Commentary (Page 441)

A stock’s price is not calculated. It also is not set by a governing body. Rather, the stock price is developed in an incredibly efficient method of supply and demand. The more investors want to own a piece of a company, the higher the price will be, and it will continue to rise until investors no longer want to own the shares at that price.

You may think that supply and demand would equalize and make for a stable stock price for many companies. However, an auction allows for relatively large movements in price. Many companies are significantly affected by the moves of commodity prices, government economic indicators, or the stock price of other companies. If you combine those influences with a large and diverse investor community, there can be a wide degree of opinion as to what the company’s stock price should be at any given time. In these situations, one investor may consider a stock price to be expensive while another considers it cheap. This difference in perspective causes constant movement of a stock price.

Many influences from outside the company affect the stock price. Changes in the pricing of competitive companies or suppliers can make a stock price look attractive (or less attractive). Also, the general news of the day regarding raw materials, consumer spending, labor issues and geo-political confrontations can cause investors to re-evaluate the value of a company. This requires a level of omniscience to interpret the best value that most investors simply do not possess.

Some investors, typically known as technical traders, do not look at the value of a company’s operations but only consider its stock price and trading volume. They make guesses as to the direction of the stock’s movement for the next minute, hour, day, week, month, or longer. Technical traders use indicators that are built by mathematicians to try to interpret a company’s price based on price changes without regard to the fundamentals of the company. They may then trade that stock based on this prediction of future stock price levels. Typically, technical traders are not investors, they are not taking a long-term holding in the company but rather are going to flip the shares quickly in response to their favorite technical indicators.

I try to put some rationality into establishing a stock price in my book, The Confident Investor. I don’t assume your omniscience; you don’t have to understand every possible variable to arrive at a reasonable price. You also do not need to understand all of the technical math theory of the technical traders.

My technique that I call GOPM (Grow on Other People’s Money) allows you to find high-quality companies that are fundamentally well-run. You then use a focused set of technical trading skills to know when to buy and when to sell that stock. This allows you to take advantage of the rises and falls of the stock market. These rises and falls are caused by the various theories of the value of the company that I describe at the beginning of this article.

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.

It is important to review your investment choices on a regular basis. If you invest in mutual funds, you should review them each February. I suggest February because you will receive your end-of-year statements by February so that you can pay taxes. You should look at these long-term investments and decide if it still fits your strategy and that your mix of investments is correct. If you want some advice on how to balance your portfolio, check out this article that I wrote. As always, I strongly suggest you confine your mutual funds to index funds rather than actively managed funds.

For stocks, the review needs to be a bit more frequent. You need to get out of stocks that no longer perform to your satisfaction. If you are not sure how to evaluate the growth rate and performance of your stocks, please consider reading my book, “The Confident Investor” as it will help you analyze companies to find the Good ones.

For the next several weeks, I will be doing a daily review of the companies on my Watch List. I will take off those companies that are no longer performing to my satisfaction. As a point of disclaimer, as quickly as possible after taking the stock off of my Watch List, I will also be selling any holding that I have in any of those poorly performing companies. If you would like to make sure you get these updates:

• You can subscribe to my weekly newsletter digest of this site.
• You can follow me on Twitter @ConfidentInvest.
• You can subscribe to my RSS feed.

I regularly enjoy watching Jim Cramer of Mad Money on CNBC. One of the things that I most enjoy about him is that occasionally he admits when he is wrong. While I am not saying that I was wrong to put a company on my Watch List and then eventually take it off, I am saying that the base fundamentals of the company have changed. I am firing that company from my portfolio (I guess that makes me a little like another famous investor, Donald Trump).

A few days ago, I described the basics of mutual funds. In this article, I will cover the basic types of different mutual funds and how the value of a mutual fund “share” is calculated.

You can buy a mutual fund’s shares in a few different ways. Funds are often described as either “no-load” or “load” funds. The designation depends on whether or not the fund charges a sales commission.

• Many funds are no-load funds that charge no (or a very low) sales fee or commission. No-load funds are typically sold directly to investors with ads in newspapers, magazines, and the Internet. In this case, you complete all the paperwork yourself.
• Load funds charge a sales fee or commission for purchases. Some funds charge the fee when you buy shares; others charge when you sell them. Brokerage firms and banks often sell load funds.

You may wish to invest in mutual funds, in addition to individual companies. There are reputable funds in both categories. Because sales charges reduce your return, I recommend that investors purchase no-load funds over load funds whenever possible.

The value of a mutual fund share is calculated on the basis of the value of the assets owned by the fund at the end of every trading day. A share’s value is called the Net Asset Value (NAV). The fund calculates the NAV by adding up the total value of all of the securities it owns, subtracting the expenses of the fund, and then dividing by the number of outstanding fund shares.

Since the value of stocks and bonds owned by the fund changes daily, the fund’s value will also change daily. Therefore, a mutual fund adjusts its price once every trading day to provide investors with the most current NAV. This is different from the price of stocks because:

• The NAV updates only once at the end of the day as opposed to every second of the day with stocks.
• The NAV is not directly tied to the whims and moods of the market. However, since the price of a mutual fund is determined by the sum of the value of all of its components, the various market moves (however logical or illogical) of stocks, bonds, and cash that the fund owns are ultimately reflected in the NAV.

While you cannot buy a fraction of a share of a company, you can have a fraction of a mutual fund share. This happens when the amount you invest does not divide evenly by the NAV. If you send the mutual fund company a check, the managers will divide that investment by the current NAV. This results in your number of shares in the fund, even if it is a fraction. This breaks the “share” concept and demonstrates that you are simply pooling your money into a large pool.

I repeatedly try to encourage my readers to cut back on spending to enable a higher level of savings. It is best if you automatically deduct 10% of your income from your paycheck and immediately divert it to another account in a separate institution. This means that you effectively take a 10% income hit.

In order to afford that income hit, you may need to reduce your spending. I came across this article on Mainstreet.com on the 12 things to stop paying for in 2012 but I think it is timeless. You shouldn’t pay for this stuff in ANY year.

1. Coffee Shop Visits
2. Incandescent Light Bulbs
3. Disposable Water Bottles
4. Baggage Fees
5. Subscriptions You Don’t Use
6. Baby Food
7. Credit Score Fees
8. Cable
9. Landline Phones
10. Cleaning Supplies
11. ATM Fees
12. Home Repairs You Can Do Yourself

You may find that this list includes things that are more frugal than you desire. This is false bravado. If you are not investing 10% of your after-tax income as I suggest in my book, The Confident Investor, then you are making a mistake. Do not be wasteful AND a poor investor!