May 3, 2011

Why You Should Sell All Your Stocks Right Now

sell-all-stocksI recently sold off all my shares of another company that I  invested in, leaving me with only one stock investment left (that I’m likely to sell soon, too).  This stock I just sold performed poorly (I lost money) since a bought it a couple years ago, but that’s not even my principal reason for selling.  In fact, I’m not jaded by my stock investing experience at all.  I’ve had good luck (yes, I really do feel my other pick came down to luck, not skill), as my remaining stock investment has returned about 250% in the two years I’ve owned it.

My reason for selling is that stocks are not the best choice for the casual investor. I would consider anyone that’s not some sort of investing professional a “casual investor”. In fact, many of those that consider themselves seasoned investors should be looking to options other than stocks, too.

Why No Stocks?

First off, the idea of picking individual stocks turns people off to the idea of investing in the first place.  People think all investing is complicated and only for the elite.  Others think they need insider knowledge or to read magazines and other sources constantly to keep up with the changing markets. They also believe that you need to constantly manage a portfolio, making trades on a weekly or monthly basis.  This simply isn’t the case.

Secondly, anyone that thinks they are going to consistently beat the market picking stocks is foolish.  As Ramit points out in I Will Teach You To Be Rich, Warren Buffet, among the best of the best on investors, has returned about 22 percent annually on his investments for forty years.  22 percent is fairly modest to you and me, especially if you’re only investing a few thousand dollars each year. And, let’s not forget: You’re not Warren Buffet!  Even greatest investors out there can’t expect a return that’s a hell of a lot higher than the market itself returns (which is about 10% per year, historically).

The Easy Alternative to Stocks

What’s the solution without stocks? Investing in mutual and index funds.

I personally like index funds because they have a much lower expense ratio than mutual funds typically do.  Owning a mutual fund will typically cost 1.5-3% of your investment each year, while index funds often cost around 0.25% (my Fidelity Total Market Index Fund is 0.10%).  This is because index funds are essentially run by a computer whereas mutual funds are run by a person (and that person wants to be paid!) While mutual founds may not sound expensive, that 1.5-3% eats into your earnings and can have large affects over long compounding periods.  Besides expense ratios, many index funds outperform mutual funds anyway.  Easy choice, right?

The returns you can expect on index funds are essentially the same as how the market performs: about 10%, annually . I know that no one’s stock market fantasy involves an 10% return, but expecting more than that is incredibly unrealistic when considering what the pros return on their investments.

If You Still Want to Buy Stocks

If you really want to buy stocks (I know several people that love the idea of owning a piece of Apple), keep it to a small portion of your total investment portfolio. I try to keep individual stocks around 5% of my total portfolio.  Given the volatility and difficulty of trading stocks, it gives me the opportunity to have some fun taking a shot on stocks, but doesn’t risk my retirement savings at the same time.

Invest! Now!

The important part of investing is to get started right away.  You need to do so to take advantage of compounding returns that will grow your money the longer you have it invested. Now that you know that you can’t expect 1,000% returns on your investments (even if you are Warren Buffet), that means you have to make up for it by getting time on your side.

If you’re unsure where to start, I recommend checking out I Will Teach You To Be Rich or Your Money: The Missing Manual for an introduction to index funds. If you still need help, you can work with a financial planner to invest in index funds and give up the hassle and complication of dealing with stocks.

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photo by: BlatantWorld.com

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March 31, 2011

The Magic of Compounding Returns and Investing Early

compounding returnsWhile I have a very mathy background to begin with, I’ve recently been mesmerized by how powerful compounding returns are when it comes to investments.  Ramit Sethi does a great job of pointing this out in his book I Will Teach You to be Rich with a very simple example:  Simple Sally invests $100/month for 10 years starting at age 25.  Dumb Dan invests $100/month for 30 years starting at age 35.  Each earn an 8% rate of return, which is about what the stock market returns annually.  The difference : at age 65, Sally has $200,000 and Dan only has $149,000!  That’s right, even though Dan invested 3 times more out of pocket, Sally has him beat by $50,000.

Many only dream of ever being a millionaire.  Thanks to compounding returns, you don’t have to actually save $1 million to be a millionaire.  If $5,000 a year is invested in a Roth IRA starting at age 20, there will be almost $2 million in your account by age 65!

This says only one thing to me: You need to start investing as soon as you can! The mathematical evidence of compounding returns clearly shows that you are at a disadvantage if you start investing later. It’s really hard to make up for the time lost in years later, even if you throw more money at the fire.

You may worried about investing when the market is having a bad year and the Dow is dropping.  There’s no cause for concern, as this factor is definitely not as important as simply getting your money invested.  A few points on this:

1.  Unless you’re Warren Buffet, timing the market is difficult and totally unnecessary.

2. If you invest early (and over a longer period), you’re are much less susceptible to sharp fluctuations that occur during shorter periods.  Yes, the stock market sucked in 2008 and killed a lot of investments, but, before that, returns were fantastic (and they’ve actually been good in 2009 and 2010, too).

3. Most people don’t invest large, lump sums of money all at once.  Instead, a portion of monthly income is invested, so you’ll be constantly investing in good months and bad.  Don’t worry, you have point #2 on your side.

4. If you suddenly have a big chunk of money to invest, you can use dollar cost averaging to spread the risk.  I won’t get into too much detail here, but you can read more on dollar cost averaging at Get Rich Slowly if you’re interested.

Just Get Started!

No matter what your age, you need to get started now to take advantage of compounding returns!  Here’s what to do:

1.  Open an investment account if you don’t already have one.  I have one with Fidelity, but others like Charles Schwab work grat, too.

2. Open a Roth IRA.  This will take about 2 minutes.

3.  Link to your checking account.  Again, quick and easy.

4.  Set up automatic withdrawals from your checking account to your Roth IRA.  Even if it’s only $50 a month, just get started.

5.  Choose an mutual or index fund.  Don’t get bogged down by this. Investing isn’t as complicated as you think.  Specific investments are outside the scope of this post, but I recommend I Will Teach You To Be Rich or Your Money: The Missing Manual to help pick out a lifestyle or index fund.  You don’t have to pick an investment fund on day 1.  Just start sending money to your Roth IRA and invest it as soon as possible.

6.  Reap the benefits when you’re ready to retire.

I hope I’ve convinced you that compounding is really powerful.  Not to be a downer, but it’s also really powerful on your credit card balances, too.  Keep that in mind, and always be sure that compounding is working for you, not against you.

If you’re interested in investigating more compounding returns and interest scenarios, head over to dinkytown.net

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January 19, 2011

3 Personal Investments With Better Returns Than the Stock Market

While I probably grabbed your attention with the headline, the three investments I’m referring to may not produce direct financial returns to you at all.  But that isn’t the point.  There are lots of investments you can make that are a much more important that getting 10% ROI.  Instead of squirreling away all your earnings in the stock market, consider these instead:

Yourself.  There’s (hopefully) not a lot of risk in this investment, but the returns can be long-lasting and invaluable.  By investing in you, you can improve your career, your relationships, and your outlook on life.

Photo by eflon

A practical way to invest in yourself is through education. But while I have both a bachelor’s and master’s degree, I would caution against going after another degree just for the sake of doing it.  Earning new degrees are often very expensive and you may not end up with the skills and knowledge you expected to gain.

Instead of a traditional educational path, consider more practical experiences.  Take adult education classes, attend seminars, or utilize courses that that will develop your skills in areas you’re most interested in.  For example, I spend on myself by purchasing courses that develop my online business skills, like David Risley’s Blog Masters Club.  Courses like these teach what I know I will put to use immediately and relate directly to my personal business and entrepreneurship goals.

Whatever you want to do now, find a way to invest and make that happen.  Maybe you want to learn a language or start a small business making crafts.  Whatever it is, spend a little money to make it happen.

Your Life.  While I preach quite a bit of frugality on here, I don’t support taking frugality to an extreme.  To me, investing in my life means not making severe sacrifices now just to save for later.  Sure, I could save thousands a year if I didn’t go travel on vacations to Greece, eat out a couple times a week, or take up hobbies like biking and beer brewing.  I’m positive eliminating these things would do wonders for my retirement fund, but it’s just not worth it to sacrifice life now for later.  I’m not suggesting that anyone should go into massive debt to live life now.  That’s not the idea.  But life right now shouldn’t be neglected for saving for the future. When I’m older I might not be able (or want) to do the same things on my travels, like long hikes or weeks-long camping trips.  But I know these things make me happy right now.

Plan a trip or something else fun that you’ve been holding back on.  If needed, work extra hard to earn the money to make that possible.  Just don’t make your life miserable now to save for later in life.

Your values and beliefs.  I’m sure there a lot of movements, charities, or ideals that you have an personal attachment to.  Everyone does.  On top of that, there are a lot of great organizations that severely need financial help.  While we may not all have time to volunteer regularly, almost everyone can afford to give something.  Regular giving to charity should be a priority.  I’ve donated $20 a month for the last 10 years to Children International, where I have an “adopted” child in Colombia.  It may not be a lot of money in the grand scheme of my life, but I’d gladly give up eating out once a month in return for making this gift.

I donate to other places, too, with a goal of donating 10% of what I make.  This might not be possible for me or you all of the time, but it’s a good benchmark to shoot for.  There are a lot of other great charities out there that I wish I could support at a greater level.  Having more to give to those in need is part of my motivation for earning more.

While I’ll continue to invest in stocks, bonds, and mutual funds, I’ll never stop contributing to these personal investments.

Do you have personal investment ideas of your own?

Photo credit: eflon

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