Report inappropriate ad

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:

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

Help! I’m Trying to Determine My Asset Allocation

August 6, 2008 · Filed Under Investing · 4 Comments 

I recently transferred a Rollover IRA and some mutual funds in a taxable account to new Vanguard accounts. Unfortunately, I have not actually done anything with either account yet. The taxable account currently consists of two funds – a S&P 500 Index fund and a global equity fund – and some cash. The IRA is completely in cash.

Asset allocation is key

After some mistakes over the past few years (more on those in a future post), I have decided to go the way of ultra-low expense index funds for these two accounts (that is why I transferred them to Vanguard). The most important component of any investing plan (other than doing something) is the asset allocation plan. That is not to say that there is one magical asset allocation that works for everyone in all situations. Rather, choosing a plan for your situation and sticking to it through thick and thin usually leads to good long-term investing results. Click here to continue reading…

  • Blending simple and straightforward financial discussion with Biblical principles to assist normal people like us in being good stewards of our finances. This site is for ordinary people who have better things to do than watch the stock market every day, study countless mutual funds, and constantly stress about their financial situation!

  • Subscribe to Borrow From None

  • Currently Studying…

  • Currently Reading…

  • Affiliates

  • Social Networking

  • Links of Interest

  • Blogging