One of the most important rules of investing is this:  Don’t invest in anything you don’t understand. If you don’t understand stocks, don’t invest in them.  If you don’t understand options, don’t invest in them.  If you don’t understand futures contracts, don’t invest in them.  If you don’t understand credit default swaps, well … don’t worry, because no one understands them.

Good money education is a critical component to your financial soundness.  Why?  Because no one cares as much about your money as you do. Everyone else cares about their money, and if they can get some of your money by offering you a product to make money, they will.  Whether you make money or not is largely immaterial to them.  What makes them money is very important.

When Vanguard (and just about every other financial blogger on the planet) talks about why index funds are good investments, they talk about the low fees that come with not having to be as active in managing the makeup of the fund.  “Low fees” are nothing more than a selling point. What are the advantages and disadvantages of owning an index fund?  Heck, what’s in the index fund?  What’s the market it’s indexing?  These are all questions that need understandable answers.

I asked a question over at Cash Commons about what stock screeners people use.  No answers yet, but Frugal Lawyer piped up and asked: “What’s a stock screener?”

I’m very glad she asked this question. It’s a bit like raising your hand in a lecture with 200 people to ask a basic question about what’s being discussed.  It takes courage.  And just like in the lecture situation, there are probably a whole bunch of other people that had the same question, but were afraid to ask it, and were glad you did.

Fundamental knowledge is the most important kind of knowledge to have about a subject.  Part of this is understanding the basic terms used in the subject.  Next is understanding the terms that can get easily confused.  Then, with a basic vocabulary in place, now you can read something and begin to understand what’s being discussed.

Don’t be afraid to ask about what you don’t know.  It could cost you.

Follow me on Twitter for random acts of Mighty Bargain Hunter

The author’s marketing company kindly sent me a complimentary company of Bill Schultheis’ latest reworking of his book: The New Coffeehouse Investor.  According to the “about the author” section in the book, Mr. Schultheis is an investment adviser with Soundmark Wealth Management, LLC, a fee-only registered investment adviser located in Kirkland, Washington.

In the preface and in the final chapter of the book, the author outlines the three big points:

• Don’t put all your eggs in one basket.
• There is no such thing as a free lunch.
• Save for a rainy day.
  

The book’s weapon of choice to reaching these goals largely centers around the well-worn merits of thrift and buy-and-hold stock market index investing:

• By “buying the whole market” you diversify and minimize the risk of buying heavily in an overbought sector, or in a bad company.
• Actively-managed stock funds that outperform the broad market are in the minority.
• The fees of actively-managed funds are higher than those for index funds.
• The turnover ratios for actively-managed funds is usually higher than those of index funds, so current tax implications are usually lower for index funds.
• The market wrings out any inefficiencies, so the best response to chasing gains is to say “homey don’t play that.”
• Compounding, compounding, compounding, reinvesting the dividends, spend less than you earn, etc.

It mentions bonds and bond funds briefly, but it’s clear that the book’s primary focus is low-cost index funds.

Would I recommend this book? It depends to whom.  For someone who’s a seasoned investor and uses stocks, bonds, and cash as a starting point for their options, I don’t think that person would be stretched by the investing content of the book.  It’s basic stuff.  (The anecdotes and analogies might be interesting to a person more outdoorsy than myself, though.)

For someone who’s never heard of index-fund investing, it would be informative.  Along with my recommendation, though, I’d also make it clear that this is a starting point and not an end-all, be-all, for the same reason that it’s limited in scope.  This isn’t just meant to pick on this book in particular:  It would be true for any broad-market book on investing that doesn’t stray beyond the cozy confines of stocks, bonds, and cash.  It’s necessary to understand what stocks, bonds, and cash can do for you, but it’s also important to understand what they can’t do for you.  For starters, index funds avoid the problem of “putting all your eggs in one basket” with respect to stocks, but those little baskets can still be all within a bigger basket:  stocks.

Competent investment advisers certainly need to provide advice that match their client’s level of understanding, and (I would hope) encourage them to learn more.  But everyone must start somewhere, and The New Coffeehouse Investor is a good overview of mainstream investment advice with a unique voice.

Follow me on Twitter for random acts of Mighty Bargain Hunter

Over at the MBN Forums there was some discussion about a short video presentation called Drive Free, Retire Rich over at Dave Ramsey’s website.

The first part of the presentation (up through Slide 11) was very well put together, and showed perfectly the value of buying used over borrowing and buying new.  A synopsis of the first 11 slides:

1. Getting a loan and buying new is a bad way to buy a car because you pay for up to six years, the car loses a big chunk of its value the moment you drive it off the lot, and it’s not what it once was after a few years, but you’re still paying for it.
2. Instead, save up to buy an inexpensive used car, and pay yourself the car payment.
3. After 10 months, sell your used car for (close to) what you paid for it, and upgrade to a better used car using the proceeds and your saved money.
4. Rinse and repeat until you’re driving a pretty nice car, and saving what you would have spent on the car loan for an emergency fund, retirement, etc.

The presentation paints very broad strokes, but the premise is a viable solution to borrowing for a car.  It will be slowed by things like taxes, registration, repairs, etc., but there’s nothing wrong with the method at all.

Then, at the end of Slide 12, the video takes a right turn at Albuquerque and enters Fantasy Land:

At the end of six years, your $11,000 paid-for car has just about run its course.  It’s been great, but it’s time to upgrade.  But hey, that’s no problem:  You’ve got a mutual fund specifically earmarked as a car-replacement fund.  You know how much is sitting in that fund right now?  At the stock market average of twelve percent, you’d have about $32,000.

What freakin’ stock market averages 12%? That’s the ballsiest claim I’ve heard about the stock market.  It’s a full 5% higher than the real return of the S&P 500 from 1950 to 2008.  How they can say that with a straight face is beyond me.  What’s more, the video goes on to make calculations assuming that this rate will hold for forty years.  Sorry, there’s little chance of that happening, unless the 12% includes inflation.  Then I suppose it can happen, but if that’s the case, then the $5-million-plus the video claims we’ll have at the end of 40 years if we follow the plan won’t be enough to retire on.

Bottom line:  Buying an inexpensive used car, paying the car payment to yourself, and upgrading every year or so is a great way to get into a nice car that you actually own.

Just don’t count on a double-digit stock market for the next 40 years to pay for your retirement, too.  Please!

Follow me on Twitter for random acts of Mighty Bargain Hunter

People invested in less-volatile vehicles just can’t catch a break.  According to this article, Generation Y may not be able to retire because they’re not invested in a portfolio with an “appropriate” risk level for their age.

The article cites Brad Klontz, a psychologist who specializes in money disorders, says that he sees a lot of Gen Y clients investing in things like cash, Treasurys, and gold, to “preserve” their savings.

There’s more evidence from other studies cited in the article that younger investors are by and large not investing in employer-sponsored retirement plans, and if they’re investing outside of them, they’re investing in less-volatile vehicles rather than equities.

The overarching tone:  Young investors need to get with the program, listen to the cookie-cutter advice from financial planners, get back into stocks, and take the roller coaster ride like real men and real women, because the return in the long run will be a lot better than what they’ll get from the mattress they’re stuffing their savings in.  We promise.

What I think of Generation Y:  GIT-R-DONE!!

Generation Y has every reason not to do what is described in this article, and every reason to continue investing how it has been. It could be true that they might not be saving much.  But if they have their money in cash instead of stocks, I’d take it as a sign that they’re not fearful, but instead that they’re thinking for themselves.  If they’re not investing in their company’s 401(k) and instead putting the same money in a savings account, might it not be that they’re (a) concerned about losing their job and need an emergency fund, or (b) they’re concerned that their company could go under and take their 401(k) with it?

Conservative investing is certainly not something to see a psychologist about!  They’re just not drinking the dollar-cost-averaging Kool-Aid® that’s being served to them.  Good for them!

It will take years for people to break even from the beating their portfolios have taken over the past year and a half — if they stayed in stocks.  If people got out of stocks then, they’re probably not doing too badly.  If they get out now, they’ll likely avoid Round 2 of the beating.  (If you ask why I say this, look around you.  Do you see things getting better?)  But if they stay in stocks (or get into them) they’ll experience the full thrill of the roller coaster.

Misery loves company, but I’d rather not be miserable.
UPDATE: Thanks to Earn What You Spend for including this post in the Carnival of Personal Finance!

Follow me on Twitter for random acts of Mighty Bargain Hunter

This morning in Sunday school someone threw out that a substantial fraction of Americans have a lottery win comprising their retirement plans.  (”How did we get to talking about gambling in Sunday school?” you might ask.  It was just a chance discussion, that’s all.)

I just shook my head at that statistic.  I figured it wasn’t far from the truth, but looked around a little bit to verify.  This three-year-old article over at the Motley Fool cites a survey survey by the Opinion Research Corporation for the Consumer Federation of America that found about one-quarter of those surveyed thought that winning the lottery was the most practical way to amass $200,000 or more.  (Here is a summary of the survey.)

Since I’m a math-oriented guy, I thought it’d be neat to figure out the return on “investing” in Powerball® tickets.  Tickets cost $1 each.  The odds of winning different prizes, plus the average payout for each prize, are as follows (PB = red Powerball, W = white ball):

The five white ball + red Powerball win is the Jackpot. This varies from week to week and I calculated the payout by taking the sum of the cash payouts for all the Jackpots in 2008 (a little over half a billion dollars) and dividing by 104 (two drawings per week).  The payout is about 20 cents for each dollars’ worth of tickets bought, or a return of minus 80%.  (Add a few percent perhaps if you take the annuity.)

The loss gets a little bit less if you chip in an extra buck per ticket to get the Multiplier.  Each week the Multiplier is 2, 3, 4, or 5; the chance of each multiplier showing up is 25%.  If a winning ticket is a Multiplier ticket, then the payouts (except the Jackpot) will be multiplied by the Multiplier.  These tickets cost twice as much, but the average Multiplier is 3.5, which means that the payout of the first eight prizes is multiplied by 1.75.  This ends up being a loss of “only” 67%.

Ok, that’s pretty a bad return, as one should expect: the average lottery player should get taken for a ride.  But how did the Standard and Poor’s 500 Index do last year?  It was pretty bad, too.

The S&P was 1,411.63 on January 4th, 2008.  It was 931.80 on January 2nd, 2009, a loss of 34%.

So, investing in the S&P 500 was (on average) better than putting an equivalent amount of money into Powerball tickets.  But certainly our investments can aspire to better things than just outperforming the lottery, can’t they?

Follow me on Twitter for random acts of Mighty Bargain Hunter

Finding time to invest in yourself is smart, especially in today’s rocky job market. If you have a commute, as many do, listening to audiobooks is a straightforward way to make productive use of that time. Popping in some thought-provoking or inspirational material can broaden your knowledge and sharpen your effectiveness at work, which will increase the likelihood that you’ll stick around longer as your colleagues are getting pink slips.

One of the guys in my church home group is a self-professed audiobook junkie, and he pays for a bunch of them. There’s no doubt a market for audiobooks. However, there is a fairly good selection available absolutely free.

Here are a few sources for free audiobooks worth checking out. I’ve tried to limit the links to free audiobooks that are narrated by humans. There are more sites that have free recordings of digitally-produced audio, but these recordings, though understandable, are probably a second choice behind human-read books mainly because they sound like digitally-produced audio.

• Librivox.org has the aim of providing all public domain books as free audiobooks. It has close to 2,000 free audiobook downloads. Not all of them are in English, but many are.
• Project Gutenberg has a few hundred public-domain works narrated by humans. Jane Austen, Arthur Conan Doyle, Rudyard Kipling, Henry David Thoreau, William Shakespeare, and many others are represented here.
• AudioBooksForFree.com has even more works all freely downloadable. The catch here is that the free versions of the audiobooks are split up into several files and the audio is low-quality, but “bearable,” as the site puts it. Higher-quality and bigger files cost.
• AudioBookQuest.com has 45 free downloads. A bunch of them are teasers but there are a few longer downloads.
• ChristianAudio.com has a monthly free audiobook download with a coupon code.
• SimplyAudiobooks.com also has a free monthly download. This month’s is a collection of stories by Guy de Maupassant.
• You can get one free audiobook download during a free 14-day trial of Audible.com. There are 50,000 titles to choose from. Try Audible Now and Get TWO FREE DOWNLOADS!

Follow me on Twitter for random acts of Mighty Bargain Hunter

This Michelle Singletary column on the Washington Post website has answers to a few readers’ questions regarding debt and debt reduction.  The first question outlines a situation that stings a bit.  Here’s a summary:

• Husband has less construction work coming in; takes lesser-paying jobs to bring in something.
• Couple cuts budget but is still short $250/month, which is depleting their savings.
• She contributes to her 401(k) only enough to get match from employer.
• Question: Give up the free money to shore up the shortfall?

Ms. Singletary’s answer is yes, do this until the employment situation improves, even though it hurts to give up the free money.

I have to agree with this.  I’d go for one more round of cost-cutting before throwing in the towel, or cut as much as I could but just reduce my contribution so that I’d still get some of the match, but yeah, money more or less locked away in a 401(k) doesn’t do much good when the credit card balances start going up.

I think this would especially hurt someone who had been doing the right thing and taking advantage of matching money from their employer.  Plenty of people just let this money float right by them down the drain each and every paycheck.  (Just to set the record straight: I’m not completely sold on maxing out 401(k) contributions, but getting as much as you can out of your employer in matching money is usually a good idea.)

Keeping your income streams flowing is key, just as doing little money-saving things.  Investing should be used with excess funds, and if there are no excess funds, then there should be no investing, for retirement or otherwise.  And if there’s debt to be reduced, then this is even a stronger reason for not investing.

Follow me on Twitter for random acts of Mighty Bargain Hunter

(This is a guest post written by ABCs of Investing, a brand new site for novice investors which offers two short and simple investing posts per week.  Feel free to subscribe to the feed.)

The majority of investors use a financial advisor or broker to help with their investing planning.  There is nothing wrong with getting some help with investing since it is a fairly intimidating subject.  Most people just don’t have the time or the interest to read investment books and become knowledgeable enough to be able to handle all of their own investments.  Do-it-yourself investors forget how much time they have put into learning about finances and think that investing is easier than it really is.

The great thing about investing is you don’t have to choose between being an expert DIYer or a clueless investor who needs an advisor.  You can hire professional help AND know what you are doing at the same time!

A few years ago I bought a basic electrical book.  It showed how to do electrical repair jobs and even how to plan various circuits in a house.  One of the things that I found most interesting about the book was in the introduction; it said that learning the basics of your electrical system is useful whether you do the work yourself or hire someone else.  The point was that even if you end up hiring a contractor to complete your electrical work, any knowledge you have about the electrical system in your house and how it works will assist you greatly.  The same logic applies to investing: the more investment knowledge you have when dealing with an advisor, the better off you will be.  It is worthwhile to spend a bit of time learning about investing.

There are number of areas where some investing knowledge will help if you have an advisor:

• It won’t be as easy for the advisor to take advantage of you.  Let’s face it: some financial advisors, like real estate agents, make money on commission, and unscrupulous ones can rob you blind if you let them.  Knowledge about proper investments and for that matter knowledge about how advisors make their money will help you a lot.
• You’ll have more productive advisor/client meetings.  Usually when a client visits or talks with their advisor, the advisor is telling them what to buy.  If you can spend some time before meetings looking over your portfolio then you can drive the meeting agenda and make sure that your questions get answered.
• You’ll know better what you want from your advisor.  A lot of investors just hand over the financial reins to their advisor and just do whatever they are told.  If you have some investment knowledge then you will be in a lot better shape to determine what you want from the advisor, communicate your desires to them and make sure that they are the right advisor for you.

The single best way to learn about investing is to read.  Read, read and then read some more.  Books, blogs, websites, newspapers are all sources of information.  Talking with friends, relatives, co-workers can also be helpful.  But beware, all the “good” ways to learn about investing can unfortunately also be “bad” ways to learn about investing.  The best way to protect yourself is to read as much as you can and eventually you will be able to figure out where the good information sources are.

Knowledge is power!  Make sure you have as much as possible when dealing with your advisor.  Even a little bit of knowledge is a lot better than none at all.

(Photo credit: net efekt)

Follow me on Twitter for random acts of Mighty Bargain Hunter

Jim posted a bit back about shutting off the financial news and watching lolcats.  Synopsis:  If the market news makes your stomach churn, just put your brain on autopilot for a while.

I’ve checked out ICanHasCheezburger and FailBlog and they’re pretty amusing.  No, actually, some of the posts are downright side-splitting.  (This recent one is apropos.)

This avoids the real question, though:  Why is the market news giving you an ulcer?

Maybe, because, you’ve lost a lot of money in the markets, and every day there’s a several-hundred point drop in the Dow you lose even more?

Tuning out bad news because it reminds you of your paper losses is denial, plain and simple.  Looking at funny pictures of animals won’t bring the value of your portfolio up, and it’s hours upon hours of wasted time that you could be investing in yourself.  (I’ve learned this the hard way with failblog.  Bad time-suck.)  Invest in your job so that you can continue earning and, therefore, continue to invest.  Or learn more about your investments to evaluate whether your money would be better elsewhere.

But please don’t be scared of your portfolio!  Learn about it, develop a plan for investing that you’re comfortable with, and sleep well at night knowing you’re doing what you can.

What separates us is what we do in our “spare” time.  Time-sucks have a negative rate of return.  There are enough negative rates of return going around without adding to them.

Follow me on Twitter for random acts of Mighty Bargain Hunter

Prosper.com is currently in a quiet period during which it will not accept new lenders or new loan commitments from existing lenders.  They state that they are registering promissory notes with the appropriate regulatory agencies, which may be offered and sold to lenders.

The primary market — as is was before the quiet period — consisted of lenders competing for a slice of a borrower’s loan by bidding down the rate that they’ll accept.  Each lender that “wins” can view a promissory note within their members’ section that states the terms of the loan.  This forms the legal ownership of the loan, and allows collection and recovery to occur should the loan go into default.

This secondary market, as I understand it, would possibly allow me to sell that promissory note to another lender.  As it stands now, all I can do is sit on the note and wait for it to get paid off or go into default.  The secondary market would make those notes more liquid, and it would seem to help everybody (or at least not hurt anybody).  Lenders could cash out of their existing loans if they wanted to.  Lenders would have more choices for loans to buy.  Prosper could collect fees on the transactions.  And borrowers wouldn’t know the difference.

The short notice of this quiet period has generated discussion as to whether Prosper is running afoul of regulatory agencies.  (Why shut things down so suddenly?)  I had suspected that Prosper was more in compliance than some other peer-to-peer lending companies, but maybe not.  I just don’t know.

I currently have over 30 loans out in Prosper.  More than 20% are not current, ranging from a few days late to “bankruptcy filed.”  I stopped putting new money into Prosper quite a while ago, and have only bought new loans using the principal/interest payments received from the existing loans, and the initial money invested wasn’t going to kill me even if I lost it all.

Selling off my loans would be tempting, even if it means taking a small loss, because the economy is going sour.  Better to have money back in a bank account than to watch those delinquencies pile up.  But whether I take a loss to the principal value or not ultimately depends on whatever market is set up by Prosper.

One thing is certain though: those of us that lend at Prosper will just have to sit tight and wait.

Follow me on Twitter for random acts of Mighty Bargain Hunter