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Investing 101
By Kathy Kristof
Sample Pages
Contents
1 Fixing Money Problems
Finding and fixing the psychological
ills that keeps us from investing
wisely.
2 Risks and Reward
The basics about how taking a few risks
can reap long-term benefits.
3 The Starting Point
How to allocate your assets based on
your goals.
4 Diversification
Dividing your assets among different
investment categories is easier when you
think about what different types of
investments can do for you, rather than
what they are. When you boil things down
that way, there are just five investment
categories, each of which offers an
array of specific investments. Here are
the categories and the choices within
them.
5 Picking Individual Stocks
Using fundamental indicators of value to
pick good stocks.
6 Tough Sell
How to figure out when it's time to call
quits with an investment.
7 Investing in Bonds
Where to put bonds in your portfolio and
which bonds to choose.
8 Mutual Funds
A primer on mutual funds, from what they
are to where to find one that suits your
needs.
9 Socially Responsible Investing
What social investing is about and how
to find socially conscious mutual funds.
10 Real Estate Investment Trusts
REITs allow individuals to invest in
commercial real estate to diversify their
portfolio and stabilize investment
returns.
11 International Investing
The basics on investing outside of the
United States.
12 Tax-Favored Investing
Uncle Sam gives Americans lots of ways
to defer taxes while we save. Using
these tax-favored vehicles can give your
portfolio a boost. hare are your choices
and what they can do for you.
13 Starting Small
Think you can't invest because you don't
have a pile of cash to start? Never
fear. There are several choices for
people with as little as $20 or $25 a
month.
14 The Lazy Investor's Portfolio Planner
The quintessential hands-off portfolio
for the wise investor with very little
time on his hands. You can do well
quickly and easily with only a few hours
a year.
15 How to Fix Your Broken Records
Record keeping is one of the most
important - and widely ignored - steps
in wise investing/ But good records can
help you monitor your portfolio and help
you determine when to buy and sell. They
can also save you a small fortune in
taxes.
16 Getting Help
Read it all, but still don't want to go
it alone? Here's a quick guide on how to
hire someone to help you.
Glossary
Definitions for commonly used jargon so
you can interpret Wall Street speak.
Index
1
FIXING MONEY PROBLEMS
When I started writing about finance,
the world according to Wall Street was
promoting something called the
"efficient markets theory." In a
nutshell, this theory contends that the
day-to-day price movements of stocks and
bonds are ultimately rational - based on
investors making informed and savvy
choices about what to do with their cash
at any given moment of the day. The idea
was that we all went into the investment
markets with a fist full of cash and all
the accurate information we'd need.
Then, our conversations would go
something like this: "Hmm, that stock is
a bargain at this price: Buy! Those
bonds aren't yielding enough: Sell and
redeploy our capital!" As the market
moved to reflect the increasing demand
on the savviest investments and the
dearth of buyers for the less attractive
investments, the prices would shift
accordingly and investors would make new
choices. Supply and demand are always in
sync and investors are always rational.
The bulk of the world has now
recognized this controversial theory to
be largely irrelevant to individual
investors.
It's not that people never make rational
decisions about their money. They do -
just not all the time and not even when
taken as a group. Wall Street's favorite
theory is now "behavioral finance." This
theory explains why smart people often
make dumb decisions about their money.
The great thing about this shift is
that behavioral finance is something we
all can relate to. we know instinctively
- or from personal experience - that
ignorance, fear, or greed can get in the
way of making smart choices. Instead of
decisions, we make excuses. Instead of
making money, we make...well, a mess.
This book is going to tell you how to
invest wisely. Investing 101 is
simple. It's straightforward. You'll get
step-by-step instructions throughout.
Anyone who reads and follows the
directions will find investing easy to
do. But if you let bad money habits
overshadow your money smarts, your road
to wealth will be long and bumpy.
How do you avoid that? Like anything
else: You identify the problem and find
a solution.
Here are some of the most common
problems that face investors and simple
ways to fix them. Many of these problems
won't relate to you, so skip them,
unless you simply want to gloat.
Certain investment roadblocks are
universal and can be relevant for any
investor. Other problems are more likely
to strike women than men, or men than
women. The following sections look at
all three types.
UNIVERSAL PROBLEMS
PROBLEM: Saving too little, or
not at all.
"I would invest, but I just don't have
the money," says the well-dressed
twenty-five-year-old driving a BMW. "I'm
going to start as soon as I get a
raise."
Okay. That was a slight exaggeration.
And it would be easier to save if you
earned more money, but sometimes life is
just not fair.
Now, be fair with yourself and answer
honestly: When was the last time you
bought lunch or dinner at a restaurant
instead of going for the cheaper
alternative of packing a sack lunch or
making your own dinner? When was the
last time you bought a suit, a high-tech
gadget, or a pair of shoes that you knew
you didn't need?
If you have a job that pays a decent
wage - meaning anything that keeps you
above subsistence level - you can afford
to invest. Spend $2 less per day - the
cost of one Starbucks coffee or one
snack from the vending machines - and
you've got $60 a month. That's enough to
plop into an automatic investment plan
with a mutual fund.
Still think it's a matter of poverty,
not spending habits?
DID YOU KNOW?
Saving Habits and Salary Bumps
A number of studies have been done about
whether individuals can afford to save,
based on their income. They have found
that aside from people at the polar ends
of the income scale - the very rich and
the very poor - the bulk of people in
between think they could save, at least
small amounts. Often, it's a matter of
whether they do, rather than whether
they can. Increases in salary often lead
to incremental increases in spending
rather than increases in savings. This
suggests that saving is a matter of
habit, not income. If you aren't saving
now, you won't start when you get a
raise.
SOLUTION: You need a budget.
A budget doesn't necessarily spell
deprivation. In fact, a good budget is
like a good diet. It feeds both your
wants and needs in a healthy and
sustainable way.
To put together a good budget - a real
budget - you need to gather some
records:
• Pull out your check register and bank
statements.
• Collect your credit card bills.
• And find either your most recent tax
return or your pay stubs.
You'll need these to remind yourself of
your monthly, annual, and semiannual
expenses - from rent or house payments
to car insurance. The chart on the
following pages will help you plot out
what you're shelling out each month.
You thought you were going to make up a
projected budget? People who try to make
up budgets without looking at their
actual expenses are kidding themselves.
The amount that you think you're
spending - or think you ought to be - is
almost always less than what you
actually spent. By writing down your
actual purchases, you're going to
uncover your own personal money pits -
places where you're spending more money
than you meant to. It might be dining
out. It might be dry cleaning. It might
be a shopping habit.
This isn't about fitting your expenses
into smaller boxes. This is about
figuring out where your money is going
and determining whether that's where you
want it to go. If it is, leave things
alone. But if lots of little outlays are
robbing you of long-term happiness by
making it impossible to save for big
goals - like a house or car or
retirement - you might want to nip and
tuck here or there. So, fill out the
worksheet to find the flab in your
financial life.
You've done the worksheets, but still
can't figure out where the money is
going? You're underestimating some
expense because you're paying more cash
than attention. Do this; Start carrying
a notebook around with you. Jot down
every expense, from the $1 bagel to the
$50 you spend filling up your car.
Review your notebook after a month.
Include the expenses in the budget and
see it if there's something You can trim
to add to savings. Realize that if you
cut just $3.35 per day, you've found
$100 a month to save. Viola.
PROBLEM: Getting greedy.
You bought a stock figuring that it was
going to go to $50. Then lo and behold,
it popped up to $65. Based on all of
your market knowledge, this is an
incredibly high price for this stock.
Its price/earnings ratio (see Chapter 5)
has never been this high. and you can't
imagine why it might be now. And yet, if
it went to $65 it could go to $70,
right? Maybe you ought to hang on just a
little longer and see.
The fact is, the stock could go higher.
Or it could go much, much lower.
Consider 1999, when the prices of
technology stocks had soared into the
stratosphere and market pundits were
contending that the sky was the limit.
"It's a new paradigm!" they shouted. It
was hype. During the following three
years. those stocks crashed and burned.
A few have recovered. Many have not.
People who were smart enough to sell
when the prices were high made a
killing. Those who got greedy got
killed.
SOLUTION: Target price.
Every time you buy a stock, you should
have a target - a price at which you
would either sell the stock or
reevaluate its prospects before you
decide to leave it in your portfolio
(see Chapter 6). Don't let emotion -
regardless of whether that emotion is
fear, greed, or hope - rule your
actions.
Evaluate all your stocks once a year
Make reasonable decisions about whether
each one is a buy, a hold, or a sell. If
you realize that you wouldn't buy a
stock today given its future prospects
and that there are better opportunities
out there, sell it. Live with the idea
that you may never sell at the peak.
That's okay, as long as you also don't
sell at the nadir.
PROBLEM: Being tax-wise and
bottom-line foolish.
I hear it all the time: "Never pay off
your house. Your mortgage interest is
tax deductible!" I'm always tempted to
respond, "Okay, humor me for a minute
here and let's go through the math. If I
pay $1 in mortgage interest. I'll get TO
deduct it, which will save me, say,
thirty cents on my federal income tax
return. Aren't I still out seventy
cents?"
There are dozens of equally "tax-wise"
investments being marketed in today's
world. My favorite is the variable
tax-deferred annuity. What these say
they do is allow you to save additional
money for retirement in investments that
mimic stock mutual funds.
The money you invest in this type of
annuity isn't tax deductible going in,
but the investment gains are not taxed
as returns and accumulate in the
account. This allows you to trade all
you want within the annuity and not
immediately pay taxes on your gains.
That's the selling point that continues
to push variable annuity sales ever
higher. Roughly $90.6 billion in
variable annuities were purchased during
the first half of 2007. Total assets in
these accounts were nearly 1.5 trillion,
according to LIMRA International Inc.,
an insurance research and consulting
firm.
Annuities are able to offer this
benefit because they're an insurance
product. The insurance you get with an
annuity generally is a guarantee that if
the stock market crashes which causes
you to have a heart attack and die, your
heirs are guaranteed to get at least as
much as you originally invested in the
annuity. That's not much of a guarantee,
but you pay for it dearly. The typical
mortality and expense ratio on an
annuity is around 1 percent. In other
words, if the investments you hold
within the annuity yield 10 percent,
you'll get 9 percent of that after the
mortality expense is taken off the top.
(To get a good read on the
dollars-and-cents impact of that fee.
read "The Real Cost of Fund Fees" in
Chapter 8.)
But there's a second cost too.
Ironically, it's a tax.
Note: the rest of the chapter
is omitted.
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