Monday, October 27, 2008

Announcing Smart Financial Values

The big day is finally here.  It took a little longer than I had hoped, but the revamped version of this blog has been launched.

Please head on over to Smart Financial Values ( to check it out!  From now on, all new material will be posted at Smart Financial Values.

Tuesday, October 21, 2008

Big changes coming to Financial Values

You may have noticed that recently I have not been posting as frequently as usual.  This is because I am working hard at giving this blog a new, more memorable domain name and an updated look.  I am really pleased at the way it is shaping up and I hope to announce the launch of the new and improved blog before the end of the month.  Stick around, I think that you'll like it.

Sunday, October 19, 2008

Good advice and a vote of confidence

Warren Buffet, one of the most successful investors ever, and currently, according to Forbes magazine, the richest man in the world, submitted a fantastic letter to the editor of the New York Times.  If you are an investor and have not yet read this letter, you owe it to yourself to do so.

Buffet explains that while he cannot predict the direction of the market in the short term, "fears regarding the long-term prosperity of the nation's many sound companies make no sense.  These businesses will indeed suffer earnings hiccups, as they always have.  But most major companies will be setting new profit records 5, 10, and 20 years from now."  Buffet also says that if prices continue to look this attractive, his personal investments will soon consist entirely of stocks of American companies.

The advice that Buffet offers - to be greedy when others are fearful, and fearful when others are greedy - is great advice but often tough to put into practice.  It can be difficult to put money into stocks and stock funds in these conditions.  But this is exactly what prudent investors like Warren Buffet are doing.  You should be doing it too.  As I mentioned earlier, stocks are on sale now.  Buy as many as you can before the prices go back up!

Thursday, October 16, 2008

Finance Fiesta

A Financial Values blog post has been included in the Finance Fiesta.  Head on over to Broke Grad Student to check out the other great entries in the carnival.  I especially enjoyed the post on Living Almost Large about the challenges that new immigrants to the United States must face because they do not have a credit score.

Tuesday, October 14, 2008

Unexpected money - what do you do with it?

What do you do with unexpected money?  Every once in a while, most of us end up with small or large amounts of money that we did not expect.  It can be from a bonus at work, a tax refund, a gift, an inheritance, or something else.  My wife's Great Uncle passed away, and we recently learned that she will inherit about $4,600 from his estate.  We certainly had not expected to receive a generous gift like this.

While you might not receive unexpected cash infusions very often, I believe that how you choose to use them can have a big impact on your overall financial situation.  Although everyone's financial situation is different, this is how I would prioritize the use of any windfall:

1. Establishment of emergency funds.  If you are living paycheck to paycheck and have no savings cushion, this is a great time to create one.
2. Debt repayment.  Knocking off debt ahead of schedule is always a good idea.
3. Charitable giving.  Giving is important.   Even if you are not regularly supporting charities that are important to you when you receive some unexpected cash, it can be an easy time to start.  After all, you weren't counting on that money for anything else.
4. Retirement savings.  Are you behind the curve?  Catch up!
5. Other long term savings goals.  Use unexpected money to boost your savings for a down payment on a home, your kid's college expenses, your next car, or anything else that you are saving for.
6. Something fun for you and your family.  Take at least part of the money to buy something nice for or do something fun with your family. 

After looking over our finances we decide to us this gift for these purposes:

$500 - Give to charity.  We believe that giving is important and try to give at least 10% of our income to charity.
$800 - Furniture for Baby's room.  We needed some furniture for our new baby's room.  This is a purchase that we would have made anyway, but we might not have spent quite this much.
$500 - College fund for our daughter.  We don't have any debt other than our mortgages and we are doing well with our retirement savings.  However, we are not yet saving as much as we should be for our 8-month-old daughter's college expenses.
$1200 - Savings account.  One of the weakness in my own budget is that I tend to keep a pretty anemic savings account.  As money builds up in my savings I always feel that it could be put to better use in one of my investment accounts.  However, now that I have a child, I really want to work on building up that savings account balance.  When do kids need braces?
$1000 - Investment account.  This is a good time to invest.  We created this account so that at least some of our long term investments are not locked up in a retirement account.
$600 - Something fun.  We have not yet decided what to use this part for.  Possibly for photography classes for my wife--something she has always wanted to do.

We think that this allocation works very well for our situation.  How would you use an unexpected influx of cash?

Sunday, October 12, 2008

Don't hesitate

I have known many people, both friends and clients, that knew they needed to start saving and investing (for retirement, their children's college expenses, or something else) yet they kept putting it off.  The most common reason was that they didn't know what to invest in and they didn't want to make a bad choice.  So, they didn't invest in anything.

A poorly chosen investment, generally speaking, is better than no investment.  If you start investing in a mutual fund or college savings plan and later learn that your fund or plan isn't the best option for meeting your needs, that's OK.  You can always discontinue investing in the product that you don't like and move on to what you have learned is a more suitable investment.  You will probably be able to transfer all of your funds from the first investment into the second.

I tend to spend whatever money is not specifically set aside for something and I think that most other people do too.  So, if you are delaying your investing for any reason, you are likely spending money that you should be saving and losing time that you can never regain.  If you are investing in anything, even a less than perfect investment, you will have something to show for it months and years from now.  You can always refine your investments as your knowledge of investing grows.  If your not investing, it is just going to be that much harder to meet your goals when you finally start.

You can never make up for lost time.  If you know that you need to invest but are not currently doing so, then get to it.

Friday, October 10, 2008

When the markets go down, where does the money go?

A reader recently asked a great question:
Where do the missing billions [now trillions] go?  When the stock market goes down does that money just disappear or does someone somewhere gain as a result?
Unfortunately, wealth does not follow Newton's Second Law of Thermodynamics.  It can be both created and destroyed.  When the stock market goes down wealth disappears.

Consider the example of a kid with $5 and a baseball card that he bought for $1.  If the other kids in the neighborhood think that the player on his card is the coolest player in the league and offer to buy the card for ten bucks, how much money does this kid have?  Unless he sells the card, all he's got is five dollars.  He also has a baseball card that even though he only paid for one dollar for it is worth ten dollars.  So, his net worth has gone up by nine dollars because the value of the baseball card increased.  However, the baseball card isn't money (and stocks aren't money).  Only money is money.

Now as the season goes on, the other kids start to think that this player quite as cool as they thought he was.  If Johnny, who owns the card, wants to sell it now all he could get would be two dollars.  Therefore, his net worth has just decreased by eight dollars.  That eight dollars has just plain disappeared.  If Johnny agrees that the card in only worth one dollar then he might sell the card.  However, if he thinks that everyone else is wrong about this player and given time they will come around to like him, Johnny might decide to hold onto the card in order to sell it for a better price later.  Johnny will not actually realize any financial gains or losses until he sells the card.

As the value of Johnny's card went up and down, his net worth increased and decreased.  That wealth was first created and then destroyed.  When Johnny's net worth went down nobody else's wealth went up as a result.  Stocks work the same way as that baseball card.

When you buy a share of stock, you are buying partial ownership of a company.  The price of stocks is set in an auction type market.  People value stocks based on the expectation of the future cash that the company will earn.  If lots of people believe that a company will generate lots of cash they will all buy stock in this company.  As they compete with each other in the market to buy these shares they will drive up the price.  If as time goes on, the company fails to earn as much money as expected, the perceived value of the company will fall.  As the perceived value of the company falls, fewer people will be interested in buying the stock and the price of the stock will fall as well.  If stocks that you own lose value, it is because the perceived value of the underlying company has decreased.  The value of your portfolio then falls.  That wealth that you had yesterday has been destroyed today.

Any gains or losses from your stock investments are called paper gains or losses for as long as you actually own the investment.  Until you sell the investment and convert it back to real money, all your gains and losses are just numbers on a sheet of paper and can change at any moment.  They are not real money until you sell.

On a side note, it is possible to bet against the market by "short selling" a stock.  If you do this, you will make money when if the market goes down and lose money if it goes up.  However, the total amount of money lost by investors as a stock falls is not connected to money made by anyone who might be shorting that stock.

Wednesday, October 8, 2008

Worst argument ever for a bailout

I very much believe that government action is needed to help stabilize our economy.  However, some of these bailouts, even if necessary, are hard to swallow.  According to this article, less than one week after AIG received an $85 billion bailout, the company spent almost half a million dollars to send a group of their executives to a Southern California resort.  In addition to paying for golf and catered buffets, AIG spent over $23,000 on spa treatments.  What do you suppose AIG spent money on before they ran their company into the ground?

If there are any AIG executives that read this blog, can you please leave a comment to let me know what you were thinking?  For the rest of you out there, what are your thoughts on reigning in corporate excess?

Monday, October 6, 2008

Breakdown of mutual fund fees

Disclaimer: My wife asked me to warn my readers that this post is longer and a bit more technical than usual.  However, we both agree that it contains important information and is well worth reading.

When you invest in a mutual fund, you have no way of knowing how much money you will earn from that fund.  However, you do know - or at least you should know - how much money you will pay in order to invest in that fund.  You also know that for every mutual fund, the total amount of money you earn is equal to the funds return minus the fund's expenses.  Therefore, when I am given a choice between two similar funds, one with high fees and one with low fees, I will choose the low fees every time.

I am right to do so.  Low fee funds as a whole outperform high fee funds.  Walter Updegrave at CNN Money recently compared the fifteen year track record of all large company stock funds.  The quartile of funds with the highest fees had an average annual expense ratio of 1.78% and the quartile with the lowest fees had an average annual expense ratio of .43%.  The expensive funds, over fifteen years produced an average return of 8.42%/year.  Not bad, but significantly less than the average return of 9.86%/year produced by the low cost funds.  Not surprisingly, the difference between the fees (1.35%) almost entirely accounts for the difference in performance (1.44%).

In order to make sure that you are paying reasonable fees, it is important to understand what kind of fees mutual funds charge.  All funds - even "no load" funds - charge fees.  They all have operating expenses, offices to lease, and employees to pay.  Here is a basic primer on the types of fees that mutual funds charge:

1. Annual Fees:  The following fees are annual fees.  They are taken out of your investment every year.  You will never see a bill for them nor will you see your account balance suddenly drop.  They are taken out, drip by drip, over time.

Management fee:  This fee is an annual fee that pays for the investment managers of your fund.  It pays their salaries and a few other expenses related to managing the fund's investments.  All funds have this fee.

12b-1 fee: This fee is used to pay for marketing and distribution expenses (which could include sales commissions).  By law, this fee can not be greater than .75% per year.  Not all funds charge this fee.

Expense Ratio: The annual expense ratio is the management fee plus the 12b-1 fee.

2. Sales Charge:  If a financial advisor is receiving a commission for selling a fund to you, the bulk of it will likely come from a sales charge or "load".  Not all funds charge these fees.  Funds with a sales charge, or load, are usually sold as class A, B, and C.

Class A funds charge a front end sales charge.  A front end charge is paid at the time that you purchase shares of the fund.  This fee can not be higher than 8.5%.  If you purchase $1000 of a class A fund with a 5% load, the mutual fund company will immediately keep $50 (5%) of your deposit and credit your account with $950.  You will pay this fee every time you purchase additional shares of this fund.

Class B funds charge a back end sales charge.  A back end sales charge is paid when you cash in your investment.  Some class B funds will lower the back end load for every year that you own the fund until it disappears after several years.  However, the fund will likely charge a higher 12b-1 fee until you have owned the fund long enough to eliminate the back end load.

Class C funds do not charge either a front end or back end sales charge.  However, they will likely have a much higher 12b-1 fee for as long as you own shares of the fund.

I recommend purchasing funds without sales loads.  If you do pay a load, make sure that you are getting something for your money.  That sales load you are paying is compensating the person who sold you the fund.  If you are not getting valuable advice, you should not be paying these fees.

Also, if you choose to pay a sales load, class A shares are generally the best value in the long run, followed by class B, followed by class C.

3. Other fees:

Brokerage charge:  If you chose to purchase funds through a broker (online or brick and mortar) you may be charged a brokerage fee.  This fee will be charged every time you buy or sell shares of the fund.  If you are making one large purchase it might not be a big deal.  However, if you are adding to your account every month, this type of charge can really add up.

Redemption fees: A redemption fee is a fee that you are charged when you sell shares of your fund.  It is a separate fee from a back end sales charge, limited by law to no more than 2%, and it is not charged by all funds.  Most funds that do charge this fee will charge it only if you redeem your shares within a few months of purchasing them.  Frequent trading of mutual funds can drive up management expenses so companies like to discourage this practice.

As you purchase mutual funds I would encourage you to avoid sales charges and try to minimize the management fees and 12b-1 fees that you pay.  I believe that Vanguard funds and E*Trade funds are some of the best and cheapest funds out there.  If you are looking for a good point of comparison, they are a great place to start.

Wednesday, October 1, 2008

Preparing for a financial storm

These have been tumultuous days for our financial markets and our economy.  Many economists are convinced that we are heading into a recession.  Some are even talking about a slowdown of the same order as the Great Depression.  The truth is, nobody can accurately predict what our economy and our financial markets will do.  But, there are steps that you can take to prepare for the future.  These recommendations will not only prepare you for rough times; they will help prepare you for any economy and are smart moves to make regardless of what happens in our economy or financial markets.

Here are five smart moves to make right now:
  1. Build up your emergency cash reserves.  Make sure that you have enough money on hand to carry you through tough times.  What if you or your spouse is laid off?  What if the gas bills and food bills keep going up and your income does not?  The more cash that you have set aside, the better position you will be in to handle whatever life throws at you.
  2. Pay off your debt.  If you have credit card debt, pay it off.  Pay off your student loans.  Pay off your car loans.  The less debt you have, the more control you have over your financial situation.  Remember, debt is a fancy term for spending tomorrow's income today.  If you have already spent your future income, it gives you far less financial flexibility in the future.
  3. Make sure that you and your family have enough life insurance.  It is devastating to lose a loved one.  It is even worse to lose a loved one and be in a financial bind because of it. Don't let this happen to you.
  4. Keep up your retirement savings, education savings, and everything else that you are saving for.  If you can, increase your savings.  Nobody knows when the stock market will hit bottom.  However, we do know for certain that stocks are a better value this month than they were last month.  Take advantage of it.
  5. Make sure that your investments are exposing you to the right amount of risk.  If you are saving for a goal that is less than 10 years away, then that money probably shouldn't be in the stock market.  If you are saving for something more then ten years away, then you can afford losses in the short term.  If your investments are exposing you to too much or too little risk, realign them.  (But be sure to remember that your retirement savings deadline is a moving target.  You will not cash in all your investments on the day you retire.  You will need some of the right away, but some of them you will not use for 10, 20 or more years after you retire.)
These five steps will help you be in control of your finances regardless of what the economy does.  By taking these steps, you will position yourself for good markets, bad markets and everything in between.  If you have not addressed all of these issues then do it now.