I was intimidated by investing, but here’s how I got started

This article is by staff writer Kristin Wong.

The first time I felt the intimidating pressure of adult responsibility, I was three months out of college. It was my very first job interview, and I was wearing an old sweater and a pair of ill-fitted slacks, sweating. My would-be boss, the man sitting across from me, was only five or six years older than I was, which made me even more nervous. I’d never met someone in my age group who was that confident and self-assured. It was distressing.

He led me through a series of noisy workshops filled with strange smells and industrial machinery. He managed a small engineering firm, and I was applying to be their technical writer, which I was excited about because, if I got the job, I’d be a writer (technically).

The interview was going pretty well; but at the end, he asked me one final, bottom-line question:

“Are you confident you could write a thorough instruction manual for this piston?” He pointed across the workshop to a piece of equipment that looked like a prop from a Ridley Scott movie.

“Yes,” I lied. “Definitely.”

Surprisingly, I got the job, and, even more surprisingly, a few months later, I did write a thorough instruction manual for that thingamajig. (I was more formal in the manual).

As with most intimidating things, I’ve found that, after you attempt them, they’re not nearly as terrifying as they seem. Here are some things that terrified me at first but turned out to be pretty simple, actually:

• 
  

  Driving downtown

  
  


• 
  

  Moving across the country

  
  


• 
  

  Parallel parking

  
  


• 
  

  Investing

  
  

Investing intimidated me for a few of reasons. First, it seemed like a really, really boring topic. Two, some well-meaning people told me it was like gambling. Three, there was just so much jargon (see Reason #1).

But I treated it like I did the technical writing. I didn’t understand it, but I broke it down into a series of small bites to digest and that seemed to help in terms of how overwhelming it was. There’s still a lot of stuff about it I don’t understand, but I’m much further along with it now than I was even a year ago. Here’s how I started, step by step.

Searching for my lost 401k

Two years after I quit my job and moved, I decided to look into my old 401(k). On the plus side, I was at least smart enough to take advantage of my company’s match. But for two years, I had no idea what to do with it or even how to access it. In that time, I undoubtedly incurred high fees and missed out on better returns.

When I started getting my finances in shape, I realized I needed to do something with that old 401(k), which was my money, parked in some mystery location. I emailed my old employer, got the necessary info and decided I should continue saving for retirement. That meant rolling it over into an IRA.

Now I just had to find out what an IRA was.

Opening a retirement account

At this point, I needed to know a couple of things:

• 
  

  What kind of retirement account should I open?

  
  


• 
  

  Where should I open it?

  
  

I learned that there were two main types of IRAs: traditional and Roth. We’ve written about this topic at length, but if you’re unsure of the difference, start here. To sum it up:

“The biggest difference between a Roth IRA and a traditional IRA is the tax treatment of contributions and withdrawals. With the Roth, contributions aren’t tax-deductible, but withdrawals are tax-free (as long as you follow the rules). For the traditional IRA, contributions might be deductible; investments grow tax-deferred, but withdrawals are taxed as ordinary income — the highest rate possible.

“The conventional wisdom is that a traditional IRA is better if your tax bracket today is higher than what it will be in retirement.”

I decided to roll my 401(k) over into a traditional IRA with Vanguard. It just seemed easier, and I felt like it was more important than anything just to start saving. Vanguard talked me through the process. I learned that I had to specifically initiate a rollover. I couldn’t just take the money out and then open an IRA separately; that would mean all kinds of crazy taxes and fees.

(Lately, I’ve been thinking about switching to a Roth, or opening one up separately because I appreciate the idea of tax-free growth.)

But — yea! I opened an account, and it was time to start investing and saving.

Learning about index funds

About two months after I rolled over my 401(k) and saved a little bit in my new retirement account, I decided to look at the earnings. “What’s going on here?” I thought. “Nothing has changed.” There were no earnings, no real action whatsoever. I called Vanguard.

“Your funds are in a money market account,” they told me.

“Oh! Okay.” I said. “Now, what exactly is that?”

I learned that a money market account is basically a glorified savings account. My money was parked there, not really doing anything for me — not exactly the way investments are meant to work. It was time to pick my actual investments. This was much easier when I had a company-sponsored 401(k). They gave me a menu; I pointed to what I wanted.

But now I actually had to find out what made up these menu items and build my own portfolio. So I did what anyone does when they need to understand something that’s way over their head: I Googled it.

Of course, I also looked through Get Rich Slowly’s massive investing archive, and I found that index funds were the way to go. From our intro article on index funds:

“With active investing, an investor tries to pick stocks that will outperform other stocks. With passive investing (also known as index investing or ‘investing in index funds’) an investor simply uses mutual funds to buy all of the stocks in the market. The basic idea is that with greater diversification and lower costs, a passive investor will generally do better than someone who buys actively-managed mutual funds.”

That sounded good … I guess? I had no idea what half of those words meant, and I spent a lot of time looking up definitions while reading that article. It took me at least an hour to get a grasp on even the basic definition of an index fund.

But in that hour, I digested a bit of information that would benefit my finances enormously. I also learned that there were different types of asset classes in which to invest, namely stocks and bonds — and there were index funds for those too. Since I already had Vanguard, I decided to go with their funds.

Figuring out how to diversify

After learning that diversification meant investing in different assets, I needed to find out how to do it.

There are a lot of different resources and calculators you can use to figure out how to diversify your investments. I started with a basic allocation of 80 percent stocks and 20 percent bonds, but I’ve tweaked it a bit since then. Honestly, it’s something I’m still learning. I’ve found that Personal Capital’s investment checkup tool is pretty helpful. It actually tells you how your current portfolio is invested and how they suggest you invest based on the information you give them.

A lot of people would scoff at that oversimplified 80/20 allocation, but the bigger point was that it started me in the right direction.

Investing beyond the standard IRA

As a self-employed writer, I no longer had the luxury of 401(k). And IRAs have contribution limits. I was determined to save more than that, so I started learning about retirement options for self-employed people. I read “The Money Book for Freelancers,” per El Nerdo’s suggestion. They listed all kinds of options and, after doing more research, I decided to go with a SEP-IRA.

After a while, the earnings in my retirement accounts were so good that I wanted to invest my non-retirement savings too. I wanted to make big returns on my regular savings, without having it locked up in retirement. So I opened up a taxable brokerage account and I started to invest in index funds within that account as well.

Understanding taxes

Finally, I learned that there are those investing accounts that are taxable and those that are tax-advantaged. Ideally, you want to invest in tax-advantaged accounts first, to take advantage of those, uh, “advantages.” Common tax-advantaged accounts include:

• 
  

  IRAs

  
  


• 
  

  401(k)s

  
  


• 
  

  529 college savings

  
  


• 
  

  HSAs

  
  

But if you have a savings goal, maybe you want to put it in a regular taxable account, like I did. Either way, it’s important to understand how taxes work when you invest. I learned that when you sell your investments, if you earned money on them, that money is called a capital gain and it’s taxable.

Separately, stocks earn dividends and bonds earn interest. Those are taxable too.

Sure, there are a few things I could have done differently. After opening my taxable brokerage/savings account, I learned that you can withdraw your contributions from a Roth IRA, penalty free. (Only contributions, though). So I guess I could have opened a Roth IRA and used it as a place to park my savings.

To recap, the steps I took to get started with investing:

1. 
   

   Find my abandoned 401(k).

   
   


2. 
   

   Learn about the different types of IRAs and open one.

   
   


3. 
   

   Roll over my 401(k).

   
   


4. 
   

   Learn what index funds are.

   
   


5. 
   

   Figure out how to diversify my investments.

   
   


6. 
   

   Pick some index funds to invest in, based on that diversification.

   
   


7. 
   

   Find other ways to invest aside from standard IRAs.

   
   


8. 
   

   Understand how taxes work in regards to my investments.

   
   

Of course, this is a very basic overview, and I’m still learning — but that’s kind of the point. Investing is something I never thought I’d understand or even care to understand. But now, by jumping in and taking small steps, I’ve found it’s actually not that hard. I actually understand what people are saying when they talk about their portfolios and stuff. And, more important than that, my finances are the better for it.

Get Rich Slowly – Personal Finance That Makes Sense.

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Personal Finance, here’s, intimidated, investing, started

You can learn how to make money investing: Just do it!

This article is by staff writer William Cowie.

Several readers responded to our “Big Question” post by saying they’d like to see something about investing, and some elaborated that they’d like to see some advice for investing on a small scale. Small in scale obviously means different things to different people — but I’ll relate my experiences, for what it’s worth.

My background is in finance and accounting. You’d think having 10 years of college, focusing on business and money, I, sooner or later, would know what I was doing with my money. You would be wrong. Coming out of college, I joined the rat race in the fast lane and zoomed past most of my peers, landing a top executive job in a fast-growing computer company at a young age, and ending up with a small minority stake in it. When it was sold to a major conglomerate, all the stockholders received generous payouts. I was 30 at the time and decided to retire. For my retirement, I wanted to come to America and study some more — isn’t that just the geeky “investment” to make?

Not wanting to become a professor, I rejoined the rat race, only this time taking care to stay away from the fast lane. It may look attractive to those getting passed, but staying in it requires too much time and dedication, and you have no life beyond it. I wanted to visit, smell and photograph some roses along the way.

I never gave retirement another thought. I just figured that I’ve done it once, I can do it again anytime I like. Well, that’s not quite as easy when you don’t make fast-lane money anymore. It took me a few years to realize this. I know, I know: I may have degrees up the ying-yang, but that doesn’t mean I’m smart. I was now in my 40s, and starting all over with close to nothing.

The smart people (like J.D. Roth) say you have to invest and start early. Sounds good, of course … but I couldn’t get myself to actually do it. Looking back, I can see several things which held me back.

Roadblocks

1. I didn’t make enough money. At least that’s what I told myself. If you want to invest, you need to have some “over and above” money, right? I had myself convinced I couldn’t check that box.

2. I didn’t want to make sacrifices. In graduate school, we had a Polish couple living next to us in student housing, Wojcek and Kinga. He was an out-of-state student and had to pay high tuition fees. Yet, when he graduated, they had a down payment for a house. Amazed, I asked him how he did it. His answer boiled down to living close to the poverty line and squirreling away every penny they could. In five years, they saved up $ 18,000 and they bought a $ 180,000 house. My earlier life, on the other hand, had accustomed me to an inflated lifestyle. It doesn’t take many years for that to turn into a sense of entitlement. “Hey, I’m entitled to eat out so many times, drive such-and-such a car, and live in a house with so many square feet.”

3. I failed once. I tried to open a brokerage account with Charles Schwab, back when they were the only discount brokerage around, to invest in stocks. I didn’t have the minimum required to open an account. It was humiliating to be told I don’t have enough money and, for some weird reason, that just stuck in my mind, reinforcing the first point I made up above. Worse, it made me not want to try again.

4. What’s the point? Even if I had the minimum (as I recall, it was something like $ 1,000 back in those days) it was so little, there was no way it could ever be enough to give me a comfortable retirement. Besides, even back then everyone was talking about the market being rigged against the little guy. So why bother? I may end up losing it all, anyway.

5. I didn’t know enough. Talking to friends, coworkers and acquaintances, it sounded to me like you needed a lot of luck to make good investments. At the time, I remember Microsoft and Walmart were the hot, high-growth stocks. But were they going to mature right when I bought? When a growth stock matures, its stock price crashes as the P/E (price-to-earnings) multiple gets deflated (like happened to Apple last year and Whole Foods this year). Because I didn’t know enough about the stock market, I figured I had better stay out of it.

Other people told me they don’t have time to invest, but I knew that didn’t apply to me (or to anyone else, for that matter). If someone told you you’ll win a million dollars if you set aside an hour every Saturday, we’d all do it. We all make time for something we truly value. I knew that I would make time for investing if I truly believed in it. Trouble was I didn’t.

What changed?

Three things:

1. Our 401(k) plans. We both got jobs which offered what was still a fairly new thing back then — 401(k) retirement plans. These things are not perfect, and they’ve generated a lot of criticism; but at the time, I thought it was a great thing for only one reason: I got to take it with me.

Until the early ’80s, the default retirement option at most employers was a pension. The problem with a pension, though, was you often lost it all when you changed jobs — and that was by design. Back in the day, employers used their pensions as a golden handcuff, an incentive/reward for staying there. A 401(k) was different because you could take it with you when you moved on, or if you were “asked” to move on.

So, we embraced our 401(k) plans and contributed to the level our employers matched. It wasn’t much, but at least there was some “free money” (the matching) to give us the motivation to do it.

And then we forgot about them. In hindsight, that was probably a good thing because they grew quietly and undisturbed. You avoid using any 401(k) plan at your own future peril.

2. Our savings. My wife and I grew up in frugal households and we tend to live below our means. So, we opened a savings account to serve as an emergency fund. We lived on a strict budget — not overly tight, but it was a high priority never to exceed it. And, every month, we’d transfer everything left over to the savings account and start fresh for the next month. The emergency fund slowly grew, and we never paid it much attention. There were a few times a car needed repairs and so on, and it was nice to have enough for that. But, other than that, we never really thought of it.

Then, one year, we got a bigger income tax refund than we expected. The natural thing was to put it into the savings account, which we did. But then, suddenly, we looked and saw that we had “real money” in that account.

It dawned on me that we had enough to risk opening a brokerage account without the fear of being told we’re insignificant cockroaches.

3. Old age suddenly drew closer. After we turned 50, and the over-the-hill parties faded in the rear view mirror, we looked through the windshield of time and gulped. What’ll we do when, like the Beatles song, we turn 64? Funny how you never think of this when you’re young. But, as they say in the sports world, Father Time is undefeated. Sooner or later he’ll beat you.

My (and your) only defense against that old fart is our investments.

Decisions

So, all of a sudden, I was confronted with the question: What am I going to invest in? I had no clue. That’s when, as my wife put it, I went to “night school.” Every night, for months, I’d hit the Internet after dinner till past midnight and learn everything I could about investing in general and stocks in particular.

Why stocks? If I were a different person, I’d probably go for rental real estate, because you can (literally) buy the house next door and keep a watchful eye as other people pay down your mortgage and inflation builds you a lovely nest egg. However, to make that work, you need a modicum of handyman skills and you should be somewhat of a people person, engaging enough to attract tenants, and tough enough to kick them out when they don’t pay on time. I’m neither. I am enough of a geek, though, with enough education to understand companies and stocks. So that’s why I became like the little robot in the movie “Short Circuit,” muttering “input, input” night after night.

What I learned

1. Investing matters. I can kick myself for the years I avoided it, and the overcome-able reasons I used to justify that. As time passes, we’ll be less and less able to rely on Social Security or pensions. Therefore, you will be the master of your fate, and there’s no way other than investing to master your fate when you’re older.

2. You get nothing for nothing. To get something in the future, you have to forgo something now. It is what it is.

3. Time is everything. Even if the amounts you work with are small — and they can be — they will add up the longer you give them.

4. Patience is essential. As Warren Buffett puts it: Investing is like planting a tree — nothing happens overnight.

5. Perfection is not required. Nobody, not even Warren Buffett, has a flawless track record in their investments. That’s the bad news. The good news is investing is robust enough that, as long as you are patient and diligent, the good will far, far outweigh the mistakes and misfortunes. My perfectionist tendencies kept me from investing for too long. (“If I can’t do it right, why do it?”) Imperfect investing, started earlier, will always beat perfectionist investing delayed.

6. You can learn. There are plenty of resources, free and paid, to learn everything you need to know to succeed at investing. The good news is it’s not rocket science, so anyone can learn it. The bad news is it’s not all obvious, so you do need to put in time (nothing for nothing, again).

But…

7. It’s never too late. We got serious after reaching 50, so we had to sacrifice more than we would have needed to if we started earlier, but that’s the price of folly. The good news is you can learn from my mistake. And if you think you’re too old, stop. Just stop. You can always catch up; it’s never too late.

The key to success, though, is the old Nike slogan: “Just do it.”

Get Rich Slowly – Personal Finance That Makes Sense.

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Personal Finance, investing, just, learn, money

I Just Received $6,000. What Should I Do with It?

via MoneyNing:

Receiving a lump sum of money is something you think will never happen to you — until it does.

And though it will often be due to unfortunate circumstances, like a death in the family, you’ll still have to know what to do with it.

A family member recently gifted me $6,000, which was one of the largest sums of money I’ve ever received. Now I’m wondering what the smartest move is.

My current financial situation:

After getting divorced in 2012, I moved in with my dad for a few months. Frustrated by sharing a bedroom (and bed) with my two daughters, I took out a $10,000 loan against my car, purchased a trailer, and put it on land owned by my dad.

This loan was on a four-year term, with the interest hovering a little over 3%. The current payoff is right around $6,700, and it is my only debt.

My emergency fund is in place, but I wouldn’t mind having more in savings. I also just began putting my extra money in a personal investment account.

I’m now presented with a choice: Would it make the most sense to save the money, pay off debt, or invest it?

Save

Having an adequate amount of savings makes me feel comfortable. I also have other savings goals, like purchasing an investment property, towards which I could use this money.

I started freelancing full-time in October of last year, and I need to have plenty of money to back me up. Fortunately, I live a very low-cost lifestyle and am pretty confident I can earn extra money if I need to. And I haven’t had to touch my emergency fund yet, which I’m thankful for.

Normally, I’d recommend starting an emergency fund after receiving a windfall. But since I’m okay with the amount I’ve saved, I’m not sure saving more is the right choice.

Pay Off Debt

I hate payments. Hate them. To me, there’s nothing worse than writing a check and mailing someone else my hard-earned money.

That’s why I’m leaning toward putting the whole check toward my debt and just being done with it. But with such a low-interest rate and payment amount, I’m not sure it’s worth it.

If I had high-interest debt, there would be no doubt in my mind about how to spend the money. It’d be my first step (after starting an emergency fund).

Invest

There are so many options when it comes to investing. Buying stocks, investing in real estate, funding a retirement account, etc.

The returns from investing could be far more lucrative than the 3% interest I’m paying on my current debt. While paying off debt is certain, however, investing is not. As hopeful as I might be that things would work out, it’s impossible to know for sure.

What would you do if you were in my shoes — save, pay off debt, or invest?

This article originally appeared on MoneyNing.com. Let us know what you think (or read what others thought) here.

Related posts:

1. How to Reach Your Goals Using the Percentage Method


2. How Do Extra Payments Get Applied to My Loan? – Money Mailbox


3. 3 Money Excuses You Need to Destroy This Year

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I Just Received $6,000. What Should I Do with It?

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Personal Finance, investing, money management, money stories

Personal Finance 101: What Is a Dividend?

via The Simple Dollar:

A few days ago, I was working on an article where I referred to dividends. Since I didn’t really provide any sort of explanation of what dividends were, I went looking for an article where I explained in detail what a dividend actually is and, to my amazement, I never found a good, thorough explanation of dividends! (I ended up sticking a brief explanation into the article.)

Since dividends are a pretty big part of personal finance planning (they affect retirement savings significantly and also play a role in many other investment choices), it’s incredibly useful to know what exactly a dividend is, how they work, and how they put money in your pocket.

As always with explanations like this, I’m choosing to use simple language and simple examples. Business schools offer entire classes on these topics, so this is just a brief introduction.

Let’s dig in.

Start with stocks…

Before I explain what a dividend is, it’s important to know what stocks are. A share of stock means that you own a small fraction of a company. Obviously, then, a stock market is where people trade those shares of stock. The word “stocks” just means some number of shares of stock.

Companies usually start as partnerships between people. At some point, these people may want to make it clear how much of the business they each own, so the company issues shares of stock (usually just called “stocks”) to them. If Joe and Kevin started a business, they might decide that the business would issue them each 50 shares of stock. These shares would each state that the holder owns a share of the business.

Let’s say that the business wanted to raise some money. The business might choose to make more stocks and sell them. If Joe and Kevin wanted to bring some money into their company, that company might create 25 more shares of stock and sell them to Kevin’s uncle Larry (and name the company the JKL Company). Then, Joe and Kevin would each own 50 shares and Larry would own 25 shares. (Often, companies do this and sell the shares to the public – it’s called an “initial public offering” when they do it for the first time.)

In the old days, stocks were often represented by pieces of paper. Today, they’re usually stored electronically.

The role of dividends

What happens when The JKL Company makes a profit? The company might invest in itself to buy better equipment or to keep cash on hand. Of course, the reason people start businesses is to make money – and that’s where dividends come in.

The JKL Company might decide to issue a dividend to its shareholders. A dividend is a small payment that a company makes to each person that holds each share of stock in the company. Let’s say that The JKL Company decides to issue a $1 dividend. Since Joe and Kevin each own 50 shares of stock, they would get $50 each. Larry would get $25 because he owns 25 shares. That’s a dividend!

Let’s see what a real company does. Let’s look at Verizon.

As you can see on this page, Verizon issues a dividend every three months to its shareholders. The next dividend payment they’re going to make is on May 1, and it consists of $0.53 to the owner of every share of stock out there.

If I own 1,000 shares of Verizon, Verizon will cut me a check for $530 on May 1.

The catch, of course, is that a single share of Verizon stock, right now, costs $46.91. So, to own 1,000 shares of Verizon, I’d have to pay (roughly) $46,910 (plus some brokerage fees). As long as I sat on those shares, Verizon would issue me a check every time they issued a dividend.

Dividends in mutual funds and your retirement account

So, how does this impact most people? For most of us, dividends are most common in our retirement account. We might own a mutual fund within our retirement account and we’ll see that the mutual fund issued a dividend. Since a mutual fund is made up of a bunch of different stocks that pay dividends, the fund will collect all of those dividends and then share that dividend “profit” with all of the people who hold shares in the mutual fund.

Let’s say that in your retirement account, you own two shares of the ABC Mutual Fund, of which only 100 shares exist in the whole world. The ABC Mutual Fund consists of just 25 shares of The JKL Company and 25 shares of Verizon. In a particular quarter, The JKL Company issues a $1 dividend and Verizon issues a $0.50 dividend, like we talked about earlier. So, the ABC Mutual Fund is going to collect $25 from The JKL Company and $12.50 from Verizon, for a total of $37.50.

Since there are 100 shares of the ABC Mutual Fund, that $37.50 gets split up 100 ways, with $0.375 going to each shareholder of the ABC Mutual Fund. Since you own two shares in the ABC Mutual Fund, you get a total dividend payment of $0.75!

A mutual fund might own thousands of different stocks and have thousands of people that own shares in that mutual fund. This is one big reason why computers are really helpful in doing that math and handling that bookkeeping.

Many people who own mutual funds elect to have their dividends reinvested. In that case, that $0.75 would end up going toward buying another share of the ABC Mutual Fund – probably not a whole share, but you can usually buy fractions of a mutual fund share. So, after that dividend, you might now own 2.1 shares in the ABC Mutual Fund. You would now be eligible to receive a little bit more the next time your mutual fund issues dividends!

The risk of dividends

When people first learn about dividends, it’s really obvious why people would want to buy stocks and sit on them. They just get checks in the mail. If someone owned 20,000 shares of Verizon, for example, they would get a check for $10,600 on May 1 and similar checks every three months. A person could live quite well on that!

There are a few catches. First, companies can change their dividend. It’s considered very standard for companies to issue dividends every three months, but companies sometimes cut their dividends and sometimes eliminate them entirely. It’s at the company’s discretion to do that if they so choose (though the people who own the stocks would be rather angry with the company).

Companies that do that kind of thing are usually struggling just to survive, of course, which points to another risk – companies don’t live forever. People owned shares in Enron, WorldCom, and Lehman Brothers and those all paid dividends for a while – then the companies died, the stocks became worthless, and there were no more dividends to be had.

Owning stocks that pay dividends means that you’re relying on that company to be successful and keep paying dividends.

When people choose to invest in order to earn dividends, they typically choose a number of very large companies that are healthy and have paid a nice dividend for a long time. They’ll buy shares in those companies and just sit on them. This is somewhat risky for the reasons stated above, but by investing in big healthy companies they reduce the risk of a company cutting their dividend and by investing in a lot of companies they reduce the risk of losing their shirt if a single company runs into trouble.

Dividends and taxes

I discussed all of this in detail in that earlier post, so I’d go there for full details.

To put it simply, if you haven’t owned stock in a particular company for very long, the dividends are taxed just like normal income. If you’ve owned the stock for more than six months or so, the dividends are taxed at a lower rate – 15% at the moment for most people. You have to record that information on your tax return at the end of the year and pay the taxes out of your pocket.

Final thoughts

If you have a retirement account of any kind, you’re probably receiving dividends. If you own stocks, you’re probably receiving dividends. It’s likely that dividends either directly impact you or impacts someone of financial significance in your life. Knowing more about dividends makes it easier to understand one significant way in which your investments (or the investments of your loved ones) earn money for you.

The post Personal Finance 101: What Is a Dividend? appeared first on The Simple Dollar.

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Personal Finance, insurance, investing, personal finance

Professional investment advice (and why you should ignore it)

This article is from J.D. Roth, who founded Get Rich Slowly in 2006. J.D. recently appeared on the Microblogger podcast, where he talked about taking control of his financial life, moving from debt to wealth.In January, I accompanied Kim to an appointment with Paul, her investment adviser from Edward Jones. Paul’s brother was my best friend in grade school and junior high, and we have many mutual friends. I sat and listened while Kim and Paul talked about her investments and how she ought to invest for retirement. I didn’t participate much, though, because this is Kim’s money, and I didn’t feel like it was right for me to take an active role.I did ask some questions about index funds, though. Kim’s money is …

via Get Rich Slowly – Personal Finance That Makes Sense.:

This article is from J.D. Roth, who founded Get Rich Slowly in 2006. J.D. recently appeared on the Microblogger podcast, where he talked about taking control of his financial life, moving from debt to wealth.

In January, I accompanied Kim to an appointment with Paul, her investment adviser from Edward Jones. Paul’s brother was my best friend in grade school and junior high, and we have many mutual friends. I sat and listened while Kim and Paul talked about her investments and how she ought to invest for retirement. I didn’t participate much, though, because this is Kim’s money, and I didn’t feel like it was right for me to take an active role.

I did ask some questions about index funds, though. Kim’s money is entirely in individual stocks (like Apple) and expensive load-bearing funds such as VFCAX (Federated Clover Value Fund), which has an expense ratio of 1.19 percent and a sales load of 5.5 percent.

Paul argued against index funds, saying:

• Mutual-fund managers earn back the sales load (and high expense ratio) in time so that, long term, actively managed mutual funds outperform index funds. (Note: Studies show that, in general, this is not true.)


• Part of the reason people pay him to manage their investment accounts is because he protects them from making foolish emotional decisions about the market and he alerts them to possible opportunities.

Afterward, I asked Kim what she thought of the meeting. She got the gist of things, but found a lot of it confusing. No surprise. I know this stuff and still found some of the presentation confusing.

“What do you think I should do?” she asked.

“Well, I still think you should be in index funds,” I said, but I didn’t push it. Again, we’ve been dating almost two years, but it’s not like we’re married. I didn’t feel comfortable making this decision for her.

Over the next few weeks, I wrote the investment chapter for my ebook. And then I rewrote the chapter. And then I rewrote it again. (This ebook will finally see the light of day at the end of April, by the way.)

As I wrote, I realized that I truly believe index funds are the right way for most people to invest. And it’s not just me. Warren Buffett believes this, as do many other well-known investors. The evidence is overwhelming. The smartest way for the average person to invest is to put all of their money in broad-based, low-cost index funds and never touch it. End of story.

Meet the new adviser — same as the old adviser

Between January and March, Kim switched jobs. Her new employer also contributes to retirement, but uses a different investment adviser. Last week, we met with the new guy, Evan. This time, I asked Kim how she viewed my role before the meeting. “I want you to speak up,” she said. “I want you to act like you’re my husband.” Well then, OK.

The meeting with Evan started very much like the meeting with Paul. Evan talked about how much Kim needs to save to meet her retirement goals (answer: a lot!). He also talked about where she should put the money. He agreed with me that it’s probably best not to shift around Kim’s existing investments (although I can’t help thinking we’re falling victim to a sunk-cost fallacy by not moving to index funds). He recommended that all of her new money should go into shiny new mutual funds that his company sells — funds that carry loads of 5.75 percent.

Note: These mutual funds are from American Funds, and I’m very familiar with them. When I was married, Kris put a lot of her savings into the American Funds family.)

“How are you compensated?” I asked.

“Great question,” Evan said. “I’m paid out of the sales charge, out of the front-end load of the mutual funds. A part of that goes to me, a part of that goes to my company, and a part of that goes to the mutual fund company itself.”

After a few minutes of discussing these new funds, I decided to speak up.

“Look,” I said. “I write about money. I’m not an investment guru and I don’t have any specific training, but I’ve read and written a lot about investing over the past few years. Everything I’ve read says that the only reliable indicator of future mutual fund performance comes from a fund’s fees. The lower they are, the better the fund is likely to perform in the future.”

“That may be so,” Evan said, “but that’s only part of the story. With proper management, a traditional fund can outperform an index fund. Besides, index funds only work if you’re able to control your emotions. Studies show that most investors earn returns far below those of the market because they make poor choices under the influence of emotion.”

“Sure,” I said. “The Dalbar study shows that every year.” I cite this study over and over again in the articles and books I write. “But investor behavior is only one part of the problem. The other part is costs.”

Evan protested. I didn’t blame him. His livelihood is tied up in this. Besides, I think he truly believes in his funds.

“If Kim were to buy index funds through Vanguard or Fidelity, how would you be compensated?” I asked.

“I’d take 1 percent,” Evan said.

“One percent up front?” I asked. “Or 1 percent per year?”

“One percent per year,” he said. With the roughly 0.25 percent expense ratio for a typical index fund, that would give her a cost of 1.25 percent annually. That beats the expense ratios from the funds Evan was proposing, especially when you factor in the 5.75 percent sales load.

Following my own advice

At the end of the meeting, Kim smiled and shook Evan’s hand. “Thanks for your help,” she said. “We’ll go home and figure this out.”

We walked next door to have a glass of wine while gazing out at the stormy Willamette River. “What do you think I should do?” she asked.

“Do you want to know what I would do if this were my money?” I asked.

“Yes,” she said.

“First, I’d contribute as much to retirement as needed to get the match from your boss. I’d have that put into an index fund, and I’d pay Evan his 1 percent per year. I don’t like it, but that’s your best option to get the match from work.”

“For everything else, though, I’d invest on my own. I wouldn’t do it through Evan. I’d open an account at Vanguard or Fidelity and schedule monthly contributions. He says you need to be putting away $920 per month for the next 20 years in order to have the equivalent of $50,000 per year at retirement. Do that. To be honest, I’d rather you didn’t pay me rent or utilities. I don’t need that money. I’d rather see you put it directly into an investment account every month. It’ll still feel like you’re paying me rent, but it’ll be going to your future instead. Does that make sense?”

Kim nodded. “It does,” she said, “but I still don’t like it.” (We’re still hammering out the financial side of our relationship. She wants to pay her half of things — which I appreciate — but I don’t want to take her money. When she pays me for rent or utilities or anything else, I tuck the money into a “secret” savings account at Capital One 360. That makes both of us happy.)

Unconventional Success

After our meeting with Evan, I began to have bouts of self doubt. It’s one thing to make decisions with my own money; it’s another to make them for somebody else.

To boost my confidence, I turned to books. I re-read the rationale behind investing in index funds. In particular, I turned to David Swensen’s Unconventional Success . During our meeting, Evan had pointed to the Yale University endowment as an example of investing success. Swensen is the mastermind behind that endowment. He’s also a passionate supporter of passive investing.

Unconventional Success contains nearly 400 pages laying out the arguments for index funds as “a fundamental approach to personal investment.” It explores asset allocation, market timing, and security selection before ultimately concluding that “overwhelming evidence proves the failure of the for-profit mutual-fund industry.”

Note: You can read a much shorter version of Swensen’s arguments in his 2011 New York Times editorial about the mutual fund merry-go-round.

Refreshing myself about the evidence in favor of index funds allowed me feel much better about our second meeting with Evan. On Monday night, we returned to his office to explain our decision. In short, we wanted to put all of Kim’s future funds into the following asset allocation using Vanguard index funds:

• 45% into VTSMX, the Vanguard Total Stock Market index fund


• 25% into VGTSX, the Vanguard Total International Stock index fund


• 20% into VBMFX, the Vanguard Total Bond Market index fund


• 10% into VGSIX, the Vanguard REIT index fund (a REIT is like a mutual fund for real estate)

“That’s great,” Evan told us. “We can do that. But there’s just one problem. Our investment platform requires a $25,000 minimum in order to make this happen. Otherwise, it’s not worth our time.”

At first, I thought this was a barrier. Kim doesn’t have $25,000 in new money to invest. But then I hit upon a couple of solutions.

First, we could move our shared “dream fund” from the Capital One 360 savings account where it currently resides. Instead, we could place it in index funds. Sure, this would introduce greater risk, but I’m OK with that. By the time we’re ready to tap this fund, the stock market should be higher than it is today — and it should outperform savings accounts in the meantime.

Second, we could liquidate Kim’s existing mutual funds and move the money to Vanguard funds instead. That’s probably the smartest move anyhow. We had planned to leave her existing accounts at Edwards Jones, but this makes more sense.

In the end, Kim came up with a fun plan. Here’s what we’re going to do:

• We’ll move all of her investment accounts from Edward Jones to the new company.


• We’ll sell half of her existing funds in order to meet the minimum requirements to begin putting money into a Vanguard retirement account. (And because index funds are the better choice.)


• We’ll keep half of her existing funds as they are and allow her new adviser to manage them as he sees fit. Let’s see if he can actually beat a portfolio of index funds.


• Meanwhile, she’ll funnel $460 per month into her employer-sponsored retirement account.


• Finally, she’ll open a personal Roth IRA account at Vanguard. Into this, she’ll contribute $460 per month. This will give her a chance to see what it’s like to manage an investment account on her own.

This process illustrated some of the problems the typical investor faces. First, she receives self-serving advice from advisers (even when they don’t intend to be self-serving). Second, even when she knows the right thing to do, it can be tough to stick to her guns in the face of trained expertise. Third, there can be barriers to making smart choices, barriers like high minimums and additional fees.

In the end, it’s important to make your own informed investment decisions. Remember: Nobody cares more about your money than you do. If you don’t take the time to educate yourself, you can’t expect anyone else to make the right decisions for you.

For more info: Professional investment advice (and why you should ignore it)

Get Rich Slowly – Personal Finance That Makes Sense.

Professional investment advice (and why you should ignore it)

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Barron’s Best Online Broker Rankings 2014

Barron’s Best Online Broker Rankings 2014

via My Money Blog:

Weekly business newspaper Barron’s just released their 2014 annual broker survey rankings. Here’s a snippet about their criteria (emphasis mine):

Our evaluation criteria focus on the needs of wealthy, active traders. We looked at eight categories of service, examining what can be traded online, how the tools work together across platforms, the design and capabilities of mobile platforms, educational offerings and customer service, as well as the nuts and bolts of placing and executing a trade. We closely scrutinized the various tools available for finding appropriate trades, including scanners and charts. When examining costs, we considered stock and options commissions as well as platform or maintenance fees, margin debt, and charges for transferring an account out.

Their overall winner was again Interactive Brokers, a broker designed for highly-active traders with an extensive feature set, low commissions, and low margin rates. However, IB also has a minimum opening balance of $10,000, a minimum monthly fee of $10 even if you don’t trade at all, and customer service that does not cater to casual investors. They recently starting waiving the $10 minimum monthly fee if your account value is at least $100,000.

I am not an active trader, but I still like having real-time quotes, a clean user interface, and helpful customer service when I need it. Thankfully, Barron’s again ranked the brokers for the rest of us:

Top 5 Brokers for Novice Investors

1. TD Ameritrade . Performed well in customer service & education, research tools, and mobile offerings. Improved desktop site and mobile apps integration. Free real-time quotes from NYSE, AMEX, and NASDAQ Level 1 and 2.


2. Fidelity


3. E-Trade


4. Charles Schwab


5. Capital One Sharebuilder

Top 5 Brokers for Long-Term Investing

1. TD Ameritrade . The only broker to provide a wide range of commission-free ETFs from various providers (not just their own in-house ETFs).


2. Fidelity


3. Charles Schwab


4. Merrill Edge


5. E-Trade

Top 5 Brokers for In-Person Service

1. Scottrade . Scottrade has over 500 physical branches across US, so that when you call you reach a human in that local branch. Free in-person educational seminars are offered as well.


2. Merrill Edge


3. Charles Schwab


4. Fidelity


5. TD Ameritrade

Reading through the entire article, most of the brokers made a few incremental changes (better mobile app, new options tools) but nothing game-changing. So it shouldn’t come as a surprise that for the three niche rankings above, the Top 5 ended up exactly the same as the 2013 rankings. Again, Vanguard’s brokerage declined to participate and thus was not eligible for the rankings.

Prosper vs. LendingClub Investor Experiment: 15.5 Month Update

Prosper vs. LendingClub Investor Experiment: 15.5 Month Update

via My Money Blog:

After posting the 1-year update (Part 1, Part 2) of my Beat-The-Market experiment back on November, I got bored. I had started with $10,000 split evenly between Prosper Lending and Lending Club , but although this alternative asset class had potential, I just didn’t find it reliable enough for me to invest significant funds in it.

I didn’t sell off my existing loans, but I stopped reinvesting in new ones. I hadn’t logged into either account for months, but this week I wanted to download my tax documents. So, I figured another update was in order, 3.5 months later.

$5,000 LendingClub Portfolio. As of February 19th, 2014, the LendingClub portfolio had 199 current and active loans, 36 loans that were paid off early, and none in funding. 6 loans are between 1-30 days late. 8 loans are between 31-120 days late, which I will assume to be unrecoverable. 7 loans have been charged off ($152 in principal). $1,814 in uninvested cash. Total adjusted balance is $5,305. This is only $1 higher than 3.5 months ago.

$5,000 Prosper Portfolio. My Prosper portfolio now has 185 current and active loans, 56 loans that were paid off early or payoff in progress, and none in funding. 4 loans are between 1-30 days late. 10 are over 30 days late, which to be conservative I am also going to write off completely (~$183 in remaining principal). 14 have been charged-off ($302 in principal). $1,619 in uninvested cash. Total adjusted balance is $5,255. This is $45 less than 3.5 months ago.

What has happened since my last check-in on November 1st?

1. My total adjusted balance is $10,560, which is a $44 drop over the last 3.5 months. Even with the increase in idle cash, my total balances should still be inching up, not down. It appears that an increasing number of late and defaulting loans are starting to catch up to me.


2. My idle cash balance across both accounts has increased by $1,527 in just 3.5 months, indicating an increasing number of early loan payoffs and thus fewer people paying me 10% interest rates.


3. Prosper is currently doing worse relatively than LendingClub. This could change again in the future. Here’s an updated chart tracking the LendingClub and Prosper adjusted balances over these past 15.5 months:
   
   

I suppose that I’ll hang onto these loans and see how the rest unfolds. I know that other people report 10%+ annual returns on Prosper and Lending Club and may be better loan pickers than me, but I still be wary setting such high expectations for the average P2P investor. I’m still in the black and doing okay, but I wouldn’t count your chickens until the loans get a bit more mature.

World Stock Market Cap Breakdown by Country: 1900 vs. 2013

World Stock Market Cap Breakdown by Country: 1900 vs. 2013

via My Money Blog:

When learning about investing, it is good to remember that nearly all the “commonly accepted advice” out there is based on at most 100 years of historical returns. Meanwhile, many of us still have 50 or more years ahead of us. Is that enough data? I’m pretty comfortable with broad patterns such as stocks outperforming bonds over long periods across nearly every developed country. However, as the conclusions get finer I get more and more skeptical.

For example, I wouldn’t bet all my chips on any one country. The world will look very different in 50 years, and I doubt we’ll be able to predict much of it. (Though I’m sure it will seem “obvious” in retrospect.) Take a look at these two charts comparing the relative market capitalizations of world equity markets as of the end of 1899 and 2013.

I’ll check back in around 2050…

Source: Credit Suisse Global Investment Returns Yearbook (via Abnormal Returns)

The Importance of Calculating After-Tax Returns

The Importance of Calculating After-Tax Returns

via My Money Blog:

Gus Sauter, former CIO at Vanguard, talks about the need to focus on after-tax investment returns in an interview with the WSJ (found via Abnormal Returns). He answers the question What’s your most important tax advice for mutual-fund investors?:

For equity investors with a long time horizon, it is important to search for funds that have low annual distributions of capital gains. Grinding through the math, it turns out that a fund that realizes and distributes most of its capital gains annually would have to outperform a fund that distributes minimal capital gains by as much as 2% per year in order to provide the same long-term, after-tax return. Funds that have lower turnover are a pretty good place to start looking for low capital-gain distributions. Index funds are an obvious candidate.

For fixed-income investors in higher tax brackets, municipal-bond funds can be an attractive alternative to taxable bond funds.

In 2013, many successful active funds that trade frequently (high turnover) distributed sizable capital gains. Resources like Morningstar.com can provide information about turnover ratio and after-tax returns for specific funds.

Here are the 2013 capital gains distributions for all Vanguard funds. Both Vanguard’s Total US Stock and Total International Stock funds distributed zero capital gains for 2013. For your own holdings, you can check your tax statements to compare the relative size of the capital gains with the share price (NAV).

The Sheep and the Wolves: Smart investing made simple

Note: This article is from J.D. Roth, who founded Get Rich Slowly in 2006. J.D.’s non-financial writing can be found at More Than Money, where he recently wrote about winning the jackpot.Imagine that you’re a farmer. You live in a rural county where everybody raises sheep.The county’s farmers, on the whole, prosper. Their flocks tend to grow by 10 percent every year. Some years are better than others. In the best years, the sheep population in the county grows by 40 percent. Little lambs are everywhere! But in the worst years — years filled with frost, famine, and disease — the sheep population can collapse to half of what it was before.Further imagine that the county becomes home to vicious predators. Wolves, perhaps. …

via Get Rich Slowly – Personal Finance That Makes Sense.:

Note: This article is from J.D. Roth, who founded Get Rich Slowly in 2006. J.D.’s non-financial writing can be found at More Than Money, where he recently wrote about winning the jackpot.

Imagine that you’re a farmer. You live in a rural county where everybody raises sheep.

The county’s farmers, on the whole, prosper. Their flocks tend to grow by 10 percent every year. Some years are better than others. In the best years, the sheep population in the county grows by 40 percent. Little lambs are everywhere! But in the worst years — years filled with frost, famine, and disease — the sheep population can collapse to half of what it was before.

Further imagine that the county becomes home to vicious predators. Wolves, perhaps. The wolves descend from the mountains and begin to eat the sheep. Some farmers protect themselves from loss, but others don’t know how — and some don’t even realize their flocks are being attacked.

The farmers who take precautions aren’t able to prevent all losses, but they come close. On farms with vigilant shepherds, only 0.10 percent of sheep are lost to wolves every year. For every thousand sheep, the wolves pick off one animal.

The farmers who don’t take precautions, on the other hand, suffer terrible losses. During the initial onslaught they lose 5 percent of their sheep. (Plus, every time they add more sheep to their herds, the wolves manage to grab another 5 percent.) To make matters worse, the wolves steadily steal 2 percent of the beasts every year. For every thousand sheep, this group of farmers loses 50 in the initial attack, and 20 more each year thereafter.

Think of it: After the first year, the smart farmers will have lost just one of every thousand sheep. The other shepherds will have lost 70 sheep.

If the county’s flocks each grew at the long-term 10 percent average during that first year, the vigilant folks would now have 1,099 sheep for every thousand they started with. The unwary farmers would have 1,024 sheep.

Now imagine that in the second year, the same pattern continues. All flocks grow at the long-term average of 10 percent, and the wolves snatch 2 percent of the animals from those farmers who aren’t paying attention. At the end of the second year, the wolf-free flocks would have grown to 1,208 sheep for every thousand that were present at the start. The flocks where the wolves run wild would have just 1,104 sheep.

Both populations of farmers enjoy the same growth rate among their flocks. The difference is that one group loses fewer sheep to the wolves.

And at the end of 10 years following this pattern? The wolf-less flocks would have grown from 1,000 to 2,566 sheep. Those under attack would still have increased, but at a much slower rate. They’d have 2,013 sheep.

Things are even worse when you look at the farmers who add more animals to their farms every year. Remember that I said the wolves slaughter 5 percent of the sheep added to the unlucky flocks? Well, assume that wealthy farmers from both populations are able to buy 100 new sheep every year — but that the wolves snatch five of these from the one group.

At the end of a decade, these wealthy farmers will have contributed a total of 2,000 sheep to their flocks for each 1,000 sheep they started with. With average long-term growth, these flocks will have grown to 4,154 animals for the lucky shepherds and 3,374 sheep for those ravaged by wolves.

Which population of farmers would you prefer to join?

I won’t belabor this analogy any longer. I think most of you get my point.

Stock-market investors are like these sheep farmers. Collectively, they enjoy investment returns of roughly 10 percent per year. Individually, however, things are different. Most investors suffer severe losses from the wolves of Wall Street. Wolves, by the way, who don sheep’s clothing to convince investors to trust them. (These investors also have a tendency to make things worse by selling their flocks when sheep prices fall and expanding them when prices rise.)

If you want to be a successful farmer, you have to understand how farming works, and how to protect yourself from the wolves. Fortunately, it’s not as tough as it seems.

The financial industry wants you to believe that investing is difficult. If you buy into their message, if you accept the premise that you need help to invest wisely, they can charge you big bucks to handle your money.

The truth is somewhat different. Investing is simple. In fact, it can be one of the easiest things you do while managing your finances. How simple? Let’s boil it down to just a few sentences.

Here’s how to invest wisely:

• Set aside as much as you can in investment accounts. Prefer tax-advantaged accounts (like a 401(k) or Roth IRA) before taxable accounts.


• Invest all of your money in a low-cost stock index fund, such as Vanguard’s VTSMX or Fidelity’s FSTMX.


• If the stock market makes you nervous, allocate some portion of your money to a bond fund. Or invest instead in a low-cost combo fund like Vanguard’s VGSTX or Fidelity’s FFNOX.


• Continue investing as much money as possible. Never touch it.(Nothing makes a bigger difference to the size of your flock investments than how much you contribute.)


• Ignore the news and ignore your fund.

That’s it. Seriously. That’s all you have to do to earn returns better than 90 percent of other investors.

There are scores of books and published research papers that support this strategy. It’s also the strategy that Warren Buffett (and other top pros) recommend for 99 percent of investors. If you’d like, you can spend days or weeks or months reading about why this works. Or you can trust these folks and do it.

Longer ago, my own flock of sheep was crippled by predators and my own bad behavior. After many mistakes, I got smart. I moved to greener pastures far from danger. Now I can ignore my sheep and go about my daily life, comfortable that the animals will continue reproducing at the long-term average without any intervention on my part. And with no danger of being consumed by wolves.

Note: Photo by James Bowe.

For more info: The Sheep and the Wolves: Smart investing made simple

Get Rich Slowly – Personal Finance That Makes Sense.

The Sheep and the Wolves: Smart investing made simple

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