A10, Stock Trader Dude

Chapter three is Wipe out your debt and the author recommends paying off your debts since it should be obvious that you are paying more in interest than any of your investments are generating, and if you don’t have any investments, the idea is the same, the return you are getting is what you are saving in interest charges. Chapter four, Your safety net, and it states – You buy life insurance for just one reason: to support the people who depend on your income if you die prematurely. That’s it. Everything else is noise.

Prepaying your mortgage is an investment and I can tell you exactly what the return on that investment will be. Your gain is always the same as the interest rate you pay. So when does the book recommend paying early would be appropriate?

1. In middle age

2. In a flat housing market

3. If you inherit money (prepaying reduces your cost of living)

4. If prepaying looks like a good investment

5. To shorten a long-term mortgage

6. If you just hate debt

Add 1/12 of a payment each month to what you are already paying.

I see a number of problems with the above. While you may be building equity faster in your home, there is no inherent return associated with your home equity investment and you reduce your tax deductions. If prepaying is your preference, without an audit of how your additional 1/12 payment is being applied – you don’t know if it is going directly to the principal loan balance or how soon that portion of the payment is being applied. Prepaying your mortgage doesn’t maximize your leverage. The author doesn’t understand the pitfalls of traditional IRA and 401k account investments, nor the tax consequences compared to alternative investments and tax deductions that can be duplicated with a mortgage. An interest only mortgage can be your best friend when properly utilized.

Only a few things work and they work really well. If you set up a system that runs automatically, you can’t fail. Success comes from starting right, then keeping a hands-off approach. You can’t see the future but if you’re saving money steadily, that doesn’t matter. All that really matters is getting more out of life.

Chapter seven, Better investing, I like how the book ends. Good news: The smartest investments are the simplest ones. Ignore it all! You don’t need 99.9% of what Wall Street is selling.

How to apply time-tested principles to create, manage and build personal wealth. Wait a minute, principles aren’t secrets; here we go with another thick book to waste time… but I’ll spare you a few hours.

Seven main reasons people fail

1.      Procrastination

2.      Failure to establish goals

3.      Ignorance about what money must do to accomplish those goals

4.      Failure to understand and manage credit

5.      Failure to understand and apply tax laws

6.      Failure to properly prepare for the unexpected

7.      Failure to develop a winning financial attitude

The good point is, those issues need to be addressed and if you do that you’ll be prepared to win by not losing because you started on a good foundation. As for the principles:

1.      Set goals

2.      Pay yourself first

3.      Harness the power of time

4.      Diversify your investments

5.      Manage your credit wisely (good debt)

6.      Safeguard your future (insurance)

7.      Seek professional guidance

It’s interesting to see what a professional will say in a book considering all the hucksters out there that discuss investment and stock market wealth along with self-proclaimed experts that don’t have the credentials that Mr. Schwab has. Here’s what his guidance is:

1. Invest for growth

2. Divide your portfolio

3. Know yourself

4. Keep your perspective

5. Stay informed

Taking care of the basics:

1. Create a financial safety net (savings of 2 months to 6 months of living expenses)

2. Make sure you are adequately insured

3. Contribute the maximum amount to an IRA and 401(k) or 403(b) plan

4. Pay yourself first (Make it a habit and start with at least 5 to 10 percent of your gross income)

5. Get started now

He discussed being 24 years old and going into high-growth stocks because he wanted to get away from the number zero, as in where he started from, at a rapid rate. But he does stress that before you invest, handle the basics. Your personality plays an important role in the kind of investment plan you develop. The two most important aspects to look at are your time frame and your attitude toward risk.

A penny for your stocks:

When you buy penny stocks, you’re seldom buying quality, something that’s crucial in stocks. Schwab claims that although penny stocks rank at the bottom in terms of quality, people get involved because they act on a hunch and believe these stocks look like easy money can be made – both bad reasons to invest.

If you include only US stocks in your portfolio you are bypassing nearly half of the world’s stock market opportunities.

What armchair investment strategy works? Here are the eight criteria for a near-perfect investment strategy:1. The strategy must be easy to start.2. The strategy must be easy to maintain.3. The strategy must be easy to understand.4. The strategy must be inexpensive to implement and maintain.5. The strategy must be tax-efficient.6. The strategy must be widely available.7. The strategy must have a lot of history to judge it by.8. The strategy must make a lot of money.The author claims there is only one way to do that which meets all the criteria – indexing. This book could have been one page long: it simply suggests buying an index fund. The author cites Warren Buffet as saying that it is the best approach for 97 percent of all investors. Why does the author think buying an index fund is a great idea? Well, he cites that from 1995 to 1999, nearly 85 percent of all mutual funds that were set up to beat the S&P 500 failed to meet that goal in any particular year. Eight out of ten mutual funds can’t beat the market. For the ten-year period ending in mid 1995, the S&P 500 index beat 83 percent of all actively-managed general stock market mutual funds. Here is what the author is missing, from a fundamental standpoint, over the very long term, like a thousand years, all investments have done poorly. Also, there are ETFs in addition to index funds, and ETFs might be better for lump sum investments. More importantly, after a boom period, the S&P 500 doesn’t do very well and it can stagnate with low returns for seventeen years for example. So, while index funds are great, why limit yourself to the S&P 500 when other world stock markets may see better growth or the bulk of the growth over the next fifty years? So, while it is important how you invest, the primary factor in determining your investment returns is what you invested in. For most folks, investment grade life insurance contracts may offer the best blend of tax benefits and stability, as you can opt for a guaranteed rate of return so that you never lose, with or without it linked to the S&P 500 index. And in case you’re wondering, no, I don’t sell insurance. Most of these books have a fancy way of making a point when one page will do fine… so while these criteria are fine to evaluate an investment, no one can see out fifty years and know which investment will be the most promising.

There are plenty of books on making money by men and women who haven’t made much. That’s exactly why I like this book by J. Paul Getty, there is no disputing the author’s credentials. He wrote it to convince young businessmen that there are no sure-fire, quick-and-easy formulas for success in business, that there are no ways in which a man can automatically become a millionaire in business.

And specifically when it comes to stock investments he discusses why the average person will not attain wealth in the stock market. The average person may risk a little of his or her capital and if the investment doesn’t work out the person loses a little. It is precisely this kind of risk that everyone can take that negates the creation of wealth. If the investment works out, the gain is usually little. You would have had to invest a substantial amount in a superior asset/stock in order to benefit from the movement of the share price and this is the kind of risk that few are willing to accept.

An extraordinary portfolio, even on an ordinary income, by following one commonsense investing strategy… Well, before you get excited, let me explain what the author is advertising: saving your money and putting it in an index fund. Is this a good strategy? There isn’t anything wrong with saving money and putting it into index funds but there are a number of errors in implementing it. The author fails to understand the risks of tax consequences (which will reduce the expected millions), and fails to understand that there are cycles in investments, so why would you want to be invested in the US market, with an S&P 500 index, when other areas of the world, such as the Asia Pacific region, may have more potential over the long-term for growth? Why limit yourself to the US market that could very well under-perform for seventeen years, for example, as it has before after a boom period? The author lacks a filter on understanding what is and what isn’t a good investment. Investment grade life insurance can offer a stable return, or linked through an index, where you get the upside in a good market but not the downside. This is the way to go if you want index exposure and you are eligible for tax free retirement income with investment grade insurance contracts. The bonus is that should something happen to you, you also have life insurance, so your family will have tax free income to provide for themselves. That’s going to be a lot better for your dependents than your IRA or 401k, especially if the death benefit is high. So while I don’t see this book as being valuable you still may be curious so here are some notes:

Five steps to financial freedom (I’m getting tired of them calling it that)

1.      Max out all tax-deferred savings (I say, may or may not be the best choice, you can also get another mortgage or refinance into interest only and get the same or higher tax deduction benefit)

2.      Pay yourself first

3.      Invest automatically – and benefit from dollar cost averaging

4.      Use the armchair investment strategy (nothing more than buying an index fund)

5.      Start today – put the power of compounding interest to work for you

Here’s the objective: turn a hundred thousand dollars into a million in the stock market. I’ll make a couple of unlikely set-ups here, such as the hundred thousand is sitting in a Roth IRA account – that eliminates tax issues. This hundred thousand may only reflect one part of the overall retirement monies – for example, perhaps the other money is invested in an investment grade insurance contract. That way, the person is going to have a guaranteed income for retirement even without the hundred thousand in the Roth IRA.

I’m generally not agreeable to cheap stocks, much less penny stocks as meaningful investments but here we go anyway:

Bought 22,000 shares of RBS at $4.35 (Friday’s closing price)

Risk: 20 cents per share, for stop out around $4.15; total risk is approximately $4400. The Royal Bank of Scotland isn’t being favored by investors but who’s to say things can’t change, and if the stock is high or a value?

And now here is the lottery ticket, 100,000 shares of IFLI at 1.5 cents. That’s right, a penny and a half, for an investment of $1,500. We may never see this money again, yet, if all this talk of the rise of MMA as the next big sport takes off and the IFL benefits, and if luck may have it that the share price goes up ten points we’ve got seven figures just on this position (and therefore our million dollar objective). I would not dare say that buying IFL is like buying the equivalent of an NFL in its infancy. You may recall the XFL, a professional football league in 2001 that only lasted one season. The XFL was intended to be a major professional sports league to complement the off-season of the NFL, but didn’t quickly pick up a large audience and ended after one season. The IFL lacks the same kind of organization that makes the NFL, NBA, MLB, World Wrestling Federation, etc. operate as a powerful force. The more organized you are, the greater your edge, be it, in a personal sense or a corporate one. I would never spend a dollar on a lotto ticket, but a penny and a half or two cents on a dream… well, for some this is going be like taking those annual lotto dollars and putting it to work someplace else.

*Update: RBS went up approximately fifty cents, then down, so at best it brought a small immediate profit, broke even or triggered a small loss depending on timing/exit ability. This bank was caught up in bailout activity and due to reverse stock splits the stock trades approximately from $9 to $19. The best we could have hoped for was this kind of run without a reverse-split. This part of the experiment failed.

*Update: IFLI never made any progress, it held on for a fraction of a cent and in 2010 it sought a reverse stock split of perhaps 200 shares to become one new share. Yikes! This long-shot failed.

Chapter two deals with spending and saving and like many other authors an emergency fund is recommended as the first step, but in this case, it is being called a cushion fund. Have at least three times your monthly expenses. Other tips for putting your financial life on cruise control:

First automatic savings idea: an employer retirement plan

A personal retirement plan you start yourself (IRA or Roth IRA)

Pay off your credit card debt

Reinvest all dividends

Start a college fund

Pay off your mortgage

For retirement, you must put 10 percent to 15 percent away. You must reduce and then eliminate credit card debt. You must create a cushion fund. Start with saving one month of expenses. College savings is next, but it’s just an option. It’s an error to put college ahead of retirement savings, if you can’t afford both. Kids can always get student loans, but banks don’t give retirement loans. Prepaying your mortgage is last. Most of this is fine, in principle, what’s lacking is the critical review of the excessive fees of the investment industry and that over time almost all mutual fund managers fail to exceed the S&P 500 annual returns. So, actively managed funds aren’t a great investment if you want stock market exposure, an index fund will track the S&P 500 at much less cost. Think about it, if you pay a 1 percent management fee for your mutual fund investment over the course of your lifetime you are leaving a lot of money on the table… especially given the statistical certainty that no fund has been able to outperform the S&P 500 or Dow Jones benchmark over long periods of time. It depends on the fund, be it load or no-load, and tax consequences if the fund is held outside of a retirement account but you could still have three to four percent of your assets disappear each year due to investment costs! See the book, the Great Mutual Fund Trap for detailed information on fees and professional money manager lack of performance.

Here’s a funny thing about business and how we spend our time on income producing activities. We can narrow the field and avoid a lot of nonsense by simplifying to three guidelines for making money in business:

Do what makes money now.

Do what makes money soon.

Do what makes money later.

If you are feeling financial pressure, and things are falling to pieces, the combination of these activities may lead to buffering your financial downturn. Of course, a solid savings account specifically for this purpose will bolster financial peace of mind when things aren’t so well. If you want to remain in business, you can’t ignore the logic in doing the thing that makes money first. For traders, this might be an income producing option position, or a covered call play, which can act as a breakeven if the stock declines, etc. Some positions we may build up because we feel they will be valuable later on and at some distant point we cash out with an income from it. The point is, if the bulk of your activities are not spent on income producing activities, you won’t be prepared when less favorable conditions emerge.

Truth creates money, lies destroy it. That is going to be called a law of money? Life is composed of a series of lies we tell ourselves. In my view, the truth is the truth. We keep it from ourselves. Ideas that are implemented have a chance to create money, not the truth. If we are limiting the discussion to responsibly providing for ourselves, then just like all the other gurus, it leads to a discussion on savings. Fine, so think like an investor and not like a consumer. We’ve heard the message in so many books. Living within your means is essential to reducing overall financial stress. If we are not doing that, facing the truth about going in the opposite direction is the first step to addressing the situation. The next law is not to think about where you were at one time with your investments but where you are now. This completely skips over the fundamental reason why people have invested money and lost substantially. They didn’t fully understand the game because they didn’t know all of the appropriate options to hedge their exposure. Why would you expose your entire investment to risk if it is possible to limit risk to an acceptable level and maintain the same upside? Suze Orman told the story of a guy without any stock investment experience that bought 9,000 shares of Cisco in January 2000 after he had watched it continually move up for several months because his friends had bought some many months before at a much lower price. Cisco continued to go up. The fellow had a profit on paper of $130,000 in just a few months. He bought 9,000 additional shares on margin and Cisco went up ten or eleven points from that point before working its way back down over the next few months. The guy had a chance to sell out of all or part of his position, hedge with options or a short position but he wasn’t experienced and he didn’t have anyone to guide him on all the options available to him. It’s not so much his inexperience that led to his loss but his loss of focus because he had no plan for getting out of the investment. He took out a home equity loan to go into the market and buy his original 9,000 shares. The guy needed a stop-loss order placed somewhere above his break even point in order to protect his position of 9,000 or 18,000 shares. Do you think the author has ever been up $200,000 in a few months in one stock? I don’t. Not when she says buy at least 25 stocks or go into a mutual fund. If she’s never been up that amount that quickly, she’s never played the game in the same way he has. I don’t see any story showing how she can relate to being in that position. This guy is my hero, he did the right thing in going for it but because of a fundamental downward shift in technology stocks he didn’t have much time or the clarity of mind to exit the position with a profit. He kept waiting for Cisco to go back up ten points from the last point where he bought it. The real problem was playing the game without a plan. He never would have gotten into serious financial trouble if he had put in an order ahead of time to sell in case the stock price reversed. His focus was on how much profit was on the line instead of protecting his capital. And in the investment world if you are not protecting your capital (and hopefully your potential profit), you’re just gambling.