Pay Yourself First

The difficult thing about saving money is that from the moment you get that paycheck, there are many demands for that cash.  You need to pay yourself first.  Once the paycheck hits your checking account, the many demands of your life will quickly gobble up all your available funds.  To see how you can “pay yourself first” and start saving, establish a monthly budget and stick to it.

Its tough at first, but it does get easier and it becomes rewarding as you see your debt load shrink and your saving grow.  You need to prioritize and determine what is really a need versus what you just want to have.  A great way to think about budgeting, is to look at everything that wasn’t around when your parents were your age as a “nice to have item”.   For example, our parents didn’t have cell phones or high definition digital cable.  What’s more, these are often expensive items and you pay them every month. 

Look at it this way, going for the high definition digital cable probably costs you $75 a month more than basic cable.  That works out to $900 a year.  How about switching to a less expensive cell phone plan – probably another $250 a year.  Eat out for lunch every day?  At $10-$12 a pop, that can add up to $1,200 a year more than it would cost you to bring your lunch to work.

Create a budget spreadsheet to see where you can save some money.  Don’t let the size task overwhelm you, just start filling in what you know and start tracking what you don’t.  See where you can do with a little less and watch your money grow.

 

Stop the junk mail

Raise your hand if you think the big banks, mortgage brokers, credit bureaus and finance companies do everything they possibly can to make a buck.  Now that I see you all have your hands up, let me tell you about one more thing they do that you’ve probably never heard about.

The credit bureaus have alerting systems that many of the big banks, mortgage brokers, and finance companies subscribe to in an attempt to get leads on people applying for a loan. 

Here’s how it works.  When you fill out a loan application, the lender pulls a credit report to see your payment history and other financial information.  Interestingly, the credit bureaus offer a service to alert subscribing lenders that a certain type of inquiry just occurred and the provide these companies your financial information.

Guess what happens next – you got it, your mail box fills up with offers and your phone rings off the hook!!  If you were asked, I am certain that most of you wouldn’t consent to this sharing of your information. 

What can you do?  For starters you can contact each of the credit bureaus asking them to place you on their “do not market” list.  Be specific that you want to be on both the “do not mail” and “do not call” lists.  Include your current and previous address and full name.  Here are the contact details for each bureau:

Credit Bureau Main Opt-Out Line  (888) 567-8688

DMA – Direct Marketing Association Opt-Out

Mail Preference Service

P.O. Box 282
Carmel, NY 10512

Telephone Preference Service
Direct Marketing Association

PO Box 1559
Carmel, NY 10512

The DMA is an industry organization that major direct mailers join and the company provides members a list of people who want to opt-out of mail or telemarketing campaigns.

List Brokers

These companies sell mailing lists to businesses and organizations. Write all of them and ask them to remove your name from all their lists.

Dunn & Bradstreet
Customer Service

899 Eaton Ave.
Bethlehem, PA 18025

Metromail Corporation
List Maintenance
901 West Bond
Lincoln, NE 68521

R.L. Polk & Co. – Name Deletion File
List Compilation Development
26955 Northwestern Hwy
Southfield, MI 48034-4716

Database America
Compilation Department
470 Chestnut Ridge Road
Woodcliff, NJ 07677

It takes some time to have an impact, but you should see a lot less mail and telemarketing calls before long

 

Mutual Fund Basics

A mutual fund is a company that pools money from many investors and invests the money in stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of these investments. The combined holdings the mutual fund owns are known as its portfolio. Each share represents an investor’s proportionate ownership of the fund’s holdings and the income those holdings generate.

Buying mutual funds has many advantages to the average investor.  First, it is easier to build a diversified portfolio through mutual funds than it is to buy individual stocks to do the same.  You also benefit from the professional management of the fund.  Professional managers identify stocks, research their risks and prospects, and monitor their performance.  To do that on a portfolio of 10 or more stocks would likely prove to be  time prohibitive for the average investor.  Mutual funds are quite liquid and provide a low cost of entry in building a diversified portfolio. 

Funds often specialize in a certain kind of investment.  Some focus on certain types of stocks such as growth or large capitalization stocks.  Other focus on bonds and yet another group called money markets focus only on short-term, high-quality investments issues by state, local and federal governments.

You can earn money from your mutual fund investment in three ways:

1. Dividend Payments — A fund may earn income in the form of dividends and interest on the securities in its portfolio. The fund then pays its shareholders nearly all of the income (minus disclosed expenses) it has earned in the form of dividends.
    
2. Capital Gains Distributions — The price of the securities a fund owns may increase. When a fund sells a security that has increased in price, the fund has a capital gain. At the end of the year, most funds distribute these capital gains (minus any capital losses) to investors.
    
3. Increased NAV— If the market value of a fund’s portfolio increases after deduction of expenses and liabilities, then the value (NAV) of the fund and its shares increases. The higher NAV reflects the higher value of your investment.

With respect to dividend payments and capital gains distributions, funds usually will give you a choice: the fund can send you a check or other form of payment, or you can have your dividends or distributions reinvested in the fund to buy more shares (often without paying an additional sales load).

There are many factors to consider in purchasing a fund such as cost, risk, and tax treatment.  Research your choices carefully, review the fund prospectus and even talk to your advisor before making a fund purchase.

 

Risk Tolerance and Asset Models

One of the keys to effective asset allocation for your investments is to determine your risk tolerance.  Many web sites offer tools to help you do this.  They’ll ask questions about what is the largest loss you would be willing to bear in any single year in hopes of better long term returns.  Based on your answers to a series of questions they will recommend different allocation models.  A couple hypothetical allocation models are provided below:

Conservative Portfolio:  20% in stocks (15% large cap, 5% international), 50% in bonds, 30% in cash.  From 1970 – 2005 this portfolio would have delivered an 8.6% average annual return.  Its best year would produce a 22% gain and its worst would be a 0.1% gain.

Moderate Portfolio: 60% in stocks (35% large cap, 10% small cap, 15% international), 30% in bonds, 5% in cash.  From 1970 – 2005 this portfolio would have delivered a 10.5% average annual return.  Its best year would produce a 30.9% gain and its worst would be a 12.9% loss.

Aggressive Portfolio: 95% in stocks (50% large cap, 20% small cap, 25% international), 0% in bonds, 5% in cash.  From 1970 – 2005 this portfolio would have delivered an 11.2% average annual return.  Its best year would produce a 39.9% gain and its worst would be a 23.8% loss.

As you can see, you can greatly vary your investing experience simply by your choice of asset classes.  Once you’ve diversified based on asset class, you can further manage risk and target returns through your allocation within an asset class.  This may mean targeting certain industires like technologies or utilities or investing in funds targeting a certain geography such as South America or the Asian Pacific.

One of the most critical aspects is to evaluate the mutual fund managers.  You want to avoid the one hit wonders and those don’t invest in the funds they manage.  Consistency and commitment to their fund is an important aspect in picking a fund manager.   You want to find the managers that will consistently outperform and have a strong commitment to the fund through their own investment.

 

Asset Allocation

Think of asset allocation as a way of reducing your risk by not putting all your eggs in one basket.  Imagine if you put your entire nest egg in a single stock like Enron.  When that one stock plummets, you lose nearly everything.  More generally, think what might have happened if you owned nothing but Technology stocks at the end of the bubble.  This time you may have owned dozens of stock, but you likely lost a substantial portion of your investments.  Asset allocation is a way to spread risk by not putting money in only one kind of investment.  You invest in different asset classes.  This could mean buying stocks of companies that are different sizes, industries and countries, while also putting money into bonds, money markets and even real estate.

 

The idea is that asset classes come in and out of favor at different times.  By rebalancing on a periodic basis, you shift money from classes just in favor to classes that were recently out of favor.  In a sense, by doing this regularly, you are buying low and selling high. All the while you are minimizing your risk.

 

Modern Portfolio Theory

Basically modern portfolio theory boils down to attempting to find a portfolio with the maximum return for a given level of risk.  Individual investments are evaluated for the potential long term return and short term volatility (price fluctuation).  If you have two stocks whose prices generally move in the same direction, their short term volatility, or risk, will be greater than two stocks whose price fluctuations generally move in opposite directions.  The goal of modern portfolio theory is to take advantage of assets whose price movements differ, but offer the most opportunity for long term gain.  Thus, short term fluctuations and losses are less likely to occur.

 

Hello world!

Welcome to Charleston Money!? This is a site dedicated to discussions on asset allocation, mutual fund investing, and modern portfolio theory.

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