Archive for August, 2010

Is Investing in the Stock Market Gambling? An Answer from Tortoise and Hare

Posted By damien on August 30th, 2010

Stock Market Gambling

My first encounter with someone trying to time the stock market occurred when I was nine years old, at church, of all places. I was sitting in the foyer, waiting for my parents to finish socializing so that I could go home and jump on the trampoline.

While waiting as patiently as a nine-year-old could, I (naturally) eavesdropped on the conversation of two “old” guys standing next to me. (Old, when one is a child, is anyone over 30.) One guy was complaining to the other about his recent losses:

…so it climbs to $3.63 per share, and I think, “This is definitely the top!” So I sell all my shares.

By the end of the day, it closed at $3.96! If I’d only waited 4 more hours, I would have made $12,000 more…

The other guy just shrugged his shoulders and sighed, as if saying, “Well, that’s just how investing in the stock market goes…”

I shook my head in amazement that such fortunes could be made and lost so quickly. It seemed the Gods of the market were more fickle than my infant sister.

But I didn’t philosophize on the stock market for long, there was a 10-foot wide trampoline waiting at home for me.

Back to the Future

As I aged and thought more about that experience, I started to believe that stock market investing was nothing more than an elegant form of gambling. That the guys (and girls) who made money were the ones lucky enough to guess when to buy low and sell high. And the losers were the suckers on the other end.

But was I right?

Is investing in the stock market gambling?

The Answer

The answer, I would submit, is more nuanced than a simple yes or no. I believe that it is possible to invest in good businesses and it’s also possible to speculate (gamble) on stocks.

Let me show you the difference. There are two ways to determine whether you are gambling or investing: (1) time horizon and  (2) chosen instruments.

Let’s look at both.

You Gotta Know When to Hold ‘Em

The first distinction between gambling and investing has to do with how long you hold on to the stocks you buy–what the industry calls your “investment horizon”. The gambler (hare) will buy and sell stocks hourly, daily or weekly depending on the short-term rise or fall of the price of the stock.

The gambler cares not about the underlying company whose stock he buys and sells, only that the price goes up or down.

The investor (tortoise), on the other hand, is in it for the long haul. She chooses companies (or groups of companies) that she believes in and buys a part of that company for the future.

She is optimistic about the long-term outlook for the market/economy that she invests in and ignores the day-to-day fluctuations in prices.

In short, the gambler buys and sells stocks based on short-term performance. The investor buys part of a company based on its long-term prospects for growth.

Wrath of the Alphabet Soup

Another way to distinguish between stock investing and gambling is by the instruments one buys.

The gambler loves the latest and greatest newfangled type of exotic investment. MBSs, options, futures…the gambler (hare) loves to bet on stock prices.

Options are bets that the price of a stock will rise or fall to a certain price at a certain date. Futures are contracts to buy or sell an asset in the future at a price specified today. Betting on prices–a clear winner and loser.

MBSs (mortgage-backed securities) and its cousins form the alphabet soup of investment inventions too complicated for most people and even self-proclaimed financial experts to understand.

The investor takes a much simpler route: she buys stocks and stock (mutual) funds. Simple and easy to comprehend. She purchases a part of a company (or many companies) and her success rises or falls with the performance of that company and the overall market.

For the investor to win, there does not have to be a loser.

By now, you should know my investing philosophy. Be an investor (tortoise) not a gambler (hare). And pick up my free Minimalist Guide to Investing to learn how to start investing for your future.

Posted in Building Wealth
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The 3 Things You Must Do Every Time You Get Money

Posted By damien on August 26th, 2010

How to use your money

Do you ever get a paycheck and ask yourself, “What should I do with this money?”

Probably not.

You probably know exactly which pair of shoes or which Justin Bieber song you want to buy.  Or maybe the latest gadget from that 3 a.m. infomercial.

I’m sure you have plenty of ideas how you want to spend money.

But what about how to save it?

Or who to give it away to?

In this post, I’ll fill you in on the three things you should be doing with your money.  The only three things.  Here they are: give it away, save it, and spend it.

That’s it. Not for toilet paper. Not for gambling. Not even for starting a fire. You should do all three of these things, and only these three things.  And in this order: give away, save, spend. Let’s look at each.

3) Give It Away

Whenever you receive money, you should first give some away.  Why? There are many reasons, here are a few:

  • Giving money away helps keep us humble.  When we give our things to the less-fortunate, it reminds us of how blessed our lives are.
  • Those who give money away are more wealthy. Arthur C. Brooks explains the research behind this claim in his book Gross National Happiness. Call it karma or whatever you wish, but what we give away comes back to us.
  • Those who give to charity are happier. This is also explained in Gross National Happiness.

Giving some of our money to the less-fortunate is just the right thing to do.  But how much should you give?

This is for you to decide.  If you are married, discuss it with your spouse. If you are religious, pray a bit and seek direction.  Historically, a tithe has been 10% of one’s income.  After determining how much to give, now figure out who to give it to.

If you attend a church, there’s a good chance that they accept voluntary donations that go to help the needy.  That’s an easy place to start.  If you are not affiliated with a church, there are many noble non-profit organizations that could use your donations for much good. (Question: does anyone know a good site/service that evaluates the honesty of non-profit organizations?)

The first thing you must do with your money is give some away.  Your soul needs that experience.

2) Save It

After donating some of your money, you need to save some.  Your soul needed you to give some away, now your future needs you to invest.  I’ve written in several other places about saving, because no one is doing enough of it!

There are many things to be saving for:

  • your wedding (hopefully only one)
  • a new house
  • your kids’ college tuition
  • vacation in Italy
  • retirement

Ideally, you’ll be saving for retirement throughout your whole life. The mid-range goals of a wedding or house hopefully come sequentially and not simultaneously, so that you can focus on one at a time.

So, how much should you save for all of these expensive life events? I’ve written an extensive post on retirement saving, so I’ll focus elsewhere today. Most financial gurus say you should save at least 15% of your take-home pay. I say more.

AT LEAST 15%. That’s the bare minimum. Save more and your future will love you for it. Save less and there will be much weeping, wailing and gnashing of teeth when the kids decide that a cheapo state school is just not posh enough for them.

Spend It

After donating and saving, this is the last thing to use your money for.  Your soul needs to give. Your future needs you to save. And your present self needs to live comfortably.

There are sooo many things to spend your money on. But which are the most important? How to prioritize?

  1. Utilities, rent and food: You need to spend to survive.
  2. Debts: You need to spend to fulfill your borrowing obligations.
  3. Stuff: You need to spend to fill other physical and emotional needs.

The awesome thing about spending in this order, is that once you get to spending on stuff, you can do it WITHOUT ANY GUILT! You have fulfilled all of the necessities: improving the world by donating, saving for tomorrow, and spending to meet your needs. Once you’re here, you are free to spend as you wish.

Earned Income vs. Found Money

I wrote an earlier post about the problem with “found money”. Since you weren’t expecting it, you blow it on Snuggies for the whole family. We’re not bad at figuring out how much of our paychecks to donate, save and spend, but everything goes out the window when we get a check from Grandma for Christmas.

I think you should work out a plan for found money. Along with spending a good portion, you should save some and give some away. Just think about it.

So, that’s all there is to it. The three things you should do with your money: donate, save and spend, in that order.

As my wife says:

Pay God first, then yourself, then others.

Posted in Building Wealth, Dumping Debt
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5 Personal Finance Writers to Avoid If You Want to Stay Broke and Ignorant

Posted By damien on August 24th, 2010

Personal finance writers

Here at BSI, the goal is to give you big ideas in bite-sized portions. To break down complicated concepts into manageable chunks. And personal finance is definitely complicated.

Or is it?

The self-proclaimed “experts” in such areas as investing and retirement planning prefer to keep their subjects as murky and technical as possible, so that you need their help. Your continued dependence keeps the repo men away from your stockbroker’s Mercedes.

(Have you seen Operation Repo? It’s over the top!)

If you can cut through all the noise and self-promotion, the realm of personal finance can be boiled down to a few key principles:

In order to stay up-to-date on financial topics, I read a wide range of source material. Personal finance books are my favorite way to learn the foundations of money management, defeating debt and investing. I have recommended several here.

But the problem with books is that they can quickly become outdated. (Especially personal finance books, since legislators cry “Financial reform now!” seemingly every quarter.) To stay up-to-date on personal finance issues, I read several blogs.

And I must say, there are some very good financial writers out there. For your curiosity and enlightenment, listed below are my top five favorite personal finance bloggers. Included are links to their blogs so that you can share in the fun. Just be sure to continue reading here!

J.D. at GetRichSlowly.org

J.D. Roth could be called the granddaddy of personal finance bloggers. He started writing after getting deep into debt and reading lots of books on personal finance. He wanted a place to record what he’d learned and track his progress.

His blog has been around for so long now that he employs a few staff writers who cover subjects in addition to personal finance.

Trent at TheSimpleDollar.com

Trent Hamm began writing about personal finance after his self-described “financial armageddon”. His blog is a mix of general money advice mixed with personal experiences.

One of my favorite aspects of his writing is the personal, warm tone–he deals with his and others’ real, everyday situations.

Ramit at IWillTeachYouToBeRich.com

Ramit Sethi is my favorite Indian, and yes, I do know a few. His writing has a special way of connecting with 20-somethings. He gets us to stop reading and take action in our financial lives.

His book (of the same name as the blog) set me on the path to automated, simple money management. Ramit’s specialty is in showing how to leverage technology to improve finances.

??? at MintLife

I have no idea who writes here, probably several people. This is an awesome blog from the makers of a stellar money management service. They keep you up-to-date on the latest legislative changes that affect your money.

Read the blog and sign up for the free money management service.

David at MoneyNing.com

Another great entry in the personal finance genre, MoneyNing covers topics from money management to frugal living to investing. David writes in a personable style that let’s you know that yes, he’s a real person and yes, he cares about your financial well-being.

Now that you know the secret to my money knowledge, do something about it! Visit these blogs. Read their most popular posts.

Who knows, it may just improve your life!

Posted in Building Wealth, Dumping Debt
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6 Easy Ways to Dump, Defeat, & Dominate Your Debt

Posted By damien on August 19th, 2010

Breaking the chains of debt

(This is a guest post by Jack Reed of fileyourbankruptcy.org. He writes on various financial topics with a special focus on bankruptcy)

Are you so much in debt that now you have started considering it a part of your normal life? Do you realize that this type of thought process would push you further into the hole? It’s true, millions of Americans are today submerged in massive debts and declaring themselves bankrupt.

The sad part is that most of them have conditioned themselves to live happily with their debts. If you are one of them, then read on to know how you can avoid this escapism!

1) Build Your Budget

You have probably heard it a thousand times, but the importance of budget cannot be undermined. Prepare a budget and determine to stick to it. This will help you to spend within your means and avoid falling into debt.

If you are a spendthrift, then your budget would even help to inculcate a sense of financial discipline in you!

2) Limit Your Expenditure

Plan out in advance what you really need to buy. Without proper planning, one tends to indulge in a shopping spree especially with the credit card in wide use today. The point is, before buying anything, evaluate its usefulness to you.

Try not to be an impulsive buyer, take your time and decide if you really need to purchase something.

3) Avoid Using Credit Cards

Using credit card has become a style statement today, especially with the teens. The satisfaction of swiping your card and making big purchases is mentally satisfying. This leads most of us to the shackles of debt when the overwhelming monthly statement arrives at the end of the month.

If you are not wise with your money management, stop using your credit card right now!

4) Create An Emergency Fund

An extreme financial emergency can strike you from the blue. What do you do in such situations? Rely on your credit cards? This will just compound your problems. Build up an emergency fund to bail yourself out of such emergencies. Keep aside a part of your income each month to fill up your emergency fund.

5) Learn to Manage Your Debt

Instead of running away from your debt, chalk out a pro-active plan to fight it off. Move all your debts to the lowest possible interest paying account. Before you transfer your balance, check if the lower rate card has a reasonable introductory period so that you have enough time to clear your debts at the lower rate.

6) Educate Yourself

Utilize the free advice on the internet to manage your finances. There are millions of pages out there which promise to help you get wise with your money. Not all information is correct but it can help you make better decisions financially and keep you away from debts.

Don’t Do Drugs Debt

Debt is like a slippery slope, it will lead you to bankruptcy if you keep running away from it. Keep the above mentioned points in mind to enjoy a debt-free life. After all, you would not like to spend your life worrying about mounting debt figures. Isn’t it?

Posted in Dumping Debt
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Where Da Gold At? Or, What Are You Saving For Retirement?

Posted By damien on August 16th, 2010

End of the rainbow

We young people (and middle-aged, and uh, mature people) have a financial problem.

We’re not saving enough for retirement. Not even close. The American savings rate is in the dismal single digits. How the heck is anyone going to live for 20-25 years on $250,000? I’ll tell you how:

by eating dog food and living in government housing

Back in the good ol’ days grandparents lived with their children and people worked pretty much until they dropped dead. Nowadays, we want independence, we want to retire early and, thanks to modern medicine, we’re living even longer. It’s not unfathomable that the average, healthy person currently in their mid-thirties could live 30+ years in retirement.

So why don’t we save enough for retirement? Why do we suck so much? Just kidding. You don’t suck, but here are a few reasons you aren’t saving enough for the golden years:

1) You’re Busy Buying Stuff Now

The latest generation iPhone is one sexy piece of consumer electronics. Why put $300 in a place you won’t touch for 40 years when you could be rockin’ the latest time-wasting app on your smartphone?

2) You Can Always Catch Up Later…

This goes along with the previous reason. You’re busy with mani-pedis. You know that once you hit 55, you can put an extra $5,500 per year in your 401(k). You’ll catch up then, you tell yourself.

Problem is, by then you’ve missed decades of visits from the magical leprechaun known as compounding interest.

Your pot at the end of the rainbow is full of Purina Dog Chow

and the leprechaun there to greet you is not the friendly one from Lucky Charms, but rather the killer from these movies that haunted my nightmares as a wee lad.

Whew, I just went to a difficult place…let’s get back on track.

3) You Forgot Inflation

A million dollars ain’t what it used to be. And in 30 years, how much do you think it will be worth then?

At an average of 4% per year, it’ll be worth $293,858. Ouch. You need to invest in assets that outpace inflation. Get out of CDs and into the stock market.

So…Where Do We Go From Here?

How much will you need to retire comfortably? I’ve heard many ways to estimate. I’ll give you one of the most common.

First, calculate 70% of your current annual income. Hopefully, by the time you retire, you’ll be out of all debt including the mortgage. Also, the kids should be on their own, lowering your expenses a bit more.

Next, divide that number by the withdrawal rate you’ll use in retirement. The “withdrawal rate” is the percent of your nest egg you’ll pull out each year to live on. Financial folks say 4-5% is a safe amount in order to use only interest and keep the principal intact.

The result of this calculation will give you a ballpark figure of how much you’ll need to retire comfortably. Let’s do an example. Say 70% of your annual income is $50,000. And we’ll use the more conservative withdrawal rate of 4%.

$50,000 / .04 = $1.25 million.

This means you should be able to spend $50,000 per year indefinitely.

Remember, there are so many variables in play (inflation rate, rate of return on your investments, actual expenses, etc.) that this is only an estimate.

Now, how much per year will you need to invest to reach this goal? Use this handy retirement calculator to figure it out. Enter 8-10% for the expected interest rate.

I know you don’t suck. I know that deep down, you really are concerned about saving for your retirement.

So get to it! Don’t let the normal reasons for underinvestment slow you down.

  1. Figure out your retirement goal
  2. Determine your monthly contribution
  3. Read my free guide to learn where and how to invest for your golden years

Because that’s what we want your pot at the end of the rainbow to be full of:

Gold, not dog food.

And you won’t be stuck saying, “Where da gold at?“

Posted in Building Wealth
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