The Invention of Money

Important to the understanding of finance.

In three centuries, the heresies of two bankers became the basis of our modern economy.

This links to a The New Yorker (August 5 & 12, 2019) article which I hope remains available for some time.

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WHY STUDY MONEY…

The delights of having discretionary spending money!

Why Study Money?

As we go through life, we progress through ages and stages; we attempt to direct our life’s energy based on moment-to-moment, minute-to-minute, month-to-month, year-to-year expectations of our future wants and needs. In modern developed countries, it is extremely rare to try and satisfy basic needs by building our own shelter and growing our own food, so we turn to the medium of exchange of money to satisfy basic needs; after that, we again turn to money to satisfy our wants.

We can look upon work for which we are paid as a transformation of our time and physical energy into money, which offers us a storable, portable means of using our energy in a delayed manner. How we use that money then becomes our judgment call as to what is important to us at that moment.

In an affluent society, many teenagers have an expectation that sufficient money will be available for their wants and needs–the only work required is asking for it. Yet most youth recognize the reality of limitations on the money available to them from the usual sources–their parents. Usually, the parents are able to meet the needs of their children, supplying them with food, shelter, and clothing (though some clothing might more accurately be termed a want rather than a need).

Why Study Money?

As a youth, it is sometimes difficult to see the difference between a need and a want. Also, as a youth, the time horizon may be very short. We look at this evening, this weekend, as vitally important and next month, next year as hardly worth worrying about.

Then comes the transition to independent living. Separation from the parental monetary support is often received as a shocking development. Too soon, then comes the time we see the truth of the old adage, “We grow too soon old and too late smart”.

We grow through the peak earning years, working and earning money. We have apportioned the money we receive between our wants and our needs. How good that apportionment is, is a value judgment each of us will have to live with as time goes by.

At some point in time it dawns on us that we may be alive at a time when we cannot work to earn enough money for our wants and needs. The dreaded or anticipated notion “retirement” rears its ugly (or pleasant, it’s only a matter of perspective) head, and our degree of dread or anticipation may well depend on the degree to which we have wisely handled our money.

WhyStudyMoney?

Throughout the life process outlined above, we have been using and abusing, certainly wasting in some measure the money we have earned. I doubt you will find anyone who could say that every use of his money was wise and prudent–hindsight really is better than foresight. So how do we work toward a comfortable relationship with our money?

This web site holds no secrets for becoming instantly wealthy. Many books and newsletters almost promise that. The truth is, many things in life are happenstance. One estimate says your odds of being struck by lightning in a year are perhaps 1 in 700,000. If you think you have any chance at all of winning a lottery, you might look at http://www.webmath.com/lottery.html (ironically, complete with an ad that starts out “Lottery Wins Guaranteed”). I don’t have any desire to see you struck by lightning, but that’s more likely than your striking it rich by winning a lottery.

Enough frippery! Our use of our money, like our use of our time, is mostly under our own control, and not paying attention to it lets it fritter away, just as our time passes, either self-directed or passively drifting by.

WhyStudyMoney?

There are many resources available to you to learn in depth about money, and your relationship to it.  None are free. Some require only the expenditure of your time. You may wish to actually spend money on financial advice, and there are many ways to do this. But generally, time and your own brainpower is the most important expenditure. See especially the category, “Reference Library” for the General Purpose Bibliography.

WhyStudyMoney?

In the end, the study of money is the study of ourselves–where we put our efforts and our energy. We put some of ourselves into ourselves, satisfying our vital needs (basic food and shelter, normal clothing), coping with social necessities (the car or train or bus to get to work, perhaps uniforms for the job), indulging our whims (Mickey D’s, the Bugs Bunny necktie). Do we also put some of ourselves into our future (savings for more expensive items, end-of-year tax bills, down payment on house, etc)? Do we also put some of ourselves into the future of our society (churches, schools, civic and fraternal organizations)?  When we look at that picture of ourselves, are we comfortable with ourselves and our day-to-day financial picture? We study money to give us a satisfaction with our own life.

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Just Getting Started

If you’re an individual investor, how do you get started? We’ll assume here that you have your financial house generally in order, three or four month’s income equivalent in a savings account or credit union, some readily accessible account, and now you have another small chunk of money that you can invest in some other instrument. My personal feeling is that individual stocks are not immediately appropriate, because of volatility and lack of diversity. Before starting with individual stocks, I would want a minimum ten to twenty thousand dollar base in a balanced or blend type of mutual fund. By the way, this might be part in an IRA or 401k type of account, and part regular taxable account. At this level though, the main objective is safety rather than a focus on growth.

How do you find the appropriate fund? You can do a lot of reading, but you can also look at charts of mutual fund performance. Yes, past performance doesn’t… and so forth, but at this level, you do want an indication the investment company has been around a while.

You can find charts of fund performance in many of the popular magazines; Kiplinger’s includes a tool (look at the bottom of the mutual fund links, “create your own filter” which lets you search for mutual funds which meet certain criteria you select based on one, three, and five year performance. Remember that five years back from 2006 is 2001, and early 2000 was much better, so even five years doesn’t necessarily show the precipitous drop of 2000.  Find a chart of the Dow Jones Industrial Average for the last five to ten years, so you have a basis for comparing a particular fund’s performance against the market. You can also look on the web sites of the large fund companies like Fidelity and Vanguard and Janus-Henderson and T. Rowe Price. Generally, with a little effort, you can get a chart of past performance of their funds, usually past quarter or so, past one year, past five years, past ten years or life of fund.

Your objective is to select a fund for relatively steady performance, because until you’re comfortable with the ups and downs of investing, you don’t want a fund that might go down so precipitously that you will be tempted to panic and sell just as it hits its lowest point.

When you’ve found a few funds that seem interesting, do a little more research. Search the web site for the fund’s prospectus, which will show in more detail its past performance, and how much is charged as management fees, and whether there is a charge to invest (called a “load”) or whether it is a no-load fund (the investment companies mentioned above generally offer no-load funds), and what the minimum is for further investments.

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Starting Out Strapped

Most of the books on personal finance and money management start by assuming you can first, pay off all loans and credit card debt, then build up a cash reserve, as we do in the article, “Just Getting Started”.

But if you are in the 20- to 30-something age range, just starting an independent lifestyle, you may well wonder if you will ever be free of debt. The book Strapped: Why America’s 20- and 30-Somethings Can’t Get Ahead by Tamara Draut –very effectively documents the problem.

Capital (assets, cash) is constantly in motion. It is being transferred from individual to individual, from a corporation to an individual, from individual to corporation, from corporation to corporation. We can also see it being transferred from a class of individuals to another class, when we look at general trends. What Draut’s research so effectively illustrates is how capital is moving from the less wealthy to the more wealthy, and the very negative effects this has on the American society in general. The American dream has never been easy, but it is becoming tougher and tougher to get ahead. As young adults mature, they do understand that they will not start at the level of their parents, but more and more they see themselves as unable to achieve even ultimately the same level of class and wealth as their parents. Burdened by student loans and credit card debt, they start the race to success with two legs hobbled.

The necessity of a college education to achieve even nominal middle-class status need not be argued here. The trend is aptly illustrated by a table from Draut’s book:

To bring this a bit more up-to-date, here’s another quote from the National Center for Education Statistics:

The value of a high school diploma has generally declined, while having the college degree just means you can keep up. Obviously, there is also a premium for having a Master’s degree – in teaching and some social work fields, the Master’s is pretty much the norm.

While parents can generally afford to put their children through high school (though there is a significant percentage who cannot do that) the question of college becomes much more problematic. For the Baby Boomer generation, and even earlier (The “Greatest Generation”) there was a high degree of needs-based support through the G.I. Bill, Pell grants, and more. But as the last century wound to a close, costs of higher education increasingly went up. Teaching science, medicine, biology, more subjects that used to be considered esoteric, requires more expensive “stuff”. The University of Iowa says its tuition and fees are the lowest in the Big Ten, but an undergraduate living on campus can expect to spend over sixteen thousand dollars undergraduate living on campus can expect to spend over sixteen thousand dollars for one year of study. So a college degree is more necessary than ever, yet more costly than ever. See also, “Empty Promises: The Myth of College Access in America“, A Report of the Advisory Committee on Student Financial Assistance.This was a 2002 report. By 2005, the problems had dissolved so they could be fixed by web access to on-line application forms (this is an almost totally sarcastic comment).

Yet as a society the money flows, through tax cuts and tax benefits and public policy, more and more from the less wealthy to the more wealthy.

Student loans, as a replacement for lower tuition (which would require tax support) or scholarships (many of which which would require tax support) puts a long-term burden on young adults, and while the interest might be at favorable levels, it still will represent a transfer of wealth from the less wealthy to the more wealthy.

So the young adult enters the workforce hobbled by student loans, but hoping to move upword in class and income (isn’t upward mobility the American Dream?). Now he or she finds that, as we said above, more and more the bachelor’s degree is only a basic requirement for a job. So that first job isn’t going to pay very much, but he has to live somewhere, and has to buy a car to get to work, and being a cheap car, has to pay to have it repaired… the only answer is the all-too-readily available credit card. Shortly a debt has been run up, and the credit card cannot be paid off each month. So credit card interest starts building up, at rates that most people, if they really looked at them, would consider immoral and usurious. Again, money flows from the less wealthy to the more wealthy.

Now the young adult enters married life – and all too often two incomes are joined by two debts. The couple possibly saves a little on housing costs, though that is definitely not a given. And if the wife becomes pregnant, costs go up, healthcare and debt goes up (because starter jobs probably don’t have healthcare benefits), and income goes down. Can such a couple ever look forward to a quietly prosperous middle class middle age? Is the American Dream lost in the dust of Reaganomics? Bush-whacked by the Bushies?

There are no easy answers here. The older generation (these young-adults’ parents) may well have their own insecurities. They think Social Security will be there for them, yet they realize politicians are trying to turn Social Security over to the financial markets – to abrogate a depression-born social contract. Such parents may be reluctant to provide any support for their young-adult children.

On a national scale, the effects of reaganomics, and tax cuts that transfer wealth effectively from the less wealthy to the more wealthy – the better off you are, the better off you’ll be – are apparent. But to an individual, what can you do about them?

The only advice this writer can offer is to talk frankly with your parents or your young-adult children, whichever is appropriate for you. The young-adult may feel ashamed – thinking he should be able to do better on his own, and may avoid discussing exactly the situation he is in. Perhaps early on letting parents know that he/she will need help getting started postgraduate, or building understanding that money isn’t there for finishing college, or for going on to graduate school, whatever the aims. For the parent, open lines of communication to your adult children. Inquire, and not in a condemnatory manner, just how much debt they are carrying, especially the most onerous credit-card debt. Ask in detail with real interest, just what their monthly expenses are, and how you can help.

It has been said that “we stand on the shoulders of giants”. The obligation of each of us is to build on the strengths of those who have gone before us. What this means is that every rich old fogey has an obligation to every young person, to make the weak stronger, to leave a better society, more especially for those we love. When we look at the flow of assets, of capital, to, from, and around us, are we meeting our obligation as best we can?

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Financial Advice

There are all kinds of ways to get financial information. There is a distinction, though, between specific financial advice for your particular situation on the one hand, and general financial information more or less applicable to everyone, on the other hand. This site, along with many others, seeks to provide general information for the good of the public, and as such, the information may not be applicable to your particular situation.

Patrick Astre, in his book “This is not Your Parent’s Retirement” (see <a href=”http://www.whystudymoney.com/index.php/weblog/category/Reference%20Library/” title=”Reference Library”><b>Reference Library</b></a>) makes a good case for using a financial planner. Yet how do you know who a good financial planner is, and at what point does it make sense to use one? Certainly it’s obvious that a millionaire sports star, a lottery winner and such should have a financial planner and will be able to pay appropriately for that advice. I guess in these conditions I would start with the Certified Financial Planner Board of Standards,   though I would make sure I understood how a particular individual with that certification was being compensated. Certified Financial Planners do have a form from the certifying Board that the client is to sign saying he understands he has the right to ask for compensation information as relates to his relationships, but the form itself does not necessarily furnish it (a template download from the CFP Board site is available). As always, let the buyer beware.

If you’re not in that particular income bracket, but just an ordinary individual, you may be approached by someone offering “financial services”, to help you with your “financial plan”. They may simply be insurance salesmen selling annuities, or more broad-based, suggesting replacement of whole life insurance policies with term policies and replacement of Certificates of Deposit with mutual funds (probably funds carrying a “load”, or an initial percentage payment, of which the salesman and his agency get a cut). If you are really ignorant of financial instruments and basic handling of your finances, this may not be an altogether bad thing, but you can do better. Start by reading some of the books in the <a href=”http://www.whystudymoney.com/index.php/weblog/category/Reference%20Library/” title=”Reference Library”><b>Reference Library</b></a>, especially the Downey book or the Sheard book.

You should note also that there is a plethora of newsletters and other information available for investors. To see one website I find interesting, go to MarketWatch.com. Buried at the bottom they do have a link for Premium Products, and you might consider subscribing to one of those. Quite popular is Motley Fool’s Stock Advisor; one web page says they have over 400 thousand subscribers, which would seem to me to be enough to actually impact the stock price of any recommendation, but I have no empirical evidence to take that position. I consider Bob Carlson’s Retirement Watch newsletter valuable for its take on financial and personal aspects of pre- and post-retirement affairs, though I don’t like his emphasis on diversification of investments through a large bundle of mutual funds – I’d want fewer funds then my own stock picks of companies not likely to be in the funds, and I’d use a newsletter like The Prudent Speculator or Personal Finance Newsletter and ValueLine Investment Advisor to help me choose those other investments, and I do so with the full realization that anything in any of these newsletters may be wrong (they all seem responsible journalist and advisors, but nobody can see the future with one hundred percent clarity). Having said that, Carlson’s approach might be just right for someone retiring with substantial assets (more so than mine) who simply doesn’t want to pay a whole lot of attention to them.

The important point, I believe, is that you must take responsibility for your own financial health. It may not be a nuclear disarmament treaty you are negotiating, but as President Reagan was fond of saying, “Trust, but verify”.

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Stocks, Bonds, and Mutual Funds — The Basics

There are no “hot tips” here, but rather an attempt to introduce you to the world of investing, and give a springboard for further development. First, the requisite disclaimer: this writer is not a “Certified Financial Planner” nor does he have any educational degree relevant to financial planning. In another section you will find personal stories that give some background, but when investing it is always important to get as much information as possible on proposed investments, from as many different resources as possible – “due diligence”.  Always add to this common sense and a reasonable dose of skepticism.

When you are investing in stocks, bonds and mutual funds, you are investing in business, in commerce. The exception, of course, is government bonds, but even there the resemblance to business is sufficient to lump them together for our discussion.

Always the first question to ask is, “what is the risk”? If you give someone else your money, what are the chances that you will get it back, and with a profit? If you buy a stock, you become part owner of a company. If the company does well, perhaps you can sell your stock for more than you paid for it, and your investment will have been worthwhile. Perhaps while you own it, the company management will decide to share profits with the shareholders, and pay a dividend, usually a worthy (but not a necessary) feature of stock ownership. If dividends are paid, they may be paid every three months (quarterly) or every month, or only annually. But you may find that, whether or not the company pays a dividend, at any given time, nobody else is willing to pay the amount you paid for your stock – you can’t sell it for what you paid for it. This is risk, the downside versus the possible rewards on the upside. And of course don’t expect your brokerage to insulate you from any such losses, they are merely intermediaries (in most cases) and your agreement with them clearly says, in the fine print, you are responsible for your own gains or losses.

BONDS

MUTUAL FUNDS

COMMON STOCKS

PREFERRED STOCKS

STOCK RIGHTS

STOCK WARRANTS

Bonds are a somewhat different animal. The company issuing the bonds is borrowing money from you, and promising to repay the amount borrowed, with a certain amount of interest paid to you in some stated way. If you see the stock market moving down, you might think it a good thing to have a promised repayment, plus a “guaranteed” interest payment. But there are several kinds of risks with bonds. First, the stability of the company—well, General Motors is not likely to go bankrupt, is it? Or would Enron? Second, while your money is on loan in a bond, the stock market might go up quite a bit, and you risk missing better returns. Third, while your money is tied up—you put a hundred dollars in a bond, a year later you’ll be getting a hundred back, with some interest, say five dollars– in that year, inflation may have made the purchasing power of that hundred and five worth much less that it was at the beginning of the year. So bonds bear their own form of risk. You can see that government bonds, while not likely to suffer bankruptcy, would still have the latter forms of risks, as would bank certificates of deposit.

MUTUAL FUNDS

Mutual funds provide a convenient way of investing in shares of a variety of businesses. As such, they provide a bit of “padding” around the risk of an individual stock (or bond, in the case of bond funds), but they can and do vary in value as the stock market moves up and down. Index funds, of course, generally move with the market index they model. Other mutual funds are managed to attempt to make money regardless of the overall market, and some do more or less succeed in that. But every fund, in its prospectus as it shows its past results, includes a statement to the effect that “past performance does not guarantee future results”, and every investor should take that statement to heart, even as he closely examines an investment’s history.

COMMON STOCKS

When you purchase common stocks, generally you may expect the purchase to come with the right to vote on matters the issuing company’s board wishes to bring before the stockholders at its annual, or at a specially called, meeting. You may receive dividends, if the board decides to issue them. The board is always balancing the use of profits between rewarding stockholders with dividends or reinvesting for growth of the company, so low or no dividends may be either a bad thing or a good thing for the company.

You have the right to sell the stock. That is, you have liquidity in your investment. But you have no guarantee that you can sell the stock for the amount you paid for it.

You have residual rights. If the company is dissolved, after all creditors are satisfied, any remaining value may be distributed to the shareholders of common stock – but you’re last in line.

PREFERRED STOCKS

A company may issue one or more types of preferred stocks, usually paying an attractive dividend. These stocks sell more or less at a par value, often a hundred dollars a share, but maybe twenty-five or fifty dollars. After issue, the market will determine the exact dollar value. Most are callable. At a set date, or perhaps after a grace period (usually five years) the issuing company can call them back in, giving the holder the stock’s par value. This may result in some capital gains or losses, but you usually pay close enough to par value that capital gains may not be too significant. There may be special cases where this is not true, so always try to be aware of any other circumstances that might influence a high discount to par value when you are purchasing a preferred stock.

Dividends are set as a percent of par value, and the preferred dividend must be paid in full before any dividend can be paid to the holders of common stock. For most issues, dividends are cumulative. This means if a dividend is missed, it is still owed to the preferred stockholder, and must be paid as soon as the company is able to do so, whereas for the holder of common stock, if a dividend is missed, it’s just too bad.

Some preferred issues are convertible to common stock. Because (if the common stock price goes up) this could be a real benefit, the dividend probably will be lower than would be the case for a straight preferred issue.

STOCK RIGHTS

Purchasing a common stock may or may not include certain rights, such as the right to buy any new issue of stock at a set price, usually under the market price. This right may be only for a brief period of time (one month, perhaps) after the new issue.

STOCK WARRANTS

Warrants give the right to buy stock at a fixed price for a period (perhaps ten years or more). This is usually a higher price than the stock is selling for at the time of the warrant issue, so if the stock doesn’t go up it’s not a good deal, but if the stock price does go up substantially, the warrant holder could buy at the warrant price and sell at the market price for a capital gains profit.

<br>Where to go from here? Scan the annotations in the <a href=”http://www.whystudymoney.com/index.php/weblog/category/Reference%20Library/” title=”Reference Library”><b><u>Reference Library</u></b></a> category of this site, and look for books such as these in your local library.

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Annuities

I’m again’em! And my financial structure had a couple within it. My objection centers on two notions. I think most investments would have better returns (there’s a reason insurance companies can afford deluxe buildings), and they are generally very inflexible instruments.

I’ll argue against an illustration in Patrick Astre’s book (see “<a href=”http://64.62.152.173/index.php/weblog/category/Reference%20Library#astre” title=”Reference Library”>Reference Library</a>” on this site). A couple (or an individual- whatever) in early middle age plans on leaving the workforce at something like 55 years of age. In some occupations, such as military service, police, fireman, this would be a realistic goal, certainly a possibility. But from full-scale salary, there will be quite a reduction when this occurs. At 62 to 66, Social Security benefits will be added to pension, so the goal is to “kick up” income in the gap. Astre’s suggestion is to pay into an annuity that will then, at the set time (say, 55, that’s what we’re working toward), start paying out on a monthly basis so that the proceeds are exhausted as Social Security begins to pay.

The alternative would be to pick a solid mutual fund, do the numbers based on a 5% growth rate, and handle it yourself.

Weighing on the side of the annuity, if you fund it from a lump-sum payment, it’s a known quantity, almost risk-free, almost guaranteed (nothing’s guaranteed except death and taxes, and we’re working on death). If you pay it by monthly payments, you regard it as a primary payment, and are likely to keep up the payments in almost every circumstance.

Weighing against the annuity, if you fund it with a lump-sum payment, the moment you are committed to it, your lump-sum becomes perhaps close to three quarters of the size the lump was. The sum the annuity company says they are working with may still be the size of your deposit, but the cash value you can withdraw has suffered a severe case of the shrinkage. Typically, the cash value goes back up as you hold the annuity toward its term, but if you absolutely need the money in the interim, the penalty can really hurt. Further, when the payout starts, you are being paid from dividends and interest and your own principal, but the payments might well be taxed as regular income (this should be checked with a tax expert, not the annuity salesman and not me; I’m not a tax expert).

Suppose you try to achieve the same thing with a mutual fund. The pros include flexibility, access to your money at almost any time, and the opportunity, if you choose the fund wisely, to do better than the annuity would in final payout. Against that is the need for greater discipline (keep your hands off the money, you don’t <i>need</i> it to pay for the swimming pool) and the fact that mutual funds do go up and down in value, which means you should be keeping your eyes on your investments (always a good idea anyway).<br>Why did I say to calculate 5% growth above, when many people say the market will generally grow 10%? Well, we’ve just seen several years when the market didn’t grow 10%. On this point it’s instructive to look at some mutual fund performance charts. Most charts would be like <a href=”http://personal.fidelity.com/products/funds/content/browse.shtml.tvsr” title=”Fidelity Investment’s” target=”_new”>Fidelity Investment’s.</a></b>

Look at the 10-year or life-of-fund columns, Look at the 5year column, and you can see which ones were hit hardest by the 2000 dot.com crash. These returns also do not consider any taxes you may or may not have to pay (it’s probable you’ll have to pay at least a 15% tax on your fund’s <i>earnings</i>).

So, which would you opt for- put your money in annuity jail for low risk inflexible usage, or put your money in somewhat more risky mutual funds, for <i>probably</i> higher rewards?

At the beginning of this article I said I was against annuities as a general principle, although I had some of my own. One was a small tax sheltered annuity from my work, paying a modest return but better than a bank CD or some such. At retirement, I moved it into a higher income investment.

My second annuity is a variable annuity. I had a mutual fund IRA that was becoming mediocre in its performance, I felt, and I was approached by an acquaintance from church who gave me a presentation on the benefits of his variable annuity. My mistakes were several—first, I was comforted by his presentation that the investments that formed the annuity were, if not great, at least OK (I should be equating OK with mediocre); second, when I received my copy of the annuity document, I should have immediately read and understood it; and third, at the time I didn’t realize the taxation aspect. My income tax on income from the annuity will be at a rate perhaps 10 to 15 percent higher than it would have been had I retained the mutual fund IRA.

Now, none of the issues mentioned above are disasters. I won’t throw eggs at the salesman’s porch. I probably won’t need the money any time before it can be paid out without penalty. What bugs me most is the feeling I could have done a lot better.

For another view of a particular type of annuity, <a href=”http://finance.yahoo.com/focus-retirement/article/109450/when-is-an-innuity-worth-it?mod=fidelity-managingwealth” title=”Goes to the CNN/Money web site in a new tab or window.” target=”_new”>look at this article from the CNN/Money web site</a>.

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Starting With Stocks

The assumption here is that you have a base of liquid savings, generally no credit card debt (pay off each card each month) and a stable base of mutual funds that are doing at least fair for you. Now you feel ready to open a brokerage account and look at buying stocks.

If you are reading this, you’re probably already fairly comfortable with working on the Internet. If you have children who use the same computer that you do, however, I urge you to be extremely paranoid about the security of your computer. A youth will go to a music-sharing site, thinking “Wow- free music”, and wind up with spyware lodging itself on your computer, transmitting keystrokes (like your username and password) back to a Chinese or Ukraine or even American crook specializing in identity theft- and your only clue is a little extra activity by your computer, which may not even be noticeable.

That said, if you practice good Internet hygiene, Internet trading is a fine way to do business.

You can go to a local brokerage (in-town) house, and buy stocks that way.  Which stocks? Whatever the broker is pushing that day, if you don’t have other orders for him or her. Will they be good stocks? Surely, for the broker, maybe, for you.

You can go to an on-line brokerage, and there are a number. You see the ads on TV just about every day: Schwab, E-Trade, Fidelity, Vanguard, many others. Look at the commission structure, but remember that under a value approach to stock picking, and with a somewhat limited portfolio, you won’t be doing a lot of buying and selling; a dollar difference in trade commission might only add up to perhaps thirty dollars over a year of modest investing (such as a buy and sell a month, for example). That means you look at other factors as well; where are your mutual fund accounts? What investing information do they seem to offer?

With a brokerage decided upon, which stocks do you want to buy? There are plenty of suggestions in the media; perhaps a department store chain opens a new store near you and you’re impressed. Should you buy that stock?  You can see the difficulties of simply choosing which stock to buy.

You need to analyze what you expect to happen with a stock. You may buy a stock expecting its price to go up by a certain percentage by this time next year. You’re looking for growth. You may buy a stock that pays a dividend on a regular basis, so you’re looking for income. Nice if you get both, and nicer if there is also a growth in the dividend. By the way, mutual funds usually simply re-invest dividends so that your number of shares increases. Brokerage accounts usually include a cash account where dividends can build up (usually parked in a money market account earning a little interest of its own) until you hopefully use them to purchase yet more stock, thus building your portfolio over time.

Back to the central problem: which stocks should you buy? It would be nice if there were a pre-screener for you, so that you weren’t simply throwing darts at a newspaper stock listing. Or listening to Mad Money Cramer screaming stock advice at you on one of the cable channels. And there are! Some of the on-line brokerages offer tools that will let you see which stocks have gone up or down in price over some past time periods (remember, Past Performance Does Not…).

Better yet, there are newsletters that build exemplary portfolios, many newsletters claiming their chief writer is a star stock-picker, making huge gains, yada, yada. But some newsletters really are good, and do provide useful advice.

Newsletter portfolios, I believe, are to be tempered by your own judgment. I have one stock that has, over many years, done very well for me, and it is not a part of the portfolio of my favorite newsletter. However, I have bought stocks recommended by the newsletter, after looking at the individual company’s information (about every company has a website with investor information), and seeing what other information I could determine about the industry. I look at the discussion about the company, and see if the writer’s expectations make sense, in light of what else I know about the industry sector, the economy, the world… In other words, even for what you think is good advice, check it out. Do your own due diligence.

One factor I give at least token consideration to is whether a stock I am considering buying is in any of the mutual funds I own. It’s not a major consideration, for my stock portfolio is small enough that one stock price movement (hopefully upward) will have more impact on my stock portfolio, than the same stock movement would have on a mutual fund with far more stocks in it than my own portfolio.

At what point should an individual expect to have to use professional money management for his portfolio? Money management builds in its costs, so it would seem to have to earn more than it costs. Where would that point be? If you have any thoughts on that, register for this site (you will never be spammed from here), and leave your comments.

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Using Margin

In dealing with the trading and purchase of stocks through a brokerage, you may consider using margin. There is not a great mystery to using margin, it is simply borrowing other people’s money (usually, the brokerage’s). As always, when you consider borrowing money, there are good times to do it and bad times to do it. And as always, TANSTAAFL (There Ain’t No Such Thing As A Free Lunch).

You need always to keep in mind that a margin loan is accumulating interest every day; and if you look at the interest rates charged, especially in the smaller amounts, you will probably find them somewhat steep (nothing compared to what credit card rates are usually set at, but still…). Typically, the more money you borrow on margin, the lower the interest rate, but it is still a very real factor.

When you use margin, you are promising that you can pay the money borrowed back to the brokerage, by giving them the stocks in your account. If your account has 50,000 dollars worth of stocks, the brokerage may be willing to lend you (give you margin) of perhaps 40,000 dollars more. The brokerage would have a formula for this, and it would also depend on the quality (whatever that means to the brokerage) of the existing holdings.

If you borrowed the full amount allowed, and the value of your holdings dropped substantially, the brokerage might issue what is termed a margin call. They are simply asking you to pony up the cash so that the value of your stock holdings is more than what you have borrowed (however their formula works). If you have a lot borrowed, and the value of your stocks goes down dramatically, you can see the potential for disaster. Let’s look at some illustrations. Here we’re showing only gross generalizations.

In this example, there are a number of factors to consider. First, will the market in the particular securities you have purchased go up? How confident are you in your judgment of that factor? Second, how long will it take for the stock to go up? If it takes a year to go up 10 percent, and you are paying 10 percent margin interest, it doesn’t take a Fulbright scholar to see you haven’t really gained much. How about another example?

In this example, it looks like your sales proceeds of  $18,000 isn’t too disastrous, but remember that $10,000 is borrowed (margin), and so has to be paid back. That’s why the value of holding at close is less than $8,000.

The above examples, of course, do not include any applicable fees, commissions, or charges, all of which would impact your profit or loss on your investments.

There are some advantages to using margin:

Competitive interest rates — Certainly compared to credit card rates, and perhaps many bank or credit union rates. It is also worth noting that margin is essentially a line of credit, and can be used for other purposes than buying securities.</li>

Repayment flexibility — There may be no set repayment schedule as long as the required level of equity is maintained in your account. Interest charges on outstanding balances are posted to your account monthly. Any cash dividends (not enrolled in dividend reinvestment) and interest received may be expected to be automatically applied to your margin balance.</li>

Convenience — As mentioned above, you may be able to borrow for any purpose, at any time. Once you have been approved for margin borrowing, there are no additional forms to complete, application fees to pay, or loan officers to consult.

As the tone of this discussion may imply, it is the opinion of this author that margin can be a useful tool when the market is in a fairly stable upward trend, and you are fully aware of the pitfalls of using margin. Most of the books mentioned in the Reference Library discuss the stable household as one that is not burdened with a lot of debt. Using margin debt should be done only when you are very confident (based on knowledge, not wishful thinking) that margin’s usefulness will clearly outweigh its costs. Caveat emptor!

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Real Estate as an Investment

Your Own Home

Many people, perhaps yourself among them, dream of owning your own home. If you do not now own one, but do see it as a desirable goal, you should probably be stressing your savings actions more than you might ordinarily want. You need to be saving to build up your net worth, and that savings needs to be in a form that is generally liquid, and that can grow on its own. If you use this savings as down payment on a house, it becomes illiquid, and its growth, if any, is also illiquid. Therefore it makes sense to stress finances a bit more to save especially for the down payment on a house. While there may be some cases where you can buy a home with little or no down payment, you pay more in the long run in higher interest rates or longer payment terms. The bigger the down payment, the better the deal.

Because it costs so much, you might consider your house a part of your financial estate, and of course it is that. It is probably a mistake to consider it in that regard, though. You have to live somewhere, and if you are living in your home, you will not want to do anything that will jeopardize its stability. So, it is better than paying rent, and rather than thinking about the amount of equity you have in your house, you should simply consider it a part of your living expenses, and leave it out of the day-to-day consideration of your “wealth health”. Yes, if you own your home and have been paying on it for some time, perhaps you have built up equity and perhaps you can borrow against that equity. Most often, though, the reasons for borrowing against that equity come as a result of misjudgments in other areas of financial (mis)management. For instance, taking out a 20-year second mortgage to pay off high-interest maxed-out credit card debt is probably just digging yourself deeper into a hole, when you should be looking at why you have so much credit card debt in the first place. You really want your home to be a sacrosanct part of your financial picture, kind of in its own partition. As one writer put it, consider its value as money that’s “in jail” for you.

You may decide that you need or want (need to move due to a change in job perhaps, want to move for more room or different neighborhood) to change homes; then the equity of the current home becomes an important part of the consideration — the home partition has to be viewed along with the rest of your financial picture to see what is feasible and practical for future courses of action.

Also in the category of personal residential real estate, you might consider rural acreage on which you’d plan to build a retirement home. Perhaps instead it would be a second home on the lake, or the mountainside retreat. In any case, the goal here is personal satisfaction, and you will not reasonably consider it a part of your financial growth strategy. After purchase payments, insurance and taxes, even growth is problematical. In some areas, growth in investment value is quite likely, but to make use of it you have to part with your investment, thus removing it from your “lifestyle portfolio”.

Beyond Your Own Home

If you have sufficient liquid investments –checking, savings accounts, stock market accounts, mutual funds (they are, after all reasonably liquid, though perhaps disadvantageous to make use of in this fashion), and the interest moves you, you might consider investing in local real estate. Perhaps you buy a duplex, live in one half and rent out the other half. Or if you’re a handyman type, perhaps you buy a few old houses, repair and recondition them, and then either rent or sell them. Some professional people will build an office for themselves, but enlarge it sufficiently to rent sections to other professionals. Or you just have a feeling that a strip mall is going to be needed at a certain location, and you want to take on the challenge of working with city or county officials, contractors, rental agencies, etc. to get the thing built. Certainly this is high risk, but it could also be high reward; it also assumes you have built up a good deal of your own working capital, because you won’t be able to borrow to finance the total costs. Which leads naturally into the next topic…

Commercial Real Estate

To participate in real estate on a larger scale, if you have lots of money, you can be a part of a limited partnership to buy, build, or remodel office buildings, apartments, or residential developments. If you go into such an arrangement with friends or business colleagues, you really need to have an attorney looking out for your interests. The money spent for legal advice may save you much in the event of some unforeseen disaster.

You can also invest in essentially the same thing, and starting on a much smaller scale, by investing in REITs, Real Estate Investment Trusts. You buy REITs in the stock market, through a brokerage, either discount or full-service, and most REITs have a web site with investor information. Each REIT will have its main focus defined, for instance, business rental in the Southwest, or apartment buildings in the east coast, particularly around Washington, D.C. REITs generally have to pay their owners (as an investor, you would be a part owner) a portion of their Funds From Operations, so you generally will be paid a dividend. The value of a REIT’s stock, however, can vary up or down. If you buy when it’s high priced, and sell after it has gone down, even a dividend payment may not make up for the difference in capital gains (losses). Do a Google or Yahoo Finance search on REIT or enter REIT in the “Search Amazon” box at the side of this web page (I’d suggest using the pull-down menu above the search box to limit the responses to “books”). If you’re going to invest even just a couple thousand dollars in REITs, you should take the time to become somewhat knowledgeable about them.

Real Estate Options

In the option scenario, you notice a property that you feel is just ripe for some kind of development—farmland at the intersection with a four-lane, heavily traveled highway, for example. Perhaps you don’t want to undertake its development on your own, but you think someone should be interested in buying it sooner or later. You learn more about optioning property than is outlined here, but the general idea is that you offer the owner cash for the right (but not the obligation) to buy his or her property at a certain price and on or before a certain date. You then find somebody who is interested in developing the property, or at least buying it from you (your option should mean that the owner cannot sell the property directly to somebody else without satisfying your terms). Presumably, the money or value you receive from your (client, customer, partner) pays the cost of the option and enough extra to turn a worthwhile profit. Here again, you need to know much more about this than this one paragraph tells you, and this probably should (and in some cases must) be handled with the assistance of your attorney.

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