The majority of investment activities is carried out by institutional investors, including mutual funds.  They buy and sell large quantities of shares and get preferential treatment on trade commissions.  Although everyone can try investing for him or herself, investment is a profession and requires professional knowledge and expertise, as well as resources.  With a certain degree of share concentration, some mutual funds may even seek board seats of their portfolio companies and try to exert a more active role in corporate governance.  As a result, funds can have more control over their investments and that often leads to better investment performance.

Professional Management

Mutual funds are investment companies that are highly regulated by the Securities and Exchange Commission for the protection of the investing public.  Like corporations, mutual funds have boards of directors to oversee fund management and the boards appoint registered investment advisers for its portfolio management.  Professional money managers have the expertise and resources to perform in-depth analysis for any investment made.  There are many research organizations such as Morningstar that track and compare mutual fund performance, which creates competition and encourages fund managers to deliver better returns for investors.

Fund Diversification

Most mutual funds are actively managed and invest in a diverse range of securities, which individual investors without enough capital can hardly match.  There are well over a thousand mutual funds to choose from and they represent a full range of industries and companies, from value or growth stocks, small cap or large cap companies, to domestic or emerging markets, to bonds and various cash equivalents.  Investors should study a fund’s prospectus and learn about its investment objectives and investing methods in order to make informed selections.

Fund Liquidity

Buying mutual fund shares has almost the same level of liquidity as trading stocks.  By law, mutual funds must redeem their fund shares upon investor request.  Trading mutual funds can be easily done through either placing orders with a broker or directly contacting fund companies.  Mutual fund share value, known as net asset value NAV, is calculated and announced once at the end of the trading day based on share prices of a portfolio’s underlying securities.  Normally prior day NAV is applicable for share redemption application received before a cut off time.

Mutual Fund Popularity

As of July 2010, the U.S. combined mutual fund assets under management is over $10 trillion.  Not only have mutual funds been popular among individual investors, but also for the nations massive 401(k) plans that have continued to have their retirement money invested in mutual funds.  For 401(k) administrators, when it comes to provide investment choices for a plan’s employees, it seems that mutual funds are the automatic option.  The mutual fund industry has also lobbied hard to secure this valuable funding source.

Buyer Beware

Though mutual funds have many clear advantages as an investment vehicle, they aren’t all created equal.  Make sure the mutual funds you invest in meet your investment goals and aren’t full of fees, such as loads, that will sap your return.  Watch who has managed the fund and how long they have run the fund and what they have invested themselves in the fund.  Take a close look at the prospectus to see the underlying investments.  You may find that a fund’s investments don’t match as well as you would like to their description or name.

In all, mutual funds are a great way for a person to invest in a broad variety of investments without having to buy each individual security. Chosen carefully, mutual funds can help create and grow wealth for years to come.

What do you think of mutual funds?  What do you look for in a fund?

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Why Invest In Mutual Funds

Despite all the latest turmoil of the stock market during the Great Recession of 2008, as we now call it, investing in stocks remains the premier means to investing. The stock market tends to have volatile performances in times of any economic uncertainties, but that is why it is a good barometer for the economy.  The stock market in general will always deliver long-term returns, just as the economy eventually advances after trying times.  No other investment vehicles are as closely and directly related to the many aspects of an economy as the stock market.  As risky as it may seem, the stock market is still arguably the most rewarding investment place.  Two critical elements are worth considering in answering “why invest in stocks?”

Long-Term Capital Appreciation

Real wealth creation comes from growing investments not out of earning only fixed interests or dividends.  For $1,000 invested in Berkshire Hathaway in 1964, the investment would have grown to $8 million in value today.  Results on smaller scales compared to what Warren Buffett has consistently delivered are certainly achievable with other long-running corporate America stocks.  At around 15 percent annualized return, an investor who started with $1,000 elsewhere could also have become a millionaire after the same length of time.  No bonds of any kind can reach such a level of growth as any price appreciation in bonds depends on the few single-digit changes in market interest rates.  Investment results from real-estate investing could on the other hand vary widely as no uniform market pricing mechanism exists, especially considering the transparency and efficiency of the stock market.  When it comes to investment growth, the stock market delivers.

Short-Term Trading Advantage

Investing in stocks is often said as owning a piece of business.  On a fundamental level, it is very true.  Investors, institutional or retail, analyze companies in different sectors and industries in search for both value and growth stocks.  Whenever investing is detached from the underlying business, it becomes the trading of mere ticker symbols.   However, having designed a solid, business-focused investment plan, it would be foolish not to take advantage of trading opportunities.  Trading has become increasingly convenient for investors at any level.  Buying and selling stocks can be done with only a mouse click and in the comfort of one‘s home, while other investing such as bond trading is not nearly as accessible to average investors.  Market volatility makes stock prices of even good businesses rise and fall on their way up.  Investors with an eye on trading allow themselves to generate higher returns.  If an investment stays all the way in, it may produce only 15 percent.  But if, from time to time, an investor tries to sell at near tops and then buying back at close to bottoms, such a trading element incorporated into investing may help turn a boring 15 percentage rate into an awesome 60 percent.

Buyer Beware

Though stock investing has, at times, clear cut advantages to other investment vehicles, there is still substantial risk if the investor doesn’t do his homework.  One still needs to do their research and understand the value of the company they are buying into.

What do you think?  Why should one invest in stocks?

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Why Invest In Stocks

Why invest in bonds? We hear so much about stocks in the news but bonds don’t get mentioned with the same level importance and urgency (the Dow stock index gets all the glory on the 6 o’clock news).  Yet bonds are an integral piece of most portfolios as well as being an important debt instrument, used to create capital for businesses and municipalities.

While the stock market is a leading economic indicator, the bond market reveals what actually happens in the current economy. Bond prices rise and fall as interest rates change over time under different economic conditions.  The bond market is also a size of many times as the stock market.  Issuing bonds are much easier than launching IPO’s for a company (and government agencies can’t exactly launch an IPO).  Financing through various bond markets provide the necessary liquidity beyond any capital injection like by stock issuing.  In a modern economy, even the baking system must co-exist with the bond market.  For serious investors, the bond market holds certain real opportunities.

Here are some key reason to invest in bonds:

Principal Preservation

Despite the ongoing price change in any bond market, if a bond is held to maturity, investment principal is paid back by the issuer.  In a low rate environment, bond prices can keep rising and bond investors will also have the chance to participate in capital appreciation.  Low interest rates often persist when an economy is emerging from recovery and before it gets overheated.  In the event of a bond default and issuer bankruptcy, bond investors have preferential claims over equity investors.  Sometimes when a company’s common stock continues to perform poorly, in a capital restructure, bonds may be converted to preferred shares, which gives bond holders continued income payments as dividends.  Although the bond maturity is put on hold, note that certain preferred shares are not perpetual.

Predictable Income

While common dividends can be suspended and scraped, preferred dividends can be put in arrear, bond interest must be paid every six months in the form of coupon payments.  No dividends are excluded from personal income tax, but certain bonds are tax exempt with no tax paid on interest at either the state level or the federal level.  For investors with safety in mind, bond investing is a decent choice.  It offers a much higher yield than savings from banks but without raising risk considerably.  Bond investing is especially suitable for retirees and savers, such as of college funds.

Portfolio Balancing

Without bonds as part of a portfolio, investment losses from time to time could be in a much higher percentage if invested in stocks alone.  Although stocks can return well over the long run, in short or immediate term, they may well be outperformed by bonds, especially at certain times in the economic cycle.  Another layer of bond safety is through credit ratings.  While ratings on more exotic securities have failed, corporate bond rating has been fairly reliable.  No other investments provide such a systematic risk evaluation, be it real estate, stocks, or commodities.  Bond investors have an advantage when using bond rating as an investing guide to construct a balanced portfolio that stresses both safety and return.

Another important aspect of portfolio balancing is that bond prices tend to move opposite of stock prices in general.  Investing in bonds can help ease a period of dropping stock prices.

So you see, stocks get all the glory when it comes to investing but bonds are an important tool for many businesses as well as an important piece of a balanced investing portfolio.

What do you think of bond investing?  Why do you invest in bonds?

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Why Invest in Bonds?

In my humble opinion, I think that all of us should invest our savings. In fact, the sooner we start investing, the better our results will be.  Often the problem is that investment language sounds like Chinese and there are more products that you can find in a Dollar Store.  The key point to remember when you are a beginner investor is to start with a simple investment method. Then, along the path to becoming a knowledgeable investor, you will be able to implement more complex investment theories.

Before starting to invest, the very first step is to know your asset classes and determine how you want to invest your money at the beginning.  You can put most of your investment in the same account or work with investment buckets as suggested by Anthony Robbins.  So how do you start investing?  Here are a few guidelines:

Set up the investing habit

All right, you are all pumped up and you want to make money.  At the same time, you are a bit scared of the markets (remember, the great depression is about to come… tsss) and you don’t know how to start your investment strategy.

The very first thing you need to do is to open an investment account.  At first, I’d suggest you do it with a good financial advisor.  Usually, bankers or independent advisors have decent investment products for the masses and they will be able to help you set up your account.  For more advanced investors, opening a brokerage account will be the best thing to do but I’ll talk about that later on.  Don’t forget to shop around and I would also suggest not investing in funds with high MER’s (management fees) or load fees (penalties when cashing your money prematurely).

Some great places to open investment accounts are ShareBuilder, Zecco, and TradeKing.

Once your investment account is opened, you need to determine a monthly or bi-weekly investment amount.  The easiest way to succeed as a beginner is investor is through systematic investments. Start with a small amount and increase it over time.  If you consider your investment as another payment, you will make it on time and will simply get used to living with less disposable cash in your pocket.

One last note for investment beginners; if you start with systematic investments, you can start as low as $25 a month or lower!

Select an investment strategy for beginners

My favorite investment solution for investment beginners is packaged mutual funds.  They offer a variety of levels of risk (from very safe to extremely volatile) and they are low in transaction costs.  While it is far from being the most sophisticated investment solution, I think it is perfect for someone who wants to get familiar with the world of investing.

This is why I am suggesting to go with a banker or a financial advisor.  He will complete an investor profile and will make sure to invest your money according to your goals, the time horizon the money will be invested for and your risk tolerance.  He will then offer you a mutual fund where your money will be invested among the stock markets, fixed income as well as other asset classes.

This kind of mutual fund is managed by a team of portfolio managers and they rebalance your portfolio to make sure you always have a consistent proportion of each asset class in your investment account.

So, just to keep things simple, I’ve gathered the Investment Beginners Baby Steps:

Remember, investing is a long path to financial freedom.  It’s not a highway!

What do you think of Mike’s investment strategy for beginners?

This post has been written by Mike from Green Panda Treehouse.  He is a financial planner and runs several finance blogs within his online company.  If you like this post, make sure to stop by Green Panda Treehouse and subscribe to his RSS feed.

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Investment Strategy For Beginner Investors

We are all human here, right? And one thing you can always count on with humans is that we are emotional beings.  We experience fear, pride, lust, greed and everything in between.

What the heck am I talking about?  I’m talking about investment strategy!

Investing is one of those financial musts to get ahead yet it stirs just about every emotion humans are capable of feeling.  When thinking about possible returns, you will get excited, enthused and even start to feel greedy…to think you will be able to retire fat and happy with a boatload of money!  What a joy that would be.  But investing also produces fear, anger and confusion because investing is difficult to understand and if you fail at it, you could lose everything.

What if there was an investment strategy that could disconnect you from the emotional side of investing and still provide results? I am talking about Dollar Cost Averaging. This investment strategy solves two of the most common problems with investing; emotion clouds judgment and the general unpredictability of the market itself.

Let’s address these issues one at a time.

Humans and our emotions

We have all seen what emotional investing can do.  During the meltdown of 2008, it seemed everyone was pulling out of the market.  Weathered investors were tossing fine tuned investment strategies to the wind because they stopped listening to their brains, and started thinking with their emotions.

“Be fearful when others are greedy and greedy when others are fearful” – Warren Buffet

The fact that everyone was pulling out of the market (fear) caused everyone to doubt the stability of the country.  The economy took a dive and the rest is history.  That is what emotional investment brings to the table.  A plan is worthless if not followed through and when emotions like fear, or even greed interfere with an investment strategy, then you are better off dropping your fortune on the roulette table in Vegas.

Emotion aside, the unpredictability of the market throws a wrench into the gears.

The unpredictability of the market, and the reverse of humans

You will never be able to accurately predict the market. You may be able to guess a stock here or there but the second you make a bad guess, and lose $80,000 on that guess, you may rethink your lack of strategy.

The market will never become more predictable…so how do people make any money in the stocks?

One way is Dollar Cost Averaging

Dollar Cost Averaging is investing a set amount of money over a set period of time, regardless of what the market does.  By doing this, your portfolio will average out the major ups and downs of the market to create more balance and reduce risk.  The strategy works best for buy and hold investors.

I am not an investment guru but this strategy is pure logic and is one of the best ways to go for the regulars like you and me that are not only in it for the long haul, but want to avoid the stress of trading while still making money doing it.

This strategy, coupled with other investment rules of thumb such as having a diversified portfolio, can ease you into the market and mitigate much of the risk of going at it without a strategy at all.

Let me give you two scenarios to illustrate the strategy.

Scenario A: Timing the market

You have $1000 set aside each month to invest in the stock market.  You watch the market and do your research.  You pick a company that you want to buy and it looks like a sound choice.  They have a good running history and look to be doing well, but seem undervalued.  Great.  The next step is to actually put that money into action and buy stock in that company.  You continue to hold off, watching the companies ticker for that big dip when you will get in, but the stock continues to rise.  You start to feel like you are missing out on the opportunity.  You get nervous and your emotions start to take over.  Time is ticking and you decide to just go for it.  The stock is nearing it’s 52 week historic high but you don’t want to miss out on gains as it continues to rise!  You go for it…pumping that $1000 you set aside for the past few months into this golden goose.  To your dismay, in the following days, your company announces a change in direction into within the company, and the stock price begins to decline!

“It’s ok”, you tell yourself as you watch the little red ticker sink lower and lower each day.  “The company will turn things around.  The public will eventually take a liking to what the company is doing now and the stock will start to go back up…right?”  You wait, and watch.  Fear takes hold again and you can’t stand to see any more of your money lost on this poor choice…on this failure…so you sell…

Well, just like you said, the public took notice of the companies new direction and the stock started to gain value again.  The stock went back up, even higher than when you bought it.  Not only did you lose potential gain, you lost your investment money by selling at the bottom.

Scenario B: Dollar Cost Averaging

You have that same $1000.  You decide you aren’t “that guy” that has all the luck, so you set up an automatic investment strategy.  Your $1000 will be invested into the company of your choice, at $250 chunks each week.  You will leave that account alone and let it do it’s thing, checking it periodically out of curiosity.  You insist to yourself that you won’t meddle with the plan you have put in place.  You will let that account continue to invest automatically, every week, for the next year then review your progress.

You continue to watch the stock ticker of the company you have chosen but you swore to let it ride.  Each week, with the shifts in the market, your company stock shifts.  One week it was way up, the next it dropped a little, and the next it was well below the 52 week low.

At the end of the year, you review your progress.  After checking the general standing of the account, which is overall very positive, you investigate how this happened, with all the ups and downs of the market.

The outcome

With Scenario A, you lost money, were an emotional wreck, and developed an ulcer from the stress.  Your emotions took over while trying to time the market and you ended up with a big loss.

With Scenario B, you gained a profit, were able to relax and watch your money grow and emotion had nothing to do with it.  Sure, you felt a bit stressed when the market went down.  We all do!  But you had a strategy, stuck to it, and in the end came out golden.

Here’s why it works

There are a couple things you need to understand about Dollar Cost Averaging.  First, because you set this up and let the computers take over, you aren’t actually “pulling the trigger” on any decisions.  This puts emotions in the back seat and distances you from the actual process.  That’s a good thing.

Second, because the plan is a long term strategy and doesn’t rely on the market itself when making decisions, you aren’t timing the market at all and the volatility of the market will have much less effect on your portfolio’s overall gains.

And third, why you will profit from this strategy is because while your money is being invested automatically at set intervals, the stock price is changing.  But you have a set amount to be invested so when the stock price is higher, you will buy less shares; when the stock price is lower, you will end up with more shares.  Getting more shares at a lower price and less at a higher gives your portfolio more opportunity for that stock to climb when it’s low and won’t allow you to buy a large amount when it’s high so your potential for a huge fall is limited.

As long as the company stock gains overall for the period of time you are investing in it, regardless of the market ups and downs, you will generally come out with a profit.

A great way to dollar cost average stock purchases is with ShareBuilder’s automatic investing.  Check it out!

What do you think of dollar cost averaging?

Jesse Michelsen, who writes at Personal Finance Firewall, is a regular guy with a family.  He has a modest stock portfolio and does what he can to reduce risk while still planning out his retirement.  This is his interpretation of Dollar Cost Averaging and why it works but it is also opinionated.  Disclosure: Investing comes with risk.  This blog, nor this author, can be held responsible for investment loss.  Do your research before investing!

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Dollar Cost Averaging Helps Eliminate Emotion And Market Risk

A 401(k) plan is an awesome vehicle to save for retirement! But what do you do if you leave your job?  Do you take the 401(k) with you?  Where do you put it?  Should you leave it?  You have some choices for your 401(k) which I’ll outline for you below:

Choices For Your 401(k) When You Leave Your Job

Leave the money in your prior employer’s 401(k) plan

Pros:

• Easy – What’s easier than doing nothing?  If you leave the money in your prior company’s plan then you don’t have to worry about paperwork or finding new funds to put the money into.
• Continue to save tax-deferred – Your money still gets the benefit of growing tax-deferred in the old 401(k) plan.
• Same investment choices – You may already be happy with the investments your 401(k) plan was in.  Moving the money may require you to find new funds which, in some cases, could cost you more in expenses.
• Re-balancing options – Many 401(k) plans offer re-balancing options where the fund company will automatically re-balance your investments based on your instructions or alert you to re-balance once the investments grow a specified percentage from their original allocation.  An IRA plan may not offer this.
• No cost to move between plan options – The 401(k) plan may not cost you anything to move money between the different investments offered in the plan.  With an IRA you may have to pay commissions.

Cons:

• Not good investment choices – Not all 401(k) plans are created equal.  Some only offer a few funds to choose among while others may have high fund expenses.
• Less options for beneficiaries and withdrawals – The old 401(k) may limits on your future withdrawals and who you can designate as a beneficiary.
• Plan can change – You old employer can decide to move their 401(k) to another company that doesn’t offer the same options or could cost you more in fund expenses (which means a lower overall return).

Roll the money to your new employer’s 401(k) plan

Pros:

• Continue to save tax-deferred – Just like leaving your money in your prior employer’s plan, your money can continue to grow tax-deferred in the new plan.  You also get to add money and possibly add employer matches.
• Consolidate 401(k) accounts – You can keep all of your 401(k) accounts in one place, making them easier to manage.  Over time, a person may have 401(k)’s from a number of jobs so it can be nice to have all of that money consolidated in one place.
• May have plan options you prefer – Your current employer may have a great plan with lots of investment options and very low fees.  Sometimes a large corporation will have funds in their 401(k) plan that have lower fees than are available if you tried to buy the same fund on your own.
• Loan option may be available – You can’t take a loan against a 401(k) plan where you aren’t employed and you can’t take a loan against an IRA.  It may not be the best option to take a loan but you at least have the option with your current employer’s 401(k) plan.
• Re-balance options may be available – You new employer’s plan may have options for automatic re-balancing of your portfolio and/or alerts when the allocations change.
• Defer distributions if over 70 1/2 and still working – You may be able to hold off required distributions meaning you get to let the money to continue to grow tax-deferred until you need it.

Cons:

• Limited investment options – There may not be many option for your money.
• High fund expenses – Some company plans have investment options with higher fees than if you invested on your own in an IRA.
• Plan could change – The company could change their plan and you may end up with less investment choices or higher fund fees.  You can’t roll the money back out of the plan until you leave the company.
• New company has no plan – Not all companies have 401(k) plans.  In this case you have no option to roll money into a new 401(k) plan.
• Limited withdrawal and beneficiary options – Just like in an older company’s plan, there may be limitations on future withdrawals and who you can designate as a beneficiary.

Rollover your money to an IRA

Pros:

• Continued tax-deferred savings – You still get to earn tax-deferred savings until you take the money out.
• Keep accounts together – If you have 401(k)’s from previous employers, as well your own IRA, you may want to roll everything into one IRA so you can better manage your money.  With everything in one account it is much easier to pay attention to asset allocation and you re-balance all of the money one time.
• More investment choices – When you put the money into a Rollover IRA you get to choose the fund company meaning you can choose which company has the most choices for you.  Most IRA custodians offer way more investment choices than a 401(k) does.  In fact, with a brokerage account linked to your IRA you can have thousands of places to put your money.
• Better asset allocation – With more investment choices you also get more options for asset allocation.  Sometimes there isn’t much diversity in the choices in a 401(k).  You can fix this when you put your money in a rollover IRA.
• More choices for timing – When the money is in a rollover IRA, rather than a 401(k), you can pretty much add to the account and move money between funds whenever you want (when the market is open to trade that is).  With a 401(k) you pretty much add to the account when you are paid and some plans have limitations on how many moves you can make with your money.  A rollover IRA allows you more freedom.
• Penalty-free withdrawal for education and first-time homebuying -  A rollover IRA may allow you the option to take money out, penalty free, for education expenses as well as for a first-time home purchase ($10,000 limit).  You still pay income taxes but this is a nice option you don’t have with a 401(k).

Cons:

• Can’t take a loan – I wouldn’t say this is a great option anyway, but there may be times when it’s necessary.  A rollover IRA doesn’t have the option to take out a loan while a 401(k) may.
• Your 401(k) may be in old company’s stock – If part of your 401(k) is in your prior employer’s stock then there are special considerations to take into account regarding taxes and Net Unrealized Appreciation.  Check out this article on MarketWatch for more information on moving company stocks in a 401(k) to an IRA.
• May not have same investment choices as 401(k) – Even though you may have a ton of choices in a rollover IRA you may not have the exact same choices as you did in your 401(k).  Or if you do have the options there may be high commissions on the trades.  If you like the options in your 401(k) then it could be less expensive to keep your money there rather then buy the same investments in a rollover IRA.
• Commission costs – Many times, you can move money between investments in a 401(k) without and fees or commissions.  In a rollover IRA, depending on the plan, you may have to pay commissions when you move money between investments.
• Too many choices – Thousands of options sounds great until you have to pick out a few of them.  Then the options are overwhelming.  More options means more research and work.  For some, too many choices can lead to paralysis analysis.

Cash out the 401(k)

Pros:

• You get cash. Now! – You get access to the money in your 401(k) to do with as you please.  This could come in handy of you have some severe debt to take care of.

Cons:

• Early withdrawal penalty – If you are under 59 1/2 then you will be subject to a 10% early withdrawal penalty.  Right off the bat you lose 10% of your money.
• Taxes – On top of an early withdrawal penalty, you will also get hit with a 20% tax hit which could even turn our to be more when you file your taxes.
• Loss of earning power – You lose out on the opportunity cost of what that money could have earned had you left it to grow tax-deferred until retirement.
• Small amounts add up – Your 401(k)’s from various jobs may not add up to much individually, but together, and over time, the money can add up to a tidy sum.  When you cash out your 401(k) every time you switch jobs you miss out on building wealth.

So what to do?

Personally, I like to have control of my money and have the option to change the investments as I like.  I recently moved money from my prior job to a rollover IRA and the process was pretty easy overall.

Still, you need to look at what works best for you.  I think there are a lot of easy options to invest with in a rollover IRA if you aren’t investing savvy, but for some people it might be less worrisome to leave their money in their 401(k).

In my opinion cashing out is the least desirable option.  Getting a nice lump sum seems nice but you take a big penalty and tax hit and then lose out on future earnings.  Seriously consider the consequences of cashing your 401(k) out.

Some places to open a rollover IRA

Most investment firms these days have options for opening up a rollover IRA.  If you are considering opening up a rollover IRA look at the investment options, fund fees, custodian fees, and commissions.

Some popular places to open up a rollover IRA are Vanguard, Fidelity, ShareBuilder, Zecco, Charles Schwab, E*Trade, and tradeMONSTER.

A few other options for your 401(k)

You may be able to rollover a 401(k) to the following places as well as those described above: Roth IRA, SEP-IRA, 457(b), 403(b), profit-sharing plan.

For more information on rollovers the IRS has some good resources to read: IRA Online Resource Guide – Information About Rollovers and Retirement Topics – Rollovers of Retirement Plan Distributions.

What do you think are the best options for a 401(k) at a prior employer?

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Choices For Your 401(k) When You Leave Your Job

Why do people get excited when their favorite retailer holds a sale, but not when Wall Street does?

Let’s start with the obligatory disclaimer – this is not an encouragement nor a discouragement to buy or sell particular securities, stocks carry risk, consult a financial advisor but you don’t have to, etc.  That was for that infinitesimally small segment of the population that is a) literate enough to read this post, yet b) dumb enough to do whatever a disembodied online voice suggests.  There, now you can read the post absolved of any obligation to think.

Most investors know, in theory, that it’s foolish to buy at the top of the market and sell at the bottom. (Of course, human nature means that the opposite is true in practice – otherwise the top and bottom wouldn’t be where they are.)  But it’s equally foolish to assume that the market will carry you along indefinitely if you just buy a flat representation of it and don’t research at all.  We have 12+ years of real-world evidence of that.  Factoring in inflation, the Dow has risen by an average of .4% annually since February of 1997.  Your index fund would have been better off if it had collected tin cans since the Packers last won a Super Bowl.

There is such a thing as overdiversification. You might find stability in a comprehensive index fund, but it’s impossible to find any significant value.  Buying a basket of Dow stocks, or something similar like a Wilshire 5000 index fund, will likely give fantastic returns over an 80-year period.  If you plan on not waiting until you’re 115 years old to enjoy your money, there are more targeted ways to go about attempting to build wealth in the stock market.

Instead, look at companies that are temporarily wounded, i.e. whose stock sells at a discount. Earlier this year, when the global CEO of Toyota (NYSE: TM) was being grilled on Capitol Hill for selling cars to people who confused the brake with the accelerator, the company’s stock sank.  But some fleeting bad PR can’t negate a decades-long reputation for value and quality.  A few weeks after our demonstrative congressmen and senators finally pulled the curtain on their combination political theater/witch trial, Toyota stock had quietly gained 15%.

Around the time Toyota emerged from a bruising at the unfair hands of public opinion, British Petroleum (NYSE: BP) made Toyota’s problems look trivial.  BP traded at $60.48 the day the Deepwater Horizon spill began.  Today it’s at $36.52, a 60% drop.  The rig’s manufacturer, Transocean (NYSE: RIG), has fallen from $92.03 to $50.04 over the same period, a 46% decline.  Fortunately for Transocean, it’s in an industry with few players.  Also, most people had barely heard of it since it doesn’t sell directly to the public.  (When was the last time you bought an oil rig?)  This distinguishes Transocean from BP, which plasters its logo everywhere and goes out of its way to embed itself in the public consciousness.  Thanks to that insistence, almost everyone identifies the Gulf of Mexico spill with BP more than they do Transocean.

Both BP and Transocean have otherwise healthy financials that can normally withstand a one-time event. Then again, Deepwater Horizon is some event.  But a wounded company isn’t a doomed company: despite the Exxon Valdez disaster, ExxonMobil went from pariah to the world’s most profitable company in just a few years.  Johnson & Johnson rebounded after the Tylenol scare of 1982 and came back stronger than ever.  There are several ways to murder a company along with its stock: obsolescence (Atari), poor economics (General Motors) and rampant crime (Enron) are three of the most efficient.  But for a temporarily disabled company with a history of success and goodwill (in the general sense, not the accounting sense)?  A resurgence is more likely than you think.  Don’t confuse a broken bone with a bullet wound through the cranium.

One more time: there’s always value somewhere in the stock market, but very rarely can you make money simply by buying into the market as a whole.  In fact, the times when the market (as a whole) rises fastest are when the gains are most dubious and tentative – case in point, the dot-com bubble and ensuing crash.  More accurately, there’s always value in the stock market among particular entrants.  Finding the ones whose stock prices have suffered for no better reason than that of public perception is as wise a place as any to start.

What do you think?  Are companies like BP and Transocean good deals now?  Would you not invest due to moral conflicts?

Greg McFarlane is an advertising copywriter who lives in Las Vegas and Lahaina – testament to the power of entrepreneurship.  He recently wrote Control Your Cash: Making Money Make Sense, a financial primer for people in their 20s and 30s who know nothing about money.  Buy the book here (physical) or here (Kindle) and reach Greg at greg@ControlYourCash.com.

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Buy Low. Better Yet, Buy Lower.

Craig/FFB, just wrote a great article discussing the differences between Term and Permanent Life Insurance, and to my amazement he was very fair when it came to permanent life insurance.  Most financial bloggers aren’t as partial, and spout (without ever running numbers) the standard “buy term and invest the difference” kool aid. So I asked FFB for the opportunity to actually run the numbers between term and permanent life insurance.

Since we need to start somewhere, lets start with our guy who needs life insurance:

• Male
• Born 7/1/1977 (Middle age between Craig and Myself)
• Good Health – Rated Second highest (above standard but below
  Superman)
• Non-Smoker
• $5,000/yr Budget

The illustration I am running is from a AAA Rated Company that is older than a lot States.  Considering it is an industry leader, it is not the cheapest around.  We are going to look at 20 Year Term + Investment Account Returning 4% net VS. Whole Life Product. [Craig: Remember we are considering that a lot of people say to buy a Term policy and invest the difference between the Term and Whole life product rather than buy the Whole life insurance policy.]

Buying 20 Year Term and Investing the Difference

Since the $5,000/year budget buys $495,495 of whole life insurance coverage (we will discuss those calculations below), we will buy that death benefit amount in 20 year term life insurance, and then invest the difference.  To purchase that amount of term life insurance costs $450/yr and thus our difference is $4,500/yr.

So at year 20 you have a couple grand more, and your options
include:

• Cashing out the policy – taking the cash and walking
• Create a ‘paid up’ policy – Using the cash to buy some amount of
  death benefit that where you won’t have to pay anymore premium
• 1035 (a tax free exchange) into an annuity
• Use the Whole Life Policy as a personal Pension

What about a Higher Return?  Different Gender?  Different Insurance
Company?

A change in any of the variables will change the whole exercise.  I just think people should actually run the numbers before quoting talking heads.

I will note that I only used a 4% return, because I consider the cash value in the policy safety money (the particular company I used to create the illustration has been well-established in the industry.)  If however I were to use 8% Net the numbers would look very different.  By Year 20 the End of Year investments would be worth about $220,000.

So you can see, choosing between a Term Life Insurance is not always the better option than a Whole Life Insurance policy.  You need to run the numbers yourself for your particular goals.

This is a guest post by Evan author of the Blog My Journey to Millions.  Evan is an attorney, admitted to practice in the State of New York and works as a Director of Financial Planning overseeing the firm’s high net worth gift and estate planning.  My Journey to Millions covers topics ranging from Estate Planning, his personal financial situation to libertarian views and hatred for big government.

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Term VS Whole Life Insurance – What Do The Numbers Show?

Exchange Traded Funds are created to gain broad market exposure, like mutual funds, that individual investors could not have achieved on their own.  But built upon mutual funds, exchange traded funds actually combine different features of different types of mutual funds to make them available all in one single ETF, namely the valuation feature of open-end mutual funds and the tradability feature of closed-end funds.

Trading and Pricing of Exchange Traded Funds

As we know, shares of ETFs can be traded on exchanges, just as closed-end funds are also exchange-traded, whereas shares of open-end mutual funds can be bought and redeemed only at the end of the day through fund companies.  On the other hand, thanks to the arbitrage mechanism that all ETFs have and similar to open-end mutual fund valuation, the value of an ETF as traded stays very close to the net asset value of the underlying securities in the ETF, with a spread of around 1% if any.  Market prices of closed-end funds could sometimes trade at a 10% or more premium or discount to their net asset value depending on market conditions.  Thus, ETFs provide both the pricing stability and the trading convenience in one single product.

Cost Comparison Between ETF’s and Mutual Funds

Three types of costs can be borne by investors of a typical mutual funds: fund expense, transaction fees, and loads (sales commissions charged by brokers).  But for ETFs, since investors buy and sell shares all through trading with each other, there are no transaction fees and loads of any kind, front end or back end.  The only cost is the operation expense charged by the ETF.  Expense ratios of ETFs are much lower, often in the range of 0.1% to 1%, comparing to mutual funds’ 1% to 3% or more.  One big reason for the lower expense ratio is that ETFs do not need to constantly buy and sell securities to accommodate shareholder purchases and redemptions.  Another reason is that most ETFs are index funds and not actively managed (generally), reducing costs substantially.

Tax Efficiency of Exchange Traded Funds

The more investment turnovers, the less tax efficiency from having to pay capital-gain tax on all sales.  The reasons why ETFs are low cost also provide the ground for their tax efficiency, that is, ETFs acquire and dispose of underlying securities only through in-kind exchange with authorized market makers on the initial market level in so-called creation units, i.e. ETF shares as issued.  Investors pay capital-gain tax, if any, only when they sell ETF shares they own on the secondary market themselves.  In the case of mutual funds, all investors must bear the tax when the fund has to sell securities just to meet the redemptions of certain shareholders.  And most mutual funds, except index mutual funds, are actively managed, potentially generating more capital gains and thus more taxes on them.

Commissions and Exchange Traded Funds

In addition to expense costs charged by ETFs, investors do incur regular brokerage trading commissions every time they buy and sell ETF shares, just like trading stocks.  Mutual fund shares obtained directly from fund companies involve no commissions.  But again, share redemptions almost always have transaction fees.  (Using a company such as TradeKing, Zecco, or Sharebuilder can help keep commissions low.)

Index ETFs vs. Actively Managed ETFs

One reason why mutual funds are still in need to many investors is that most of the mutual funds are professionally and actively managed, whereas many ETFs are index funds.  There will be always investors who believe in picking stocks in order to beat the market and that’s one thing ETFs can not provide.  For now, actively managed ETFs are still rare, with the first one offered only in March 2008.

Who Should Invest in ETFs

Investors who look for broad exposures to different markets, trade more frequently but don’t want to handle huge price swings, don’t have either the time or the required expertise to pick winners and losers, and are not willing to pay too much for the benefits of an investment product, should find ETFs a very good fit.

Do you invest in exchange traded funds (ETF’s)?  What do you think of them?

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Exchange Traded Funds – Pros and Cons

Online investment company ShareBuilder (owned by ING Direct) is offering up 10 free investment credits to new and existing customers who set up an Automatic Investment Plan before January 31st.  This is a great way to start investing for the New Year!  Normally automatic investments are $4 per trade.

The Automatic Investment Plan allows you to set up recurring weekly, or monthly (or one-time) investments which occur on Tuesdays every week.  Why is this great?  Fractional shares!  You can pick an amount you want to invest and ShareBuilder will buy that amount of shares, even as a fraction.  It’s through this plan that I’m able to own a piece of Warren Buffet’s Berkshire Hathaway.  The shares are quite expensive but I’m able to still buy a piece of it.

ShareBuilder also offers real-time trades (not part of this offer) and allows for dividend re-investing.

One of the things I particularly like about ShareBuilder is that they are part of ING Direct where I have an online savings and checking account.  When I want to fund my ShareBuilder account I can quickly transfer money over.  I can also see all of my account totals on one page.

Here’s the legal mumbo jumbo from the ShareBuilder site:

The 10 free Automatic Investment Plan credits are available 2-4 weeks after you create a Plan during the month of January 2010 with at least one security. With an Automatic Investment Plan you can invest any dollar amount on Tuesdays exclusively online, schedule investments on a weekly or monthly basis. Select from our list of over 7,000 stocks and ETFs. Investment and funding instructions can be edited up to 5:00 pm ET on the Monday before your purchase. Real-time trade commissions apply to all sales. All sales of stock are made real-time and are subject to Real-time Trade commissions.

If you have been looking to start investing then this might be a nice place to start looking.

Bonus: If you sign up as a new customer and use the code 50DOLLARS you will get a $50 bonus in your account!! (You need to open the account with $50) Expires 3/31/10

As always, do your research before investing and make sure you understand the account and make sure it is right for you before you sign up!

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10 Free Investment Credits From ShareBuilder (And $50 Signup Bonus)