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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
Investing During Uncertainty
Every day it seems like the world is getting smaller. If you watch any financial television station or read the newspaper, you are most likely aware of how events in one country seem to have an ever-increasing effect on other countries around the world. We are more interconnected now than at any other time in history. It goes without mention that globalization definitely has its positives, but when threats of financial crisis, war, global recession, trade imbalances, etc, do occur it often leads to talk of moving money to safer investments and increasing government deficits. This rising uncertainty can confuse even the well-informed investor.
Uncertainty
Any time you put money at risk for the chance of profit there is an inherent level of uncertainty. When new threats such as war or recession arise, the level of uncertainty increases significantly as companies can no longer accurately predict their future earnings. As a result,institutional investors will reduce their holdings in stocks considered unsafe and move the funds to other sources like precious metals, government bonds and money-market instruments. This selloff, which occurs as large portfolios reposition themselves, can cause the stock market to depreciate.
Effects of Uncertainty
Uncertainty is the inability to forecast future events; people cant predict the extent of a possible recession, when its going to start/end, how much it will cost, or what companies will be able to make it through unscathed. Most companies normally predict sales and production trends for theinvesting public to follow assuming normal market conditions, but increasing levels of uncertainty can make these numbers significantly inaccurate.
Uncertainty itself can affect the economy on both the micro and macro level; a description of uncertainty on a micro level focuses on the effect on individual companies within an economy faced with the threat of war or recession, whereas the view of uncertainty on a macro level looks at the economy as a whole (To learn more, see Economics Basics.):
• From a company-specific point of view, uncertainty provides a major concern for those that produce consumer goods every day. For example, consumption may fall on the threat of a recession as individuals refrain from purchasing new cars, computers and other non-essentials. This uncertainty may force the companies in certain sectors to lay off some of their employees to combat the impacts of lower sales. The level of uncertainty that surrounds a companys sales also extends into the stock market. Consequently, stock prices of companies that produce non-essential goods sometimes experience a selloff when levels of uncertainty rise. (For more, see The Impact Of Recession On Businesses.)
• On a macro level, uncertainty is magnified if the countries at war are major suppliers or consumers of goods. A good example is a country that supplies a large portion of the worlds oil. Should this country go to war, uncertainty regarding the level of the worlds oil reserves would grow. Because the demand for oil would be high and the supply uncertain, a country unable to produce enough oil within its own borders would be required to ensure that enough oil was stored to cover operations. As a result, the price of oil would increase.
• Another macro-level event that affects companies and investors is the flight of capital and devaluation of exchange rates. When a country faces the threat of war or recession, its economy is considered uncertain. Investors attempt to move their currency away from unstable sources to stable ones; the currency of a country under a threat of war is sold and the currencies from countries without the threat are bought. The average investor probably would not do this, but the large institutional investors and currency futures traders would. These actions translate into a devaluation of exchange rates.
Whats an Investor to Do?
When situations of heightened uncertainty arise, the best defense is to be as well informed as possible. Keep updated by reading the newspaper and researching individual companies. Analyze which sectors have more to gain and lose in a crises and decide on a long-term plan. Times of heightened uncertainty can lead to great opportunities for investors who position themselves to take advantage of it. Some investors might decide to be offensive and search for companies that provide goods or services that will lead to great returns when things turn around. It is difficult to commit capital during uncertain times, but it can often reap huge rewards in the long run. Those who want to mitigate uncertainty and risk might be content leaving their money where it is or perhaps moving it to safer securities.
Regardless of which strategy you decide to take (if any), you cant go wrong over the long term by keeping yourself well informed and getting into a position so that you can take advantage of prices when the things reverse.
Trust In Utilities
Utilities become desirable, to both novice and seasoned investors, whenever the market or the economy is going through a downturn. Picking individual utility companies to invest in can be time consuming, and if you choose poorly, you will not take part in the benefits that investing in public utilities can provide.
Mutual funds that specialize in utility companies are most often where investors place their money. They offer instant diversification, but that comes at a price – in the form of management fees, which are normally passed along to investors. Utility trusts that operate or invest in public utilities can be a good alternative for many investors. (For more on mutual fund fees, take a look at Stop Paying High Mutual Fund Fees.)
What Are Utility Trusts?
Utility trusts are a type of income trust that are less growth focused than traditional income trusts. An income trust is simply an investment trust that holds income-generating assets; in this case, it would be utilities. The income produced is passed on to the investors (usually called unitholders). These payments are generally higher than a typical stock dividend because, relative to income trusts, non-income trusts use more of their income to fuel more growth instead of paying it out to shareholders.
Income trusts typically aim to pay out a consistent cash flow to their unitholders. It is important to remember that, like dividend-paying stocks, income trusts do not guarantee a dividend, though they strive to pay one. If the underlying business loses money, the trust can reduce or eliminate payouts altogether.
Understanding Utilities
A public utility is a company or organization that operates and maintains the infrastructure for a public service. Public utility companies are subject to state and government regulation, and can either be privately or publicly owned. The biggest difference between the two is that a privately-owned utility may be listed on a stock exchange. Prices charged by public utility companies are regulated by the state or local government. In order for a public utility to charge higher prices, it needs to get approval from a committee. However, these can often take time and have little to no guarantee that the rate increases will be approved. (To learn more about these companies, be sure to check out the Utilities Industry Handbook.)
Advantages of Utility Trusts
Public utility companies are relatively safe and constant when it comes to dividend return. This predictable dividend makes cash flows similar to a bonds cash flow, and therefore they react similarly to changes in interest rates - but not always. Also, like a bond, a higher yield generally means taking on higher risk. The income produced by the underlying utility companies held in a utility trust is easily passed along to the unit holders. The portfolio for a utility trust usually does not change often, which ensures a steady dividend stream if the underlying companies are stable.
The Government Cloud
When it comes to public utility companies, one cannot escape the role the government plays. Each utility company - whether private or public - has to deal with government regulations and red tape. The biggest trend among government in regards to public utilities is deregulation. As of September 2010, 27 states have either passed legislation or are in the process of restructuring the electric power industry (8 of those have suspended their restructuring for now).
Electric utilities have gone through the most dramatic change due to deregulation. Most public utility companies that deal with electricity no longer generate the power. Instead, they service and maintain the grid the power is delivered on. Private companies are now generating the power and selling it to the public utility companies. Investors thinking about public utilities need to be watchful of government regulations and climate when they choose this field. (To learn more about deregulation, read Free Markets: Whats The Cost?)
One concern when it comes to this sector is that, thus far, governments have been hesitant to allow public utilities to raise rates, which makes it challenging to recoup their investment in capital spending and construction of new plants. Government regulations and the restriction on rate increases is what sent the public service of New Hampshire into Chapter 11 for the construction of the Seabrook Nuclear Power Plant. Keeping an eye on the climate in Washington can help an investor looking to put their money into this sector.
When to Invest
When it comes to utilities, there are better times to buy than others, and its important to remember that public utility companies are considered a defensive play. Tough economic times usually benefit utilities, as people still need water, electricity and natural gas to flow uninterrupted, regardless of the economy.
Also, lower interest rates make the steady and high dividend yields offered by utility companies an attractive place to invest. Those interested in capturing income from their investments look to utility companies as a good place to put their money. Keep an eye on a turning market and rising rates, which typically have an inverse effect on the public utilities stock price. (For more defensive investing, read Guard Your Portfolio With Defensive Stocks.)
Green Movement
One of the biggest risks facing public utility companies is the green energy movement, and electric utility companies are feeling the pressure. Whether they create or buy the electricity, governments want the power to be created from renewable sources. This can be costly to upgrade and, with the existing government reluctance to allow public utility companies to recoup their capital expenditure through raising rates, it can hurt the dividend. Any time funds that could otherwise be paid out to shareholders in the form of dividends are instead used for improvement, lower cash flow to the investor in the short term is inevitable. So be careful if your primary interest is on a steady dividend cash flow from utilities, and the utilities are making a lot of capital expenditures instead of paying it out as dividends.
When it comes to investing in utility trusts, one must look at the portfolio and the underlying companies carefully. The risks common to public utility companies should be screened by investors looking to invest their money with a utility trust. So, if there are risks that can affect the future dividend payout of one of these utilities, steer clear of that utility trust.
Summing It All Up
Utility trusts are a great way to invest in the public utility sector. Public utilities are a great place to invest in during tough economic times and tough market conditions. Their inverse relationship with interest rates means you can still make money when the economy is not doing as well. Trusts offer an investor an easy way to quickly diversify within the public utilities sector without having the costs that are associated with mutual funds. Dividends are paid out quickly to trustees, so earning a steady income is possible.
Investing In Oil And Gas UITs
The substantial rise in energy prices in the mid-2000s attracted many investors seeking aggressive growth and profits in the oil and gas industry. Although many of these investors cashed in on the gains posted by various energy and natural resources equities, exchange-traded funds (ETFs) and mutual funds , there are other alternatives available that provide more direct exposure to the energy markets.
Limited partnerships, working interests and unit investment trusts (UITs) all provide pass-through treatment of both income and deductions derived from oil and gas investments at the wellhead. This article will examine the nature and purpose of oil and gas UITs, their advantages and disadvantages, and help you decide if they should be fueling your portfolio.
Nature and Composition
By definition, oil and gas UITs are very similar to other UITs that invest in stocks or real estate. Each trust is broken down into individual units that are priced and sold to investors. Each unit represents an undivided proportional interest in all of the oil and gas properties held by the trust, and each trust has a set maturity date upon which all gains and losses from the sale of the assets are dispersed to the unit-holders.
Unlike stock unit trusts or real estate investment trusts (REITs), oil and gas UITs invest directly in either production or exploratory drilling oil and gas assets, then pass through the income and expenses realized from the actual production of oil and natural gas.
Who Should Invest in Oil and Gas UITs?
Investors who are seeking more direct, tax-advantaged exposure to oil and gas investments should consider oil and gas UITs, as the UITs can pass through deductible operational expenses and investment income that is eligible for the depletion allowance.
Energy-focused mutual funds may only buy equity interests in various oil, gas and other energy companies, but seldom offer direct participation of any kind. Energy mutual funds cannot offer pass-through treatment, and usually can only post fully taxable dividends and capital gains.
Furthermore, oil and gas UITs will not post taxable capital gains of any kind until the trust matures, unlike mutual funds that pass through capital gains annually. Aggressive investors seeking larger profits in the energy sector may also benefit from the more direct arrangement of oil and gas UITs as opposed to energy mutual funds.
Pros and Cons
One of the main advantages that holders of energy trusts enjoy is the pass-through tax status, similar to that of limited partnerships or direct working interests. As stated previously, income derived from oil and gas UITs can be eligible for the depletion deduction, and a proportional share of deductible operational expenses is passed through as well.
It should be noted that oil and gas UITs are usually riskier by nature than energy mutual funds, as any properties that cease to produce, for whatever reason, during the tenure of the trust cannot be replaced until maturity. Another factor to consider is that oil and gas units are wasting assets, as their value will automatically decline as producing properties within the trust become depleted over time. Furthermore, investor income is reduced by maintenance and operating costs associated with oil and gas production at the wellhead, such as electric fees, pumping fees and parts replacement.
Income realized from oil and gas UITs is also subject to fluctuation with the rise and fall of energy prices. This risk can be at least partially offset with an investment in both oil and gas properties within the same trust, as the prices of oil and gas do not necessarily move in lock-step.
Finally, oil and gas UITs that participate in drilling of any kind include the risk of unsuccessful development, where one or more wells that are drilled produce little or no oil or gas. This occurrence can obviously lower the value of the trust, as well as deprive the investor of income from the anticipated current production that is never realized.
How Do I Pick the Right Oil and Gas UIT?
When choosing a UIT that invests in oil and gas properties, the most important criteria for investors generally will be the level of risk inherent in the trust. Aggressive trusts that focus on exploratory drilling projects are much more speculative in nature than UITs that invest solely in producing properties. However, successful exploratory drilling also offers greater tax deductions and the potential for higher income. Moderate or conservative investors seeking a regular stream of income should probably restrict their investing to UITs that contain mature producing oil and gas fields.
The Bottom Line
Although oil and gas UITs are similar securities to REITs or trusts that invest in stocks or bonds in many respects, they offer a relatively unique set of advantages and risks to investors. Those seeking more direct exposure to the energy sector (as well as those needing tax-advantaged income) can benefit from investing in these trusts. Investors considering UITs should consult with a tax advisor to determine the efficacy of UITs given their individual tax situations.
How To Invest In Corporate Bonds
When investors buy a bond, they are lending money to the entity that issues the bond. The bond is a promise to repay the face value of the bond (the amount loaned) with an additional specified interest rate within a specified period of time. The bond, therefore, may be called an I.O.U.
Bond Types
The various types of bonds include U.S. government securities, municipals, mortgage and asset-backed, foreign bonds and corporate bonds.
Corporate bonds are issued by companies and are either publicly traded or private. Bond rating services such as Standard
Financial Wisdom From Three Wise Men
December 25 2011| Filed Under » Futures, Investing Basics, Options, Technical Analysis, Warren Buffett
Some of us are more disciplined than others. Shortly after we are born, we start to learn the rules of life. Some of these rules we had to learn the hard way, through trial and error. Others we learned from our parents. Learning from others in this way is often easier, however, we seem to do a better job of remembering the lessons we learn the hard way. As investors, we have a choice. We can learn the hard way and hope that well survive our lessons and not run out of money, or we can learn from the following three wise men.
Tutorial: Top Stock-Picking Strategies
Three wise men - Warren Buffett, Dennis Gartmen and Puggy Pearson - found very different methods to achieve financial success, but they all share a common trait - their success came by following a strict set of rules. In this article well show you nine rules that three wise investors live by.
The Worlds Greatest Investor
Warren Buffett, the Oracle of Omaha, is considered by many to be the greatest investor ever. He is also known for giving much of his $40 billion fortune to the Bill
Uncovering The Securities Firm
December 31 2011| Filed Under » Brokers, Careers, Investing Basics, Portfolio Management
As individual investors, many of us trust our money to large securities firms or investment dealers. Typically employing tens of thousands of employees, the most recognized firms give investors confidence that their investment funds are managed by a seasoned team of professionals. However, we usually interact with these large businesses only by means of a single intermediary, such as our investment advisor or broker. So how does a large securities house really work? In this article, we will look at a typical securities firm, including its different departments and the roles of various employees. (To learn more about financial planners read Financial Planners: Practice What You Preach.)
TUTORIAL: Investing 101 For Beginner Investors
Departments and Divisions
Typically, a large firm has the following departments: sales, underwriting and financing, trading, research and portfolio, and administration. There are many small boutique firms that may serve only a single department of a business (i.e. retail sales), but even in this limited operation, their activities might resemble those of the respective department of a larger firm.
Sales
Sales is likely the department employing the largest number of people in the firm and it is the area that individual retail investors interact with the most. Within the retail sales force, investment advisors may focus on servicing a specific area of the investment industry, or they may provide a one-stop-shop for all retail investment needs. For example, an investment advisor may perform only those services that are associated with a stock broker, or offer other services as well, such as stock and mutual fund transactions, bond trading, life insurance sales and so forth. In a small firm, the activities of the investment advisor are likely to be more diverse.
A second division within the sales department is institutional sales. It is primarily involved in selling new securities issues to traders working at institutional client firms, such as pension funds and mutual funds. If a hot new securities issue generates so much interest that it quickly becomes oversubscribed, the job of institutional sales is as simple as allocating shares to the best clients (as a reward for their ongoing business).
Due to the large dollar volume of transactions and the commissions from both new issues and existing accounts, the institutional sales department often generates a significant portion of the firms profits (making institutional salespeople some of the best-paid personnel in the entire firm). The institutional sales department works closely with the firms trading department (discussed below) to maintain accounts in good standing.
Underwriting / Financing
The firms institutional sales division also works closely with the underwriting or financing department, which coordinates new securities issues and/or follow-up securities issues on the secondary market. The underwriting or finance department negotiates with the companies or governments issuing the securities, establishing their type of security, its price, an interest rate (if applicable) and other special features and protective provisions.
Penny Stocks can help you beat the stock market!
The firms underwriting or financing department may be split into two divisions: the first relating to matters of corporate finance and the second to those of government finance. In a fully-integrated firm, these departments would be quite distinct, as the needs of corporations and governments vary widely. For example, the corporate finance department would require familiarity with stocks, bonds, and other securities, while the government department might be more geared toward bond and Treasury bill issues.
Trading
The firms trading department also has separate divisions, most likely according to the type of securities being traded: bonds, stocks and various other specialized financial instruments. Traders in the bond division may have sub-specializations, such as government or corporate money market instruments or bonds, or even such instruments as debentures.
The stock-trading department executes orders from retail and institutional sales staff. Stock traders maintain close links with traders on the floor of stock exchanges; although, with the rise of electronic trading, the interaction may be with a trading computer instead of a human being.
The firms trading department may also include a division geared toward various other specialized instruments, perhaps mutual funds or exchange-traded options, or commodity and financial futures contracts.
Research and Portfolio
The research department supports all other departments. Its securities analysts provide vital analysis and data to aid traders, salespeople and underwriters. This data is necessary for the selling and pricing of existing securities trades and new issues. The firms research department may consist of economists, technical analysts, and research analysts who specialize in specific types of securities or specific industries (within the equities specialization).
The research department may be further divided into retail and institutional divisions, although if the firm has only one research department, research reports geared to institutional clients may also be made available to retail investors. If the firm hosts a single institutional research department, it would be geared toward analyzing potential new issues, takeovers, and mergers, in addition to providing ongoing coverage of securities held by institutional clients. Together with the retail department, analysts may be further involved in structuring portfolios for individual and small-business accounts.
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Administration
The administration department is a vital component of the firms organization. It not only maintains proper paperwork and accounting for all trades and transactions, but also ensures compliance with securities legislation and oversees internal human resources matters. All trades made by the firm must be accounted for, and all incoming and outgoing funds and securities must be continually balanced. Securities must be checked for registration, and delivery requirements and dividend payments must be credited to accounts as received.
In the credit and compliance division, client accounts are constantly monitored for industry and firm compliance, ensuring that payments and securities are received by their due dates and that margin accounts fulfill applicable margin requirements. The financial division oversees accounting matters such as payroll, budgeting, and financial reports and statements. Minimum capital levels are maintained according to industry requirements, ensuring that the various departments within the firm hold sufficient funds to accommodate changes in the firms business.
The Bottom Line
Despite their importance to the investment industry and the economy at large, securities firms are still somewhat of a mystery to the average investor. Securities firms tend to maintain a rather secretive culture of inner-circle participants, due largely to the players specialized roles and occupations. Many retail investors interact with only their personal financial advisor or broker, and therefore lack insight into the larger set of roles within the firm. It benefits every investor to know whos who behind that set of magnificent oak doors, as each of the employees in a securities firm affects the real returns of ones investment portfolio.
4 Basic Facts To Know About IRAs
You might have heard a lot about individual retirement accounts (IRAs) but know very little about what they are or how they can help you reach your retirement goal. Instead of bogging you down with a whole of lot of technicalities, lets take a look at the basics of the IRA. What do you need to know before you get started? (For related reading, see 11 Things You May Not Know About Your IRA.) An individual retirement account or IRA is a vehicle set up to help you reach your retirement goals. Weve all heard that having all of our financial eggs in one basket is a bad idea. So the Internal Revenue Service (IRS) set up the IRA with similar tax benefits as a 401(k) that you may have at work. Its a good idea to have both a 401(k) and an IRA to remain diversified.
The Limits
The IRS allows you to deposit up to $5,000 per year if youre under the age of 50 and $6,000 per year if youre over 50. These maximums will stay in place for the 2012 tax year but may change in future years. You must also have earned income to contribute to an IRA, but that could include a spouse if youre married.
Two Types
What can quickly turn people off to the IRA is the fact that there are two different types of IRAs . The traditional IRA doesnt require that you pay taxes on your gains until you start taking distributions. (Distribution is the term used to describe the withdrawals you make once you reach retirement age.) The traditional IRA keeps more money in your account over time and that allows the money to compound at a faster rate.
The Roth IRA requires that you pay taxes now, at your current rate, because the money youre contributing was already taxed before you received your check. This allows your earnings to grow tax fee, and if you anticipate being in a higher tax bracket in the future, the Roth is probably your best choice. (For additional reading, see Roth Vs. Traditional IRA: Which Is Right For You?)
Eligibility
With both IRAs there are eligibility requirements. With the traditional IRA, you can only deduct your contributions if your family earnings fall below certain maximums and if youre covered under an employee sponsored plan like a 401(k). According to the Vanguard Group, if your traditional IRA isnt deductible, a Roth IRA is the better choice. With the Roth, your contributions are never deductible and there are income limits. If youre single and make more than $125,000 in 2012, you arent eligible to open a Roth.
Fact 4: The Costs
In order to open an IRA , youll need a bank or investment broker. Some of the discount brokers offer no-fee IRAs other than the commissions charged to buy and sell within the account. Other brokers will charge a yearly management fee even if they arent managing the account for you. Look for a no fee IRA. If youre charged a 1% management fee, that could equate to a 30% lower balance over a 30 year period. So keeping fees to a minimum is key.
Whether its a Roth or traditional IRA , get started. The money that is sitting in your savings account earning little to no interest could work harder for you in an IRA with safe investment choices. Dont know how to invest the money? Ask a fee only advisor for some help. Many are happy to charge you a one-time fee and a fee for an annual consultation. (To learn more, check out Paying Your Investment Advisor - Fees Or Commissions?)
The 6 Most Common Portfolio Protection Strategies
The key to successful long-term investing is the preservation of capital. Warren Buffett, arguably the worlds greatest investor, has one rule when investing - never lose money. This doesnt mean you should sell your investment holdings the moment they enter losing territory, but you should remain keenly aware of your portfolio and the losses youre willing to endure in an effort to increase your wealth. While its impossible to avoid risk entirely when investing in the markets, these five strategies can help protect your portfolio.
Diversification
One of the cornerstones of Modern Portfolio Theory (MPT) is diversification. In a market downturn, MPT disciples believe a well-diversified portfolio will outperform a concentrated one. Investors create deeper and more broadly diversified portfolios by owning a large number of investments in more than one asset class, thus reducing unsystematic risk. This is the risk that comes with investing in a particular company as opposed to systematic risk, which is the risk associated with investing in the markets generally.
Non-Correlating Assets
According to some financial experts, stock portfolios that include 12, 18 or even 30 stocks can eliminate most, if not all, unsystematic risk. Unfortunately, systematic risk is always present and cant be diversified away. However, by adding non-correlating asset classes such as bonds, commodities, currencies and real estate to a group of stocks, the end-result is often lower volatility and reduced systematic risk due to the fact that non-correlating assets react differently to changes in the markets compared to stocks; when one asset is down, another is up.
Ultimately, the use of non-correlating assets eliminates the highs and lows in performance, providing more balanced returns. At least thats the theory. In recent years, however, evidence suggests that assets that were once non-correlating now mimic each other, thereby reducing the strategys effectiveness. (See why investors today still follow this old set of principles that reduce risk and increase returns through diversification. Check out Modern Portfolio Theory: Why Its Still Hip.)
Leap Puts and Other Option Strategies
Between 1926 and 2009, the S
The Knowledge-Experience Continuum: Where Do You Fall?
It is only through studying the practicalities of investments that people learn and understand how it really works. Even so, their knowledge and understanding always has its limits, and learning and doing are two very different things.
These issues apply to a greater or lesser extent to almost everyone in the industry - theory and practice are often worlds apart, but many people dangerously treat them as one and the same.
In this article, we will look at what constitutes learning, understanding, experience and real expertise, as well as what sets the limits. The basic issue is that when it comes to investing, there is a huge gap between theory and practice. For this reason, it is important to take a look at the different levels of knowledge and how we achieve them.
The Dangers of Theoretical Knowledge
People who study business or economics in college generally learn passively just to pass exams. Many do not really understand the material until they start teaching the same theories. And even then, this is still just theory. Practice happens when students apply this theory in their personal investing.
Even business professors who write articles in related areas, such as economics, tend to do so theoretically and do not necessarily know much about the real world of investment. In fact, their own investments may be run by other people.
Unfortunately, some types of theory just arent helpful in practice. For example, although a good theoretical knowledge of economics, should help you learn quickly about real-world investments; unfortunately, the theory alone is of little practical use. Knowing about supply and demand, neoclassical interest rate theory and Keynesian cross diagrams is light years away from the real world of conflicts of interest, commission-hungry brokers and failed attempts at market timing. In other words, these theoretical models often assume the world has very specific and predictable conditions; does this sound like the world you live (and invest) in? (For related reading, see Economics Basics.)
In the world of investment, theory alone can even be dangerous, and this applies particularly to a limited degree of practical knowledge. The old saying that a little knowledge is a dangerous thing applies in this context, because it can inspire confidence in the investor, even when he or she has little experience and should be cautious.
The main problem is that the investment industry does not work the way an inexperienced person is likely to think. For example, who would ever dream that many fund managers try to beat an index and fail? How could the man in the street know that brokers may sell risky investments because these bring in the most money? Similarly, naive investors might put too much confidence in their brokers abilities and assume that they know what theyre doing without further investigation. Unfortunately, mismanagement is not uncommon, but for an investor with limited experience, this may not be apparent.
Experience Versus Real Expertise
As you now know, passive knowledge alone does not count for much; you need to actually do things to develop real expertise and skills. Nonetheless, it is also possible to have a lot of experience with something, without having a profound understanding of how it works. (To learn from experienced money managers, read Words From The Wise On Active Management.)
For example, someone who simply works in a bank may administer funds and other assets for years and or decades and not really know much about them. This is particularly the case with routine activities at lower levels. Another danger is that someone who worked with pensions for 20 years may get transferred to hedge funds two weeks before you turn up with your money. This person is then very experienced, but perhaps not in the right area.
The combination of directly relevant experience and various aspects of sophistication is really essential to good money management, both on the part of the investor and his or her broker /advisor. Motivation is also vital. This means being genuinely interested in and caring about your portfolio. If you do your own investing, this may not be a problem, but if you hire a broker, you will need to find one who is motivated to help you. No amount of education and experience counts if it is not applied appropriately. These are complex issues, but they are of fundamental importance.
Knowledge in One Area Is Still Ignorance in Another
Given the extraordinarily wide range of investments, someone who knows a lot about stocks may know (almost) nothing about bonds. And even a government bond expert could be relatively ignorant about the ins and outs of corporate bonds. The term experienced investor can therefore be extremely misleading.
Only experience in a specific sector is really likely to help. The extent to which knowledge with one asset class applies to another, for example, is extremely variable and cannot be taken for granted. Therefore, never assume that someone has the right package of skills, experience and expertise to advise or work in a particular field - do your research and determine exactly what experience a professional has and how directly it applies to his or her current line of work.
The Knowledge-Experience Continuum
Given the above, we can divide up private investors into three main knowledge-experience categories:
1. The Know Nothings. The first category would be those who, for all intents and purposes, know nothing. Almost everyone earns some money and perhaps even invests part of it, but if this is purely passive, uninterested and unmotivated, people can go through their entire adult lives without gaining any real knowledge or understanding of the investment process and what it entails.
2. The Know A Littles. The next group would be those with a limited degree of knowledge and experience. This knowledge could be very theoretical, such as from university economics or even some college finance courses, or it could be more practical, from reading newspapers, magazines and books.
Many people fall into this category. They know a bit or even a fair amount about stocks, bonds and real estate, but this knowledge may remain superficial and narrow. They would not necessarily know what constitutes a high versus low-risk portfolio or the difference between amutual fund and a hedge fund . They still have to rely heavily on the experts.
3. The Know A Lots. Moving on from the above level, there are obviously those with above-average or advanced levels of knowledge and experience. These people have been reading extensively for years, maybe even teaching or writing on investments or have been managing their own money or that of others quite actively. Despite this, they too will inevitably have gaps in their knowledge and experience.
Applying the Continuum to People in the Industry
When it comes to investment professionals , the three groups above still apply, but with some important differences. Professionals are extremely varied in terms of their area(s) of expertise and commitment to customers, so it is important to find out not only how experienced a professional is, but also in what areas.
Conclusions
What people really know, understand and can do in the investment industry is absolutely fundamental to managing your money or hiring someone else to manage your money properly. A complex interplay of education, motivation, relevance and sophistication all determine whether an investor or a professional can successfully manage a portfolio. It is therefore extremely important to know who you are really dealing with. This in itself constitutes one of the great challenges of the investment scene.
Will Corporate Debt Drag Your Stock Down?
When you invest in a company, you need to look at many different financial records to see if it is a worthwhile investment. But what does it mean to you if, after doing all your research, you invest in a company and then it decides to borrow money? Here we take a look at how you can evaluate whether the debt will affect your investment.
How Do Companies Borrow Money?
Before we can begin, we need to discuss the different types of debt that a company can take on. There are two main methods by which a company can borrow money :
1. by issuing fixed-income (debt) securities - like bonds, notes, bills and corporate papers
2. by taking out a loan at a bank or lending institution.
• Fixed-Income Securities
Debt securities issued by the company are purchased by investors. When you buy any type of fixed-income security, you are in essence lending money to a business or government. When issuing these securities, the company must pay underwriting fees. However, debt securities allow the company to raise more money and to borrow for longer durations than loans typically allow.
• Loans
Borrowing from a private entity means going to a bank for a loan or a line of credit. Companies will commonly have open lines of credit from which they may draw in order to meet their cash requirements of day-to-day activities. The loan a company borrows from an institution may be used to pay for the company payrolls, buy inventories and new equipment, or to keep as a safety net. For the most part, loans require repayment in a shorter time period than most fixed income securities .
What to Look for
There are a few obvious things that an investor should look for when whether deciding to continue his or her investment in a company that is taking on new debt. Here are some questions you can ask yourself:
How much debt does the company currently have?
If a company has absolutely no debt, then taking on some debt may be beneficial because it can give the company more opportunity to reinvest resources into its operations. However, if the company in question already has a substantial amount of debt, you might want to think twice. Generally, too much debt is a bad thing for companies and shareholders because it inhibits a companys ability to create a surplus in cash. Furthermore, high debt levels may negatively affect common stockholders, who are last in line for claiming payback from a company that becomes insolvent.
What kind of debt is the company trying to take on?
Loans and fixed-income securities that a company issues differ dramatically in their maturity dates. Some loans must be repaid within a few days of issue while others dont need to be paid for a several years. Typically, debt securities issued to the public (investors ) will have longer maturities than the loans offered by private institutions (banks). Large short-term loans may be harder for companies to repay, but long-term fixed-income securities with high interest rates may not be easier on the company. Try to determine if the length and interest rate of the debt is suitable for financing the project that the company wishes to undertake.
What is the debt for?
Is the debt a company is taking on meant to repay or refinance old debts, or is it for new projects that have the potential to increase revenues? Typically, you should think twice before purchasing stock in companies that have repeatedly refinanced their existing debt, which indicates an inability to meet financial obligations. A company that must consistently refinance may be doing so because it is spending more than it is making (expenses are exceeding revenues), which obviously is bad for investors. One thing to note, however, is that it is a good idea for companies to refinance their debt to lower their interest rates. However, this type of refinancing, which aims to reduce the debt burden, shouldnt affect the debt load and isnt considered new debt.
Can the company afford the debt?
Most companies will be sure of their ideas before committing money to them; however, not all companies succeed in making the ideas work. It is important you determine whether the company can still make its payments if it gets into trouble or its projects fail. You should look to see if thecompanys cash flows are sufficient enough to meet its debt obligations. And do make sure the company has diversified its prospects. (For more on how to analyze corporate debt and refinancing, read Debt Reckoning.)
Are there any special provisions that may force immediate pay back?
When looking at a companys debt, look to see if there are any loan provisions that may be detrimental to the company if the provision is enacted. For example, some banks require minimum financial ratio levels, so if any of the stated ratios of the company drop below a predetermined level, the bank has the right to call (or demand repayment) of the loan. Being forced to repay the loan unexpectedly can magnify any problem within the company and sometimes even force it into a liquidation state.
How does the companys new debt compare to its industry?
There are many different fundamental analysis ratios that may help you along the way. The following ratios are a good way to compare companies within the same industry.
• Quick Ratio (Acid Test) - This ratio tells investors approximately how capable the company is of paying off all of its short-term debt without having to sell any inventory.
• Current Ratio - This ratio indicates the amount of short-term assets versus short-term liabilities. The greater the short-term assets compared to liabilities, the better off the company is in paying off its short-term debts.
• Debt-to-Equity Ratio - This measures a companys financial leverage calculated by dividing long-term debt by shareholders equity. It indicates what proportions of equity and debt the company is using to finance its assets.
Conclusion
A company increasing its debt load should have a plan for repaying it. When you have to evaluate a companys debt, try to ensure that the company knows how the debt affects investors, how the debt will be repaid and how long it will take to do so.
When Stock Prices Drop, Wheres The Money?
Have you ever wondered what happened to your socks when you put them into the dryer and then never saw them again? Its an unexplained mystery that may never have an answer. Many people feel the same way when they suddenly find that their brokerage account balance has taken a nosedive. So, where did that money go? Fortunately, money that is gained or lost on a stock doesnt just disappear. Read to find out what happens to it and what causes it.
Disappearing Money
Before we get to how money disappears, it is important to understand that regardless of whether the market is in bull (appreciating) or bear (depreciating) mode, supply and demand drive the price of stocks, and fluctuations in stock prices determine whether you make money or lose it.
So, if you purchase a stock for $10 and then sell it for only $5, you will (obviously) lose $5. It may feel like that money must go to someone else, but that isnt exactly true. It doesnt go to the person who buys the stock from you. The company that issued the stock doesnt get it either. The brokerage is also left empty-handed, as you only paid it to make the transaction on your behalf. So the question remains: where did the money go?
Implicit and Explicit Value
The most straightforward answer to this question is that it actually disappeared into thin air, along with the decrease in demand for the stock, or, more specifically, the decrease in investors favorable perception of it. (For more on what drives stock price , see Stocks Basics)
But this capacity of money to dissolve into the unknown demonstrates the complex and somewhat contradictory nature of money. Yes, money is a teaser - at once intangible, flirting with our dreams and fantasies, and concrete, the thing with which we obtain our daily bread. More precisely, this duplicity of money represents the two parts that make up a stocks market value: the implicit and explicit value.
On the one hand, money can be created or dissolved with the change in a stocks implicit value, which is determined by the personal perceptions and research of investors and analysts. For example, a pharmaceutical company with the rights to the patent for the cure for cancer may have a much higher implicit value than that of a corner store.
Depending on investors perceptions and expectations for the stock, implicit value is based on revenues and earnings forecasts. If the implicit value undergoes a change - which, really, is generated by abstract things like faith and emotion - the stock price follows. A decrease in implicit value, for instance, leaves the owners of the stock with a loss because their asset is now worth less than its original price. Again, no one else necessarily received the money; it has been lost to investors perceptions.
Now that weve covered the somewhat unreal characteristic of money, we cannot ignore how money also represents explicit value, which is the concrete worth of a company. Referred to as the accounting value (or sometimes book value), the explicit value is calculated by adding up all assets and subtracting liabilities. So, this represents the amount of money that would be left over if a company were to sell all of its assets at fair market value and then pay off all of liabilities. (For more insight, read Digging Into Book Value and Value By The Book.)
But you see, without explicit value, implicit value would not exist: investors interpretation of how well a company will make use of its explicit value is the force behind implicit value.
Disappearing Trick Revealed
For instance, in February 2009, Cisco Systems Inc. (Nasdaq:CSCO) had 5.81 billion shares outstanding, which means that if the value of the shares dropped by $1, it would be the equivalent to losing more than $5.81 billion in (implicit) value. Because CSCO has many billions of dollars in concrete assets, we know that the change occurs not in explicit value, so the idea of money disappearing into thin air ironically becomes much more tangible. In essence, whats happening is that investors, analysts and market professionals are declaring that their projections for the company have narrowed. Investors are therefore not willing to pay as much for the stock as they were before.
So, faith and expectations can translate into cold hard cash, but only because of something very real: the capacity of a company to create something, whether it is a product people can use or a service people need. The better a company is at creating something, the higher the companys earnings will be and the more faith investors will have in the company.
In a bull market, there is an overall positive perception of the markets ability to keep producing and creating. Because this perception would not exist were it not for some evidence that something is being or will be created, everyone in a bull market can be making money. Of course, the exact opposite can happen in a bear market .
To sum it all up, you can think of the stock market as a huge vehicle for wealth creation and destruction.
Disappearing Socks
No one really knows why socks go into the dryer and never come out, but next time youre wondering where that stock price came from or went to, at least you can chalk it up to market perception.
The Value Line Investment Survey
Have you ever opened the statement that your mutual fund company sent to you, then looked at the returns and thought, I could do better than that?
Its an increasingly common feeling, as the returns generated by many equity mutual funds often leave investors frustrated. If you want to try your hand at picking stocks but dont know where to start, the Value Line Investment Survey can help.
The Survey
The Value Line Investment Survey consists of professional research and recommendations on approximately 1,700 stocks. According to Value Line, this represents … approximately 95% of the trading volume of all stocks traded in U.S. markets … The Survey also provides weekly updates on the financial markets, recommended portfolios, developments involving covered securities and special topical reports. For would-be stock pickers, Value Line provides an easy way to start your research.
How to Get Started
Bearing in mind that conducting your own stock research is a time-consuming task, the first step in getting familiar with the tools Value Line offers is to set aside a few hours of reading time. You will need to study the materials closely in order to understand how to use them before you will be ready to invest any cash.
Prior to delving into the literally thousands of pages of stock research at your fingertips, start by reviewing The Complete Guide to Using The Value Line Investment Survey. In roughly 40 pages, this slim volume explains Value Lines ranking system (stocks are rated from one to five in a variety of categories) provides line-by-line explanations for the information provided in each of the research reports. At the back of the booklet is a detailed glossary of investment terms that includes definitions for terms ranging from bond ratings to unit labor costs.
Next, youll want to read, A Quick Study Guide. This guide explains the information included in the two binders that serve as primary research tools for investors using the hard copy version of Value Line. (An online service is also available.) The first binder contains the Summary and Indexand Ratings and Reports. The second binder contains Selection and Opinion. The Quick Study Guide also explains how to use the research to choose stocks for your portfolio.
Binder 1: Summary and Index
Starting with the first binder, the Summary and Index provides an overview of the stock screens Value Line provides, including lists of stocks with the lowest price-to-earnings ratio, the highest dividend yields, the highest annual total revenues and a host of other choices. These screens help investors identify stocks that align well with theirpersonal investment goals. For example, investors seeking income may look for stocks that offer high dividend payments, while investors seeking growth may seek stocks that have the highest appreciation potential. If this is your first effort at picking stocks, this portion of the Survey could be of particular interest to you. In addition, the Summary and Index catalogs all of the covered stocks and provides the page number where the research reports can be found.
It also provides key statistics for the universe of covered stocks, including price-to-earnings ratio, dividend yields and appreciation potential. These statistics provide information about the universe and the direction it has been moving in, as well as providing a baseline for comparing an individual stock against the universe.
The Ratings and Reports section provides stock research on approximately 1,700 companies. The research includes an analysts report that provides a brief overview of the company, a review of its financial health and a recommendation regarding its attractiveness to investors. The data portion of the report provides a detailed statistical analysis, including a price target, transactions by company officials (buying/selling), transactions by institutions, chart of historical returns, sales figures, earnings data and much more. Perhaps the best thing about the research section, particularly if you are a novice, is its ranking system.
Every stock in the survey is ranked on a scale of one to five in three different areas: timeliness, safety and technical. A rank of one denotes stocks that are expected to outperform the rest of the Value Line universe. Timeliness refers to performance expectations for the next six to twelve months. Safety compares the securitys price stability against its peers, and the Technical ranking compares 10 price trends to provide price return potential for a three to six month period. An alphabetical listing of all covered stocks, including key statistics and the ranking numbers, is particularly convenient for investors seeking a specific rating in one or more categories.
Binder 2: Weekly Selection and Opinion
The second binder contains the Weekly Selection and Opinionsection, which includes an economic outlook, market commentary and research on selected topics. Additionally, it includes evaluations of four model portfolios, one targeting short-term growth, one for long-term growth, one for income and, lastly, one for both growth and income. The evaluations highlight both successful selections and failures, which serves as an important reminder.
While the Value Line Investment Survey is a convenient, easy-to-use tool that is particularly helpful to novice investors, investing is not an endeavor that comes with any guarantees. The information you read in the Survey is well researched and impressively packaged, but there is no guarantee that it is correct. Like any other stock research, the insight provided by Value Line does not mean that you cant lose money on an investment that you make using the research. As with all security purchases, let the buyer beware
Using the Data
Taken as a whole, the Value Line Investment survey provides all the tools an investor needs to develop a picture of the current economic landscape, learn about stock analysis and identify securities that are appropriate for a variety of investment objectives. By matching the results of the research with your personal investment needs, you should be able to put together enough information to choose a stock or build an entire portfolio.
How to Get It
The Value Line Investment Survey is available by subscription. A one-year subscription is just over $500 for the online version and just under $600 for the print version. For an additional fee, the firm also offers research on mutual funds, exchange traded funds, convertible securities and more. You can get them all for just under $1,000.
Interestingly, many large libraries receive the print version of the Value Line Investment Survey and provide it to patrons for free. This provides an opportunity to learn about, use and thoroughly evaluate the materials before plunking down the cash for a personal subscription conveniently delivered to your house.
Next Steps
The Value Line Investment Survey is not the only professional research that you can easily access. In fact, it is just the first in a long list of tools. After you have read, researched and mastered the Value Line tool set, you can expand your repertoire of investment tools by using the research reports provided through websites associated with online brokerage accounts. These sites provide access to research reports similar to those offered by Value Line. It is worth noting that reports from various research providers often contradict each other.
The Bottom Line
While these contradictions may be frustrating, think of research as data gathering. You can take in data from as many sources as possible and use that data to formulate your own opinion. Relying on any single source of data is unlikely to be a wise decision, as there are no guarantees that the researchers behind your data source will always make the right call. Of course, if reading these research reports is too time consuming, too scary or too frustrating, you can always buy a mutual fund or hire a professional financial advisor to provide investment recommendations.
The 4 Ways To Buy And Sell Securities
One key aspect in investing that we sometimes overlook is how to buy different securities. With the introduction of lower commission rates, loosening of regulatory regulations and increased public interest in investing, the financial industry is blooming with different avenues for buying and selling stocks, bonds and mutual funds. In North America, there are four main avenues of transacting investment securities:
1. through brokerages,
2. directly from the company that issues them,
3. through banks and
4. through individual investors.
TUTORIAL: Bond Basics
Brokerage Houses
One of the most common, and easiest, ways of buying and selling stocks, mutual funds and bonds is through a brokerage house. These companies typically require you to open an account with them, and deposit funds as an act of good faith. Brokerages are popular because they, rather than you, do much of the behind-the-scenes work, allowing you to focus on when and what to buy or sell. They look after things like completing the paperwork involved in transferring the ownership of stock, and ensuring dividend payments. (Choosing the right broker is an important first step for new investors. Find out what to look for in Picking Your First Broker.)
Brokers are classified into two different classes. Here we discuss the differences in the ways in which these two classes of brokerages transact orders.
Full-Service Broker
In the past, this was the main method for investors to enter into the securities market. Investors would simply contact their full-service brokers, and have them purchase different stocks and bonds. These transactions are quite straightforward, and full-service brokers will typically call their clients and provide recommendations for buying or selling particular securities.
Today, these brokers are not quite as popular, but with so many different investment products available, almost all full-service brokers are able to transact stocks, bonds and mutual funds. (To learn more about what this type of broker has to offer, read Full-Service Brokerage Or DIY?)
Discount Broker
Discount brokerages have become increasingly popular with investors thanks to their ever-decreasing commission fees. These brokerages, like large supermarkets, provide investors with almost everything they need at a low cost. However, this also means that investors have to do most of the work themselves. At almost all discount brokerages, you can buy stocks, bonds or mutual funds either by calling one of the investment representatives, or by transacting these securities yourself on the internet.
The commission for calling in to a discount broker will cost more than completing the transaction online, but the motions are all pretty much the same. First, you have to enter an order ticket. Dont be intimidated - the order ticket merely states the type of security you want to purchase (whether its a bond, stock or mutual fund), the price you want to buy it for, the quantity you would like to buy and the duration for which you want to leave the order valid (e.g., one day to one month). The order ticket must be completed, whether by yourself, on your computer, or by your broker, while getting your instructions over the telephone. After everything is filled out completely and correctly, the order is sent to the exchange, where the stock, bond or mutual fund is bought or sold at whatever terms are on the order ticket.
Directly from the Business
More often than not, the method of transacting directly with the issuing company is more difficult than buying and selling securities through the broker; albeit transacting directly does have advantages.
When evaluating this transaction method, there are a few unique considerations. First, are you comfortable with holding the securities yourself? When you buy stocks and bonds directly from the issuer, they will be held in certificates, either in bearer form or registered form, which means you are responsible for the safekeeping of the security. If you lose a security in bearer form, there is no way to retrieve it - the person who finds it is the proud new owner of your stock. If you lose a security in registered form you must, to be issued a new certificate, undertake the process of contacting the issuing company. This problem or concern, however, doesnt arise with mutual funds because you dont actually hold units individually.
Second, do you need access to the funds immediately? When you are selling mutual funds, you usually have to wait three days after the transaction date before you can receive any cash. This is irrespective of whether you bought into the fund with a brokerage or with the actual issuing firm. The wait for stocks and bonds, however, can be significantly longer. If you want to sell instruments that are in registered form, you have to sign the back of each certificate, and then send them to the issuing company before you can receive any cash. Obviously theres always some concern about whether the certificates will get there in a timely and complete manner.
Third, how important is the price of purchase or sale to you? If you are a penny pincher and like to buy stocks, bonds and mutual funds for the cheapest possible market price, dealing directly with the business may not be suitable for you. Freedom to choose a transacting price becomes limited when you buy directly from the company. When you buy stocks and bonds directly from an issuer, you will typically have to buy them at a price set by the issuer and sell them back at another set price.
After taking the above into account, here are some advantages to buying and selling direct. Businesses typically have few restrictions on the minimum number of units being purchased. Some brokerages require minimum initial mutual fund purchases of $1,000, whereas if you buy directly from the issuer, the minimum can go down to $500 or less. Additionally, you dont need to have an account, which sometimes require a minimum balance and penalizes long-term investors with inactivity fees.
Banks
Although most banks dont sell stocks, they do offer mutual funds and bonds, but their selection will be limited to funds offered by the bank itself, or through its partners. Banks also provide for a convenient location to buy bonds and mutual funds: you can simply walk to just about any corner bank and purchase these investments on the spot.
When you do go into a bank, the representative helping you should be able to tell you the different characteristics and minimum purchase amounts of the products that are available for purchase.
Person to Person
Theoretically, you can buy and sell securities individually (outside of an exchange). Suppose that a friend of yours has a stock that you would like to buy, or a relative who needs the funds immediately would like to sell you a bond; it can be done. But, this method of transacting securities poses a significant risk; you must trust the person with whom you are dealing with, and make sure you are not being scammed - for instance, you could be sold a false, laser-copied certificate.
If you are decided upon doing this type of transaction, you will, for most stocks and bonds, only have to sign the back of the certificates, and then they can be sold to another party. If you are trying to buy them, the other party will have to sign them over to you. After the security certificates are signed, they must then be sent back to the company to be reregistered under the name of the new owner.
Conclusion
There are many ways to buy and sell securities, but they all provide different advantages, difficulties and risks. Whether you decide to deal with a full-service or discount broker, issuing company, bank, friend or a relative, there are many options out there. Just make sure that youve done your homework to find out which route is best for you.
How To Dispute A Credit Card Charge
What happens when the brand-new digital camera you brought home turns out to be a bust? Or the DVD player you got for your spouses birthday gets stuck permanently on rewind? Or, when youve been double-charged for something youre sure you only came home with one of?
SEE: Check out our credit card comparison tool and find out which credit card is right for you.
If youve made these purchases on a credit card - and these days, thats a near certainty - youre in luck. Thanks to the Fair Credit Billing Act, consumers have a good deal of protection for their credit card purchases. This law allows consumers to withhold payment on poor-quality, damaged merchandise or incorrectly billed items they bought with a credit card until the matter is resolved. Read on as we show you how to dispute a credit card charge and actually come out on the winning side.
Retrace Your Steps
Your first move is always to go back and attempt to resolve the problem with the merchant. If you give them a chance to address your complaint, they very often will; especially if you approach them with politeness and courtesy. Most large retailers have customer service policies in place that err strongly on the side of being generous, at least within a certain period of time, and under ordinary circumstances.
Bottom line is, if you act promptly and reasonably, youre likely to get the full benefit of the doubt. If you dont have luck with the first representative you speak with, ask to talk with the manager or supervisor on duty. Be sure to keep records of each interaction, the person you spoke with as well as the date and time, so you can refer back to them if needed.
Put It In Writing
If the merchant wont budge, its time to put your complaint in writing. Draft a short, detailed letter outlining your particular dispute, and address it to the merchant via certified mail. Before you send it, make a few copies, so you can save one for your records and send another copy to your credit card company, as proof of your efforts to resolve this dispute.
Next youll draft a letter to your credit card company, to officially alert it of the disputed purchase amount. The Fair Credit Billing Act mandates that you do this in writing, within 60 days after the bill with the disputed charge was sent to you. In your letter, youll need to include your account number, the closing date of the bill on which the disputed charge appears, a description of the disputed item and the reason youre withholding payment. You should also enclose a copy of your complaint letter to the merchant, along with any other documentation that supports your position. This letter should also be sent via certified mail, return receipt requested; be sure you send it to the billing inquiries address at your credit card company, and not the regular address for payments (since these are often two separate departments).
Keep on Paying
Even though youre disputing an item on your current bill, its important to maintain your other payments. If youve charged anything else on your card during this cycle, youll need to send that payment and all financing charges to the regular address, otherwise youll incur interest and late-payment charges.
At this point, youre just waiting to hear the result of your challenge. Some card companies - especially the bigger firms, such as Capital One - will often give the benefit of the doubt to their consumers, and issue a temporary credit until the dispute is resolved. This isnt required by law, however, so dont assume you will get this consideration. Meanwhile, the card issuer will get in touch with the merchant to find out their side of the story. Basically, if they end up siding with you, you will enjoy a full refund. If not, youll have to pay for the disputed item, as well as any additional finance charges that may have accrued.
There are a few catches to the Fair Credit Billing Act. Technically, the sale must be for more than $50 and must have taken place in your home state or within 100 miles of your billing address, which means phone or internet orders may be immune. However, few issuers enforce these rules on purchases, because most credit card companies are eager to hold onto your business, given the highly competitive nature of the industry these days. But, theres still always a chance that your claim could be denied on these grounds.
You Have a Better Chance Than You Might Think
If you find yourself in the position of having to dispute a credit card charge, you may have more rights and advantages than you realize. The key is to act quickly and responsibly. Address the matter in a prompt and courteous fashion with the merchant in question, and if necessary, follow up with your credit card issuer. In most cases the whole matter can be resolved within a matter of weeks to your satisfaction.
Understanding The Ticker Tape
Youve seen them on business programs or financial news networks: a flashing series of baffling letters, arrows and numbers scrolling along the bottom of your TV screen. While many people simply block out the ticker tape, others use it to stay on top of market sentiment and track the activity of certain stocks. What exactly is that cryptic script reeling by? It obviously tells us something about stocks and the markets, but how does one understand the ticker tape and use it to his or her advantage?
Brief History
Firstly, a tick is any movement, up or down, however small, in the price of a security. Hence, a ticker tape automatically records each transaction that occurs on the exchange floor, including trading volume, onto a narrow strip of paper or tape.
The first ticker tape was developed in 1867, following the advent of the telegraph machine, which allowed for information to be printed in easy-to-read scripts. During the late 19th century, most brokers who traded at the New York Stock Exchange (NYSE) kept an office near it to ensure they were getting a steady supply of the tape and thus the most recent transaction figures of stocks. These latest quotes were delivered by messengers, or pad shovers, who ran a circuit between the trading floor and brokers offices. The shorter the distance between the trading floor and the brokerage, the more up-to-date the quotes were.
Ticker-tape machines introduced in 1930 and 1964 were twice as fast as their predecessors, but they still had about a 15 to 20 minute delay between the time of a transaction and the time it was recorded. It wasnt until 1996 that a real-time electronic ticker was launched. It is these up-to-the-minute transaction figures - namely price and volume - that we see today on TV news shows, financial wires and websites; while the actual tape has been done away with, it has retained the name.
Due to the nature of the markets, investors from all corners of the globe are trading a variety of stocks in different lots and blocks at any given time. Therefore what you see one minute on a ticker could change the next, particularly for those stocks with high trading volume, and it could be some time before you see your ticker symbol appear again with the latest trading activity.
Reading the Ticker Tape
Heres an example of a quote shown on a typical ticker tape:
Ticker Symbol The Unique Characters used to identify the company.
Shares Traded The volume for the trade being quoted. Abbreviations are K = 1,000, M = 1 million and B = 1 billion
Price Traded The price per share for the articular trade (the last bid price).
Change Direction Shows whether the stock is trading higher or lower than the previous days closing price.
Change Amount The difference in prie from the previous days close.
Throughout the trading day, these quotes will continually scroll across the screen of financial channels or wires, showing current, or slightly delayed, data. In most cases the ticker will quote only stocks of one exchange, but it is common to see the numbers of two exchanges scrolling across the screen.
You can tell where a stock trades by looking at the number of letters in the stock symbol. If the symbol has three letters, the stock likely trades on the NYSE or American Stock Exchange (AMEX). A four-letter symbol indicates the stock likely trades on the Nasdaq. Some Nasdaq stocks have five letters, which usually means the stock is foreign. This is designated by an F or Y at the end of the stock symbol. To learn more, see Why do some stock symbols have three letters while others have four?
On many tickers, colors are also used to indicate how the stock is trading. Here is the color scheme most TV networks use:
Green indicates the stock is trading higher than the previous days close.
Red indicates the stock is trading lower than the previous days close.
Blue or white means the stock is unchanged from the previous closing price.
Before 2001, stocks were quoted as a fraction, but with the emergence of decimalization all stocks on the NYSE and Nasdaq trade as decimals. The advantage to investors and traders is that decimalization allows investors to enter orders to the penny (as opposed to fractions like 1/16).
Which Quotes Get Priority?
There are literally millions of trades executed on more than 10,000 different stocks each and every day. As you can imagine, its impossible to report every single trade on the ticker tape. Quotes are selected according to several factors, including the stocks volume, price change, how widely they are held and if there is significant news surrounding the companies.
For example, a stock that trades 10 million shares a day will appear more times on the ticker tape than a small stock that trades 50,000 shares a day. Or if a smaller company not usually featured on the ticker has some ground-breaking news, it will likely be added to the ticker. The only times the quotes are shown in predetermined order are before the trading day starts and after it has finished. At those times, the ticker simply displays the last quote for all stocks in alphabetical order.
The Bottom Line
Constantly watching a ticker tape is not the best way to stay informed about the markets, but many believe it can provide some insight. Tick indicators are used to easily identify those stocks whose last trade was either an uptick or a downtick. This is used as an indicator of market sentiment for determining the markets trend.
So next time youre watching TV or surfing a website with a ticker, youll understand what all those numbers and symbols scrolling across your screen really mean. Just remember that it can be near impossible to see the exact price and volume at the precise moment it is being traded. Think of a ticker tape as providing you with a general picture of a stocks current activity.
Finding The Right Trading Coach
If you have ever thought about getting a trading coach or trading program, or bought a book about trading, this topic may have crossed your mind. If the coach knows so much about trading, why is he or she teaching others? This is an interesting question and relates to the old adage: Those that cant ... teach. Meaning those who were unsuccessful at an endeavor move to the teaching realm to coach others. Many people dont like the idea that a trader who cant make big money should be teaching others. But does your coachs personal success really matter? In other words, is a full-time trader in a better position to help you than someone who no longer trades or has never traded? When we break down the pros and cons you may realize you werent giving some people the credibility they deserve, and were possibly giving too much credit to others. (For general investment information refer to Top 10 Commandments Of Investing.) Arguments for Both Sides
A coach who is a trader will claim to have definite advantage over someone who doesnt trade. This may be true if the coach has the track record to back this claim up, but just because a person is successful at trading does not mean he or she can effectively relay that skill to someone else.
On the other hand, a coach who no longer trades can still provide great benefit if he or she is an effective teacher . A non-trader coach may have been successful as a trader in the past, but has chosen to give up trading. The reasons for this are numerous: some traders prefer coaching to trading, have found trading too stressful, want to help others or have already succeeded and want a new challenge, to list but a few potential reasons. However, it may also be that the trader has failed miserably. At first it may seem that this person would not be a good coach, but this is not necessarily true; we can learn a lot from other peoples failures. In addition, even though someone was unable not implement a certain system themselves due to lack of discipline, psychological or physiological reasons, this does not mean that a different person cant be successful using the same method.
Both sides can likely agree on the fact that in order to coach someone else, a teacher needs to have experience in what students will go through. Essentially, coaches must have market experience in some form or another. The coach needs to know what hurdles students will have to go over, and be able to help them navigate through those obstacles. This does not mean they need to have traded personally, but they will at least have to have been in an environment where they witnessed others trading. Observation can be a great teacher that can lead to the teaching of others.
A Deeper Look
On both sides of the argument there are examples of traders being great and horrible coaches, as well as coaches who no longer trade (or never did) that are fantastic. Think for a moment about a sport. The athletes who play professional sports are the best athletes in the world, and yet they are often coached by someone who has inferior skill. This is OK, because the coach is there to help hone another persons skills. Just because coaches dont have the qualities of a peak performance athlete does not mean they cant pick out and elevate those qualities in others. On the flip side, we have had some amazing talents who could not and cannot effectively pass on whatever it was that made them great athletes.
When we look at trading, or investing , much worth is placed in those who dont actually trade the markets professionally. Market analysts gauge the market using varying tools and methods and relay that information to others. While many analysts may not be traders, some are often very accurate in their market analysis. Having a birds eye view of the unfolding situation allows them to make predictions without an investment in the outcome. These insights are helpful to many traders, even though the information comes from someone who may have never placed a trade.
Never having placed a trade does pose a problem for the trader. The market is constantly moving, and while an analyst may be able to anticipate the direction and magnitude of a move, the gyrations along the way can have the power to wipe a trader out if he or she executes a move at the wrong time. In this case, a student trader would benefit from having the information constructed into something tradeable by a trading coach.
How to Find a Good Coach
With arguments on both sides, there is no hard-and-fast rule when it comes to which is better. The bottom line is whether someone gets you the knowledge and skills that you want. If the coach is teaching you in a way you understand and you feel you are getting your moneys worth, that is what counts.
Trading and coaching is a business. Coaches need to recruit students - this is how they make money . Therefore, sales pitches abound across media sources. When seeking to improve your trading, this can be overwhelming. That said, you can often narrow your search down quite quickly by following a few simple guidelines.
1. Dont Focus on a Coachs Personal Results
Dont worry about whether a potential coach was a trader, is a trader or what his or her personal track record is. Personal trading results dont matter; what matters is how a given coachs students are doing. Look for reviews by students about a coach or training program , and if possible contact a few students directly to ask them about their experience.
2. Avoid Getting Emotional
Sales pages are meant for the hard sell. Therefore, sift through sales pages with an analytical mind, not an emotional one. Is there any substantiation to an advertisers claims? People who know the markets know that no one is right all the time, so skip past coaches and programs that promise outlandish results.
3. Consider Your Personality and Style
If you have some experience already, look for someone who meshes with your personality and style. Do you understand the language the coach uses? Does his or her method seem simple and easy to understand? Complex methods can be hard to implement and may not be easily passed from one person to another. Also, if you cant understand what someone else is saying when you are first introduced to their work, it is likely only going to get harder to understand down the road.
Conclusion
Good information, coaching and training programs can be found, but in order to hit on the best possible program, traders need to do some research. This includes finding reviews of any product or service being considered, and touching base with those companies or individuals to see what they have to offer. We can also discard any offers that promise outlandish results or are hard to understand. Trading can be difficult, but learning about it should be much easier - especially if you take the time to seek out the best possible sources.
Get A Hold On Mishandled Accounts
Investors often look to professionals to help them navigate the markets and provide a certain level of service, but there are times when they may feel that an account is being mishandled. As tempting as it may be to find someone to blame for monetary losses, they are often the result of market conditions and investors must be prepared for such risks. However, arbitration or other avenues may be warranted if evidence suggests that a broker recommended an unsuitable investment, committed fraud, or charged excessive commissions by churning the account. In this article, well help you to decide whether your account has been mishandled and if you do need to act on the complaint. (To learn more, see Paying Your Investment Advisor - Fees Or Commissions?)
Your First Steps
If you feel that your broker has not acted in your best interest, try to exhaust all possible remedies with the investment company. After quantifying the loss, schedule a meeting with the primary contact at the investment firm to have an extensive discussion, and listen to the brokers side of the story. If this process does not yield adequate information, escalate the complaint to the next level of management until some type of resolution is reached. This may include various outcomes, including simply waiting for the markets to improve to ending all discussions and proceeding with legal action.
If the dispute is with a broker, you probably already agreed to settle through arbitration when you began working with the firm. In this case, the Financial Industry Regulatory Authority (FINRA), formerly the National Association of Securities Dealers (NASD), would handle the arbitration process from start to finish. The groups dispute resolution forum helps resolve matters between investors and securities firms, as well as industry-related issues between individual registered representatives and their firms. (To learn more, see Broker Gone Bad? What To Do If You Have A Complaint and When A Dispute With Your Broker Calls For Arbitration.)
If You Need Legal Representation
As with any potentially lucrative legal proceeding, many legal advisors offer free consultations. Consulting an attorney opens up an outside perspective and can help confirm the appropriate forum for resolving a dispute. This is a good time to begin building a short list of potential litigators, should the need arise. If an arbitration path is appropriate, the list will shrink, as more attorneys handle court cases than arbitration.
While the entire process is simplified in order for any one who has a grievance to file a claim and proceed, the majority of customers pursue their claims in conjunction with a legal team that includes at least one attorney and an expert witness. It is also a good time to set reasonable expectations with potential outcomes and time frames. Do not count on large settlements that include punitive damages, as such generous judgments are rarely rendered. Be prepared to wait months or even years before the arbitration date is set. Depending on the size of the claim and the legal participants, anticipate that arbitration that is not completed in the originally scheduled time frame may be postponed to accommodate participant and panel members schedules.
The Arbitration Process
The table below presents the number of cases handled by FINRA on an annual basis. Typically, the caseload increases in years following volatile financial markets where investors have suffered losses. Caseloads hit historically high levels in 2003, approximately two years after what the tech bubble burst and the stock market plunged.
Year Cases
2002 7,704
2003 8,945
2004 8,201
2005 6,074
2006 4,614
2007 3,238
If arbitration appears to be the best course of action, visit the FINRA website and search pending cases with the investment firm or registered representative in question. The listing will provide a summary and itemization of any pending or closed cases against the firm and its representative or advisor. It will not, however, include every issue or any cases that expunged the record as part of the settlement.
If the search is for a registered investment advisor (RIA) rather than someone who works for a brokerage firm, you will be redirected to the Securities And Exchange Commission (SEC) website, or possibly to a state-sponsored site if the advisor is state licensed. If the search is for a registered representative or a brokerage firm, FINRAs BrokerCheck program will search data from the Central Registration Depository (CRD) registration and licensing database, which gathers data reported on industry registration and licensing forms. BrokerCheck reports professional background information on currently registered brokers, registered securities firms and previously registered parties. One section provides vital information regarding events reported at the CRD, which is required by the securities industry registration and licensing process. Any number of financial disclosures can be listed here, including bankruptcies or unpaid liens. The listing might also contain formal investigations, customer disputes, disciplinary actions and criminal charges or convictions.
Filing a Complaint
If you determine that the portfolio was mishandled, the next step is to file a complaint. FINRA suggests doing so as soon as possible to avoid a delay in arbitration or mediation. Mediation, which can serve as a supplement or replacement for arbitration depending on the outcome, is a voluntary process in which both parties can settle their disputes in a non-binding format. For most claims under $25,000, the process is resolved primarily through written statements filed by each party to FINRA. At any point the claimant, respondent, or arbitrator may request a hearing. These smaller cases can be assigned to a single arbitrator and may settle fairly quickly.
Claim amounts greater than $25,000 are usually assigned to a three-person arbitration panel. Because they typically settle in-person and involve more formalities, they tend to take longer. FINRA offers a complete online claim filing process, and this is where most investors get bogged down. While FINRA has streamlined the process for the layman to follow, it is still a legal proceeding with required documents such as the statement of claim. Many frustrated investors will pursue the services of an attorney at this point.
Evaluate Your Progress
This stage of the process is a good time to step back, evaluate your progress, and set time frames and expectations. Keep in mind, however, that the relationship between you and the representative or advisor has changed. While customers sometimes stay with the company against which they have filed claims, most do not. Depending on the claim or loss, they have probably moved to another firm, liquidated their holdings or made other arrangements. The process from this point on becomes a legal proceeding, although it is slightly less formal than a typical court proceeding; you should view this process as a resolution-in-progress.
Conclusion
FINRA provides a framework for licensing, registration, education, monitoring and policing of the brokerage community to ensure the public receives the best service. While the vast majority of financial service professionals provide excellent service, some accounts are mishandled and FINRA has the process available for anyone to pursue what he or she believes is a valid claim. It is important to remember that all decisions made by either the sole arbitrator or the combined panel are binding and that the judgments are enforceable, as they would be in a court. Finally, consider that while the investor has every right to pursue a claim, doing so carries costs such as filing fees, arbitration and/or mediation fees, and if the panel decides a case is frivolous, legal and other costs will apply.
Is Warren Buffett Really A Value Investor?
Hes one of the most famous investors of all time and has certainly earned his nickname of The Oracle of Omaha. Warren Buffett has long been hailed as a value investor. But is that statement still accurate?
TUTORIAL: P/E Ratio
What Is Value Investing?
Value investing can mean a number of different things, but is generally meant to refer to a class of investors who look for investments trading at a price below where certain valuation fundamentals suggest they should be trading at. For example, a stock can trade at a price-to-earnings (P/E) or price-to-book (P/B) value below its peers or the market average in general. Overall, value investing is an investment philosophy of finding undervalued securities that should eventually increase in value to be closer in line with (or above) the metrics of rivals or stock market averages.
On the flip side, growth investors are said to be more interested in the growth potential of a security whose underlying company has above-average sales or profit expansion prospects. Given this higher growth potential, a growth investor may be willing to pay above-average P/E, P/B or other valuation metrics compared to rivals or the market in general.
The value investing crowd has its origins in the 1934 text Security Analysis by Benjamin Graham and David Dodd and has been further developed by Warren Buffett, a past student of Graham who has also preached that a security eventually trades up to its intrinsic value. Buffett championed Grahams approach to buy a security with a satisfactory margin of safety, or, in Grahams words, a favorable difference between price on the one hand and indicated or appraised value on the other. (This simple measure can help investors determine whether a stock is a good deal. For more, see Value Investing Using The Enterprise Multiple.)
Where Does Buffett Fit?
In this context, Buffett is considered a value investor. More specifically, he relies on estimating a firms future cash flows and discounting them back to the present to get an estimated intrinsic value for a company when it comes to investing in its stock. Intrinsic value is a theoretical value assuming one could know a firms future cash flows with certainty, so the reality is that it is a very subjective measure and investors may come to widely varying estimations of intrinsic value, even when looking at the same set of data, valuation metrics, etc.
But in the context of value versus growth investing, Buffett is actually a bit of both. In his words, growth and value investing are joined at the hip and that understanding is required to find a company and underlying stock with solid growth prospects and a market value well below intrinsic value. The best illustration of this is the growth of Berkshire Hathaways non-insurance businesses over the past four decades. Below is a chart that Buffett provided in Berkshires 2010 shareholder letter:
Period Annual Earnings Growth
1970-1980 20.8%
1980-1990 18.4%
1990-2000 24.5%
2000-2010 20.5%
Over this time period, earnings growth averaged 21% annually while Berkshires stock price grew at an annual compounded rate of 22.1%, almost completely mirroring the growth in earnings. In this respect, Buffett is the ultimate growth investor because earnings grew about twice the level of the stock market during this period. In Buffetts words from this years shareholder letter, market prices and intrinsic value often follow very different paths - sometimes for extended periods - but eventually they meet. (Find out how Mr. Markets mood swings can mean great opportunities for you. See Take On Risk With A Margin of Safety.)
The Bottom Line
Again, perhaps the most appropriate conclusion to make is that Buffett is both a value and growth investor. At the outset of making an investment, it is reasonable to conclude that he uses a margin of safety by purchasing a stock with valuation metrics that are well below average. But overall, growth has to be there so that the firm can eventually trade up closer to its intrinsic value and growth potential must be well above average to double the markets return over the long haul.
To be a truly successful investor, individuals must take both a value and growth perspective when it comes to spotting undervalued investments and outperforming the market over time. Valuation multiples including P/E and P/B ratios are a good starting point, but at the end of the day it is also necessary to estimate a firms growth prospects and cash flows going forward, and come to an independent determination of intrinsic value.
Invest Like A Pro
For those investors who have been lucky enough to have survived one or more major market downturns, some lessons have been learned. For example, there always seem to be some firms that not only survive those downturns, but profit handsomely from them. So why do certaininvestment companies do better than others and survive market waves? They have a long term investment philosophy that they stick to; they have a strong investment strategy that they formalize within their products and understand that while taking some risk is part of the game; a steady disciplined approach ensures long-term success. Once the key tools of successful investment firms are understood, they can easily be adopted by individual investors to become successful. By adopting some of their strategies, you can invest like the pros.
Strength in Strategy
A strong investment philosophy should be outlined before any investment strategies are considered. An investment philosophy is the basis for investment policies and procedures, and ultimately into long-term plans. In a nutshell, an investment philosophy is a set of core beliefs from which all investment strategies are developed. In order for an investment philosophy to be sound, it needs to be based on reasonable expectations, assumptions of how historical information can serve as a tool for proper investment guidance .
For example, the investment philosophy, to beat the market every year, while a positive expectation, is too vague and does not incorporate sound principles. Its also important for a sound investment philosophy to define investment time horizons, asset classes in which to invest and guidance on how to respond to market volatility while adhering to your investment principles. A sound long-term investment philosophy also keeps successful firms on track with those guidelines, rather chasing trends and temptations. Since each investment philosophy is developed to suit the investment firm, or perhaps the individual investor , there are no standard plans to write one.
If you are developing an investment philosophy for the first time, and you want to invest like a pro, its important that you consider covering the following topics to make sure the philosophy is robust:
• Define Your Core Beliefs
The most basic and fundamental beliefs are outlined regarding the reason and purpose of investment decisions.
• Time Horizons
While investors should always plan on long-term horizons, a good philosophy should outline your unique time frame to set expectations.
• Risk
Clearly define how you accept and measure risk. Contrary to investing in a savings account, the fundamental rule of investing is the risk/reward concept by increasing your expected returns with increased risk.
• Asset Allocation and Diversification
Clearly define your core beliefs on asset allocation and diversification, whether it is active or passive, tactical or strategic, tightly focused or broadly diversified. This portion of your philosophy will be the driving force in developing your investment strategies and build a foundation to which to return when your strategies need redefining or tweaking.
The Secret of Success
Successful firms also implement product funds that reflect their investment philosophies and strategies. Since the philosophy drives the development of the strategies, core style investment strategies , for example, are usually the most common in most successful product lines and should also be part of an individual plan. Core holdings or strategies have multiple interpretations, but generally, core equity and bond strategies tend to be large cap, blue chip and investment grade types of funds that reflect the overall market.
Successful firms also limit their abilities to take large sector bets in their core products. While this can limit the potential upside when making the right sector bet, directional bets, practiced by hedge funds, add significant volatility to a fund that is judged by not only its performance but its relative and absolute volatility.
When defining an investment strategy , it is very important to follow a strict discipline. For example, when defining a core strategy, restricting the temptation to follow or chase trends keeps the strategy grounded. This is not to say that one cant have additional momentum strategies with different goals, as those can be incorporated into the overall investment plan.
Outlining a Strategy
When outlining a sound investment strategy, the following issues, which are similar to those of creating a philosophy, should be considered:
• Time Horizon
A common mistake for most individual investors is that their time horizon ends when they retire. In reality, it can go well beyond retirement, and even life, if you have been saving for the next generation. Investment strategies must focus on the long-term horizon of your investment career, as well as the time for specific investments .
• Asset Allocation
This is when you clearly define what your target allocation will be. If this is a tactical strategy, ranges of allocations should be defined, if strategic in nature, hard lines need to be drawn with specific plans to rebalance when markets have moved in either direction. Successful investment firms follow strict guidelines when rebalancing, especially is strategic plans. Individuals, on the other hand, often make the mistake of straying from their strategies when markets move in sharp directions.
• Risk vs. Return
At this point you should clearly define your risk tolerance. This is one of the most important aspects of an investment strategy, since risk and return have a close relationship over long periods of time. Whether you measure it in relative to a benchmark or absolute portfolio standard deviation, just remember to stick to your predetermined limits.
Putting the Pieces Together
Its important to remember that investment strategies define specific pieces of an overall plan. Successful investors cannot beat the market 100% of the time, but can evaluate their investment decisions based on their fit to the original investment strategy.
After you have survived a few market cycles, you can potentially start to see patterns of hot or popular investment companies gathering unprecedented gains. This was a phenomenon during the internet technology investing boom. Shares of technology companies rose to rock star levels, and investors - institutional and personal - lined up at their gates to pile on funds. Unfortunately for some of those companies, success was short-lived, since these extraordinary gains were unjustified. Many investors deviated from their initial investment strategies in the hopes of chasing greater returns. Individuals can pattern themselves after successful investment companies by not trying to hit home runs and focusing on base hits, instead.
That means trying to beat the market by long shots is not only difficult to do consistently, it leads to a level of volatility that does not sit well with investors over the long term. Individual investors often make mistakes like shooting for the stars and using too much leverage when markets are moving up, and tend to shy away from markets as they are falling. Removing the human biases by sticking to a set approach and focusing on short term victories is a great way to fashion your investment strategy like the pros.
Conclusion
Taking cues from successful professional investors is the easiest way to avoid common errors and keep on a focused track. Outlining a sound investment philosophy sets the stage for professional and individual investors, just like a strong foundation in a home. Building up from that foundation to form investment strategies creates strong directions, setting the paths to follow. Investing like the pros also means avoiding the temptation to drift from your investment philosophy and strategies, and trying to outperform by large margins. While this can be done occasionally, and some firms have done it in the past, it is nearly impossible to beat the markets by large margins consistently. If you can fashion your investment plans and goals like those successful investment companies, you to can invest like the pros.
Institutional Knowledge/Research
In spite of regulations meant to level the playing field between individuals and institutions (such as Reg FD, which outlines a companys disclosure responsibilities), institutions often employ teams of seasoned industry analysts. These trained experts typically have many contacts throughout the supply chain and tend to have more frequent contact with a given companys management team than the average individual investor. (Read more about the role of Reg FD in Defining Illegal Insider Trading.)
Not surprisingly, this gives the institutional analysts a far better idea of what is going on at a company or within a given industry. In fact, it is almost impossible for the individual to ever gain the upper hand when it comes to such knowledge.
This relative lack of knowledge about future earnings potential, opportunities for growth, competitive forces, etc. can adversely impact investment results. In fact, a lack of knowledge is another major reason why many individual investors tend to underperform mutual funds over time. (You can piece together your own analysis if you have the right information. Read Do-It-Yourself Analyst Predictions to find out how.)
This is compounded by the fact that analysts can sit and wait for new information ,while the average Joe has to work and attend to other matters. This creates a lag time for individual investors, which can prevent them from getting in or out of investments at the best possible moment.
Keeping Tabs on Institutions Is Tough
Even if an individual has enough money to adequately diversify him- or herself, the willingness to hold positions for an extended period of time and the ability to accurately track and research multiple companies, it is difficult to copy the actions of most institutions.
Why? Because, unlike Berkshire Hathaway, many mutual funds buy and sell stocks with great vigor throughout a given quarter.
In fact, take T. Rowe Price as an example. According to the companys website, its Capital Opportunity Fund (which invests primarily in domestic securities) has a turnover rate of 63.5 as of July 31, 2008. Thats big. This makes positions like these are hard to mimic because even if you had access to databases that track institutional holdings the information is usually updated on a quarterly basis.
What happens in between? Frankly, those looking to mimic the institutions portfolio are left guessing, which is an extremely risky strategy, particularly in a volatile market. (Learn some ways you can keep track of institutional investment activities in Keeping An Eye On The Activities Of Insiders And Institutions.)
Trading Costs Can Be Huge, and Treatment May Vary
By definition, institutions such as mutual funds have more money to invest than the average retail investor. Perhaps not surprisingly, the fact that these funds have so much money and conduct so many trades throughout the year causes retail brokers who service these accounts to fawn over them.
Funds often receive favorable treatment. In fact, its not uncommon for some funds to be charged a penny (or in some cases a fraction of a penny) per share to sell or purchase a large block of stock – whereas individual investors will typically pay 5-10 cents per share.
In addition, even though there are rules to prevent this (and time and sales stamps that prove when certain trade tickets were entered), institutions often see their trades pushed ahead of those of retail investors. This allows them to realize more favorable entry and exit points. (ReadPatience Is A Traders Virtue and A Look At Exit Strategies for a discussion of setting entry and exit points.)
In short, the odds are that the individual, regardless of his or her wealth, will never be able to garner such preferential treatment. Therefore, even if the individual was able to match an institution in terms of holdings and diversification, the institution would probably spend fewer dollars on trades throughout the year, making its investment performance, on a net basis, better overall.
Bottom Line
While it may sound good in theory to attempt to mimic the investment style and profile of a successful institution, it is often much harder (if not impossible) to do so in practice. Institutional investors have resources and opportunities that the individual investor cannot hope to match. Retail investors may benefit more, in the long run, from an investment strategy more suited to their means.
Whats The Minimum I Need To Retire?
Can I retire with $1 million dollars? Of course you can. Truth be told, you might be able to retire with much less. Then again, you might not be able to retire with $1 million or $2 million or perhaps even $10 million. It all depends on your personal situation. On thing is sure: you want to make sure your golden years are golden, not merely a struggle for existence. (To learn more read, 10 Steps To Retire A Millionaire.)
Most advisors and financial professionals have been able to boil it down to one number, also known as the holy grail of retirement analysis: the amazing 4% sustainable withdrawal rate. Essentially, this is the amount you can withdraw through thick and thin and still expect your portfolio to last at least 30 years, if not longer. This will determine how long your retirement savings will last, and will help you determine how much money you need for the retirement you want.
So, I Can Retire With $1 Million?
If you are 65 with $1 million, you can expect your portfolio of properly diversified investments to provide $40,000 per year (in todays dollars ) until you are 95. Add that to your Social Security income and you should be bringing in roughly $70,000 a year.
Now, if this isnt enough for you to maintain the lifestyle you want, you have come to your unfortunate answer rather quickly: no, you cannot retire with $1 million.
Now wait a minute, you say, what about my spouse, who is also getting Social Security? What if Im 75, not 65? What if I want to die broke? What if Im getting a government pension and benefits? What if Im planning to retire in Costa Rica? There are many what ifs, but the math is still the math: If you plan on needing a lot more than $40,000 from you retirement nest egg, then the probability of a successful retirement on $1 million is not good.
Projecting Future Expenses
There are a lot of books and articles that discuss longevity risks, sequence of returns, healthcare costs and debt. But knowing how much you need to retire still boils down to projecting your future expenses until the day you die. Ideally, that yearly figure will add up to less than 4% of your nest egg.
So a $1 million dollar portfolio should give you, at most, $40,000 to budget. If you are forced to take out more than $40,000 adjusted for time during your retirement, you are tempting fate and relying on luck to get you by. So, if you want at least $40,000 per year, $1 million is really the least amount of money - the bare minimum - you should have before you launch into retirement.
Retirement planning means maximizing your lifestyle while maintaining a high probability of being able to maintain that lifestyle until the day you die. So scraping together a bare minimum nest egg is like an explorer heading into the jungle for a week with just enough supplies. What if something happens? Why not take extra? As a result, for the vast majority of people, $1 million is not enough if you want a high probability of a great retirement .
Three Types Of Retirees
Typically, we see three categories of people trying to decide if they are ready to retire:
1. Of course you can retire! Live it up and enjoy! If you are at least in your 70s with reasonable expenses, then there is a good chance you and your $1 million fall in this category.
2. The probability for your retirement looks good. Just dont go crazy and buy a Porsche. If you are at least 62 and have always lived a frugal lifestyle, then you and your $1 million are likely going to fall in this category.
3. Lets redefine retirement for you. This is just about everyone else - including early retirees with $1 million living frugally and 70-year-olds with $1 million spending lavishly.
Early retirement , meaning before Social Security and Medicare kick in, with only $1 million is extremely risky. You leave yourself with so few options if things go terribly wrong. Sure, you can go to Costa Rica and eat fish tacos every day. But what if you want to move back to the U.S. someday? What if you want to change? Having more money set aside will provide you with more flexibility and increase the likelihood of continued financial independence to do what you want within reason until the day you die. If you are forced to stay in Costa Rica or get a job, then you didnt make a good decision and plan.
So, once you have your $1 million, concentrate on what you can control - or at least affect. You cant control when you die but you can affect your health costs by doing your best to stay healthy until you qualify for Medicare. You cant control investment returns but you can affect the range of returns. You cant control inflation but you can affect your fixed costs and your variable costs.
Spending and Expenses
A few quick bits on expenses and spending. To a certain extent, retirement planning is the art of accurately matching future income with expenses. People seem to ignore certain expenses. For example, family vacations and a grandchilds wedding gift count the same as dental surgery and car repairs in retirement planning, but people neither include these enjoyable expenses when they are projecting their costs nor do they recognize how hard it is to cut them - try telling one child that you cant help with his wedding after paying for your other childrens weddings!
Conclusion
As a general rule, people who try to determine the minimum amount of retirement savings are usually the least likely to retire. Just getting by isnt a good way to start 30 years of unemployment and diminishing employability. If something unexpected happens, what are your options? Re-enter the work force, change your lifestyle or get more aggressive with your investments? Most people try the latter and pray. Some get lucky, but most dont. This is the equivalent of doubling down in black jack.
If you want to retire with $1 million dollars, it is going to come down to a combination of 1) how you define retirement, 2) your personal inventory of everything in your life: assets, debts, medical, family, etc. and 3) what the future holds. Remember, stuff happens in life. Do you really want to start this 30 year adventure with the bare minimum? Retirement is like most good things, it is much better to be overprepared than to wing it. You can you retire with $1 million dollars, but its better to be safe than sorry – shoot for $2 million!
The 3 Moral Types Managing Your Money
In the late 1970s, business academic Archie Carroll published some now classic work on corporate ethics and social responsibility. His work includes the well-known CSR Pyramid (Corporate Social Responsibility), which deals with stakeholders, economic responsibilities, philanthropy and many other related issues.
Of particular relevance to private investors, however, are the three moral types commonly encountered in the industry. Your financial fate is influenced very substantially by whether your broker and/or his/her firm is immoral, amoral or moral. Each type is clearly differentiated from one another and you only want to give your money to the moral ones; the immoral and the amoral are to be avoided like the plague. We will now take a look at the differences between the three methods and what this could mean for your savings.
The Immoral, the Amoral and the Moral
Immoral brokers , fund managers and firms do not care about you at all. They want to make money out of you and not for you. They are motivated only by self-interest and regard clients as factors of production to be exploited, manipulated and bled. There can be no doubt that even though such people are only fit to be shunned, they abound in the industry, which has led to many mis-selling and mismanagement scandals, not to mention major crises in recent and less recent years. Some are in jail, and many others should be.
Amoral sellers are arguably not as bad, but they are bad enough. While not blatantly dishonest, they look after themselves and just do not bother about ethics. They keep to the letter of the law, but the spirit of the law is ignored. Therefore, they fulfill their regulatory obligations, but they do not look after your interests. They are unlikely to fleece you outright, but they can lose you a lot of money through indifferent management and bad advice.
Moral people are the only ones who deserve your money. They will treat your fairly, do their best for you and sell you only what they truly believe is what you want and what is suitable for you. Fortunately, there are such people out there, but the two groups of baddies and mega-baddies are there as well, and they all want your money. Only the moral ones have a conscience, and can be trusted and relied upon.
Why Is it Like This?
Human nature has produced all three types of morality for at least 2000 years, particularly in the context of money and wealth, and that is not going to change. All professions have their black sheep, but because the financial services industry deals only with money, it has more of these than elsewhere. Furthermore, due to the nature of the industry, there is a lot of money to be made from selling excessively risky and other forms of lousy products to the unwary; and the unwary have been around since the year dot.
This precarious scenario is exacerbated by the complexity of the industry; there are a plethora of local and international products. Furthermore, it is horrendously easy to present products so that they sound far better than they really are. People are also genuinely tempted by greed and offers that are too good to be true. This is an environment in which amorality and immorality thrive.
In fact, in this day and age, dishonest people with some financial or selling skills can make a fortune with minimal risk. Why pick locks, blow up safes or ride your horse into town with guns blazing, when you can put on a snazzy suit and pretend to be a gentleman, selling the investment of a lifetime?
SEE: 8 Ethics Guidelines For Brokers
How Do You Find the Moral Ones?
As is always the case, you need to be as educated as you can on investment issues, shop around and double check. I would also emphasize that there are other ways to spot what type of seller you are dealing with.
My experience is that you can tell a lot by observing how the brokers you deal with personally handle you and your money. If they seem to really want you to understand what you are getting, that is good. If they offer you a wide range of products and do not push just one or two, that is better. If the range includes various alternative risk-return combinations, some of which really do not earn so much for the seller, such as trackers, and funds with low or no up-front fees, then you could be dealing with a moral person.
Body language is also important. Keep an eye open for some telltale and quite reliable signs of lying. These include blinking, speech errors and hesitation, self-touching and doing weird things with ones hands. Jittery feet are supposed to be a reliable sign that you are dealing with the wrong moral type. Given the importance of body language, it is often safer to ensure that you deal with sellers personally, rather than just by email or on the phone.
In general, be perceptive and have a healthy level of cynicism. In this industry, cynicism is a good investment.
SEE: Choosing A Compatible Broker
The Bottom Line
What we have here are the good, the bad and the ugly aspects of the investment industry. These types are here to stay, but you can avoid the immoral and the amoral by being careful and watching for warning signs. Watch out for pushy selling, products or policies that you do not understand, and for patterns of behavior that just dont seem right. Make sure your money stays your own and grows over time. It can also help to understand some of the ethical issues your broker faces.
10 Tips For Choosing An Online Broker
One of the most important investment decisions youll make has nothing to do with stocks, bonds or mutual funds. This crucial decision is picking a broker. There are dozens of companies offering brokerage services on the internet , and many of them are just as good or better than traditional, brick-and-mortar businesses, but how to decide which one is best for you?
Here are 10 critical factors youll want to consider:
1. Discount is not always a good deal. Consider starting out with a full-service broker. They are often best for novice investors who may still need to build confidence and knowledge of the markets. As you become a more sophisticated investor, you can graduate into investing more of your money yourself.
2. Availability is key. Try hitting the companys website at different times throughout the day, especially during peak trading hours. Watch how fast their site loads and check some of the links to ensure there are no technical difficulties.
3. Alternative trading provides flexibility. Although we all love the net, we cant always be at our computers. Check to see what other options the firm offers for placing trades. Other alternatives may include touch-tone telephone trades, fax ordering, or doing it the low-tech way - talking to a broker over the phone. Word to the wise: make sure you take note of the prices for these alternatives; they will often differ from an online trade .
4. The brokers background matters. What are others saying about the brokerage? Just as you should do your research before buying a stock, you should find out as much as possible about your broker . (To learn more, check out Picking Your First Broker.)
5. Price isnt everything. Remember the saying you get what you pay for? As with anything you buy, the price may be indicative of the quality. Dont open an account with a broker simply because it offers the lowest commission cost. Advertised rates for companies vary between zero and $40 per trade, with the average around $20. There may be fine print in the ad specifying which services the advertised rate will actually entitle you to. In most cases, there will be higher fees for limit orders, options and those trades over the phone with your broker. You might find that the advertised commission rate may not apply to the type of trade you want to execute.
6. Minimum deposits may not be minimal. See how much of an initial deposit the firm requires for opening an account. Beware of high minimum balances: some companies require as much as $10,000 to start. This might be fine for some investors, but not others.
7. Product selection is important. When choosing a brokerage, most people are probably thinking primarily about buying stocks . Remember there are also many investment alternatives that arent necessarily offered by every company. This includes CDs, municipal bonds, futures,options and even gold/silver certificates. Many brokerages also offer other financial services , such as checking accounts and credit cards.
8. Customer service counts. There is nothing more exasperating than sitting on hold for 20 minutes waiting to get help. Before you open an account, call the companys help desk with a fake question to test how long it takes to get a response.
9. Return on cash is money in the bank. You are likely to always have some cash in your brokerage account. Some brokerages will offer 3-5% interest on this money, while others wont offer you a dime. Phone or email the brokerage to find out what it offers. In fact, this is a good question to ask while youre testing its customer service!
10. Extras can make a difference. Be on the lookout for extra goodies offered by brokerages to people thinking of opening an account. Dont base your decision entirely on the $100 in free trades, but do keep this in mind.
The Bottom Line
With a click of the mouse, from just about anywhere in the world, you can buy and sell stocks using an online broker. The right tools for the trade are key to every successful venture; finding success in the market begins with choosing the right broker.
Introduction To Investment Diversification
Diversification is a familiar term to most investors. In the most general sense, it can be summed up with this phrase: Dont put all of your eggs in one basket. While that sentiment certainly captures the essence of the issue, it provides little guidance on the practical implications of the role diversification plays in an investors portfolio and offers no insight into how a diversified portfolio is actually created. In this article, well provide an overview of diversification and give you some insight into how you can make it work to your advantage.
What Is Diversification?
Taking a closer look at the concept of diversification, the idea is to create a portfolio that includes multiple investments in order to reduce risk. Consider, for example, an investment that consists of only stock issued by a single company. If that companys stock suffers a serious downturn, your portfolio will sustain the full brunt of the decline. By splitting your investment between the stocks from two different companies, you can reduce the potential risk to your portfolio.
Another way to reduce the risk in your portfolio is to include bonds and cash. Because cash is generally used as a short-term reserve, most investors develop an asset allocation strategy for their portfolios based primarily on the use of stocks and bonds. It is never a bad idea to keep a portion of your invested assets in cash or short-term money-market securities. Cash can be used incase of an emergency, and short-term money-market securities can be liquidated instantly incase an investment opportunity arises, or in the event your usual cash requirements spike and you need to sell investments to make payments. Also, keep in mind that asset allocation and diversification are closely linked concepts; a diversified portfolio is created through the process of asset allocation. When creating a portfolio that contains both stocks and bonds, aggressive investors may lean towards a mix of 80% stocks and 20% bonds, while conservative investors may prefer a 20% stocks to 80% bonds mix.
Regardless of whether you are aggressive or conservative, the use of asset allocation to reduce risk through the selection of a balance of stocks and bonds for your portfolio is a more detailed description of how a diversified portfolio is created rather than the simplistic eggs in one basket concept. With this in mind, you will notice that mutual fund portfolios composed of a mix, which includes both stocks and bonds, are referred to as balanced portfolios. The specific balance of stocks and bonds in a given portfolio is designed to create a specific risk-reward ratio that offers the opportunity to achieve a certain rate of return on your investment in exchange for your willingness to accept a certain amount of risk. In general, the more risk you are willing to take, the greater the potential return on your investment.
What Are My Options?
If you are a person of limited means or if you simply prefer uncomplicated investment scenarios, you could choose a single balanced mutual fund and invest all of your assets in the fund. For most investors, this strategy is far too simplistic. While a given mix of investments may be appropriate for a childs college education fund, that mix may not be a good match for long-term goals, such as retirement or estate planning. Likewise, investors with large sums of money often require strategies designed to address more complex needs, such as minimizing capital gains taxes or generating reliable income streams. Furthermore, while investing in a single mutual fund provides diversification among the basic asset classes of stocks, bonds and cash (funds often hold a small amount of cash from which the fees are taken), the opportunities for diversification go far beyond these basic categories.
With stocks, investors can choose a specific style, such as focusing on large, mid or small caps. In each of these areas are stocks categorized as growth or value. Additional choices include domestic and foreign stocks. Foreign stocks also offer sub-categorizations that include both developed and emerging markets. Both foreign and domestic stocks are also available in specific sectors, such as biotechnology and healthcare.
In addition to the variety of equity investment choices, bonds also offer opportunities for diversification. Investors can choose long-term or short-term issues. They can also select high-yield or municipal bonds. Once again, risk tolerance and personal investment requirements will largely dictate investment selection.
While stocks and bonds represent the traditional tools for portfolio construction, a host of alternative investments provide the opportunity for further diversification. Real estate investment trusts, hedge funds, art and other investments provide the opportunity to invest in vehicles that do not necessarily move in tandem with the traditional financial markets. Yet these investments offer another method of portfolio diversification.
Concerns
With so many investments to choose from, it may seem like diversification is an easy objective to achieve, but that sentiment is only partially true. The need to make wise choices still applies to a diversified portfolio. Furthermore, it is possible to over-diversify your portfolio, which will negatively impact your returns. Many financial experts agree that 20 stocks is the optimal number for a diversified equity portfolio. With that in mind, buying 50 individual stocks or four large-cap mutual funds may do more harm than good. Having too many investments in your portfolio doesnt allow any of the investments to have much of an impact, and an over-diversified portfolio (sometimes called diworsification) often begins to behave like an index fund. In the case of holding a few large-cap mutual funds, multiple funds bring the additional risks of overlapping holdings as well as a variety of expenses, such as low balance fees and varying expense ratios, which could have been avoided through a more careful fund selection.
Tools
Investors have many tools to choose from when creating a portfolio. For those lacking time, money or interest in investing, mutual funds provide a convenient option; there is a fund for nearly every taste, style and asset allocation strategy. For those with an interest in individual securities, there are stocks and bonds to meet every need. Sometimes investors may even add rare coins, art, real estate and other off-the-beaten-track investments to their portfolios.
The Bottom Line
Regardless of your means or method, keep in mind that there is no generic diversification model that will meet the needs of every investor. Your personal time horizon, risk tolerance, investment goals, financial means and level of investment experience will play a large role in dictating your investment mix. Start by figuring out the mix of stocks, bonds and cash that will be required to meet your needs. From there, determine exactly which investments to use in completing the mix, substituting traditional assets for alternatives as needed. If you are too overwhelmed by the choices or simply prefer to delegate, there are plenty of financial services professionals available to assist you.
The Key To High Returns Is A Disciplined Strategy
Having a disciplined investment strategy differentiates the professional from the do-it-yourself investor. An investment strategy does not have to be complicated. If you were to sum up Warren Buffetts investing strategy it might be to buy good businesses at a fair price with the intention of holding them forever. An investment strategy helps provide focus and ensures emotions are held in check when making decisions. Having an investment strategy for both asset mix and security will provide discipline to be a successful investor over the long term. In this article, we will look at different investment strategies and how you can pick the right one for you.
See also: 4 Steps To Creating A Better Investment Strategy
Strategic Asset Mix
Central to any investment plan is the strategic or long-term asset mix. In general, its purpose is to capture the benefits of diversification and the advantages of investing in assets that have a low correlation to each other. The strategic asset mix is essentially the link between your long-term investment goals and the capital markets.
Many investors want to keep the current asset mix of their portfolios close to their strategic asset mix. A simple rebalancing strategy is all that is required. Typically, as each asset class will perform differently over time, the asset mix will deviate from the strategic asset mix. (For related reading, see Diversification: Its All About (Asset) Class.)
For example, a balanced portfolio of 60% equity and 40% fixed income could become 70% equity and 30% fixed income after a strong stock market. Rebalancing would require selling equities and using the proceeds to buy fixed-income assets, so the asset mix then will get back to the long-term asset mix. The rebalancing could be done on a regular basis, semiannually, annually or when an asset class deviates by a set percentage.
A rebalancing strategy is effectively a sell high, buy low strategy, because it will always sell the assets that have been the best relative performers and buy the assets with relatively weak performance. (For more insight, read 6 Asset Allocation Strategies That Work .)
Tactical Asset Allocation
A tactical asset mix strategy attempts to add value by overweighting the asset classes that are expected to outperform, and underweighting those asset classes that are expected to underperform.
As an example, if an investor believes that over the next year the U.S. equities market will be weak, the investor might decide to underweight his exposure to equities and overweight cash or bonds. Unlike a rebalancing strategy, which is mechanical, tactical asset allocation requires some forecasting ability to make the correct decisions. (To learn more about asset allocation, read Achieving Optimal Asset Allocation.)
Security Selection Strategies
There is no shortage of strategies to choose from when buying and selling stocks. Countless books have been written describing many strategies in detail. Strategies range from growth, to value and momentum. There are fundamentally based strategies, as well as technical or quantitative strategies. There are also top-down and bottom-up strategies. (For related reading, see A Top-Down Approach To Investing.)
Each type of strategy will have its proponents, but any logical, rational strategy that is followed consistently is always better than no strategy at all. The value is in the disciplined approach a strategy provides.
Developing Your Strategy
The value of an investing strategy is not in the strategy itself, but in how it is followed and implemented.
In investing, there are two different approaches: a top-down or a bottom-up approach. In a top-down approach, the investor analyzes the major factors that will influence the capital market and the companies in it. The main factors will be the overall economy, monetary and fiscal policy, demographic changes, inflation, industrial sector trends and interest rates. Other investors will take a bottom-up approach, analyzing individual companies, their financial statements, growth prospects and industry trends.
One approach is not necessarily better than the other. However, depending on your own interests, knowledge and experience, one approach might be more appropriate for you. As an example, an economist will likely take a top-down approach to investing and an accountant might feel more comfortable with a bottom-up approach. Your orientation to analyzing investments will determine the types of investment strategies to follow.(For more insight, see Where Top Down Meets Bottoms Up.)
In addition, the amount of time you are able to commit to your investment program determines the type of strategies to use and how much of the investment decision-making you will delegate. For example, with limited time, an investor might build a portfolio using a few exchanged-traded funds (ETFs) and then rebalance once a year. Similarly, the investor might have all of their investments in a couple of balanced funds or have their funds managed by a discretionary money manager.
Information and knowledge are important to the success of any investment strategy. One should identify the sources of data, investment commentary or investment research. The biggest challenge as an investor is to be able to filter out truly useful information from the needless noise. A disciplined investment strategy forces you to focus on the information that is important for your decision-making process.
Delegating Decision Making
Recognize the fact that it is difficult to do it all when it comes to investing. If you have a well-diversified portfolio and you invest in the major assets classes - and maybe some of the sub-asset classes as well - you are not likely to be able to actively manage all your investments effectively, unless you have a lot of time to allocate. The question then becomes, what to do yourself and what to delegate to others. It is important to stick to your strengths and interests and delegate out the asset classes in which you have a limited expertise.
As an example, an investor might feel confident trading large cap value stocks. As such, this person should concentrate their efforts on that asset class and delegate the investment management of other asset classes to someone else. Investors have several choices here, including active or passive management of the funds or assets they are looking to delegate. From the passive management side, you can find an advisor to handle the areas that you have little time to manage or research; you could also purchase a mutual fund or an ETF that provides exposure to these areas.
The Bottom Line
Having an investment strategy for both asset mix and security selection is important to ensure consistent success as an investor. Having the discipline to follow an investment strategy is more important than the actual strategy chosen. Equally important to any strategy, is determining what to manage yourself and what to delegate to others.
Interpreting Your Brokers Reports
Each month, most brokers or banks send a printout of information about your investments, often accompanied by a cover letter and some other documentation. While these statements provide ongoing updates about your investments and how they have performed, the quality and presentation of the information varies. The documents and printouts are frequently unclear and investors often have trouble deciphering what is important and how to interpret the material, even after discussions with a broker. In this article, well give you some guidelines for interpreting the important information contained in these brokerage reports. (Make sure your broker is working for you with Is Your Broker Acting In Your Best Interest? and Evaluating Your Broker.)
Asset Allocation and Risk
Typically, your portfolio structure is presented as a breakdown of the various asset classes in which it is invested. Your asset allocation includes stocks, bonds, cash equivalents, alternative investments, real estate and natural resources. You may also see a breakdown within a specific asset class, such as segregating equities by market capitalization or bonds according to the type of issuer.
One problem is that the report will often not specify the level of risk you are taking in your portfolio or, even worse, will categorize it incorrectly. A moderate level of risk might entail a roughly even allocation between stocks and bonds, or at most, a 60/40 split. However, brokerage firms often categorize portfolios containing 80% equities as medium risk. Other reports simply do not address the level of risk, or insert the term medium risk somewhere discreetly at the top, bottom or side of the page, where the unwary investor barely notices it. You should be kept clearly informed of the level of risk of your overall portfolio, and if your asset allocation seems too aggressive or conservative for you, then talk to your financial advisor about the issue. (To read more on these topics, see Determining Risk And The Risk Pyramid, Risk And Diversification and How Risky Is Your Portfolio?)
Performance of Your Portfolio
Next, look at your portfolios performance for the most recent period reported, and how it compares with past performance. If returns are not satisfactory to you, talk to the advisor and determine whether any changes may be needed. A simple listing of cost, current value and other figures, with no meaningful analysis or discussion, is not very helpful.
In addition to seeing how your portfolio has performed, you need to know how well, or poorly, it has performed, compared with other investments. Comparing investment performance to benchmarks, such as market indexes or industry statistics, will provide a yardstick for evaluating your own portfolio. (Keep reading about this in Benchmark Your Returns With Indexes.)
For example, the Standard
ADRs: Invest Offshore Without Leaving Home
It was April 1927. Calvin Coolidge was president, and noteworthy events that die-hard historians or baseball fans may recall include the Italian anarchists Saccho and Vanzetti receiving their death sentences and Babe Ruth hitting the first of his 60 home runs, - a single-season record at the time. For investors, a third event in April 1927 has proved equally important and far more profitable: the debut of American depositary receipts (ADRs). (Read What Are Depositary Receipts? for background reading on this common type of security.)
An ADR represents ownership of shares in a foreign company, but it can be bought and sold just like any U.S. stock, allowing investors to diversify their portfolios with foreign assets, but skip the hassle of a foreign brokerage account. Sound intriguing? Find out how these securities work and what they can add to your portfolio.
History of the ADR and Current Stats
John Piermont Morgan (yes, that J.P. Morgan), launched the first ADR for the U.K.s Selfridges Provincial Stores Limited, the famous retailer now known as Selfridges Plc. Even the audacious J.P. Morgan probably had no idea of the trend he was touching off. As of mid-2008, there were more than 2,250 depositary programs representing more than 1,800 companies from over 70 countries listed on global stock exchanges. According to the Bank of New York Mellon, in the first half of 2008, 52 billion shares of ADRs changed hands, representing a value of $2.07 trillion.
Benefits of ADR Investing
Some benefits of ADR investing are clear. First, many international markets, especially emerging markets, have higher GDP growth rates than the United States or Europe. While the American stocks in your portfolio may be stagnating, holding a few ADRs has the potential to provide you with solid returns during downturns in domestic markets. Your broker and the financial media are always advocating diversification; ADRs represent a great avenue to diversify yourportfolio. (Read Going International to learn about this and other ways to diversify your portfolio with foreign stocks.)
Another benefit investors can realize through ADR investing is favorable currency conversions for dividends and other cash distributions. For example, if you own shares of a European ADR and the euro is strong against the dollar, a dividend increase will be that much more rewarding because the dividend payment has to be converted to dollars. (Read more in The Impact Of Currency Conversions.)
The most obvious benefit of ADRs is that they make international companies that investors would normally have to pay a premium for (or perhaps be unable to buy at all) more accessible. If you want to buy 100 shares of Petrobras, the Brazilian oil giant, all you need to do is call your broker or log onto your online brokerage account. Theres no need to find a distant relative living in Brazil to execute the trade for you.
Perils and Pitfalls
As buyers of ADRs, we treat them as we would any other securities purchase: we want to profit. However, there are issues that can arise with ADRs that arent always germane to domestic stocks. Lets use a 2008 geopolitical conflict to highlight a potential peril. Say you own some shares of a Russian oil ADR, and neighboring country Georgias military is able to knock out a couple hundred miles of pipeline. As far-flung as it seems, this scenario could come to bear, especially in a developing nation. The same goes for political unrest. Its probably best to identify dictators and not invest in companies based in nations that are ruled by these leaders, as these countries are more prone to political strife. (Due diligence is key to not getting burned by an unfamiliar investment. Read Due Diligence In 10 Easy Steps to learn what to look for.)
Of course your ADR investments are subject to some of the same risks as your domestic investments, including credit, currency and inflation risk. These should be taken into account, regardless of the state of the market. There are some markets, such as Australia and Canada, where the local currencies are tied directly to commodity prices. If gold or oil is going up, this contributes to a rise in those currencies. Of course, when those commodities fall, the currencies fall in tandem. This is just one more factor an investor needs to take into account. (Read Investing Beyond Your Borders for more risks associated with investing overseas.)
There are levels of ADRs on U.S. markets. For example, a Level I ADR trades over the counter and as such, is highly speculative. Those shares probably arent liquid and, whats worse, information on the company is scant. Keep in mind that many countries dont require their public companies to report results quarterly like the U.S. does. For better or worse, Level I issues are the fastest-growing segment of the ADR market, according to the Bank of New York Mellon.
Thinking of buying that Chinese solar company that trades 20,000 shares a day at $1.50? Its probably best to wait for it to graduate to the Nasdaq or NYSE. Level II and III ADRs are where investors want to be. These are the ADRs that trade on major U.S. exchanges and must uphold the same general reporting rules and SEC regulations as American-based corporations. (IFRS are poised to change some aspects of international reporting. Read International Reporting Standards Gain Global Recognition to learn more.)
Tax Treatment of ADRs
Tax treatment of ADRs by the IRS is generally the same as for domestic investments. Investors are subject to the same capital gains and dividend taxes at the same rates. There is a little twist, however: many countries will withhold taxes on dividends paid. While the American investor must still pay U.S. income tax on the net dividend, the amount of the foreign tax may be claimed by the investor as a deduction against income or claimed against U.S. income tax. Investors are encouraged to consult a professional tax or investment advisor to make sure they are recording (and paying taxes on) their ADR investments properly. (Read more about capital gains and dividend taxation in Dividend Facts You May Not Know.)
Conclusion
Investors should look beyond the confines of the U.S. borders in an effort to diversify and maximize returns. Many investors ignore the foreign-equity asset class entirely, and this is not beneficial to their portfolios. ADRs are one way to diversify your portfolio and help you achieve better returns when the U.S. market is in a slump.
Taking The Bite Out Of A Bear Market
A bear market is defined as a decline of 20% in the following three major stock market indexes :
• Dow Jones Industrial Average (DJIA)
• Standard
Market Capitalization Defined
You often hear companies or different mutual funds being categorized as small cap, mid cap or large cap. But what do these terms really mean? The cap part of these terms is short for capitalization, which is a measure by which we can classify a companys size. Although the criteria for the different classifications are not strictly bound, it is important for investors to understand these terms, which are not only ubiquitous but also useful for gauging a companys size and riskiness.
Calculating Market Cap
Market capitalization is just a fancy name for a straightforward concept: it is the market value of a companys outstanding shares. This figure is found by taking the stock price and multiplying it by the total number of shares outstanding. For example, if Corys Tequila Corporation (CTC) was trading at $20 per share and had a million shares outstanding, then the market capitalization would be $20 million ($20 x 1 million shares). Its that simple.
Why Its Important
A common misconception is that the higher the stock price , the larger the company. Stock price, however, may misrepresent a companys actual worth. If we look at two fairly large companies, IBM (NYSE:IBM) and Microsoft (Nasdaq:MSFT), we see that at as of March 18, 2009stock prices were $91.75 and $16.75 respectively. Although IBMs stock price is higher, it has about 1.34 billion shares outstanding, while MSFT has 8.89 billion. As a result of this difference, we can see that MSFTs market cap of $148.91 billion is actually larger than IBMs $122.95 billion. If we compared the two companies by solely looking at their stock prices, we would not be comparing their true values, which are affected by the number of outstanding shares each company has.
The classification of companies into different caps also allows investors to gauge the growth versus risk potential. Historically, large caps have experienced slower growth with lower risk. Meanwhile, small caps have experienced higher growth potential, but with higher risk.
Different Types of Capitalization
While there isnt one set framework for defining the different market caps , here are the widely published standards for each capitalization:
• Mega cap - This group includes companies that have a market cap of $200 billion and greater. They are the largest publicly traded companies such as Exxon (NYSE:XOM). Not many companies will fit in this category, and those that do are typically the leaders of their industries.
• Big/large cap - These companies have a market cap between $10 billion to $200 billion. Many well-known companies fall into this category, including companies like Microsoft, Wal-Mart (NYSE:WMT) and General Electric (NYSE:GE), and IBM. Typically, large-cap stocks are considered to be relatively stable and secure. Both mega and large cap stocks are often referred to as blue chips.
• Mid cap - Ranging from $2 billion to $10 billion, this group of companies is considered to be more volatile than the large- and mega-cap companies. Growth stocks represent a significant portion of the mid caps. Some of the companies might not be industry leaders, but they are well on their way to becoming one.
• Small cap - Typically new or relatively young companies, small caps have a market cap between $300 million to $2 billion. Although their track records wont be as lengthy as those of the mid to mega caps, small caps do present the possibility of greater capital appreciation - but at the cost of greater risk.
• Micro cap - Mainly consisting of penny stocks, this category denotes market capitalizations between $50 million to $300 million fall into this category. The upward potential of these companies is similar to the downside potential, so they do not offer the safest investment, and a great deal of research should be done before entering into such a position.
• Nano cap - Companies having market caps below $50 million are nano caps. These companies are the most risky, and the potential for gain is often relatively small. These stocks typically trade on the pink sheets or OTCBB
Remember, these ranges are not set in stone, and they are known to fluctuate depending on how the market as a whole is performing.
Conclusion
Understanding the market cap is not just important if youre investing directly in stocks. It is also useful for mutual fund investors, as many funds will list the average or median market capitalization of its holdings. As the name suggests, this gives the middle ground of the funds equity investments, letting investors know if the fund primarily invests in large-, mid- or small-cap stocks.
5 Dumb Things Investors Do With Their Money
The beginning of a new year is usually a good time to reflect on the past in order to make certain resolutions about the coming one. In investing, future success can have little to do with what has worked well in the past. Trying to predict short-term market movements is also generally an investment strategy that can lead you to financial ruin. Keeping these perspectives in mind, below are five of the dumbest things you can do with your money in 2012.
Trade Volatility
Lately, it has been en vogue to consider volatility its own asset class. Trading volatility has become possible through vehicles based off the Chicago Board Options Exchange Market Volatility Index, or VIX for short. A range of exchange-traded funds (ETFs) have been created so that investors can make bets on the extent to which the market bounces up and down. There are even ETFs that let investors gain twice the exposure to market volatility, which can be used to make bets on both advances and declines in the market.
The problem, as with most short-term strategies, is developing a compelling trading strategy capable of predicting market volatility. Trading VIX-related indexes may make sense for hedging near-term market fluctuations, but there is simply not going to be any way to predict market moves with any certainty. Major inflection points in the market are missed by the best investors and include the credit crisis, flash crash and latest concerns over sovereign debt levels in Europe. Without a crystal ball, speculating on future market volatility has to be one of the dumbest things investors can do with their money. (To learn more on volatility, read A Simplified Approach To Calculating Volatility.)
Buy Bond Funds
U.S. interest rates have been on a steady decline since around 1980 when they reached the double digits. These days, shorter-term rates are hovering around zero, while the 30-Year Treasury Bond rate is extremely low at roughly 3%. These low rates qualify as all-time lows in many instances, such as for bank Certificate of Deposits (CDs), mortgages and U.S. Treasury rates.
Savvy investors, including Pimcos Bill Gross, have lamented at the low interest rate environment. Sadly enough, Grosss near-term call on the appeal of U.S. Treasuries has left his flagship Pimco Total Return Fund badly lagging its index and an estimated 84% of its peer group. Given the low historical rates, many see it as only a matter of time before rates start to rise. As bond prices move in the opposite direction of yields, there is the potential for sizable losses for many investors in bond funds. At the very least, investors should consider investing in individual bonds to at least ensure the return of their principal at maturity. (For related reading, see Bond Basics.)
Speculate in Currencies
As with trading volatility, speculating in short-term currency movements is another dubious investment strategy. As with most investing, a long-term perspective can be much more meaningful. The Economist magazine issues a Big Mac Index, the origin of which has been described as a light-hearted way to make exchange-rate theory more digestible. Namely, it looks at the price of a Big Mac across the world as a proxy for the extent that currencies are either undervalued or overvalued, relative to each other. Specifically, it states that in the long run, the exchange rate between two countries should move towards the rate that equalizes the prices of an identical basket of goods and services in each country.
Looking for penny stocks that skyrocket?
Betting on short-term movements in currencies is a certifiably dumb strategy, as shorter-term fears and emotions can push currency relationships far off from what is reasonable over the long haul. The carry trade, or borrowing in a currency with a low interest rate to invest in one with a higher interest rate, is a case in point. A popular carry trade in recent years involved borrowing in the Japanese yen, and it has unraveled at various times, including during the credit crisis in 2007 and natural disasters earlier this year. As with many short-term market movements, many speculators were caught by surprise. (For more information, read The Big Mac Index: Food For Thought.)
Load Up on Gold
A market strategist at Fifth Third Bank recently suggested that investors in gold implement a gambling strategy that also works in Las Vegas. After a big win or run up in any investment, put your initial capital back in your pocket and continue to play with house money. This minimizes the potential that an investment, such as gold, which has had an amazing price run, stops for a breather or gives up most of its original gains. Investors in residential real estate back in 2005 and 2006 would have been well served with this strategy, and while gold may continue to have a strong run (gold is up more than 150% over the past five years, while the stock market is flat), buying it aggressively at these levels is likely a very foolish trading strategy.
Invest in Social Media
The fact that many social media firms continue to push through initial public offerings (IPOs) in the face of a difficult stock market should serve as a solid indicator that these companies have unknown underlying business appeal over the long haul. Firms including Groupon, LinkedIn, Facebook, Zynga and Twitter may be growing sales rapidly, but they are spending just as much to advertise and boost sales.
Collectively, they have unproven business models, barriers to entry are very low as competing sites are rather easy to develop, and hundreds of millions of dollars of investment capital are pursuing only a handful of good ideas in the space. It all spells a recipe for disaster, for investors looking to invest these days. (For related reading, see How An IPO Is Valued.)
The Bottom Line
Smarter investment choices include buying into blue-chip stocks and even residential real estate in many markets in the U.S. With a long-term perspective, many wise investment choices can be made. The dumber ones generally consist of trying to predict short-term market movements and piling into investments that have had very strong price runs or are extremely popular.
Cash Flow On Steroids: Why Companies Cheat
It seems that every year another top athlete is exposed in a doping scandal. But these are people who are trained since birth to believe that all that matters is their performance, so they naturally take a risk on anything likely to increase their chances of winning. Companies, similarly indoctrinated to perform well at all costs, also have a way to inflate or artificially pump up their earnings - its called cash flow manipulation. Here we look at how its done, so you are better prepared to identify it.
Reasons for Cash Flow Manipulation
Cash flow is often considered to be one of the cleaner figures in the financial statements. (WorldCom, however, has proved that this isnt true.)
Companies benefit from strong cash flow in the same way that an athlete benefits from stronger muscles - a strong cash flow means being more attractive and getting a stronger rating. After all, companies that have to use financing to raise capital, be it debt or equity, cant keep it up without exhausting themselves.
The corporate muscle that would receive the cash flow accounting injection is operating cash flow (OCF). It is found in the cash flow statement, which comes after the income statement and balance sheet . (If youd like a refresher, seeWhat Is A Cash Flow Statement? and The Essentials Of Cash Flow.)
How the Manipulation Is Done
Dishonesty in Accounts Payable
Companies can bulk up their statements simply by changing the way they deal with the accounting recognition of their outstanding payments, or their accounts payable. When a company has written a check and sent it to make an outstanding payment, the company should deduct its accounts payable. While the check is in the mail, however, a cash-manipulating company will not deduct the accounts payable with complete honesty and claim the amount in theoperating cash flow (OCF) as cash on hand.
Companies can also get a huge boost by writing all their checks late and using overdrafts. This boost, however, is a result of how Generally Accepted Accounting Principles (GAAP) treat overdrafts: they allow, among other things, for overdrafts to be lumped into accounts payable, which are then added to operating cash flow. This allowance has been seen as a weakness in the GAAP, but until the accounting rules change, youd be wise to scrutinize the numbers and footnotes to catch any such manipulation. (For more on analyzing these, see How To Read Footnotes.)
Selling Accounts Receivable
Another way a company might increase operating cash flow is by selling off its accounts receivable. This is also called securitizing. The agency buying the accounts receivable pays the company a certain amount of money, and the company passes off to this agency the entitlement to receive the money that customers owe. The company therefore secures the cash from their outstanding receivables sooner than the customers pay for it. The time between sales and collection is shortened, but the company actually receives less money than if it had just waited for the customers to pay. So, it really doesnt make sense for the company to sell its receivables just to receive the cash a little sooner - unless it is having cash troubles, and has a reason to cover up a negative performance in the operating cash flow column.
Non-Operating Cash
A subtler steroid is the inclusion of cash raised from operations that are not related to the core operations of the company. Non-operating cash is usually money from securities trading, or money borrowed to finance securities trading, which has nothing to do with business. Short-terminvestments are usually made to protect the value of excess cash before the company is ready and able to put the cash to work in the businesss operations. It may happen that these short-term investments make money, but its not money generated from the power of the businesss core operations.
Therefore, because cash flow is a metric that measures a companys health, the cash from unrelated operations should be dealt with separately. Including it would only distort the true cash flow performance of the companys business activities. GAAP requires these non-operating cash flows to be disclosed explicitly. And you can analyze how well a company does simply by looking at the corporate cash flow numbers in the cash flow statement.
Questionable Capitalization of Expenses
Also a subtle form of doping, we have the questionable capitalization of expenses.
Here is how capitalization works. A company has to spend money to make products. The costs of production come out of net income and therefore operating cash flow. Instead of taking the hit of an expense all at once, companies capitalize the expense, creating an asset on the balance sheet, in order to spread the expense out over time - meaning the company can write off the costs gradually. This type of transaction is still recorded as a negative cash flow on the cash flow statement, but it is important to note that when it is recorded it is classified as a deduction from cash flow from investing activities (not from operating cash flow). Certain types of expenditures - such as purchases of long-term manufacturing equipment - do warrant capitalization because they are a kind of investing activity.
The capitalization is questionable if the expenses are regular production expenses, which are part of the operating cash flow performance of the company. If the regular operating expenses are capitalized, they are recorded not as regular production expenses but as negative cash flows from investment activities. While it is true that the total of these figures - operating cash flow and investing cash flow - remain the same, the operating cash flow seems more muscular than that of companies that deducted their expenses in a timely fashion. Basically, companies engaging in this practice of capitalizing operating expenses are merely juggling an expense out of one column and into another for the purpose of being perceived as a company with strong core operating cash flow. But when a company capitalizes expenses, it cant hide the truth forever. Todays expenses will show up in tomorrows financial statements, at which time the stock will suffer the consequences.
Again, reading the footnotes can help expose this suspicious practice.
Summary
Whether it is the world of sports or the world of finance, people will always find some way to cheat; only a paralyzing amount of regulation can ever remove all opportunities for dishonest competition and business requires reasonable amounts of operating freedom to function effectively. Not every athlete is cycling anabolic steroids, just as many companies are honest on their financial statements . That said, the existence of steroids and dishonest accounting methods mean that we have to treat every gold medalist and every companys financial statement with the proper amount of scrutiny before we accept them.
Getting Started In Stocks
So youve decided to invest in the stock market. Congratulations! In his 2005 book The Future for Investors, Jeremy Siegel showed that, in the long run, investing in stocks has handily outperformed investing in bonds, Treasury bills, gold or cash. In the short term, one or another asset may outperform stocks, but overall stocks have historically been the winning path.
Tutorial: Stock Basics
But there are so many ways to invest in stocks. Individual stocks, mutual funds, index funds, ETFs, domestic, foreign - how can you decide what is right for you? This article will address several issues that you, as a new (or not-so-new) investor, might want to consider so that you can rest more easily while letting your money grow.
Risk Taker, Risk Averse or in the Middle?
You may be eager to get started so that you, too, can make those fabulous returns you hear so much about, but slow down and take a moment to contemplate some simple questions. The time spent now to consider the following will save you money down the road.
What kind of person are you? Are you a risk taker, willing to throw money at a chance to make a lot of money, or would you prefer a more sure thing? What would be your likely response to a 10% drop in a single stock in one day or a 35% drop over the course of a few weeks? Would you sell it all in a panic?
The answers to these and similar questions will lead you to consider different types of equity investments, such as mutual or index funds versus individual stocks. If you are naturally not someone who takes risks, and feel uncomfortable doing so but still want to invest in stocks, the best bet for you might be mutual funds or index funds. This is because they are well diversified and contain many different stocks. This reduces risk - and doesnt require individual stock research. (For more insight, read Personalizing Risk Tolerance, Mutual Fund Basics and The Lowdown On Index Funds.)
Have much time and interest do you have for investing?
Should you invest in funds, stocks or both? The answer depends on how much time you wish to devote to this endeavor. Careful selection of mutual or index funds would let you invest your money, leaving the hard work of picking stocks to the fund manager. Index funds are even simpler in that they move up or down according to the type of company, industry or market they are designed to track.
Individual stock investing is the most time consuming as it requires you to make judgments about management, earnings and future prospects. As an investor, you are attempting to distinguish between a money-making stock and financial disaster. You need to know what they do, how they make their money, the risks, the future prospects and much more.
Therefore, ask yourself how much time you have to devote to this enterprise. Are you willing to spend a couple of hours a week, or more, reading about different companies, or is your life just too busy to carve out that time? Investing in individual stocks is a skill, which, like any other, takes time to develop. (For more on this research, read Introduction To Fundamental Analysis.)
Eggs in One Basket
It is best that you not be exposed to only one type of asset. For instance, dont put all of your money in small biotech companies. Yes, the potential gain can be quite high, but what will happen to your investment if the Food and Drug Administration starts rejecting a higher percentage of new drugs? Your entire portfolio would be negatively impacted. (For related reading, see The Ups And Downs Of Biotechnology.)
It is better to be diversified across several different sectors such as real estate (a real estate investment trust is one possibility), consumer goods, commodities, insurance, etc., rather than focusing on one or two or three, as above. Consider diversifying across asset classes, as well, by keeping some money in bonds and cash, rather than being 100% invested in stocks. How much to have in these different sectors and classes is up to you, but being invested more broadly lessens the risk of losing it all at any one time. (For more insight, check out Introduction To Diversification.)
A Portfolio for Beginners
If you are just starting out, think seriously about investing most of your money in a couple of index funds, such as one tracking the broad market (e.g. the S
The 4 Basic Elements Of Stock Value
The ancient Greeks proposed earth, fire, water and air as the main building blocks of all matter, and classified all things as a mixture of these elements. Investing has a similar set of four basic elements that investors use to break down a stocks value. In this article, we will look at the four ratios and what they can tell you about a stock.
Earth: The Price-to-Book Ratio (P/B)
Made for glass-half-empty people, the price-to-book (P/B) ratio represents the value of the company if it is torn up and sold today. This is useful to know because many companies in mature industries falter in terms of growth but can still be a good value based on their assets. The book value usually includes equipment, buildings, land and anything else that can be sold, including stock holdings and bonds. With purely financial firms, the book value can fluctuate with the market as these stocks tend to have a portfolio of assets that goes up and down in value. Industrial companies tend to have a book value based more in physical assets, which depreciate year after year according to accounting rules. In either case, a low P/B ratio can protect you - but only if its accurate. This means an investor has to look deeper into the actual assets making up the ratio. (For more on this, see Digging Into Book Value.)
Fire: Price-to-Earnings Ratio (P/E)
The price to earnings (P/E) ratio is possibly the most scrutinized of all the ratios. If sudden increases in a stocks price are the sizzle, then the P/E ratio is the steak. A stock can go up in value without significant earnings increases, but the P/E ratio is what decides if it can stay up. Without earnings to back up the price, a stock will eventually fall back down.
The reason for this is simple: a P/E ratio can be thought of as how long a stock will take to pay back your investment if there is no change in the business. A stock trading at $20 per share with earning of $2 per share has a P/E ratio of 10, which is sometimes seen as meaning that youll make your money back in 10 years if nothing changes. The reason stocks tend to have high P/E ratios is that investors try to predict which stocks will enjoy progressively larger earnings. An investor may buy a stock with a P/E ratio of 30 if he or she thinks it will double its earnings every year (shortening the payoff period significantly). If this fails to happen, then the stock will fall back down to a more reasonable P/E ratio. If the stock does manage to double earnings, then it will likely continue to trade at a high P/E ratio. You should only compare P/E ratios between companies in similar industries and markets. (If these numbers have you in the dark, these easy calculations should help light the way, see How To Find P/E And PEG Ratios.)
Air: The PEG Ratio
Because the P/E ratio isnt enough in and of itself, many investors use the price to earnings growth (PEG) ratio. Instead of merely looking at the price and earnings, the PEG ratio incorporates the historical growth rate of the companys earnings. This ratio also tells you how your stock stacks up against another stock. The PEG ratio is calculated by taking the P/E ratio of a company and dividing it by the year-over-year growth rate of its earnings. The lower the value of your PEG ratio, the better the deal youre getting for the stocks future estimated earnings.
By comparing two stocks using the PEG, you can see how much youre paying for growth in each case. A PEG of 1 means youre breaking even if growth continues as it has in the past. A PEG of 2 means youre paying twice as much for projected growth when compared to a stock with a PEG of 1. This is speculative because there is no guarantee that growth will continue as it has in the past. The P/E ratio is a snap shot of where a company is and the PEG ratio is a graph plotting where it has been. Armed with this information, an investor has to decide whether it is likely to continue in that direction. (Has the P/E ratio lost its luster? The PEG ratio has many advantages over its well-known counterpart, check out Move Over P/E, Make Way For The PEG.)
Water: Dividend Yield
Its always nice to have a back-up when a stocks growth falters. This is why dividend-paying stocks are attractive to many investors - even when prices drop you get a paycheck. The dividend yield shows how much of a payday youre getting for your money. By dividing the stocks annual dividend by the stocks price, you get a percentage. You can think of that percentage as the interest on your money, with the additional chance at growth through the appreciation of the stock.
Although simple on paper, there are some things to watch for with the dividend yield. Inconsistent dividends or suspended payments in the past mean that the dividend yield cant be counted on. Like the water element, dividends can ebb and flow, so knowing which way the tide is going - like whether dividend payments have increased year over year - is essential to making the decision to buy. Dividends also vary by industry, with utilities and some banks paying a lot whereas tech firms invest almost all their earnings back into the company to fuel growth. (For more readInvestment Valuation Ratios: Dividend Yield.)
No Element Stands Alone
P/E, P/B, PEG and dividend yields are too narrowly focused to stand alone as a single measure of a stock. By combining these methods of valuation, you can get a better view of a stocks worth. Any one of these can be influenced by creative accounting - as can more complex ratios likecash flow. As you add more tools to your valuation methods though, discrepancies get easier to spot. From the Greeks four basic elements, we now have more than 100, some of which exist so briefly that we wonder if they count, and none of them are named water, earth, air, or fire. In investing, however, these four main ratios may be overshadowed by thousands of customized metrics, but they will always be useful stepping stones for finding out whether a stocks worth buying.
9 Tips For Safeguarding Your Accounts
Wisely managing your investments includes taking advantage of all possible protections. While you may already be aware of the Federal Deposit Insurance Corporation (FDIC) insurance for your bank-deposited funds, there are other ways to divide up your funds, lower your potential risk of loss and guarantee your moneys safety. Read on for some ways to keep your money safe that you may want to consider in a bear market. (For background reading, see Are Your Bank Deposits Insured?)
No. 1: Use a brokerage account to invest in brokered CDs.
By opening an account with a brokerage firm you can invest in brokered CDs. These are typically CDs with large denominations, which are issued by banks to brokerage firms for their customers investments. Brokers pool investors funds to purchase the CDs, enabling investors to get a share in larger CDs (with potentially higher interest rates) than what they would be able to access by investing on their own. Brokered CDs also allow investors to buy multiple CDs issued by different banks and qualify for FDIC coverage for each CD held.
Before investing in brokered CDs be sure that:
• You understand the terms and features of each CD you invest in
• The bank offering the CD is an FDIC-insured bank
• You dont invest in a CD offered by a bank where you already hold accounts (because you may inadvertently exceed the FDIC insured limit)
• You get documentation of your ownership (or partial ownership) of the CD from your broker (i.e. a copy of the CDs title) to ensure that you qualify as a depositor for the FDIC coverage. (To learn more, read Are Your Bank Deposits Insured?)
No. 2: Bank with a credit union that carries private excess share insurance.
Some credit unions that are members of the National Credit Union Association (NCUA) carry excess share insurance to provide members with additional coverage for their deposit accounts. (To read more about credit unions, see Tired Of Banks? Try A Credit Union and Choose To Beat The Bank.)
No. 3: Open an account with a DIF- or SIF-insured bank.
The Deposit Insurance Fund (DIF) is a private company headquartered in Massachusetts that provides insurance on deposit accounts for participating state-chartered savings banks. The Share Insurance Fund (SIF) is also a private fund that insures deposit accounts for Massachusetts-chartered co-operative banks. DIF and SIF member banks guarantee depositors funds above the FDIC limit, regardless of both the FDIC limit and the amount of money held by the depositor. All deposit account types are guaranteed, including savings and checking accounts, CDs, money market and retirement deposit accounts. By providing both FDIC insurance and DIF or SIF insurance, member banks can guarantee that their depositors funds are fully insured. Once you open a deposit account with a DIF or SIF member bank, there are no additional qualification tests to meet or forms to complete. In addition, you do not need to be a Massachusetts residents to do business with a DIF or SIF member bank.
No. 4: Invest in CDs with a CDARS network member institution.
When you invest at least $10,000 in a CD with a Certificate of Deposit Account Registry Service (CDARS) member bank, you can get up to $50 million in FDIC insurance. Thats because a CDARS bank can take your large deposit, divide it up into smaller denominations and invest in multiple CDs across the network of member banks, ensuring that you qualify for FDIC insurance protection with each investment at each member bank. By using a CDARS network member bank, you can secure one interest rate on multiple CD investments and choose the maturities that best suit your investment goals. You pay an annual fee for the service and receive one statement summarizing all of your CD investments. (For related reading, see Are CDs Good Protection For The Bear Market?)
Access to top-notch futures studies at no extra cost. Thinkorswim from TD Ameritrade.
No. 5: Open an MMAX money market account.
The Institutional Deposits Corporation (IDC) offers the Money Market Account Xtra (MMAX) through its network of participating community banks nationwide to depositors looking for additional FDIC insurance. When you open an MMAX Account, your participating IDC bank uses its relationship with other participating IDC network members to guarantee FDIC insurance for your total account balance up to $5 million. You are limited to making six withdrawals from your MMAX account monthly.
No. 6: Research your broker and brokerage firm.
While you are responsible for making and approving decisions related to your investments, its important to know your brokers, and his or her firms, record to avoid becoming a potential victim of fraud. You should check into whether your broker is properly licensed and registered and that he or she has not been the subject of investor complaints or investigation. (To learn more, read Broker Gone Bad? What To Do If You Have A Complaint and Evaluating Your Broker.)
No. 7: Check for SIPC Protection.
Check to make sure your brokerage accounts are protected by the Securities Investor Protection Corporation (SIPC). SIPC guarantees up to $500,000 of your invested funds (up to $100,000 in cash) in the event that your stocks or securities are stolen by a dishonest broker or the firm holding your investments fails and your assets are found missing. (To learn more, read Are My Investments Insured Against Loss?)
No. 8: Know your investment time horizon.
Make sure that money you will need in the short-term is invested in low-risk vehicles such as CDs, T-bills and bonds or bond funds. The closer you are to the time when you will need to access your funds, the less risk you can afford to take that you might lose your principal. (For more insight, read Personalizing Risk Tolerance.)
No. 9: Keep good records of all your investment transactions.
If you are concerned that you may be a victim of fraud or if you are simply concerned that there may be inaccurate information on your investment accounts, you will need copies of your account activity to rectify the error(s), file a complaint or take legal action. (To learn more about personal responsibility in the investing process, read Are You A Good Client?)
Conclusion
Investing is never risk-free, but there are ways to reduce your risk and gain additional insurance coverage for your funds. Take the time to protect your funds and your peace of mind by checking out options available beyond FDIC bank deposit insurance.
Investing In A Unit Investment Trust
A unit investment trust (UIT) is a U.S. investment company that buys and holds a portfolio of stocks, bonds or other securities. UITs share some similarities with two other types of investment companies : open-ended mutual funds and closed-end funds. All three are collective investments in which a large pool of investors combine their assets and entrust them to a professional portfolio manager. Units in the trust are sold to investors, or unit holders.
Basic Characteristics
Like open-ended mutual funds , UITs offer professional portfolio selection and a definitive investment objective. They are bought and sold directly from the issuing investment company, just as open-ended funds can be bought and sold directly through fund companies. In some instances, UITs can also be sold in the secondary market. Like open-ended mutual funds, UITs often have low minimum investment requirements and can often be purchased with an initial investment of as little as $1,000. (Learn about the basics - and the pitfalls - of investing in mutual funds, read the Mutual Fund Basics Tutorial.
Like closed-end funds, UITs are issued via an initial public offering (IPO). If purchased at the IPO, there are no embedded gains to be found in open-end mutual funds. Each investor receives a costs basis that reflects the net asset value (NAV) on the date of purchase, and tax considerations are based on the NAV. Open-ended funds, on the other hand, pay out dividends and capital gains each year to all shareholders regardless of the date on which the shareholder bought into the fund. This can result, for example, in an investor buying into a fund in November, but owing capital gains tax on gains that were realized in March. Even though the investor didnt own the fund in March, tax liability is shared among all investors on a yearly basis. (For more articles on taxes, check out the Tax Article Archive.)
Termination Date
Unlike either mutual funds or closed-end funds, a UIT has a stated date for termination. This date is often based on the investments held in its portfolio. For example, a portfolio that holds bonds may have a bond ladder consisting of five-, 10-, and 20-year bonds. The portfolio would be set to terminate when the 20-year bonds reach maturity. At termination, investors receive their proportionate share of the UITs net assets.
While the portfolio is constructed by professional investment managers, it is not actively traded. So after it is created, it remains intact until it is dissolved and assets are returned to investors. Securities are sold or purchased only in response to a change in the underlying investments, such as a corporate merger or bankruptcy. (Learn more about these corporate actions in the Mergers and Acquisitions Tutorial and An Overview Of Corporate Bankruptcy.)
Types
There are two types of UITs: stock trusts and bond trusts. Stock trusts conduct IPOs by making shares available during a specific amount of time known as the offering period. Investors money is collected during this period and then shares are issued. Stock trusts generally seek to provide capital appreciation, dividend income or both. Trusts that seek income may provide monthly, quarterly or semiannual payments. Some UITs invest in domestic stocks, some invest in international stocks and some invest in both.
Bond UITs have historically been more popular than stock UITs. Investors seeking steady, predictable sources of income often purchase bond UITs. Payments continue until the bonds begin to mature. As each bond matures, assets are paid out to investors. Bond UITs come in a wide range of offerings, including those that specialize in domestic corporate bonds, international corporate bonds, domestic government bonds (national and state), foreign government bonds or a combination of issues. (Find out if you need exposure to debt instruments in the Bond Tutorial.)
Early Redemption/Exchange
While UITs are designed to be bought and held until they reach termination, investors can sell their holdings back to the issuing investment company at any time. These early redemptions will be paid based on the current underlying value of the holdings. Investors in bond UITs should make particular note of this because it means that the amount paid to the investor may be less than the amount that would be received if the UIT was held until maturity, as bond prices change with market conditions.
Some UITs permit investors to exchange their holdings for a different UIT at a reduced sales charge. This flexibility can come in handy if your investment objectives change and the UIT in your portfolio no longer meets your needs.
Before You Buy
UITs are legally required to provide a prospectus to prospective investors. The prospectus highlights fees, investment objectives and other important details. Investors generally pay a load when purchasing UITs and accounts are subject to annual fees. Be sure to read about these fees and expenses before you make a purchase.
Surviving Bear Country
A bear market refers to a decline in stock prices of at least 15-20%, coupled with pessimistic sentiment underlying the market. Clearly no stock investor looks forward to these periods. Dont despair, there is hope! In this article we will walk you through some of the most important investment strategies and mindsets that one can use to limit losses - or even make gains - while the stock market is performing in such a manner.
Be Realistic!
First off, having a realistic mindset is one the most important things to do during an economic slowdown. Remember that its normal for the stock market to have negative years - its all part of the business cycle.
After a raging bull market, its easy to forget the bad times. Take, for example, the late 1990s; it was a time of spectacular growth in the equity markets, punctuated by gains in the S
How To Become A Self-Taught Finance Expert
So you want to become a financial expert, but dont know where to start? Have no fear, a wealth of information is at your fingertips, and getting started is easy. From a basic introduction to personal finances to advanced security analysis, anyone interested in learning can get access to the necessary resources. (For more on a career in finance, check out Is A Career In Financial Planning In Your Future?)
For a basic introduction to sound financial concepts, you cant do much better than The Richest Man in Babylon. Its a tiny little book, written in an uncomplicated style. It also captures the wisdom of the ages in an easy to follow manner.
Once youve covered that, the famous For Dummies series provides insight into everything from budgeting to mutual funds. Managing Your Money for Dummies, Budgeting for Dummies and Mutual Funds for Dummies are three titles that will help you expand your knowledge of basic concepts.
By the time you finish those four books, you are likely to have identified specific items that you would like to learn more about. For these inquiries, theres no better place to go for fast, easy access to information that online. Investopedia and similar sites provide access to a wealth of information that will keep you busy for weeks if not months. Investopedias tutorials are particularly notable, as they provide an in-depth look at a wide variety of topics.
Google and other search engines let you hone in on specific topics, and many mutual fund companies and financial services firms offer a wealth of free information. A visit to their websites can reveal everything from general education on a wide array of products to economic forecasts and economic insights from professional market watchers. With a just a little effort, you can even identify and follow comments from your favorite economist, investment strategists, portfolio manager, or other expert.
The library, you local bookstore and multiple online retailers also offer literally thousands of books on every conceivable topic. From financial history and Wall Street villains to hedge fund analysis and day-trading strategies, theres a book (or ten) for every topic of interest. (For more read, Can You Learn The Stock Market?)
Television, Radio and Podcasts Can Help Too
Television broadcasts and/or podcasts are from a variety of experts. At the national level, Suze Orman and other gurus cover the common topics. Kramer and his peers talk stocks. At the local level, your hometown is likely to have an expert or two that you can tune into at no cost. (To read more on gurus, see Investing Quotes You Can Bank On.)
Ready to Step Up Your Game? Hit the Books Again
After you have covered the basics and want a solid overview at a more detailed level, The Wall Street Journal Guide to Investing is a great place to start. When you are done with that, your local library or bookstore will contain a variety of magazines covering both timely and general financial services topics. When you are ready to learn about stock research, Value Line is a great publication that provides an introduction into how you can begin to research and analyze stocks. Some libraries provide access to Value Line for free. If your local library does not, the service is available by subscription. Even if you choose not to conduct your own stock analysis, the Value Line website is worth a visit.
If you make it this far, you are clearly serious about your endeavor. Now its time to make your quest a daily habit. Subscribing to the The Wall Street Journal will give you a daily overview of the issues impacting global business operations. The Journal also has a great Money and Investing section. Barrons is another fine publication read by many professionals in the financial services industry. There are many other top-quality publications dedicated to various aspects of the financial services world. Find one that matches your interests and read it. (Check out, 5 Must-Read Finance Books.)
Talk to the Experts
Once you have solid understanding of the various aspects of the financial services world, it is time to spend some time talking to the experts. Financial services professionals make a living with their expertise and can help you learn about everything from mortgages and debt management to retirement savings and estate planning. Some of these topics are covered in seminars, others in one-on-one consultations. You can even pick up a thing or two just by having an informal conversation. Talk to a professional financial advisor, talk to your banker, talk to your accountant and your attorney. Then listen and learn as they share their knowledge. (For help on locating an advisor, read Advice For Finding The Best Advisor.)
Ready for More?
If you like what you have seen and heard and are ready for more, the CFA Institute (a non-profit organization that offers a range of educational and career resources, including the Chartered Financial Analyst (CFA) and the Certificate in Investment Performance Measurement (CIPM) designations) provides access to the curriculum for several of their well-regarded programs for free:
• http://www.cfainstitute.org/cfaprogram/courseofstudy/Pages/study_sessions.aspx
• http://www.cfainstitute.org/cipm/courseofstudy/curriculum/Pages/index.aspx
The Certified Financial Analyst program is an extremely well regarded curriculum, and the Certificate in Investment Performance Measurement (CIPM) Program is the investment industrys only designation dedicated to investment performance analysis and presentation. If articles with titles like Evaluating Portfolio Performance by V. Bailey, Thomas M. Richards and David E. Tierney, and Investment Performance Measurement: Evaluating and Presenting Results, Philip Lawton and Todd Jankowski, eds. (Wiley 2009) capture your interest, the CFA institute has a reading list that you are sure to like. (For help choosing a designation, check out CPA, CFA Or CFP - Pick Your Abbreviation Carefully.)
A Life-Long Pursuit
The financial services field is constantly evolving and changing. Recent decades have seen the rise of unified managed accounts, the development of exchange traded funds, the evolution of annuities and insured investment products and a host of other developments. Change is par for the course as the industry adapts to dynamic economic conditions and changes in what investors want and how they wish to deploy their assets. In this environment, there is always something new to consider, something old to revisit and something interesting just beyond the horizon. Keeping up with the industry is an important part of a financial service professionals life, and continuing education requirements are required for many of these experts to maintain their credentials. What this means for the-self taught expert is that you will always have an opportunity to add to your body of knowledge.
Open Your Eyes To Closed-End Funds
Fixed-income investors are often attracted to closed-end funds because many of the funds are designed to provide a steady stream of income, usually on a monthly or quarterly basis as opposed to the biannual payments provided by individual bonds.
Perhaps the easiest way to understand the mechanics of closed-end mutual funds is via comparison to open-end mutual and exchange-traded funds with which most investors are familiar. All these types of funds pool the investments of numerous investors into a single basket of securities or fund portfolio. While at first glance it may seem like these funds are quite similar - as they share similar names and a few characteristics - from an operational perspective, they are actually quite different. Here well take a look at how closed-end funds work, and whether they could work for you.
Open-End Vs. Closed-End
Open-end fund shares are bought and sold directly from the mutual fund company. There is no limit to the number of available shares because the fund company can continue to create new shares, as needed, to meet investor demand. On the reverse side, a portfolio may be affected if a significant number of shares are redeemed quickly and the manager needs to make trades (sell) to meet the demands for cash created by the redemptions. All investors in the fund share costs associated with this trading activity, so the investors who remain in the fund share the financial burden created by the trading activity of investors who are redeeming their shares.
On the other hand, closed-end funds operate more like exchange-traded funds. They are launched through an initial public offering (IPO) that raises a fixed amount of money by issuing a fixed number of shares. The fund manager takes charge of the IPO proceeds and invests the shares according to the funds mandate. The closed-end fund is then configured into a stock that is listed on an exchange and traded in the secondary market. Like all shares, those of a closed-end fund are bought and sold on the open market, so investor activity has no impact on underlying assets in the funds portfolio. This trading distinction can be an advantage for money managers specializing in small-cap stocks, emerging markets, high-yield bonds and other less liquid securities. On the cost side of the equation, each investor pays a commission to cover the cost of personal trading activity (that is, the buying and selling of a closed-end funds shares in the open market).
Like open-end and exchange-traded funds, closed-end funds are available in a wide variety of offerings. Stock funds, bond funds and balanced funds provide a full range of asset allocation options, and both foreign and domestic markets are represented. Regardless of the specific fund chosen, closed-end funds (unlike some open-end and ETF counterparts) are all actively managed. Investors choose to place their assets in closed-end funds in the hope that the fund managers will use their management skills to add alpha and deliver returns in excess of those that would be available via investing in an index product that tracked the portfolios benchmark index.
Pricing and Trading: Take Note of the NAV
Pricing is one of the most notable differentiators between open-end and closed-end funds. Open-ended funds are priced once per day at the close of business. Every investor making a transaction in an open-end fund on that particular day pays the same price, called the net asset value (NAV). Closed-end funds, like ETFs, have an NAV as well, but the trading price, which is quoted throughout the day on a stock exchange , may be higher or lower than that value. The actual trading price is set by supply and demand in the marketplace. ETFs generally trade at or close to their NAVs.
If the trading price is higher than the NAV, closed-end funds and ETFs are said to be trading at a premium. When this occurs, investors are placed in the rather precarious position of paying to purchase an investment that is worth less than the price that must be paid to acquire it.
If the trading price is lower than the NAV, the fund is said to be trading at a discount. This presents an opportunity for investors to purchase the closed-end fund or ETF at a price that is lower than the value of the underlying assets. When closed-end funds trade at a significant discount, the fund manager may make an effort to close the gap between the NAV and the trading price by offering to repurchase shares or by taking other action, such as issuing reports about the funds strategy to bolster investor confidence and generate interest in the fund.
Closed-End Funds Use of Leverage
Closed-end funds have another quirk unique to their fund structure. They often make use of borrowings, which, while adding an element of risk when compared to open-end funds and ETFs, can potentially lead to greater rewards. This leverage is the main reason why closed-end funds typically generate more income than open-end and exchange-traded funds.
Why Closed-End Funds Arent More Popular
According to the Closed-End Fund Association, closed-end funds have been available since 1893, more than 30 years prior to the formation of the first open-end fund in the U.S. Despite their long history, however, closed-end funds are far outnumbered by open-ended funds in the market.
The relative lack of popularity of closed-end funds can be explained by the fact that they are a somewhat complex investment vehicle that tends to be less liquid and more volatile than open-ended funds. Also, few closed-end funds are followed by Wall Street firms or owned by institutions. After a flurry of investment banking activity surrounding an initial public offering for a closed-end fund, research coverage normally wanes and the shares languish.
For these reasons, closed-end funds have historically been, and will likely remain, a tool used primarily by relatively sophisticated investors.
The Bottom Line
Investors put their money into closed-end funds for many of the same reasons that they put their money into open-end funds. Most are seeking solid returns on their investments through the traditional means of capital gains, price appreciation and income potential. The wide variety of closed-end funds on offer and the fact that they are all actively managed (unlike open-ended funds) make closed-end funds an investment worth considering. From a cost perspective, the expense ratio for closed-end funds may be lower than the expense ratio for comparable open-ended funds.
Conglomerates: Cash Cows Or Corporate Chaos?
Conglomerates are companies that either partially or fully own a number of other companies. Not long ago, sprawling conglomerates were a prominent feature of the corporate landscape. Vast empires, such as General Electric (NYSE:GE) and Berkshire Hathaway (NYSE:BRK.A), were built up over many years with interests ranging from jet engine technology to jewelry. Corporate hodgepodges like these pride themselves on their ability to avoid bumpy markets. In some cases, they have produced impressive long-term shareholder returns - but this doesnt mean that corporate conglomerates are always a good thing for investors. If youre interested in investing in these behemoths, there are a few things you should know. Here we explain what conglomerates are and give you an overview of the pros and cons of investing in them.
The Case for Conglomerates
The case for conglomerates can be summed up in one word: diversification. According to financial theory, because the business cycle affects industries in different ways, diversification results in a reduction of investment risk. A downturn suffered by one subsidiary, for instance, can be counterbalanced by stability, or even expansion, in another venture. In other words, if Berkshire Hathaways brick-making division has a bad year, the loss might be offset by a good year in its insurance business.
At the same time, a successful conglomerate can show consistent earnings growth by acquiring companies whose shares are more lowly rated than its own. In fact, GE and Berkshire Hathaway have both promised - and delivered - double-digit earnings growth by applying this investment growth strategy.
The Case Against Conglomerates
However, the prominent success of conglomerates such as GE and Berkshire Hathaway is hardly proof that conglomeration is always a good idea. There are plenty of reasons to think twice about investing in these stocks , particularly in 2009, when both GE and Berkshire suffered as a result of the economic downturn, proving that size does not make a company infallible.
Investment guru Peter Lynch uses the phrase diworsification to describe companies that diversify into areas beyond their core competencies. A conglomerate can often be an inefficient, jumbled affair. No matter how good the management team, its energies and resources will be split over numerous businesses, which may or may not be synergistic.
For investors, conglomerates can be awfully hard to understand, and it can be a challenge to pigeonhole these companies into one category or investment theme. This means that even managers often have a hard time explaining their investment philosophy to shareholders. Furthermore, a conglomerates accounting can leave a lot to be desired and can obscure the performance of the conglomerates separate divisions. Investors inability to understand a conglomerates philosophy, direction, goals and performance can eventually lead to share underperformance.
While the counter-cyclical argument holds, there is also the risk that management will keep hold of businesses with poor performance, hoping to ride the cycle. Ultimately, lower-valued businesses prevent the value of higher-valued businesses from being fully realized in the share price . (For further reading, see The Ups And Downs Of Investing In Cyclical Stocks.)
Whats more, conglomerates do not always offer investors an advantage in terms of diversification. If investors want to diversity risk, they can do so by themselves, by investing in a few focused companies rather than putting all of their money into a single conglomerate. Investors can do this far more cheaply and efficiently than even the most acquisitive conglomerate can.
The Conglomerate Discount
The case against conglomerates is a strong one. Consequently, the market usually applies a haircut to the piecewise, or sum-of-parts, value - that is, it frequently values conglomerates at a discount to more focused companies. This is known as the conglomerate discount. According to a 2001 article in CFO Magazine, academic studies have suggested in the past that this discount could be as much as 10-12%, but more recent academic inquiries have concluded that the discount is closer to 5%. Of course, there are some conglomerates that command a premium but, in general, the market ascribes a discount.
The conglomerate discount gives investors a good idea of how the market values the conglomerate as compared to the sum value of its various parts. A deep discount signals that shareholders would benefit if the company were dismantled and its divisions left to run as separate stocks.
Lets take a shot at calculating the conglomerate discount using a simple example. Well use a fictional conglomerate called DiversiCo, which consists of two unrelated businesses: a beverage division and a biotechnology division.
DiversiCo has a stock market valuation of $2 billion and total debt of $0.75 billion. Its beverage division has balance sheet assets of $1 billion, while its biotechnology division has $0.75 billion worth of assets. Focused companies in the beverage industry have median market-to-book values of 2.5, while pure play biotech firms have market-to-book values of 2. DiversiCos divisions are fairly typical companies in their industries. From this information, we can calculate the conglomerate discount:
Example - Calculating the Conglomerate Discount
Total Market Value DiversiCo:
= Equity Debt
= $2 billion $0.75 billion
= $2.75 billion
Estimated Value Sum of the Parts:
= Value of Biotech Division Value of Beverage Division
= ($0.75 billion X 2) ($1 billion X 2.5)
= $1.5 billion $2.5 billion
= $4.0 billion
So, the conglomerate discount amounts to:
= ($4.0 billion - $2.75 billion)/$4.0 billion
= 31.25%
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DiversiCos conglomerate discount of 31.25% seems unusually deep. Its share price does not reflect the true value of its separate divisions. It becomes clear that this multibusiness company could be worth significantly more if it were broken up into individual businesses. Consequently, investors may push for divesting or spinning off its beverage and biotech divisions to create more value. If that were to happen, Diversico might be worth closer examination as a buying opportunity.
What to Look For
The big question is whether investing in conglomerates makes sense. The conglomerate discount suggests it does not. But there may be a silver lining. If you invest in conglomerates that break up into individual pieces through divestitures and spinoffs, you could capture an increase in value as the conglomerate discount disappears. As a general rule, you stand to get greater returns when conglomerates break up than when they are built.
That said, some conglomerates do command a valuation premium - or at least a slim conglomerate discount. These are extremely well-run companies. They are managed aggressively, with clear targets set for divisions. Underperforming companies are quickly sold, or divested. More importantly, successful conglomerates have financial rather than strategic or operating objectives, adopting strict approaches to portfolio management .
If you choose to invest in conglomerates, look for ones with financial discipline, rigorous analysis and valuation, a refusal to overpay for acquisitions and a willingness to sell off existing businesses. As with any investment decision , think before you buy and dont assume that big companies always come with big returns.