5 things that may mean you are too risk adverse
2014-04-05
In general, most of my readers are far too cautious with their investments. They are risk adverse almost to a fault. I see far too many people worried about losing money in their portfolio rather than making money.
Jim Cramer has made a living advising the general public on stock investments. He is not always correct in his predictions but then I don’t know of any prognosticator that is perfect. In this video, he advises that young people in general are too risk adverse. I agree.
In the video above, Jim states that he is 52 and therefore should be more cautious. I tend to disagree, 52 is still not very old. The likelihood of living to 90 if you are already 52 is incredibly high. 52 year old people have a great deal of time to recover from a stock correction and therefore should not be nearly as risk adverse as they tend to be.
So what are the typical actions of a person that is risk adverse? While almost everyone should do some of these listed items, you can go too far especially if these are your top 5 criteria for stock picking decisions.
1. Selling covered calls
If you sometimes sell covered calls on stocks to provide incremental income and limit downside risk then you may be too risk adverse. When you sell a covered call, you are giving the buyer the right to purchase the stock from you for a set period of time at a given price. For example, if you own 100 shares of stock A at $25 and, in October, sell a January covered call with a strike price of $27 at a price of $1, you will receive $100 today. If the share price is below $27 when the call option expires in January, you keep the stock and the $100. If it is above $27, you keep the $100, the call owner buys the stock at $27, and you miss out on some appreciation.
This strategy is inherently a low-risk strategy and therefore great for those that are risk adverse but it also limits your upside potential. Just buy the stock and then actively monitor it with the tools that I teach in my book, The Confident Investor. If you follow my suggestions, you will likely make more money have just as much risk control.
2. Invest primarily in dividend payers
You invest in dividend-paying stocks that provide a stream of income, so that you are not solely reliant on capital appreciation for stock portfolio performance. I have nothing against companies that pay dividends (actually, I do but that is the subject for a different article) but focusing on just those stocks rather than growth companies that need all of that cash to fund their growth is far too conservative for anyone under 60 (or maybe even 70). You have a lot of life to live and now is not the time to be risk adverse. If you want to retire in luxury then you need to not focus just on dividend stocks.
3. Risk adverse people have diversification as the top criteria for stock picks
You diversify, both by company and industry and it is a primary reason to choose a stock. Diversification spreads risk and helps to limit the effect of a disappointing investment on overall portfolio performance, which can help to smooth your portfolio’s performance over time. While diversification is not a bad thing, being too focused on it means you are hurting your overall performance. There are some markets that are simply dogs at any give time, avoid them.
4. Pick defensive stocks
You seek out defensive stocks as a category. Some stocks and some sectors (such as food companies and utilities) tend to be less economically sensitive and therefore to achieve more consistent financial results over time, which can help to reduce portfolio volatility. Their earnings growth may be slower than for more cyclical companies, but it also tends to be steadier, and they generally pay dividends.
As I said above when focusing on diversification, too many companies that are defensive can hurt your portfolio too much. There is a really good reason that my Watch List has so few food companies and utilities!
5. Dollar cost averaging
You probably learned about dollar-cost-averaging for stock purchases if you participated in company stock-purchase programs in which you arranged to buy a set dollar amount of the company stock on a regular basis. The advantage was that you bought more shares for the same amount of money when the price was down and fewer shares when it was up. While this isn’t a terrible strategy, it is very risk adverse. You are probably better served by monitoring the stock as if you are a technical investor and simply buy into the stock when it starts to increase in price. Buying on the way down, simply hurts. It is much more elegant to buy close to the bottom. My book, The Confident Investor, helps to teach you the right time to buy the stock.
Being careful with your money is not a bad thing. However, do not be so risk adverse that you are hurting your financial future. It is key that you understand the workings of the market so that you can make sound decisions. My book, The Confident Investor, will help you with that effort. You can purchase my book wherever books are sold such as Amazon, Barnes and Noble, and Books A Million. It is available paper format as well as in e-book formats for Nook, Kindle, and iPad.
5 ways to reduce your costs of investing
2014-04-01
It is wise to reduce your costs of investing. Every dollar you pay in fees is simply a dollar that cannot grow to ten dollars over time. You are using the services of others so you need to pay something, but there are smart things you can do to reduce the costs of investing.
Not too long ago, investing was seen as something expensive. Only the rich could invest their money. In fact, in the 19th century, these people were typically called “robber barons” at the worst and “capitalists” at the best. We live in a capitalist world (even if you are reading this in a country other than the USA) so investing is important way to provide for your family. The costs of investing have dropped over the years, but spending money needlessly is never wise.
It only makes sense to reduce the costs of investing and do it well. Investing is something almost anyone can do.
However, investing can still get expensive. If you pay relatively high investing costs, usually due to fees, commissions, expense ratios, and taxes, you could see lower overall returns. If you want to reduce the costs of investing, here are some suggestions:
1. Know what the costs are so that you can reduce the costs of investing
The first step to reduce the costs of investing is know what you’re paying in terms of investment costs and fees. Disclosures on your 401(k) statement should tell you exactly what you are paying. It’s also a good idea to get some help looking over the tax implications of your investing strategy, to see where you could save. Know the fees you are paying at your brokerage, and be ready make changes as necessary.
For individual stocks that you buy (this should be approximately 60-70% of your portfolio), you really need to understand the brokerage fees that you pay.
2. Comparison shop to find better rates
You do not need to be loyal to your current broker. If your broker is not earning his/her fee then change brokers to reduce the costs of investing. For some thoughts on finding a broker, read this article.
Now that you know what you are paying in fees, you can comparison shop. If you are paying $9.95 for a stock trade, you should probably know that there are brokers that charge much less, some as little is $4.95. Take the time to look for brokers and investments that come with lower costs. From brokers that will let you reinvest dividends without paying transaction fees, to no-load mutual funds, look for the best deals. When you find a better price, replace your old, more expensive investment, with a new, less expensive asset.
I have a list of brokers on this page, if you need help in looking for alternatives.
3. Consider buying index fund to reduce your costs of investing
If you buy actively managed funds, you should consider index funds. Index funds usually come without sales load fees, and often have much lower expense ratios. If you really want to have low expense ratios, you can consider an index ETF. There are ETFs with expense ratios as low as 0.04%. That’s an amazing way to save money on fees, especially over time, as your portfolio grows.
I have discussed having a balanced portfolio before on this site. I strongly suggest that you do not use actively managed funds but instead have 30-40% of your portfolio in 4 index funds. The balance should be in great stocks such as those I have on my Watch List. Not only will index funds reduce your costs of investing but they will likely earn your more in return.
4. Look for no-cost options to reduce your costs of investing
For investors who are interested in funds, it’s possible to avoid paying commission/transaction costs. Many brokers have a selection of funds that are no-cost, meaning that you won’t pay a transaction fee when you buy shares. You still have expense ratios, so pay attention to that information, but you won’t have to worry about transaction costs. Many brokers also offer commission-free ETFs, so you can take advantage of the low expense ratios.
Consider your options at different brokers, and pay attention to minimums and other account requirements. Also, realize that your selection of commission-free funds might be a little limited. Don’t let your goal to reduce your costs of investing affect your ability to make a sufficient return on that investment.
5. Move your money to a tax-advantaged account to avoid the tax penalty costs
If you are concerned about how much you have been paying in taxes, you can move your money to a tax-advantaged account. Traditional accounts, like 401(k)s and IRAs, grow tax-deferred, meaning you get a tax deduction for your contributions now, and you aren’t taxed on your earnings until later. This allows your money to stay in your account and grow more efficiently, since you aren’t taxed immediately.
It can also make sense to use an account where your money grows tax-free. Roth IRAs and Roth 401(k)s require that you make contributions after you pay your taxes. However, the money in these accounts grows tax-free; you are never taxed on your earnings. Many investors like to hold dividend stocks and Treasury securities in Roth accounts because the interest/payouts from these investments are never taxed. This can be a way to lower your investing costs over time.
I suggest that you seek advice from a qualified tax professional to understand how your investment activity affects your taxes. Don’t trust the advice of an article (even one written by me) as your situation may be unique.
My book, The Confident Investor, features a system to increase your wealth while trying to avoid unnecessary costs. You can purchase my book wherever books are sold such as Amazon, Barnes and Noble, and Books A Million. It is available in e-book formats for Nook, Kindle, and iPad.
Reduce your costs of investing. It is simply the prudent thing to do. Don’t spend more money than you need to spend.
Wall Street Bull photo provided on Flickr by thenails
SaaS operating metrics
2014-03-29
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Source: SaaS Operating Metrics Uncovered
5 ways to save money on your mortgage so that you can invest more
2014-03-27
Your mortgage is probably your largest investment. Saving money on your mortgage allows you to increase your income by the percentage rate of your loan. If you are paying 2, 3, or even 7% on a loan, the cost savings effectively pays you back at that rate. This is a guaranteed return and incredibly safe investment. It simply makes sense to save money on your mortgage as long as it doesn’t significantly hurt your cash position or your ability to pay off shorter term debt.
I assume you maintain a budget. If you don’t, you should! Your mortgage probably is the largest cash payment from your budget every month. Imagine how fast you could ramp up your retirement savings, build a college fund, or save up for a big vacation if you didn’t have that payment! In addition to the increased cash flow, having your house paid off also comes with a sense of security – that you own your home and not the bank.
Paying off your mortgage early also allows you to potentially reduce your emergency fund simply because your home could be a source of credit. It also means that your cash burn every month would be that much lower so in the event of a catastrophe, your monetary stress would be significantly reduced.
As I said about a year ago, follow the old Benjamin Franklin saying, “A penny saved is a penny earned.” All of the money that you save on your mortgage is like a guaranteed investment.
Here are some ways you can pay off your mortgage early.
1. Round up your payment of your mortgage
The easiest way to pay off your mortgage faster than normal is to simply include additional money on every payment you send to the bank. Round up your payment so that it ends in 2 zeros (e.g. $1,600 rather than $1543.86). The additional money will go straight toward the principal of your loan rather than to paying the bank interest. Over time this will slowly pay down your mortgage faster than your original financing term.
It is even better if you add a couple hundred dollars to your payment. Adding 2 or 3 hundred dollars will significantly accelerate your paying off the mortgage.
Check with your lender to see how they treat additional payments. Most banks automatically apply additional payments to any outstanding fees. How they handle extra payments after that can vary so be sure to note on your extra payment that it should be applied to your principal. If you aren’t able to make slightly larger regular payments, it may be time to consider refinancing your home with a more friendly bank.
2. Bi-weekly mortgage payments
A second way to send in additional payments is to coincide your mortgage payment with your paycheck. If you are paid bi-weekly, you simply send in half of a mortgage payment on each pay day.
This doesn’t seem like it would save you any money, but you’ll end up paying an extra month’s worth of payment every year. While there are 12 months in the year, there are 52 weeks in the year. If every month was exactly 4 weeks, there would be 13 months in the year. By paying the bank every 2 weeks, you will essentially make 13 mortgage payments rather than only 12.
3. Refinance your mortgage for a shorter term
Another way to pay your mortgage down faster is to refinance to a shorter mortgage term. If you’re three years into a 30-year mortgage and refinance to a 15-year mortgage, you’ll save money over the life of the loan. Granted your payments will be higher every month, but the shorter term combined with the higher principal payments will save you a lot of money in comparison to your previous mortgage.
4. Refinance your mortgage to a lower rate
You need to aggressively look for the lowest rate that you can pay on your mortgage. Aggressively shop for a better rate. There will likely be closing costs that you will incur. As long as you recoup the closing costs in a couple years, then it is worth refinancing.
5. Mortgage recast
It may be worthwhile to take some of your investments to recast your mortgage. This is also a consideration if you have suddenly come into a sum of money (selling a car that you don’t need to replace, inheritance, or an unusually large bonus payment).
A mortgage recast is used to pay off a big chunk of your loan at once. When you recast your mortgage your bank actually reamortizes your loan based on the remaining term left on your loan and the new loan balance. Your interest rate remains the same but because you’re paying interest on a lower balance, the amount of overall interest you pay goes down.
There are some limitations on this strategy. Not all banks are willing to recast a mortgage so if yours doesn’t allow it then it won’t work for you. Most banks will have a minimum amount that you can recast and typically they’ll charge a several hundred-dollar recast fee. Some banks have limits on the number of times they’ll recast your mortgage.
The goal in all 5 of these strategies is to give you more money to invest in the long term. Effective budget management is essential for these strategies to work. Budget management is the key for any effective investment strategy.
You can purchase my book wherever books are sold such as Amazon, Barnes and Noble, and Books A Million. It is available in e-book formats for Nook, Kindle, and iPad.
Image courtesy of Stuart Miles / FreeDigitalPhotos.net