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Financial Peace University Lesson 9 – Of Mice and Mutual Funds

December 11, 2009 · Filed Under Financial Peace University · 7 Comments 

Understanding Investments

This week we listened to Dave Ramsey discuss various types of long-term investments.  For long-term wealth building, putting your money in a standard bank account is just not going to cut it.  You need to use some other vehicle that will outpace inflation and enable you to end up with more money than you start with.  If you don’t need access to your money for at least five years, then that money can be invested instead of just saved.

Keep it simple, stupid!

Besides the statement directly above, Ramsey provided a few more rules for investing:

  • Never invest purely for tax savings
  • Never invest using borrowed money (that certainly should not shock anyone!)

Diversification is the most important tip

Diversification means to “spread around” and it lowers your overall risk.  Ramsey presented an interesting example in the workbook.  Imagine two different investors.  The first puts $10,000 into a investment that earns 7% interest for 25 years.  The second puts $2,000 dollars into five different investments and earns the following returns over the 25 years: loses all $2,000, 0% (under mattress), 5%, 10%, 15%.  Maybe surprisingly, at the end of 25 years the second investor will have almost $59,000 more!!

A (very) basic primer on investments

Remember that all investments carry different degrees of risk and that as risk increases so does the potential rate of return.  Liquidity is the ease with which you can access your money (cash is very liquid while equity in a house is not very liquid at all).  Conversely to risk, as there is more liquidity, there is typically less potential return.  Finally, remember that there are two types of risk to consider for an investment – the investment risk itself (if I buy that Enron stock, is there a chance it will go down in value?) and inflation risk as it eats away at your money over time.

Different types of investments

Ramsey spent the remainder of the class touching on a few of the various types of investments out there.  I will just highlight some of those he mentioned.

  • Single Stocks – This is small piece of a company that you own.  You gain a return when the value of the company increases or when they pay you some of their profit (dividend).  These are extremely risky and should be kept to less than 10% of your net worth.  Ramsey does not own any individual stocks.
  • Bonds – This is debt that you lend to a company.  Your return is the interest rate that the company pays you and the fluctuation in the price of the bond.  Ramsey does not own any individual bonds either.
  • Mutual Funds – An investment where many people put money into a pool to buy a bunch of different stocks providing diversification.  The pool is is usually managed by a professional portfolio manager.  Mutual funds are a good long-term investment and Ramsey does own shares of a number of funds.
  • Rental Real Estate – This is a good investment (Ramsey does own paid-for rental real estate) but he suggests that you have a lot of cash before getting involved with real estate investing.  His recommendation is to buy slowly with cash only.  Also, a reminder from him is that your money is made at the purchase – so be patient and only buy big bargains.

Bad Investments

Ramsey does not recommend the following investment vehicles (in fact, he warns to stay far away from them):

  • Gold
  • Commodities & Futures
  • Day Trading
  • Viaticals

Dave’s suggested mutual fund portfolio

Ramsey suggested creating a diversified long-term portfolio by purchasing different mutual funds in the following proportions:

  • 25% Large-cap mutual funds (growth & income)
  • 25% Mid-cap mutual funds (growth)
  • 25% Small-cap mutual funds (aggressive growth)
  • 25% International mutual funds

“Cap” means the capitalization of a company which means how big the company is.  So, a large-cap mutual fund owns companies like IBM and/or GE.  By purchasing a few different mutual funds to create a similar portfolio, you are able to reduce your risk (relatively).  To recap: putting all your money into some shares in a single company is very risky, purchasing a mutual fund is much less risky, and purchasing a diversified set of multiple mutual funds is even less risky.  Again, the term “risky” is all relative as we have seen over the past year as all types of funds decreased in value.  So, remember that investing in stocks and mutual funds is a long-term endeavor!

A good tip or two

Ramsey concluded the class by giving out the following two tips:

  • If you don’t understand the workings of an investment well enough to be able to teach it to someone else, then you don’t understand it well enough to buy it!
  • Build wealth slowly – Don’t look for short-cuts; remember who wins in the tortoise and the hare story (hint – it’s the turtle).

One other point out of our discussion

Right at the end of class during our discussion, someone asked the following question – “When was this video made?” I couldn’t really hear what he asked and his comments after the question (everyone was starting to pack up and leave) during class, so I asked my wife. His point was to insinuate that Ramsey would have changed the video after what happened in the US stock market since late 2008. I remarked to her, “So he kinda missed the entire point of the lesson then?”

Here’s a reminder from me (not Dave Ramsey though he might say the same thing): You don’t change long-term strategy based on transient short-term events. Ramsey tried to explain this during class when he took a number of events that caused a significant market drop and showed that in almost every case the market had recovered within a year of the triggering event.  Remember, the market does go up and it does go down too; thus it is possible that your investments will also go down (not just up).  That is why it is important to view investing as a long-term process.  If you need that money in the near-term, the market is not a good place to put it (Remember the five-year rule).

Check out my previous FPU posts:

http://www.borrowfromnone.com/2009/12/financial-peace-university-lesson-8-thats-not-good-enough/

ETRADE and iPhone Updates

March 13, 2009 · Filed Under Random · 2 Comments 

This must be the week for updates.  Previously, I discussed our experiences so far with our attempt at once-a-month shopping and cooking and then gave our monthly net worth update.  In this post, I’ll take a few minutes to update how everything has been going so far (including updates on my stock picking and iPhone shopping as well).

I finally bought some stocks through ETRADE

I previously disclosed my intention to purchase a pair of stocks through ETRADE .  ETRADE finally allowed me to purchase the stocks I wanted last week.  It actually worked out well for me as both stocks I purchased cost me a bit less than they would have when I first opened the account.  Again, this is not part of my long-term investing strategy as I am just using a little bit of money to speculate with these two stocks that are priced drastically lower than they were last year.  I would not be thrilled about it, but it would not cause us undue financial harm if we lost all the money we invested in these stocks (and if you’re not comfortable with that prospect in this economy, I would suggest you not buy individual stocks right now).

At the same time, this is a long-term play on my part.  I’m not looking to sell them anytime soon.  In fact, yesterday one of the stocks I purchased was up almost 40%.  I am not interested in a 40% gain on the small amount of money I invested.  I’m going to sit on them and hopefully they will return to their previous values (or close to it) which would be a 4000% gain.  Whether that takes 1 year, 3 years, or 10 years (or infinity), I’m not sure.  I am sure that I will just hold these stocks long-term and periodically check to see where they are trading.

Even after waiting an entire week, I still bought an iPhone

I put the Dave Ramsey advice of waiting overnight before making a purchase to the test last week.  In fact, I stretched it out all the way to a week.  If you remember, two weeks ago I detailed the steps that took me from being satisfied with my current mp3 player all the way to considering an iPhone .  Well, I waited an entire week and then ended up buying an iPhone anyway!  I’m actually just trying one out right now.  I’m taking advantage of the 30 day return policy to see how well it works, how much I like it, and what the cell coverage is in the areas I use it most often.

At this point, I do not see myself giving back the iPhone!  This is the first time I’ve had a cell phone that wasn’t one of the free ones you get for signing up.  I am really wowed by this thing – the phenomenal interface, the array of useful features, and all the apps (I’ve even started tweeting from my iPhone) (yeah, I’m thinking this evaluation will end a lot sooner than 30 days!).

So, waiting didn’t actually save me any money as I still opted for an expensive option but at least I can say it wasn’t an impulse buy!

If you have any recommendations for iPhone apps, please let me know!

I Opened an ETRADE Account to Buy some Stocks

February 27, 2009 · Filed Under Investing · 10 Comments 

I opened an ETRADE account the other day with the sole purpose of buying a few individual stocks (two to be exact).  Considering that I am a big advocate of index fund investing throughout this blog, I thought it might be a good idea to be transparent and mention this new account.

So you are a day trader now?

No, no, I won’t be buying and selling on an hourly basis or anything like that. In light of current economic and stock market conditions, there are a number of stocks that are trading much, much lower than they were a few months ago (well, yes, I realize that covers almost all stocks, but I do have a few particularly slammed stocks in mind).  My wife and I have decided that taking a risk and purchasing some shares in the hopes of them returning to their previous values (or closer to them) would be acceptable at this time.    I will buy some shares of these companies and hold them for a year or so while they (hopefully) (eventually) increase in value.

This is not our investing technique

To be clear, this is not part of my normal investing strategy.  This is taking a risk with the hopes of it paying off with a big reward.  To me, investing involves buying a diversified set of low-cost index funds.  After you do that, then you buy more.  And you don’t do anything with them other than occasionally rebalancing your portfolio.  That is investing to me…this is speculating.  I do own one other individual stock – that of my employer that I purchase through an employee stock purchase plan.  Ok, my wife does own one share of Disney stock (a gift) and a share or so of Johnson Controls (another, somewhat stranger, gift).

This is a big risk

If you didn’t believe it before last year, you certainly realize now that investing in the stock market is inherently risky.  Even my diversified index fund portfolios have shed a lot of value since the fall.  And if an index fund of hundreds of stocks can drop that much, certainly individual stocks can be extremely volatile and risky.  As an example, examine the plight of all the people who currently own Circuit City stock.

Minimizing the risk

The way that we have chosen to minimize the risk to our financial situation is to keep the total amount of cash invested to a very small percentage of our portfolio.  I am planning on using approximately 1% of our net worth for these stocks.  In that way, if either or both of these companies do realize the worst case scenario and cease to exist, we will not really notice a 1% drop in net worth (besides – it’s been dropping more than that each month since the fall!).

So, that’s our plan.  We’re buying a few shares of two companies and hoping that their prices return to whence they came and we realize a significant monetary increase.  I opened the account Tuesday evening and then transferred some money from my savings account into it Wednesday morning.  I then clicked the button to buy some shares Wednesday afternoon.  Unfortunately, ETRADE gently reminded me that I can not purchase stocks that cost less than $10 until 7 business days after opening a new account…..

ETRADE reminds me that you can't purchase stocks that cost less than $10 for 7 business days

so I have not actually bought any shares yet….but someday (if I can remember in seven business days from now that I started this process), I just might…

Photo Credits: wsilver

Book Review: Your Money Counts

January 15, 2009 · Filed Under Book Reviews, Finances · 6 Comments 

The biblical guide to earning, spending, saving, investing, giving, and getting out of debt

By Howard Dayton

BFN Book Reviews

Well, it has been quite a while since I did a book review here at BFN.  It’s a habit that I’d like to get back into – so why not start again today?  I provide a brief overview of the book and the author, touch on the good and bad in the book, and finally, give you my personal recommendation for whether you should borrow the book, buy the book, or neither.

What is this book about?

This book is a pretty small book but it basically tries to cover everything about money.  Specifically, to clarify, it tries to cover most of what the Bible says about finances.  It’s a pretty ambitious goal, especially given the size of the book (it is 175 pages, but it’s skinny).  It actually does cover quite a bit of the ground it mentions on the cover.  In fact, it touches on other subjects as well.  Of course, it can’t go into much detail on each portion.  Overall, however, the author is quite successful in jamming an extraordinary amount of biblical guidance into this skinny little book.

Who is the author?

Howard Dayton is a co-founder of Crown Financial Ministries with Larry Burkett.  The mission of Crown Financial Ministries is:

Equipping people worldwide to learn, apply, and teach God’s financial principles so they may know Christ more intimately, be free to serve Him, and help fund the Great Commission.

Before founding Crown Financial Ministries, he founded Crown Ministries back in 1985.  Therefore, Dayton has been studying Biblical financial principles for quite some time and attempting to teach them to others through the Crown bible studies and events.

What are the best parts of the book?

As I mentioned above, this book undertakes a very ambitious goal.  I feel that it does, for the most part, meet that goal.  This is a great introduction of  God’s teachings on money, possessions, and prosperity.  The book starts off by providing these statistics from the Bible:

  • 16 of the 38 parables regard how to handle money and possessions
  • There are approximately 500 verses about Faith
  • There are approximately 500 verses about Prayer
  • There are over 2350 verses about money & possessions

So, the author points out that the proper attitude and treatment of money and possessions is quite important.  Why is there such an emphasis on money and possessions in the Bible, you ask?  Dayton offers these three answers:

  1. How we handle money affects our relationship with the Lord (see Luke 16:11 )
  2. Possessions compete with the Lord for our focus and attention (see Matt 6:24 )
  3. Much of life as we currently live it revolves around the use of money

Dayton then spends the remainder of the book going through the various aspects of finances that touch us on a daily basis.  For each section, he discusses the main points and provides numerous Bible references.  Personally, I feel that the references are the most valuable part of the book.  For the topics covered, this book provides a great starting point for personal Bible study.

The book really does cover a lot of ground, so I can’t possible summarize even a fraction of it in this review.  Allow me to provide you with a glimpse of some of the interesting things I learned while reading it.

Giving

The author touches on the importance of giving and mentions that there are more Bible verses on giving than on any other individual financial topic.  He points out that your attitude about giving is of crucial importance.  He does not provide a set percentage that you should give, however, as he leaves that as a decision between you and God.

Working

Dayton also brings to the reader’s attention that work was designed before the fall of Adam and Eve in the Garden of Eden (Genesis 2:15 ).  So, having to do work is not a result of sin, work just got a lot harder because of it.

Investing

The author advocates being a "steady plodder" when it comes to your investing strategy.  He uses the quote "saving is making provision for tomorrow while debt is presumption upon tomorrow."  He lays out these three important investment goals:

  1. Providing for your family
  2. Becoming financially free to serve the Lord
  3. Operating your business

He also stresses that it is not an acceptable investment goal to save and invest for the sole purpose of becoming very wealthy (1 Tim 6:9-11 ).  His counsel is to determine the maximum amount of money you want to save and when you reach that number, stop saving and redirect the money you were investing to helping other people (kinda like those commercials where the people carry around those big orange numbers).

At the end of the book, there is a small section with some related questions (basically a FAQ), here are two questions and summarized answers that I thought were interesting:

How does the Bible define financial success?

It is achieved by being a faithful steward – not by how much wealth you have accumulated.

Should Christians give to secular charities?

There are many charities competing for our dollars and scripture does not specifically address whether we are only to give to Christian charities.  The author and his wife have decided that, with some certain exceptions, they themselves will only give to Christian charities.  This is mainly because, for the most part, everyone gives to secular charities but only Christians give to Christian charities.

What is not-so-good about the book?

This book covers a tremendous amount of information in a relatively short amount of time (well, I guess it depends on how fast you read).  As you might imagine, there are not enough pages to go into terrible detail on each topic.  As a result, your appetite is whetted but you will need to turn elsewhere if you want an exhaustive treatment on any specific topic.

Also, it is not nearly as practical or "step-by-step" as some other financial books.  For instance, Dayton spends about half a page on his four step process for getting your finances in order.  Dave Ramsey, in contrast, has an entire book on the subject .  I feel that this book is not really trying to be that, though.  The point of this book is to get you thinking about Biblical standards for money.  It is to give you a primer on the main points, to maybe challenge some of the (wrong) ideas you may have about money, and to pique your interest to delve into the subject more.  And in that scope, I think it performs well.

So what is my recommendation?

I think this is a good reference book to own.  It has a ton of information crammed into it.  In fact, it’s going onto BFN’s virtual bookshelf .  I think it is a valuable read to get started on your path to understanding what God teaches about money.  There are copious amounts of Bible references throughout, so it is helpful to open it up to a specific topic to see how the author summarizes the topic and start searching the Bible references provided.

As I mentioned, it’s not a practical step-by-step guide to getting out of debt or whatever.  If that is what you need in your life right now, this is not the book for you.  One option is to find a Crown Financial Ministries Bible study in your area – that’s actually where I received this book (you get it as part of the material for the class)  – as it will provide that step-by-step process you’re looking for.

I would say that if you can do the Bible study or pick up a copy of this book at a good price, then it’s a good book to have and refer back to often.

Want to borrow this book? Search your local library

Want your own copy? Buy this book now at Amazon.com

Check out the other books I’ve chosen for my virtual bookshelf

Is all this Technology Good or Bad for my Finances?

November 12, 2008 · Filed Under Finances · 5 Comments 

Like most people these days, my wife and I carry cell phones everywhere we go, read news and blogs via laptops, check our bank accounts, brokerage accounts, and retirement accounts online, pay our bills online, and arrange automatic saving and investing online.  I thought it might be interesting to take a minute to examine the effect all of this technology has on our finances?

Stuff costs money

First of all, money is required to purchase a lot of this technology which hurts our finances.  Cell phones typically cost money upfront and on a monthly basis.  There is always the pull to get a newer and fancier model with a more expensive monthly plan as well.  I currently have a basic cell phone, but most phones nowadays enable the user to check new and even stock prices through them.  In fact, Etrade recently released a mobile platform that you can access from a smart phone.

There are also costs associated with getting online to do all the tasks (and more) I listed above.  Of course a computer is required and high-speed internet access (I couldn’t imagine going back to dial-up now).  If you use a laptop, you’ll probably want a wireless router as well.  All of this costs money…and the more money you are using to purchase new technology, the less you get to keep.

This technology provides convenience and knowledge

With that being said, there are still many tangible advantages that comes along with all this technology.  If I am not sure what my checking account balance is at any hour of the day, I can check exactly how much the bank thinks I have in less than a minute (3 minutes if I have to boot-up the computer).  If I forget to mail a check to pay a bill, I can log into my online banking account and have the bill paid more conveniently, in much less time, and with less risk (and less expensively) than filling out a check and dropping it into the mail.  From a purely financial standpoint, a cost savings in envelopes and stamps is realized and that doesn’t even take into account the time savings which is typically much more significant.

Also, current technology provides many tools for managing your finances (yes, I know for some a pencil and calculator work just fine, but maybe others of us need a little more help)  There are numerous net worth tracking tools available online to help you stay on top of  your financial situation.  Also, there are many budgeting software options to facilitate managing and tracking your income and expense.  These are just but a few of the advantages that come along with these technological advances.

Investing is much easier though that is good and bad

It is also much easier to invest money in stocks, mutual funds, and options via online brokerage accounts and in US Bonds at TreasuryDirect.com.  A wonderful byproduct of these advances are that online brokerages have driven the cost of investments down drastically.  Whereas in the past you would have to call up your stock broker and pay who-knows-how-much to request a trade, you can now buy and sell stocks for $5 online (or even free in some cases).  On top of this, the internet provides an amazing wealth of useful information on investing to educate you how to invest.  As such, there is really no excuse for someone not to be able to invest in mutual funds and/or bonds for long-term growth.

On the other hand, the easy availability of this information and the ability to trade can be a negative as well.  Sure, it is easy to invest in stocks, bonds, and mutual funds, but on the downside, it is easy to invest in stocks, bonds, and mutual funds!  Making careless decisions because it is cheap and easy can lead to real difficulties down the road.  I’m sure you’ve seen the ETrade television ads of the baby buying stock – maybe this is becoming a little too easy (and that spit-up one is nasty).  This can lead to irresponsible day trading and the real possibility of losing a lot of money. It seems so easy to try to time the market and make a big score and it only costs $7.99 per trade!  I personally think this might be too enticing.

Furthermore, not only is there a generous amount of information related to finances and investing on the web but there is also a wealth of bad information out there.  There are numerous online investing newsletters available to help you under-perform the market.  I’m sure a simple search would return plenty of websites eager to hawk penny stocks in an attempt to have you make them a bunch of money.  Even from reputable sources like online magazines, too many of the articles are geared towards enticing you to stray from your long-term plan to try to time the market.  Already I’ve seen an article for the best stocks to buy during the Obama presidency.  You can always find articles on "the hottest six stocks for next month" and "where to put your money for 2009."  The point is to be very cautious in the information you rely on.

Overall I feel technology has a beneficial effect on finances – if we use it responsibly

Of course, there are pitfalls, but when you look at the big picture, I think we are much better off due to the advances of banking, investing, and personal finances compared to a few decades ago.  If you can resist the urge to drift from your long term investing plan, there is great convenience and cost savings to be had making use of the internet.  I love my online banking and being able to access my Vanguard account online.  Setting up automatic transfers from my checking account to a high-interest savings account at a different bank and to my Vanguard account makes it very easy to setup and stick to a savings and investing plan.  Technology will always advance, so we might as well figure out what pitfalls to avoid and what advances to embrace to make it easier to realize our goals.

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