oil Performance
Gold has provided an extraordinary return to buy and hold investors over the last 10 years, with the metal rising in price from under $300 per ounce to the current level of approximately $1,425 per ounce. The return on oil over the last 10 years has also been extraordinary with the price moving from less than $20 per barrel in 2001 to the current level of just under $100 per barrel.
Gold Investing Rationale
Investors have historically purchased gold as a hedge against inflation or as a reaction to a financial or political crisis. Many also invest in gold for protection when a currency is being debased or devalued by a government.
Others believe that there are strong fundamental reasons for the increase in the price of gold, as supply increases have lagged the rising demand from the market. The jewelry industry is the largest user of gold, and has seen an increase in demand for gold jewelry from the emerging economies.
Another reason for gold investing is price momentum or trend investing. As more investors pile into gold, the price keeps going up and this performance gets at10tion in the financial media. This, in turn, motivates others to buy so that they dont miss out. This type of behavior has created bubbles in other financial instruments and markets in the past. (Find out more in The Myth About Market Bubbles.)
Oil Investing Rationale
The fundamental investment case for oil is based on increased demand for energy as China, India and other emerging economies accelerate growth above historical baseline levels. This increased demand is difficult for oil producers to meet in the short and medium term as increased production requires large capital investments in multi-year projects. Some have even predicted that the worlds oil supply has peaked and rising prices for oil are inevitable. (Not sure where oil prices are headed? This theory provides some insight. See Oil As An Asset: Hotellings Theory On Price.)
Modern Innovations
Another reason that might explain the increased price of gold and oil is the ease with which investors can get exposure, as the financial industry has created many securities designed to track the performance of gold and oil.
Many of these instruments trade on the major exchanges and are extremely liquid. Investors can buy an instrument on the long or short side of gold or oil, and can leverage that exposure as well.
The SPDR Gold Trust Exchange Traded Fund (ETF) is the largest and most liquid gold ETF available (NYSE:GLD), with average daily volume of more than 14 million shares over the last three months. The trust held 1,217.3 metric tons of gold as of March 10, 2011. Another liquid ETF is the iShares Gold Trust (NYSE:IAU), which traded an average of 5.5 million shares a day over the last three months.
Looking for penny stocks that skyrocket?
On the oil side, the United States Oil Fund, LP (NYSE:USO) attempts to track the spot price of West Texas Intermediate (WTI) crude and is also liquid, with average daily volume of 14 million shares a day.
Buyer Beware
Bullish investors are passionate about the reasons to own oil and gold, and discount any talk that the strong investment performance in either of these are the result of speculation. Investors that are long these might want to think back to other investments over the last decade, where prognosticators sounded just as convinced that nothing could go wrong. Who can forget back in 1999 and 2000 when the consensus said that paying forty times the markets earnings was the right thing to do?
Another item to consider is that the downside of a bubble bursting is usually much more rapid than the ascent. The Nasdaq Composite index peaked in March 2000 and lost 87% of its value over the next thirty months until it reached the trough in September 2002. However, most of the decline occurred by early 2001, or less than a year. The price of oil fell even quicker in 2008, with the price peaking above $140 per barrel, before crashing down 75% in just five months. (These funds make investing in gold, oil or grain an easier prospect.
The Bottom Line
One of the advantages that we have over previous generations is the ease with which modern investors can invest in a wide range of securities providing exposure to asset classes and areas that used to be out of reach. Investing in gold and oil is now easy and cheap for investors, but not without risk.
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Is Your Investment Strategy Going Extinct?
Nothing lasts forever, including the effectiveness of some investment strategies. True, some basic ideas like buy the stocks of high-quality companies when theyre trading cheaply seem to operate with no expiration date, but other strategies seem to work only for a while, before reverting back to market-average or worse returns. Let us examine some of the strategies that may be on the way out. (Avoid taking premature profits or running losses by setting appropriate exit points, see A Look At Exit Strategies.)
TUTORIAL: Stock-Picking Strategies
The Safe Haven
Whenever the markets turn rough and some sector happens to go up (or go down less), investors and commentators are more than happy to anoint a new safe haven for investors. Gold has been a safe haven at many points in history. Bonds have been safe havens, as have dividend-paying stocks, utility stocks, consumer goods stocks and so on. (For related reading, see The Advantages Of Bonds.)
For example, healthcare was supposed to be a safe haven. Yet, during the recession in the late 2000s healthcare underperformed as pharmaceutical companies suffered from patent cliffs and medical device companies bore the brunt of lower patient visits and tight hospital capital budgets.
That, then, is the problem – every crisis is different, as is the optimal path through that crisis. Whats more, people often underestimate the importance of timing when it comes to picking a safe haven. If an investor has a firm conviction that Asset X is going to be a safe place to weather the next storm, he or she would do well to get in early so that the other investors piling in later push up the price. Likewise, getting out on time is important as well – once the danger passes and everybody wants out of the safe haven, prices can drop so quickly that those slow to leave end up holding the bag.
Arbitrage
Arbitrage investing is all about making dollars a few pennies at a time – trading on the small discrepancies in prices between exchanges or an announced deal and current valuations. Unfortunately, the increased liquidity and access to markets has largely eliminated these easy profits. Arbitrage is still possible, but it tends to only be profitable for traders with the infrastructure to make large trades at lightning speed. This is not something that can be handled by a friendly retail internet broker. (For related reading, see Trading The Odds With Arbitrage.)
Dogs of the Dow
The Dogs of the Dow offered a simple value-oriented approach to investing. Investors would choose from those stocks making up the Dow Jones Industrial Average, selecting for a portfolio on the basis of the highest dividend yields and lowest stock prices, with annual rebalancing. In theory, this offered up a portfolio of relatively undervalued large-cap companies that should outperform the market (based in large part on the assumption that those dividend yields should revert to the mean).
The evidence is mixed as to whether the Dogs of the Dow strategy ever worked as advertised; some academics have made the case that the advertised results were a product of data mining and not reproducible in practice. In any case, there have been several public attempts to implement the strategy and they have failed. Whether that failure is a product of the markets simply filling in a previously unknown gap or whether the strategy never worked at all is moot – the point is that it no longer seems to work. (For related reading, see Barking Up The Dogs Of The Dow Tree.)
Guru of the Month
From time to time an investment advisor pops up with a sure-fire strategy for making money in the market. Many of these approaches are outright scams, but some are sincere attempts to offer a combination of formulas and stock characteristics that seem to lead to market outperformance.
The problem with many guru approaches, the legitimate ones at least, is that they exploit an inefficiency in the market. Once enough people know about an inefficiency, it tends to disappear fairly quickly. In fact, if there is some combination of return on equity, margins and EV/EBITDA that spells investment success, investors will program computers to jump on those opportunities. Moreover, other investors who try to think one step ahead will anticipate stocks that will soon sport those characteristics to take advantage of the automated market jump these stocks can expect from the computer programs – and on it goes. With all of that buying activity, the stocks are soon revalued and the market-beating potential vanishes.
Deep Value Investing
It is probably inaccurate to describe deep value investing as going extinct; most likely the last specimens died in captivity long ago. After reading some of the seminal works of investment strategy, Benjamin Grahams Security Analysis and Intelligent Investor, it used to be possible to find stocks trading below the value of the net current assets on the balance sheet. Likewise, companies often held assets worth far in excess of their stated value and the market capitalization of the company. There were profitable trades to be made by finding these stocks and waiting for the market to realize the value. (For more on value investing, see The Value Investors Handbook.)
Now, though, the market moves much faster and information is both more easily available and available more quickly than before. As a result, companies with $1 per share of cash and a $0.50 stock price just do not stick around for long. Whats more, companies have gotten savvier about singing their own praises and maximizing the market value of both their assets and stocks.
Invest Your Age
There is a school of thought that holds that investors would do well to allocate their portfolio according to their age by matching their portfolio weighting to bonds to their age in years. In other words, a 30 year old investor should hold 30% of his or her assets in fixed income, while a 60 year old investor should have double that allocation.
Back in the days of pensions and defined-benefit retirement plans, maybe this wasnt such bad advice.
Nowadays, though, it seems like a dangerously over-conservative way to invest. Whats more, people are living longer than ever before but still retiring at basically the same age (around 65). That means that they need more money in their portfolio at the time of retirement, and must continue to earn good returns on that money throughout retirement or risk running out of money.
Though it is true that stocks are generally more volatile than fixed income investments, that volatility cuts both ways; it is relatively rare for long-term equity investors to underperform fixed income. Worse still, with the corrosive and often underreported impact of inflation on fixed income assets, over-allocation to fixed income can lead to a worker having too little money saved away for retirement. (For related reading, see Young Investors: What Are You Waiting For?)
Buy-and-Hold
Perhaps the most controversial idea is that buy-and-hold investing is dead. The idea here seems to be that markets are so quick and efficient in addressing undervaluation, there is simply no chance that a stock can be undervalued for years at a time and worth holding for the long haul.
This notion seems to have really gained currency in the wake of the tech bubble, and it is certainly possible to see a few points in its favor. After all, anybody who bought a tech stock like Cisco (Nasdaq:CSCO) or Microsoft (Nasdaq:MSFT) during the bubble is still sitting on a loss. Likewise, anyone who bought and held a high-quality bank stock like US Bancorp (NYSE:USB) or M
Broker-dealers may not give their customers prices inferior to those currently being quoted on inter-dealer quotation systems.
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Market Problems? Blame Investors
Sure, the economy sometimes hits a slump, whether because of a war or unforeseen natural disaster. Of course, these things are beyond an investors control. But turbulence in the market can often be linked not to any perceivable event but rather to investor psychology. A fair amount of your portfolio losses can be traced back to your choices and the reasons for making them, rather than unseen forces of evil that we tend to blame when things go wrong. Here we look at some of the ways investors unwittingly inflict problems on the market.
Following the Crowd
Humans are prone to a herd mentality, conforming to the activities and direction of others. This is a common mistake in investing. Imagine you and a dozen other people are caught in a theater thats on fire. The room is filled with smoke and flames are licking the walls. The people best qualified to get you out safely, such as the building owner or an off-duty firefighter, shy away from taking the lead because they fear being wrong and they know the difficulties of leading a smoke-blinded group.
Then the take-charge person steps up and everyone is happy to follow the leader. This person is not qualified to lead you to the local 7-11, let alone get you out of an unfamiliar burning building, so, sadly, you are more likely to end up as ash than find your way out. This tendency to panic and depend on the direction of others is exactly why problems arise in the stock market, except we are often following the crowd into the burning building rather than trying to get out. Here are two actions caused by herd mentality:
• Panic Buying - This is the hot-tip syndrome, whose symptoms usually show up in buzzwords such as revolution, new economy, and paradigm shift. You see a stock rising and you want to hop on for the ride, but youre in such a rush that you skip your usual scrutiny of the companys records. After all, someone must have looked at them, right? Wrong. Holding something hot can sometimes burn your hands. The best course of action is to do your due diligence. If something sounds too good to be true, it probably is.
• Panic Selling - This is the end of the world syndrome. The market (or stock) starts taking a downturn and people act like its never happened before. Symptoms include a lot of blaming, swearing, and despairing. Regardless of the losses you take, you start to get out before the market wipes out whats left of your retirement fund. The only cure for this is a level head. If you did your due diligence, things will probably be OK, and a recovery will benefit you nicely. Tuck your arms and legs in and hide under a desk as people trample their way out of the market. (For more on this kind of behaviour, check out our Behavioral Finance Tutorial.)
We Cant Control Everything
Although it is a must, due diligence cannot save you from everything. Companies that become entangled in scandals or lie on their balance sheets can deceive even the most seasoned and prudent investor. For the most part, these companies are easy to spot in hindsight (Enron), but early rumors were subtle blips on the radar screens of vigilant investors. Even when a company is honest with an investor, a related scandal can weaken the share price. Omnimedia, for example, took a severe beating for Martha Stewarts alleged insider activities. So bear in mind that it is a market of risk. (For more on stock scandals, check out The Biggest Stock Scams Of All Time.)
Holding Out for a Rare Treat
Gamblers can always tell you how many times and how much theyve won, but never how many times or how badly theyve lost. This is the problem with relying on rewards that come from luck rather than skill: you can never predict when lucky gains will come, but when they do, its such a treat that it erases the stress (psychological, not financial) youve suffered.
Investors can fall prey to both the desire to have something to show for their time and the aversion to admitting they were wrong. Thus, some investors hold onto stock that is losing, praying for a reversal for their falling angels; other investors, settling for limited profit, sell stock that has great long-term potential. The more an investor loses, however, the larger the gain must be to meet expectations.
One of the big ironies of the investing world is that most investors are risk averse when chasing gains but become risk lovers when trying to avoid a loss (often making things much worse). If you are shifting your non-risk capital into high-risk investments, youre contradicting every rule of prudence to which the stock market ascribes and asking for further problems. You can lose money on commissions by overtrading and making even worse investments. Dont let your pride stop you from selling your losers and keeping your winners.
Xenophobia
People with this psychological disorder have an extreme fear of foreigners or strangers. Even though most people consider these fears irrational, investors engage in xenophobic behavior all the time. Some of us have an inborn desire for stability and the most seemingly stable things are those that are familiar to us and close to home (country or state).
The important thing about investing is not familiarity but value. If you look at a company that happens to look new or foreign but its balance sheet looks sound, you should not eliminate the stock as a possible investment. People constantly lament that its hard to find a truly undervaluedstock, but they dont look around for one; furthermore, when everyone thinks domestic companies are more stable and try to buy in, the stock market goes up to the point of being overvalued, which ironically assures people theyre making the right choice, possibly causing a bubble. Dont take this as a commandment to quit investing domestically; just remember to scrutinize a domestic company as closely as you would a foreign one. (For ideas on how to get involved with foreign stocks, check out Go International With Foreign Index Funds.)
Concluding with a Handy List
Some problems investors face are not isolated to the investing world. Lets look at the seven deadly sins of investing that often lead investors to blindly follow the herd:
1. Pride - This occurs when you are trying to save face by holding a bad investment instead of realizing your losses. Admit when you are wrong, cut your losses, and sell your losers. At the same time, admit when you are right and keep the winners rather than trying to over-trade your way up.
2. Lust – Lust in investing makes you chase a company for its body (stock price) instead of its personality (fundamentals). Lust is a definite no-no and a cause of bubbles and crazes.
3. Avarice – This is the act of selling dependable investments and putting that money into higher-yield, higher-risk investments. This is a good way to lose your shirt--the world is cold enough without having to face it naked.
4. Wrath – This is something that always happens after a loss. You blame the companies, brokerages, brokers, advisors, the CNBC news staff, the paperboy - everyone but yourself and all because you didnt do your due diligence. Instead of losing your cool, realize that you now know what you have to do next time.
5. Gluttony – A complete lack of self-control or balance, gluttony causes you to put all your eggs in one basket, possibly an over-hyped basket that doesnt deserve your eggs (Enron, anyone?). Remember balance and diversification are essential to a portfolio. Too much of anything is exactly that: TOO MUCH!
6. Sloth – You guessed it, this means being lazy and not doing your due diligence. On the flip side, a little sloth can be OK as long as its in the context of portfolio activity. Passive investors can profit with less effort and risk than over-active investors.
7. Envy – Coveting the portfolios of successful investors and resenting them for it can eat you up. Rather than cursing successful investors, why not try to learn from them? There are worse people to emulate than Warren Buffett. Try reading a book or two: knowledge rarely harms the holder.
Conclusion
Humans are prone to herd mentality, but if you can recognize what the herd is doing and examine it rationally, you will be less likely to follow the stampede when its headed in an unprofitable direction.
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Do You Understand Investment Risk?
A study conducted by Englands Financial Services Authority (FSA) in 2004 called Consumer Understanding Of Financial Risk has shed some light on how well people understand their investments. Such understanding or, in some cases, the lack of understanding, leads to specific types of behavior. It is important for both investors and providers to be aware of the differences. In this article, well go over this study and what it can teach investors about their own understanding of their personal finances.
Types of Investors
The respondents in the study were divided into three main groups:
• Trusters
were defined as unsophisticated investors who primarily rely on their advisors.
• Partners are those with an intermediate level of sophistication who work together with their advisors to some extent.
• Controllers are sophisticated and often experienced investors who rely on their own understanding and make their own decisions. This simple categorization provides considerable insight into the nature of investors, what they do and expect, and the associated risks and opportunities that exist for both buyers and sellers. (Learn more in What Is Your Risk Tolerance?)
Education and Financial Sophistication Are Not the Same Thing
It is important to note that general or even business education doesnt necessarily translate into specific knowledge about the world of investment. A business graduate is certainly likely to know something about investments, but this knowledge may be very theoretical and, therefore, less applicable to the graduates own experiences. Conversely, a doctor who happens to be very interested in getting the most bang for his buck on his investments may turn out to have a relatively sophisticated understanding of investing. Likewise, retired people with no formal financial education or qualifications may spend hours pouring over the financial pages of the newspaper every day. In this case, they may know more than their advisors about day-to-day developments.
Lets look in more detail at each of the three groups.
Trusters Rely On Others
Not surprisingly, the lower the level of sophistication, the less people understand about the risks to which their money is exposed and the more naive they tend to be about what their advisors or investment companies can really do for them. The FSA study points out that this naiveté can lead to excessive reliance on people in the industry, which can open the door for potential abuse. Alternatively, it may lead nervous and distrusting people to adopt a savings approach, which may be too risk averse to benefit the investor. (For related reading, see Determining Risk And The Risk Pyramid.)
When investors lack understanding of their investments, this often means that they are uninformed about what is meant by high, medium and low risk, the three standard categories prevalent in much of the investment literature. The problem is compounded by the failure of many brokers to present people with clear options with clear risk labels. Investors often think that anything to do with shares is risky, or that fund managers generally buy shares with such astuteness and expertise that there is little risk involved. Generally speaking, the reality is that the greater the value of equities that an investor has in his or her portfolio, the greater the amount of risk the person is taking on compared to leaving that money in a savings account.
While many investors understand the principles of diversification and risk well enough to know it is bad to put all of their eggs in one basket, they do not always know how to avoid this in practice. Trusters, for example, were shown to have a poor understanding of asset classes and very little, if any, awareness of the range of products available in the market. As a result, they tend to delegate most of the responsibility to others, which predictably leads to somewhat mixed results. (For more insight, see Introduction To Diversification and The Importance Of Diversification.)
Partners Make Mutual Decisions
Partners tend to have a medium level of sophistication and often want to be involved in the decision-making process. They generally read newspapers or magazines in and attempt to follow the markets. They also rely on advisors for help, but certainly not for the basic-level financial matters. They are interested in the second opinion that brokers or advisors provide, and also seek professional assistance to ensure that paperwork is completed correctly and that they understand any applicable legal jargon.
The main difficulty with partners is finding the right balance between control and delegation. While some advisors do not welcome client input, and others tend to think customers know more than they really do, it is essential for the investor-advisor roles to be quite clear to both parties. It may be best to have some form of written agreement - even if its an informal one - that highlights the nature of each players respective roles.
Controllers Want to Run the Show
Controllers are sophisticated investors (or at least think they are!) and prefer to take charge of the investing process. They are very interested in the financial sector and have a good understanding of both products and markets. They are aware of and understand the array of products that are available and they know what they want. They also spend a considerable amount of time researching products and markets, and they actively send off for financial statements, buy the latest books, and even attend investment seminars and conferences. This does not necessarily make them risk friendly, but they understand risk and know how to construct an optimal portfolio. Such investors often purchase on execution only, which means that they dont seek an advisors advice.
With respect to controllers who think they are sophisticated, there are certainly those who ought to delegate more of their investing tasks to a professional. Investors who seriously overestimate their knowledge or abilities can get into trouble.
Who Are You and Who Are You Dealing With?
The FSA study reinforces the need for informed financial planning; it also suggests the vulnerability of investors who are either too trusting or not trusting enough. For trusters, and to a lesser extent, partners, ease of understanding is fundamental and checks need to be built into any investment process to ensure that peoples personal and financial circumstances and willingness to take risk are taken into account. If investors are to be served well, what they know and, more importantly, what they do not know, must form a fundamental component of the advisory process. Advisors must take the level of investor knowledge and understanding very seriously.
There are a wide variety of companies – spanning all major sectors and industries, with market capitalizations ranging from large cap to micro cap – quoted and traded in the OTC market.
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5 Essential Things You Need To Know About Every Stock You Buy
Investing is easy but investing successfully is tough. Statistics show that the majority of retail investors, those who arent investment professionals, lose money every year. There could be a variety of reasons why, but there is one that every investor with a career outside of the investment market understands: they dont have time to research a large amount of stocks and they dont have a research team to help with that monumental task. (For related reading, check out The 4 Basic Elements Of Stock Value.)
For that reason, investments made after little research often result in losses. Thats the bad news. The good news is that, although the ideal way to purchase a stock is after a large amount of research, an investor can cut down on the amount of research by looking at these select items:
What They Do
Jim Cramer, in his book Real Money, advises investors to never purchase a stock unless they have an exhaustive knowledge of how they make money. What do they manufacture? What kind of service do they offer? In what countries do they operate? What is their flagship product and how is it selling? Are they known as the leader in their field? Think of this as a first date. You probably wouldnt go on date with somebody if you had no idea who they were. If you do, youre asking for trouble.
This information is very easy to find. Using the search engine of your choice, go to their company website and read about them. Then, as Cramer advises, go to a family member and educate them on your potential investment. If you can answer all of their questions, you know enough.
Price/Earnings Ratio
Imagine for a moment you were in the market for somebody who could help you with your investments. You interview two people. One person has a long history of making people a lot of money. Your friends have seen a big return from this person and you cant find any reason why you shouldnt hand this guy your investment dollars. He tells you that for every dollar he makes for you, hes going to keep 40 cents leaving you with 60 cents.
The other guy is just getting started in the business. He has very little experience and, although he seems promising, he doesnt have much of a track record of success. The advantage to this guy is that hes cheaper. He only wants to keep 20 cents for every dollar he makes you - but what if he doesnt make you as many dollars as the first guy?
If you understand this example, you understand the P/E or price/earnings ratio. If you notice that a company has a P/E of 20, this means that investors are willing to pay $20 for every $1 per earnings. That might seem expensive but not if the company is growing fast.
The P/E can be found by comparing the current market price to the cumulative earnings of the last 4 quarters. Compare this number to other companies similar to the one youre researching. If your company has a higher P/E than other similar companies, there had better be a reason. If it has a lower P/E but is growing fast, thats an investment worth watching. (If these numbers have you in the dark, these easy calculations should help light the way, seeHow To Find P/E And PEG Ratios.)
Beta
Beta seems like something difficult to understand, but its not. In fact, and can be found on the same page as the P/E Ratio on a major stock data provider such as Yahoo or Google. Beta measures volatility or how moody your companys stock has acted over the last 5 years. Think of the S
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The Highest Priced Stocks In America
Why do so few stocks get over $400, or even over $200, and should you care? Most companies care about the price of their stock, and actually take measures to keep it down. Splitting shares or issuing new stock can keep the price low. But price is not the same as value. Shares which are trading for over $1,000 each can make it sometimes tough to even afford a handful of shares.
Berkshire Hathaway (NYSE:BRK.A) $114,700
Berkshire Hathaway has the highest shares on the New York Stock Exchange, so it needs special attention. It is over $110,000 because it doesnt split its shares. Normally a company will complete several 2;1 splits over the years, which doubles the shares outstanding but also cuts the price in half. Famous investor Warren Buffett keeps the price high to deter short-term traders from creating excessive volatility. At one point this year it cost over $140,000 per share. At that price it trades about 450 shares every day. There is a lower priced option with Berkshire Hathaway B shares (NYSE:BRK.B), which trade around $75 which were $3,000 per share until a 50;1 split in 2010.
Buffett created this holding company, which is so big that it doesnt just acquire buildings or factories; instead it often gobbles up whole companies. A true conglomerate, Berkshire owns retail, insurance, railways, furniture stores and more.
Seaboard Corporation (NYSE:SEB) $2,460
Seaboard Corporation went public in 1959 through a merger with Hathaway Industries, Inc. It deals in several areas including ocean transportation, pork production, commodity merchandising as well as an energy producer in the Dominican Republic. As you will see in most of these companies it has never split its shares and operations span several industries.
NVR, Inc. (NYSE:NVR) $700
NVR is a homebuilder and mortgage banking company in the United States. It has also never split any of its stock. Its shares took off in the early 2000s just as the tech bubble was popping. Shares went from $70 to about $700 in about 10 years.
Google Inc. (Nasdaq:GOOG) $600
Google waited until after the dotcom bust to go public when it issued shares in 2004. This was a highly anticipated IPO which closed the day around $100. Since then there have no splits and nearly a 500% return to those who have bought and held.
Priceline.com, Inc. (Nasdaq:PCLN) $525
Priceline held its initial public offering in 1999 at $16 per share. This was in the last stages of the dotcom bubble. About a month later the stock jumped to $120 per share. The bubble burst and the price dropped to around $1.30 by 2001. In 2003 it did a reverse split (1:6) which means every six shares you owned was now one, but that one was worth six times the price. If this split had not happened the current price would be around $87.50 each.
The Washington Post Company (NYSE:WPO) $415
The Washington Post company has not split its shares since it went public in 1971. At that time the class B shares were available to the public at around $26.
White Mountains Insurance Group, Ltd. (NYSE:WTM) $415
White Mountains insurance Group deals in insurance and reinsurance. Buffetts invested in insurance companies back in 1967 which was the beginning of Berkshire Hathaways rise.
Alexanders Inc (NYSE:ALX) $415
Rounding out the over $400 list is Alexanders inc. which is actually a Real Estate Investment Trust (REIT). It allows you to buy shares in a company which invests in properties and distributes the profits in the form of dividends. This means a $3 dividend for every share you hold every three months. This can obviously change.
Low Prices
I once heard a friend say to stay away from stocks with prices is over $200, because a $200 stock would need a $40 increase in price to gain 20%. It would be much easier for a $20 stock to move $4. For the record this is not true, sort of. A lower priced stock can be more volatile but the value of a stock is due to many factors.
Penny stocks, for example, will usually have low volume and can be very small companies. There is often less information available and less coverage by analysts. A single event or a few speculators can easily create huge jumps or drops in share price.
Low prices dont always mean you are dealing with a small company. Take Synovus Financial Corp. (NYSE:SNV) they trade around $2 per share. Because they have 785 million shares outstanding they have a market capitalization of $1.6 billion. Ultimately, the price is based on what that share represents: partial ownership in the company.
Actual Value
To find the true value of these shares you need to look at a variety of metrics, most of which are calculated per share, to make it easier to compare to their price. For example a very popular metric is the price to earnings ratio. Investors basically see how much it costs to buy a part of the profits of the company. The lower the P/E the better the value, but be careful to only compare similar companies. For example if you bought one share of Seaboard Corp. for $2,300 you are paying about $9 for every $1 of earnings over the last year. But take a look at Hormel Foods Corp. (NYSE:HRL) it costs $29 per share but you need to pay $17 for every dollar of earnings. In this case the $2,300 share is a better value. (For more on the P/E ratio check out Profit With The Power Of Price-To-Earnings.)
Future Prospects
The true value of a stock goes beyond the price you pay, or even what you get right now for that price. The true value of a stock is a moving target based on future prospects. Any company can have a great year, but value can be highly dependent on projections. Analysts scrutinize figures such as the potential growth rate of the economy, the strength of the industry and the prospects of specific companies. In the end, high price doesnt always mean overpriced.
In the OTC market, companies that qualify and are current in their financial disclosure may choose to apply their currently tradeable security(ies) for OTCQX. Companies may also choose to provide adequate disclosure either to regulators or OTC Markets Group in order to be classified in a ‘Current’ OTC Market Tier.
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How To Evaluate A Companys Balance Sheet
For stock investors, the balance sheet is an important consideration for investing in a company because it is a reflection of what the company owns and owes. The strength of a companys balance sheet can be evaluated by three broad categories of investment-quality measurements:working capital adequacy, asset performance and capitalization structure.
Tutorial: Financial Statement AnalysisIn this article, well look at four evaluative perspectives on a companys asset performance: (1) the cash conversion cycle, (2) the fixed asset turnover ratio, (3) the return on assets ratio and (4) the impact of intangible assets.
The Cash Conversion Cycle (CCC)
The cash conversion cycle is a key indicator of the adequacy of a companys working capital position. In addition, the CCC is equally important as the measurement of a companys ability to efficiently manage two of its most important assets - accounts receivable and inventory.
Calculated in days, the CCC reflects the time required to collect on sales and the time it takes to turn over inventory. The shorter this cycle is, the better. Cash is king, and smart managers know that fast-moving working capital is more profitable than tying up unproductive working capital in assets.
CCC = DIO DSO – DPO
DIO - Days Inventory Outstanding
DSO - Days Sales Outstanding
DPO - Days Payable Outstanding
There is no single optimal metric for the CCC, which is also referred to as a companys operating cycle. As a rule, a companys cash conversion cycle will be influenced heavily by the type of product or service it provides and industry characteristics.
Investors looking for investment quality in this area of a companys balance sheet need to track the CCC over an extended period of time (for example, five to 10 years), and compare its performance to that of competitors. Consistency and/or decreases in the operating cycle are positive signals. Conversely, erratic collection times and/or an increase in inventory on hand are generally not positive investment-quality indicators. (To read more on CCC, see Understanding the Cash Conversion Cycle and Using The Cash Conversion Cycle.)
The Fixed Asset Turnover Ratio
Property, plant and equipment (PP
If you own stock that has been delisted from an exchange and is now quoted on OTC Link or the OTC Bulletin Board, nothing has changed with the shares themselves. You are still the beneficial owner of the securities and may trade them. You should check with your current broker-dealer to make certain that they provide services in OTC securities. If not, you will need to locate a broker-dealer that does provide services in OTC securities.
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Is Your Psyche Ready For A Bull Market?
The psychological hardwiring that helped us survive in primitive times also make us vulnerable to dangerous errors and biases when handling our investments in both bull and bear markets. Read on to learn about the catch phrases to watch for in a bull market, and some of the mental errors and biases they could signal.
I know investment markets are going to pull back. I will put the money to work then.
When you hear a phrase like this, the investor could be suffering from confirmation bias. Confirmation bias is a result of our brains trying to avoid cognitive dissonance, or having two conflicting thoughts. It occurs when investors filter out relevant evidence about their investments that contradicts their beliefs. With all of the information available about the direction of investment markets and the economy, it is easy to latch on to what you want to hear and filter out information that contradicts your past judgment. In a new bull market this bias can cause investors to ignore information that the economy and the financial markets are recovering. It would mean that they were wrong about their recent decision to sell or not buy certain investments. It can cause them to sit on the sidelines too long while investment opportunities pass them by. It is always good to think independently when investing, but make sure that you keep your ego in check and have an alternative plan if markets do not go your way.
I finally had a profit, so I sold that investment.
There is nothing wrong with taking profits, but keep in mind that investors are constantly fearing regret and seeking pride. This is what is called the disposition effect. It is a result of the pain of an investment loss hurting much worse than the pleasure of a gain. Academic research has shown that investment losses hurt about two and a half times more than the positive feeling you get from an equivalent investment gain. Net of taxes, whether you have a gain or a loss in an investment says absolutely nothing about its future prospects. In a new bull market this bias causes investors to sell winners too early (seeking pride). Also, the painful regret associated with taking losses can keep investors from selling pastbear market losers to buy new bull market leaders. To help yourself avoid this bias, make sure that you have a process for buying and selling investments that is disciplined, fundamentally sound and repeatable. The bragging rights associated with quick gains are great, but the future profits you may miss could have been even better.
The market has gone up too far and too fast. We are due for a market correction
This phrase could signal what is known as anchoring or reference point. Anchoring occurs when someone assigns a number, like a 52-week high or low, to compare the price of an investment. Most academics and investment professionals would agree that the stock market is at least weak form efficient, meaning that past price movements are poor predictors of future price performance. Long-term investing using past price patterns alone can be compared to driving your car forward while using your rearview mirror as a guide.
In a new bull market, anchoring can lead to market acrophobia, where investors believe that because investment markets went up quickly from their lows they are due for a large correction. It can also give investors a false sense of value and lead to excessive risk taking in the initial stages of a bull market. Because investors have a tendency to believe that an investment is cheap or not as risky if it has already fallen a lot in price. Keep in mind that prices and investmentfundamentals are constantly changing. Whether or not an investment has risen or fallen in the past tells you very little about its current fundamental valuation and long-term investment prospects today.
I will never buy stocks again
This phrase could signal the snake bite effect. Snake bite effect occurs when investors take large losses in a certain asset class, like stocks, and become more risk adverse. The emotional toll from their past bear market losses can be so great that they feel the need to reduce exposure to the asset class or abandon it all together. It is important to think about your investment objectives, risk tolerance, and capital market expectations, and invest accordingly. In a new bull market this bias can lead to an under-diversified portfolio, or a portfolio that does not match the investors objectives. It may stink, but if it meets your long- term investment goals sometimes you just have to hold your nose and buy.
Conclusion
Famed investor Benjamin Graham once said, Individuals who cannot master their emotions are ill-suited to profit from the investment process. Mr. Graham knew that having control over your emotions when investing can mean the difference between success and failure.
It is important to understand that, because we are all humans and not computers; we will not always make perfectly rational and timely investment decisions. Knowing some of the catch phrases to look for and the mental errors and biases that they may signal can help you make more rational investment decisions and suppress your inner Captain Caveman when investing in a new bull market.
The OTC market provides an alternative to stock exchange listing for securities of issuers that either choose not to be listed on a U.S. stock exchange or do not meet the relevant listing requirements. The term ‘OTC security’ is a catch–all phrase for any security that is not listed on a U.S. stock exchange.
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5 Economic Effects Of Country Liberalization
August 24 2011| Filed Under » Economics, Economy, International Markets, Investing Basics, Investment
When a nation becomes liberalized, the economic effects can be profound for the country and for investors. Economic liberalization refers to a country opening up to the rest of the world with regards to trade, regulations, taxation and other areas that generally affect business in the country. As a general rule, you can determine to what degree a country is liberalized economically by how easy it is to invest and do business in the country. All developed countries (First World) have already gone through this liberalization process, so the focus in this article is more on the developing and emerging countries. TUTORIAL:Economic Indicators To Know
Removing Barriers to International Investing
Investing in emerging market countries can sometimes be an impossible task if the country youre investing in has several barriers to entry. These barriers can include tax laws, foreign investment restrictions, legal issues and accounting regulations that can make it difficult or impossible to gain access to the country. The economic liberalization process begins by relaxing these barriers and relinquishing some control over the direction of the economy to the private sector. This often involves some form of deregulation and a privatization of companies. (For related reading, seeThe Risks Of Investing In Emerging Markets.)
Unrestricted Flow of Capital
The primary goals of economic liberalization are the free flow of capital between nations and the efficient allocation of resources and competitive advantages. This is usually done by reducing protectionist policies such as tariffs, trade laws and other trade barriers. One of the main effects of this increased flow of capital into the country is that it makes it cheaper for companies to access capital from investors. A lower cost of capital allows companies to undertake profitable projects that they may not have been able to with a higher cost of capital pre-liberalization, leading to higher growth rates.
We saw this type of growth scenario unfold in China in the late 1970s as the Chinese government set on a path of significant economic reform. With a massive amount of resources (both human and natural), they believed the country was not growing and prospering to its full potential. Thus, to try to spark faster economic growth, China began major economic reforms that included encouraging private ownership of businesses and property, relaxing international trade and foreign investment restrictions, and relaxing state control over many aspects of the economy. Subsequently, over the next several decades, China averaged a phenomenal real GDP growth rate of over 10%.
Stock Market Performance
In general, when a country becomes liberalized, the stock market values also rise. Fund managers and investors are always on the lookout for new opportunities for profit, and so a whole country that becomes available to be invested in will tend to cause a surge of capital to flow in. The situation is similar in nature to the anticipation and flow of money into an initial public offering (IPO). A private company that was previously unavailable to an investor that suddenly becomes available typically causes a similar valuation and cash flow pattern. However, like an IPO, the initial enthusiasm also eventually dies down and returns become more normal and more in line with fundamentals.
Political Risks Reduced
In addition, liberalization reduces the political risks to investors. For the government to continue to attract more foreign investment, other areas beyond the ones mentioned earlier have to be strengthened as well. These are areas that support and foster a willingness to do business in the country such as a strong legal foundation to settle disputes, fair and enforceable contract laws, property laws, and others that allow businesses and investors to operate with confidence. Also, government bureaucracy is a common target area to be streamlined and improved in the liberalization process. All these changes together lower the political risks for investors, and this lower level of risk is also part of the reason the stock market in the liberalized country rises once the barriers are gone.
Diversification for Investors
Investors can also benefit by being able to invest a portion of their portfolio into a diversifying asset class. In general, the correlation between developed countries such as the United States and undeveloped or emerging countries is relatively low. Although the overall risk of the emerging country by itself may be higher than average, adding a low correlation asset to your portfolio can reduce your portfolios overall risk profile. (For more, see Does Investing Internationally Really Offer Diversification?)
However, a distinction should be made that although the correlation may be low, when a country becomes liberalized, the correlation may actually rise over time. This happens because the country becomes more integrated with the rest of the world and has become more sensitive to events that happen outside the country. A high degree of integration can also lead to increased contagion risk – which is the risk that crises that occur in different countries cause crises in the domestic country.
A prime example of this is the European Union (EU) and its unprecedented economic and political union. The countries in the EU are so integrated with regard to monetary policy and laws that a crisis in one country has a high probability of spreading to other countries in the EU. This is exactly what happened in the financial crisis that started in 2008-2009. Weaker countries within the EU (such as Greece) began to develop severe financial problems that quickly spread to other EU members. In this instance, investing in several different EU member countries would not have provided much of a diversification benefit as the high level of economic integration in the EU had increased correlations and increased contagion risks to the investor.
The Bottom Line
Economic liberalization is generally thought of as a beneficial and desirable process for emerging and developing countries. The underlying goal is to have unrestricted capital flowing into and out of the country in order to boost growth and efficiencies within the home country. The effects following liberalization are what should interest investors as it can provide new opportunities for diversification and profit.
The OTC market is not suitable for unsophisticated or novice investors. You should gain a thorough understanding of your rights as an investor and investigate the background of the issuing company, individual broker, and brokerage firm before you invest.
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The Risks Of Investing In Emerging Markets
Investing is always risky business; corporate scandals regularly surface in the news, corporate bonds are frequently downgraded, accounting fraud is often revealed and market imperfections such as the flash crash continuously bring a level of uncertainty. Even the most stable domestic blue chip companies will face times of tremendous volatility.
Emerging markets offer numerous benefits to investors such as elevated economic growth rates, higher expected returns and diversification benefits. However, there are a number of important risks to consider before investing in regions outside of the developed world. (Emerging markets provide new investment opportunities, but there are risks - both to residents and foreign investors. See What Is An Emerging Market Economy?)
1) Foreign Exchange Rate Risk
Foreign investments in stocks and bonds will typically produce returns in the local currency of the investment. As a result, investors will have to convert this local currency back into their domestic currency. An American who purchases a Brazilian stock in Brazil will have to buy and sell the security using the Brazilian real. Therefore, currency fluctuations can impact the total return of investment. If, for example, the local value of a held stock increased by 5%, but the real depreciated by 10%, the investor will experience a net loss in terms of total returns when selling and converting back to U.S. dollars.
2) Non-Normal Distribution
North American market returns arguably follow a pattern of normal distributions. As a result, financial models can be used to price derivatives and make somewhat accurate economic forecasts about the future of equity prices. Emerging market securities, on the other hand, cannot be valuated using the same type of mean-variance analysis. Also, because emerging markets are undergoing constant changes, it is almost impossible to utilize historical information in order to draw proper correlations between events and returns.
3) Lax Insider Trading Restrictions
Although most countries claim to enforce strict laws against insider trading, none have proved to be as rigorous as America in terms of prosecuting unfair trading practices. Insider trading and various forms of market manipulation introduce market inefficiencies, whereby equity prices will significantly deviate from their intrinsic value. Such a system can be subject to extreme speculation, and can also be heavily controlled by those holding privileged information.
4) Less Liquidity
Emerging markets are generally less liquid than those found in the developed world. This market imperfection results in higher broker fees and an increased level of price uncertainty. Investors who try to sell stocks in an illiquid market face substantial risks that their orders will not be filled at the current price, and the transactions will only go through at an unfavorable level. Additionally, brokers will charge higher commissions, as they have to make more diligent efforts to find counterparties for trades. Illiquid markets prevent investors realizing the benefits of fast transactions.
5) Difficulty Raising Capital
A poorly developed banking system will prevent firms from having the proper access to financing that is required to grow their businesses. Attained capital will usually be issued at a high required rate of return, increasing the companys weighted average cost of capital (WACC). The major concern with having a high WACC is that fewer projects will produce a high enough return to yield a positive net present value. Therefore, financial systems found in developed nations do not allow companies to undertake a higher variety of profit-generating projects. (This asset class has left much of its unstable past behind. Find out how to invest in it, in Investing In Emerging Market Debt.)
6) Poor Corporate Governance System
A solid corporate governance structure within any organization is correlated with positive stock returns. Emerging markets sometimes have weaker corporate governance systems, whereby management, or even the government, has a greater voice in the firm than shareholders. Furthermore, when countries have restrictions on corporate takeovers, management does not have the same level of incentive to perform in order to maintain job security. While corporate governance in the emerging markets has a long road to go before being considered fully effective by North American standards, many countries are showing improvements in this area in order to gain access to cheaper international financing.
7) Increased Chance of Bankruptcy
A poor system of checks and balances and weaker accounting audit procedures increase the chance of corporate bankruptcy. Despite that bankruptcy is common in every economy, such risks are most common outside of the developed world. Within emerging markets, firms can more freely cook the book to give an extended picture of profitability. Once the corporation is exposed, it experiences a sudden drop in value. This is not to say that such occurrences do not happen in North America and Europe.
Because emerging markets are viewed as being more risky, they will have to issue bonds that pay higher interest rates. The increased debt burden further increases borrowing costs and strengthens the potential for bankruptcy.
8) Political Risk
Political risk refers to uncertainty regarding adverse political decisions. Developed nations tend to follow a free market discipline of low government intervention, whereas emerging market businesses are often privatized upon demand. Some additional factors that contribute to political risk are: possibility of war, tax increase, loss of subsidy, change of market policy, inability to control inflation and laws regarding resource extraction. Major political instability can also result in civil war and a shutdown of industry, as workers either refuse or are no longer able to do their jobs. (Find out how these worldly offerings can spice up your portfolio. Check out Go International With Foreign Index Funds.)
Conclusion
Investing in emerging markets can produce substantial returns to ones portfolio. However, investors must be aware that all high returns must be judged within the risk and reward framework. The aforementioned risks are some of the most prevalent that must be assessed prior to investing. Unfortunately, however, the premiums associated with these risks can often only be estimated, rather than determined on a concrete basis.
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The Value Investors Handbook
Value investing, and any type of investing for that matter, varies in execution with each person. There are, however, some general principles that are shared by all value investors. These principles have been spelled out by famed investors like Peter Lynch, Kenneth Fisher, Warren Buffet,John Templeton and many others. In this article, we will look at these principles in the form of a value investors handbook.
Buy Businesses
If there is one thing that all value investors can agree on, its that investors should buy businesses, not stocks. This means ignoring trends in stock prices and other market noise. Instead, investors should look at the fundamentals of the company that the stock represents. Investors can make money following trending stocks, but it involves a lot more activity than value investing. Searching for good businesses selling at a good price based on probable future performance requires a larger time commitment for research, but the payoffs include less time spent buying and selling and fewer commission payments. (False signals can drown out underlying trends. Find out how to tone them down and tune them out in Trading Without Noise.)
Love the Business You Buy
You wouldnt pick a spouse based solely on his or her shoes, and you shouldnt pick a stock based on cursory research. You have to love the business you are buying, and that means being passionate about knowing everything about that company. You need to strip the attractive covering from a companys financials and get down to the naked truth. Many companies look far better when you judge them on basic price to earnings (P/E), price to book (P/B) and earnings per share (EPS) ratios than they do when you look into the quality of the numbers that make up those figures.
If you keep your standards high and make sure the companys financials look as good naked as they do dressed up, youre much more likely to keep it in your portfolio for a long time. If things change, youll notice it early. If you like the business you buy, paying attention to its ongoing trials and successes becomes more of a hobby than a chore.
Simple Is Best
If you dont understand what a company does or how, then you probably shouldnt be buying shares. Critics of value investing like to focus on this main limitation. You are stuck looking for businesses that you can easily understand because you have to be able to make an educated guess about the future earnings of the business. The more complex a business is, the more uncertain your projections will necessarily be. This moves the emphasis from educated to guess.
You can buy businesses you like but dont completely understand, but you have to factor in uncertainty as added risk. Any time a value investor has to factor in more risk, he has to look for a larger margin of safety - that is, more of adiscount from the calculated true value of the company. There can be no margin of safety if the company is already trading at many multiples of its earnings, which is a strong sign that, however exciting and new the idea is, the business is not a value play. Simple businesses also have an advantage, as its harder for incompetent management to hurt the company. (For a complete guide to reading the financial reports, check out our Financial Statements Tutorial.)
Look for Owners, Not Managers
Management can make a huge difference in a company. Good management adds value beyond a companys hard assets. Bad management can destroy even the most solid financials. There have been investors who have based their entire investing strategies on finding managers that are honest and able. To quote Buffett, look for three qualities: integrity, intelligence, and energy. And if they dont have the first, the other two will kill you. You can get a sense of managements honesty through reading several years worth of financials. How well did they deliver on past promises? If they failed, did they take responsibility, or gloss it over? (Find out more about Buffetts investing in Warren Buffett: How He Does It.)
Value investors want managers who act like owners. The best managers ignore the market value of the company and focus on growing the business, thus creating long-term shareholder value. Managers who act like employees often focus on short-term earnings in order to secure a bonus or other performance perk, sometimes to the long-term detriment of the company. Again, there are many ways to judge this, but the size and reporting of compensation is often a dead give away. If youre thinking like an owner, you pay yourself a reasonable wage and depend on gains in your stock holdings for a bonus. At the very least, you want a company that expenses its stock options. (Still wondering how to investigate the top brass? Check out Evaluating A Companys Management.)
When You Find a Good Thing, Buy a Lot
One of the areas where value investing runs contrary to commonly accepted investing principles is on the issue of diversification. There are long stretches where a value investor will be idle. This is because of the exacting standards of value investing as well as overall market forces. Toward the end of a bull market, everything gets expensive, even the dogs, so a value investor may have to sit on the sidelines waiting for the inevitable correction. Time, an important factor in compounding, is lost while waiting, so when you do find undervalued stocks, you should buy as much as you can. Be warned, this will lead to a portfolio that is high-risk according to traditional measures like beta. Investors are encouraged to avoid concentrating on only a few stocks, but value investors generally feel that they can only keep proper track of a few stocks at a time.
One obvious exception is Peter Lynch, who kept almost all of his funds in stocks at all times. Lynch broke stocks into categories and then cycled his funds through companies in each category. He also spent upwards of 12 hours every day checking and rechecking the many stocks held by his fund. As an individual value investor with a different day job, however, its better to go with a few stocks for which youve done the homework and feel good about holding long term. (Learn the basic tenets that helped this famous investor earn his fortune in Pick Stocks Like Peter Lynch.)
Measure Against Your Best Investment
Anytime you have more investment capital, your aim for investing should not be diversity, but finding an investment that is better than the ones you already own. If the opportunities dont beat what you already have in your portfolio, you may as well buy more of the companies you know and love, or simply wait for better times. During idle times, a value investor can identify the stocks he or she wants and the price at which theyll be worth buying. By keeping a wish list like this, youll be able to make decisions quickly in a correction.
Ignore the Market 99% of the Time
The market only matters when you enter or exit a position; the rest of the time, it should be ignored. If you approach buying stocks like buying a business, youll want to hold onto them as long as the fundamentals are strong. During the time you hold an investment, there will be spots where you could sell for a large profit and others were youre holding an unrealized loss. This is the nature of market volatility.
The reasons for selling a stock are numerous, but a value investor should be as slow to sell as he or she is to buy. When you sell an investment, you expose your portfolio to capital gains and usually have to sell a loser to balance it out. Both of these sales come with transaction coststhat make the loss deeper and the gain smaller. By holding investments with unrealized gains for a long time, you forestall capital gains on your portfolio. The longer you avoid capital gains and transaction costs, the more you benefit from compounding. (Find out how your profits are taxed and what to consider when making investment decisions in Tax Effects On Capital Gains.)
The Bottom Line
Value investing is a strange mix of common sense and contrarian thinking. While most investors can agree that a detailed examination of a company is important, the idea of sitting out on a bull market goes against the grain. Its undeniable that funds held constantly in the market have outperformed cash held outside the market, waiting for a down market. This is a fact, but a deceiving one. The data is derived from following the performance of indexes like the S
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The firm has the authority to immediately sell any security in your account, without notice to you, to cover any shortfall resulting from a decline in the value of your securities. You may owe a substantial amount of money even after your securities are sold.
4 Tips For Joining An Investment Club
Investing in the stock market can be intimidating - how to differentiate between the different types of securities, investing styles and trading strategies, analyzing market data, financials, and know when to act? And for beginners, this can be especially off-putting. Financial planners andbrokers are good sources of advice, but if you are interested in learning about the stock market and how to take control of your money, an investment club may be worth considering.
What Are Investment Clubs?
They can be found in most municipalities and regions, and have been around for decades as a way for people with limited funds to contribute and partake in larger investments as well as to get first-hand experience and education. Investment clubs are simply a group of people who pool their money in order to make joint investments, usually in stocks or bonds. While their primary motivation is to make the most money possible, clubs are also a great way for investors to share ideas and learn about the market.
How are Investment Clubs Set Up?
If you start a new investment club, it is a good idea to provide a solid structure to ensure the clubs agenda is carried out efficiently and without friction. An investment club is usually a legal partnership or a limited liability company consisting of 10-20 members. Once it is legally established, it is imperative that standardized accounting records are established for it. After all, unlike independent individuals investing directly into the stock market, an investment club pools money from each member.
After a member initially contributes an initial lump-sum for investment purposes, the typical investment club requires a monthly contribution of about $80 from members. Nevertheless, members may not contribute the same amount, nor be participants for the same durations. Therefore, an investment club must have a clear way of determining each members share at a given point in time since members are likely to be contributing funds on a periodic basis, and probably intend to withdraw funds from their share of the clubs assets at some time in the future.
Also, when first starting an investment club, be sure to establish a brokerage account in the investment clubs name. Shopping around for a suitable brokerage firm is a good idea, as different brokers usually have unique offers for investment clubs. (For more, see Choosing A Compatible Broker.)
To facilitate club decisions and member education, an investment club should schedule regular meetings at least once a month. Regular monthly meetings can be fun and insightful, as members present a stock they have researched and would like the club to consider buying. Club members carry the responsibility of researching potential investment purchases for the club and staying up-to-date on the performance and outlook of their holdings going forward. It is important that club members actively participate in the clubs portfolio construction and maintenance in order to maximize their own investment education - one of the key goals of an investment club. With that in mind, there are many steps an investment club can take to boost members opportunities to gain as much knowledge as possible.
Tips for Joining an Investment Club
Here are some pointers worth considering:
1.Think long-term
We cannot stress this enough. Dont buy stocks through an investment club if your time horizon is a year or less. Trying to make money over a shorter period of time is a wrong approach, not only for beginner investors, but also investment clubs. A short time horizon makes it difficult to manage the clubs money because, for short-term outlooks, decisions to buy or sell stocks need to be made very quickly. Also, most investment clubs meet only once a month, making it entirely impossible to make trade decisions for the short term. Club members should probably spend their time analyzing the fundamentals of stocks held in the club portfolio as opposed to concerning themselves with short-term movements in the clubs holdings.
Having a three- to five-year horizon is a common outlook among investment club strategies. As such, potential members should also consider joining an investment club as something of a long-term commitment of about three to five years. It is generally not very healthy for a club if members decide to leave and pull their money out after a short period of membership. Most investment clubs specify the rules or penalties for early withdrawal from the club at its inception. Most specify a liquidation price, or early-withdrawal penalty, which members must pay when withdrawing their funds, which is usually slightly lower than the value of their contributions. Generally speaking, anyone interested in starting or joining an investment club should consider it a minimum commitment of several years, and ensure all members in the club find that level of time commitment acceptable.
2. Define your style
Just as individual investors vary greatly from one another in terms of their investment style - such as value investing, income stock strategies or GARP - and so do investment clubs. It is very important for every investment club to have a clearly defined investment style, ideally with some amount of quantifiable rules or limitations on the clubs investment portfolio. For example, an investment club might specify that members can propose only stocks for purchase that have a minimum share price or market capitalization, or the club might place sector restrictions on the portfolio to ensure a minimum level of diversification always exists.
Also, for the benefit of members, it may also be useful for a new investment club to implement standardized criteria for reviewing a stock for potential purchase. This will ensure the club members increase their experience in specific areas of equity analysis, while allowing all members of the group to brief themselves better for standard material covered at meetings, and hopefully better understand the material presented to them.
Once an investment club has determined its style, it is important that every member is aware of the clubs investing style and willing to follow those guidelines. It can be very damaging to an investment clubs atmosphere when some members want to invest club funds in high-risk penny stocks while others gravitate towards blue chips. If you are starting the club, make sure every member understands and supports the clubs approach. If you are joining a club, make sure its style meets your needs. After all, there are many different types of investment clubs to be found, so before you follow through and become a full member, be sure to assess its investment style and try to judge how closely it matches your own aspirations. Chances are, you will learn much more, and enjoy a more rewarding experience if you spend a bit of time finding the investment club that best fits your personal investment style or objectives.
3. Join a club association
The National Association of Investors Corporation (NAIC) offers some excellent support and information for people wishing to join or start their own investment club in the United States. The NAIC not only provides excellent tools, but also publishes a monthly investor-learning magazine. Membership to the NAIC costs $40 for a new club, $30 for individual club members and $79 for individuals. According to NAIC data, the number of investment clubs registered with the association has seen strong growth in the early 21st century, and, to the chagrin of industry professionals, about half of all registered clubs have been able to outperform the S
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FINRA applies short sale delivery requirements to those equity securities not otherwise covered by the delivery requirements of SEC Regulation SHO. Reg. SHO applies to all securities of all reporting issuers whether listed for trading on an exchange or quoted in the OTC market. New Rule 4320 expanded Reg.
Testing 3 Types Of Analysts
There are several types of analysts on Wall Street, and they produce different kinds of reports because they have different kinds of clients. Lets take a look at the different responsibilities required for each analyst, so that you can do your own litmus test to see which ones you need to pay attention to.
Sell-Side Analysts
These are the analysts that are dominating todays headlines. They are employed by brokerage houses to analyze companies and write in-depth research reports, conducting what is sometimes called primary research. These reports are used to sell an idea to individuals and institutional clients. Individual investors gain access to these reports mainly by having accounts with the brokerage firm. For example, to get free research from Merrill Lynch, you need to have an account with a Merrill Lynch broker. Sometimes the reports can be purchased through a third party such as Multex.com. Institutional clients (i.e. mutual fund managers) get research from the brokerages institutional brokers. (Keep reading about fund managers in Should You Follow Your Fund Manager? and Choose A Fund With A Winning Manager.
A good sell-side research report contains a detailed analysis of a companys competitive advantages and provides information on managements expertise and how the companys operating and stock valuation compares to a peer group and its industry. The typical report also contains an earnings model and clearly states the assumptions that are used to create the forecast.
Writing this type of report is a time consuming process. Information is obtained by reading the companys filings for the Securities
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The FINRA OTCBB system, on the other hand, is a quotation only system, as it lacks the electronic messaging capabilities of OTC Link. Furthermore, only companies that are SEC-reporting (or bank/insurance reporting) are eligible for quotation on the FINRA OTCBB. Since these securities may also be quoted on OTC Link, many BB eligible securities are ‘Dually-Quoted’ on both inter-dealer quotation systems. Currently, 99% of OTCBB eligible securities are quoted on OTC Link.
A Beginners Guide To Managing Your Money
Online brokers and easy access to financial data make investing your money as easy as starting a savings account, but in a world where the Internet has made do-it-yourselfers out of many, is investing a do-it-yourself activity and if it is, why not just fire your financial advisor or pay less fees to your mutual funds and set up a portfolio of your own? See: Risk and Diversification
The Internet has changed the way we live our lives. Not long ago purchasing stock was not as easy as it is now. The order went through a complex network of brokers and specialists before the execution was completed. In 1983, that all changed with a dentist in Michigan who made the first online stock transaction using a system developed by what is now E*TRADE Financial. (For related reading, see Brokers and Online Trading.)
The Effect
That one trade changed how investment products are transacted, researched and discussed. Computerized trading has resulted in highly liquid markets making it easy to buy and sell most securities quickly. The do-it-yourselfer now has access to the same free financial data that the professionals use, and websites like Stocktwits set up entire communities of investors and traders who exchange information in real time.
But just because its possible, does that mean that managing your own money is a good idea? Professional investors have a saying, The stock market is an expensive place to learn how to invest . They understand that its easier to lose money than it is to make money, and because of that, some argue that the wealth of information available to people with little financial background may offer a false sense of security.
Tools are only as good as the knowledge and experience of the person using them. Does a high priced software package used by the worlds best composers result in beautiful music? Does the newest innovation in surgical technology make a person with no prior training in medicine a top performing surgeon?
Theres no doubt that the Internet has given the retail investor the tools that they need to effectively manage their own money, but what about the knowledge and experience to use the tools effectively? For an investor who wants to manage their own money, what types of fundamental knowledge should they have before firing their financial adviser? (To learn more, read 4 Steps To Building A Profitable Portfolio.)
Modern Portfolio Theory
First, understand modern portfolio theory (MPT) and gain an understanding of how asset allocation is determined for an individual based on their individual factors. In order to gain a true understanding of these principals, youll have to dig deeper than the top level Internet blog articles that tell you that MPT is simply understanding allocation. MPT is not just about the allocation but also its efficiency. The best money managers understand how to position your money for maximum return with the least amount of risk. They also understand that efficiency is highly dynamic as the person ages and their financial picture changes.
Along with efficiency comes the dynamic nature of risk tolerance. At certain points in our lives, our risk tolerance may change. Along with retirement, we might have intermediate financial goals like saving for college or starting a new business, the portfolio has to be adjusted to meet those goals. Financial advisors often use proprietary software that produces detailed reports not available to the retail investor. (Read how to determine What Is Your Risk Tolerance?)
Academic Understanding of Risk
In the plethora of free resources, risk is treated too benignly. The term risk tolerance has been so overused that retail investors may believe that they understand risk if they understand that investing may involve losing money from time to time. Its much more than that.
Risk is a behavior that is hard to understand rationally because investors often act opposite of their best interests. A study conducted by Dalbar, Inc. showed that inexperienced investors tend to buy high and sell low, which often leads to losses in short-term trades.
Since risk is a behavior, its extremely difficult for an individual to have an accurate, unbiased picture of their true attitude towards risk. Day traders, often seen as having a high risk tolerance, may actually have an extremely low tolerance because theyre unwilling to hold an investment for longer periods. Great investors understand that success comes with fending off emotion and making decisions based on facts. Thats hard to do when youre working with your own money.
Efficient Market Hypothesis
Do you know how likely you are to out invest the overall market? What is the likelihood of any one football player being better than most of the other NFL players, and if they are better for a season what is the likelihood that they will be the best of the best for decades?
Efficient Market Hypothesis (EMH) might contain the answer. EMH states that everything known about an investment product is immediately factored into the price. If Intel releases information that sales will be light this quarter, the market will instantly react and adjust the value of the stock. According to EMH, there is no way to beat the market for sustained periods because all prices reflect true or fair value.
For the retail investor trying to pick individual stock names hoping to achieve gains that are larger than the market as a whole, this may work in the short term, just as gambling can sometimes produce short-term profits, but over a sustained period of decades, this strategy breaks down, say the proponents of EMH.
Even the brightest investment minds employing teams of researchers all over the world havent been able to beat the market over a sustained period. According to famed investor Charles Ellis in his book, Winning The Losers Game: Timeless Strategies For Successful Investing.
Opponents of this theory cite investors like Warren Buffett who have beat the market for most of his life, but what does EMH mean for the individual investor? Before deciding on your investing strategy , you need the knowledge and statistics to back it up.
If youre going to pick individual stocks in the hopes that theyll appreciate in value faster than the overall market, what evidence leads you to the idea that this strategy will work? If youre planning to invest in stocks for dividends, is there evidence that proves that an income strategy works? Would investing in an index fund be the best way? Where can you find the data needed to make these decisions? (For additional reading, see 7 Controversial Investing Theories.)
Experience
What do you do for a living? If you have a college degree, you might be one of the people who say that you didnt become highly skilled as a result of your degree but instead, because of the experience you amassed. When you first started your job were you highly effective from the very beginning?
Before managing your own money, you need experience. Gaining experience for investors often means losing money, and losing money in your retirement savings isnt an option.
Experience comes from watching the market and learning first-hand how it reacts to daily events. Professional investors know that the market has a personality that is constantly changing. Sometimes its hypersensitive to news events and other times it brushes them off. Some stocks are highly volatile while others have muted reactions.
The best way for the retail investor to gain experience is by setting up a virtual or paper trading account. These accounts are perfect for learning to invest while also gaining experience before committing real money to the markets. (Learn to trade with the Investopedia Stock Simulator, risk free!)
The Bottom Line
Many people have found success in managing their own money, but before putting your money at risk, become a student in the art of investing. If somebody wanted to do your job based on what they read on the Internet, would you advise it? If you were looking for a financial advisor, would you hire yourself based on your current level of knowledge? Your answer might be yes, but until you have the knowledge and experience as a money manager, managing a brokerage account with money that you could stand to lose might be OK, but leave your retirement money to the professionals.
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