Have a Great Vacation without the Financial Worries

Even the best at personal finance lose control of expenses on vacations.  There is a reason that the travel industry is so big – people tend to get the attitude of “It’s o.k., I’m on vacation” and forget about prices.  Suddenly paying eight dollars for a beer that comes $10 per six-pack is just fine.  Paying $20 to park at your own hotel is just fine.  Even shelling out $50 to check a bag is tolerable – after all, “I’m on vacation.”

These expenses add up quickly, however.  Since most people are broke (and no matter how much you earn, if you have credit card debt and less than $10,000 in the bank, you are broke), a lot of this cost goes on credit cards to be paid off over 20 years.  Do a few of these vacations and suddenly what was a tiny credit card payment becomes a substantial part of your monthly outgo.  Once the hole gets to a sufficient size, it becomes difficult to simply tread water, let alone swim your way out.

Personally, vacations can be very stressful for me.  The reason is I usually end up in the roll of gatekeeper for my family’s expenses.  “Can the kids have money for a souvenir?”  “She really wants that stuffed zebra.”  “Can we go on this helicopter tour?”  The reason I hate the role isn’t so much the expense as the feeling of being out of control.  Of not knowing how much we are spending when we keep doing all sorts of things I hadn’t planned on doing.  I hate to worry about expenses, but then again I also don’t want to end up spending twice as much as I had planned.

The secret to avoiding this worry is plan things out ahead of time, including planning for the unexpected.  This means creating a vacation budget that includes some flexibility.  Some of the key steps are as follows:

1.  Plan a budget for the costs you know will occur.  You should have a good idea of hotel expenses before you go.  Don’t forget to add about 20% for taxes.  You should also know the cost of the rental car, airfare, and attractions you know you’ll visit.  Make sure that these costs are well within your budget for the vacation (maybe within 60-75% of your total budget, unless food is included).  Otherwise, scale back the vacation a bit or work to save up more before the trip.  It is a lot more fun if your vacation fits within your budget than it is to scrimp and save all along the way.  Plan to pay for these expenses via debit card since they really can’t be changed once you’ve booked the trip.  Also, prepay as many of these as you can so that you won’t have a shock waiting for you when you get home.

2.  Budget for planned, but variable expenses.  Food is the primary item in this category, but things like parking, public transportation, and amenities fit in as well.  You don’t quite know what you’ll spend at each meal, but you have a general idea.  I usually find that we spend about $100 per day for our family of four for meals when on vacation, although as our kids are getting older that may go up to $150 per day.  We normally eat it casual but sit-down restaurants.  Expenses would be more if your family wanted to go to white table-cloth restaurants every night or less if you planned on getting pizza or counter service for several of the meals. (Note, most hotels, even fancy ones, have Domino’s pizza right on the card key.  That could be a $15 dinner some night when you or your wallet are tired.)

Plan these expenses, leaving maybe a 20% contingency in case food costs more than you think.  Once again, scale your vacation back if costs are getting way over your budget, or save up more to increase your budget.  Another trick is to find a hotel with a refrigerator and microwave.  Pick up some paper plates and plasticware and you can have left-overs from dinners for lunches, which will help both your wallet and your waistline.  This money ideally would be in cash since it is something you can vary somewhat and people spend less when they use cash, plus using cash is a good way to keep track of how much you are spending.  If this is more cash than you choose to carry, maybe plan on hitting an ATM at some points on your trip.

3.  Plan for the unexpected expenses.

There will always be things you didn’t expect along the way.  Create a budget for this.  For example, maybe have an extra $100 every day or every couple of days to do something unplanned.  This should always be in cash.  So long as you still have cash, you can do these little extras without worrying about blowing your budget.

4.  Make sure you and your spouse agree.  Before the trip ever starts, talk to your spouse about plans and expenses.  The budget should be set ahead of time, not when everyone wants to go on an unplanned harbor cruise that would blow the budget.  Make sure that the amount you have budgeted for meals and extras is reasonable to both parties and that there is an agreement.  This should be two equal partners making and sticking to a plan, rather than one spouse being the gate-keeper.

Once again, if the daily budget seems tight, consider cutting days off or choosing less expensive options for hotels and meals.  It is not fun when things feel too tight.  Also consider swapping expensive theme parks for free attractions like visits to parks and trips to the trails or beach to reduce costs if needed.  Maybe look at picking up some bagels and cereal for breakfast to save $30 per day.

With a little advanced planning to make sure your expenses are in line with your budget, scaling your vacation appropriately, and agreement with your family, vacations can be both less stressful and more fun, even for the penny-pincher.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

What do I Buy in My 401k? 401K Investing Made Easy

For an employee just starting out, figuring out how to set up their 401K can be difficult.  First of all, about 10-15% of your paycheck should be going into your 401K and/or IRA account.  At least be getting the full company match in the 401K (it’s free money).  Here, in concise steps, is a good general way to set up a 401K for a young employee:

1.  Determine the asset types of the different funds in your plan.

There should be funds that invest in growth stocks, value stocks, large stocks, mid-sized stocks, small stocks, bonds, money market, and maybe REITs, Convertibles, and other investments.  There should be a little box in the prospectus that with “Value”, Blended” and “Growth” on one side and “Small,” Medium” and ”Large” on the other.  This shows what kind of stocks the fund invests in.

2.  Determine the costs of each of your funds from the prospectus. 

This should be listed and be a small percentage such as 1.5%.  Under 1% is good, below 0.25% is great.

3.  Look at the performance for each fund, but don’t worry about it too much.

It is nice to see that a fund has done well in the past, but such a streak may not continue.  If there is one that has always done poorly, however, that may show that there is something wrong with the way it is managed.

4.  Find a large growth fund and allocate 20% of your contributions to it.

For example, a S&P500 index fund would be a good choice.  If there are more than one fund in the category, pick the one with the lowest costs.  Index funds are best.

5.  Find a smallcap fund and allocate 20%.

Once again, low fees are best.  Look for terms like “aggressive growth”.

6.  Find a largecap value fund and allocate 20%.

Value investing is another way of picking stocks where cheap stocks are bought and held until they become fairly valued.  This fund will do better in down markets and sometimes will beat the growth funds.

7.  Find an international fund and allocate 20%.

The US doesn’t always have the best stocks.  Add an international fund to profit from overseas opportunities.

8.  Find an income fund such as a convertible fund, bond fund, or RE$IT fund.  Allocate the last 20% to it.

This fund will provide a steady income stream that will help when the market if flat.  As you get older, you’ll shift a greater percentage of assets to income funds, but not until you are in your forties or fifties.

9.  Wait one year.

Probably the best thing to do is to ignore you 401K entirely.

10.  Once a year, reallocate the money in your 401K so that there is 20% in each fund.

In reallocation, you are selling the funds that did well and buying those that did badly.  This is selling high and buying low.

11.  Never borrow or take money out of your 401K.

Unless you will be out on the street, it never makes sense to borrow or take money out of your 401K.  You’ll need that money in retirement, and every dollar you take out might mean hundreds of dollars less at retirement.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

No, Mr. Yglesias, 401k’s Do Not “Suck”

Mr. Matthew Yglesias, in an article on Stale, makes the case that 401K plans “suck.”  Maybe the fact that the writer uses the term “suckish” in his article would cause one to discount his opinion, but maybe he’s just caught up in the zeitgeist of the post-millenial era.  There is no doubt that his arguments would carry some water with a lot of readers, particularly since many people are really not familiar with the way economics work, including the mechanics of 401K accounts and Social Security.

His reasons for why 401K plans “suck” are the following, as quoted from his article:

“

-Poor people get absolutely nothing

-Wealthy people who would have had large savings anyway get a nice tax cut offers no meaningful incentive effect.

-For people in the middle, the quantity of subsidy you receive is linked to the marginal tax rate you pay -in other words, it’s inverse to need.

-Most middle-class savers end up either undersaving, overtrading, investing in excessively high-fee vehicles or some combination of the three.

-A Small number of highly compensated folks now have lucrative careers offering bad investment products to a middle-class mass market based on their ability to swindle people.

“

Let’s take a look at these points, one-by-one:

-Poor people get absolutely nothing

The average food stamp benefit is $133.41 per person per month, or about $575 per month for a family of four.  The average housing subsidy is about $7000 per year, or around $600 per month.  There is also a lot of money donated privately by individuals to various charities that help the poor.  There are a lot of programs, both public and private, that provide money for low or no income families.  The taxes and donations that pay for these programs come from people who are working and producing wealth.  Most of the money for these programs come from the individuals who produce the most wealth.  Mitt Romney pays millions in taxes and gives millions more each year to charities.  The millions of middle-class people who get up and work hard each day also contribute substantially as a group.

401K’s are not directly for the poor, at least those who stay poor their whole lives, which a substantial portion do not.  They are for the middle-class, and because of 401k’s and pensions the millions of people in the middle-class can retire without becoming dependent on others.  This means there is more money available to take care of the poor.  A society works better if those who are able to provide for themselves do so.   Encouraging those who can provide for themselves to do so helps those who cannot since it is a lot easier for 100 people to support one person than for fifty people to support fifty other people.  The poor may not open or fund 401k’s, but they definitely benefit.

-Wealthy people who would have had large savings anyway get a nice tax cut that offers no meaningful incentive effect.

Contribution limits set by 401K laws limit contributions to $17,000 per year.  For someone at the 40% tax bracket, that equals a tax savings of about $6800 per year.  This deduction won’t really matter much to the wealthy person, and Mr. Yglesias is probably right that there would be little incentive for them to save since the effect on their taxes would be miniscule.  But it really doesn’t make a difference for society because the deduction they get really won’t matter either.  Someone making a million dollars per year probably pays something like $300,000 per year in taxes.  Now they would pay $293,000 instead.  They are still paying $293,000 in taxes while most people are paying less than $15,000 per year.

To earn that income they are probably doing something that allows a lot of other people to make a living and pay taxes.  They probably own a business, or are an actor that makes movies that employ dozens of others on the set, thousands of people in movie theaters, and thousands more in video stores.  They may also be pro-sports players who provide jobs for thousands of stadium workers, hundreds of reporters, and thousands of people in ad agencies and retail stores.  Mr. Yglesias seems to feel that they should not see even a small reduction in how much they pay because they are somehow evil.  Would he rather they sit home and not work?

-For people in the middle, the quantity of subsidy you receive is linked to the marginal tax rate you pay -in other words, it’s inverse to need.

Let’s see what this really means.  If someone makes $50,000 per year and falls within the 15% tax bracket, they would get to reduce their taxes by $1,500 if they put $10,000 into their 401k accounts.  Someone in the 20% bracket would reduce their taxes by $2,000.  But just as with the wealthy person, the person in the 20% bracket would still be paying a lot more in taxes than the person in the 15% bracket even if with the larger deduction.  This could be remedied, if desired, by eliminating the progressive tax structure and  have each person pay the same percentage rate on all of their income, but I’m doubtful Mr. Yglesias would like that solution.   As it is, it seems like the person in the 20% bracket “needs” the deduction more than the person in the 15% bracket since she is paying more in taxes.

Really what I think Mr. Yglesias is saying is that the less money someone makes, the more noble they are and the more they make the more evil they are.  People who make no money are the most noble of all and should be given money since they make no money and therefore won’t benefit by having their taxes reduced.  But most people who don’t make any money also don’t do anything during the day to meet the needs of other people.  They don’t even do enough to meet their own needs.

People who earn an income are almost always doing something that meets the needs of someone or they would not be paid for what they were doing.  In addition, people generally earn income in proportion to the number of people whose needs are filled through their work.  A barista at a Starbucks meets the needs of the owner to serve coffee during their shift and meets the needs of the customers whom they serve during their shifts to have coffee drinks prepared.  The owner of Starbucks meets the needs of all of their customers to have a place to get coffee, breakfast, relax during the day, and even find a place to work and meet with clients.  The owner makes more than the barista, but she also meets the needs of a lot more people.  The owner is also generally working 80-100 hours per week, ensuring that customers’ needs are being met, which also helps to ensure that the barista continues to have a job.  I would say that perhaps the owner is more deserving of a break on taxes than the barista if the criteria is nobility.

Most middle-class savers end up either undersaving, overtrading, investing in excessively high-fee vehicles or some combination of the three.

On this we fully agree.  But the outcomes of 401K accounts have been far better than the outcomes of the alternative, Social Security.  Properly invested, one can expect to receive about ten times per month from a 401K account as one receives from Social Security, even if one only invests about 10% of pay in a 401k account versus the 12.4% people are forced to provide to Social Security.  Even if someone overtrades or pays high fees they would still do far better with the 401K than they would with Social Security.  Given the 10-to-1 return, they could also just put about 2% of their income into a 401K and do better than Social Security.

Ironically, Mr. Yglesias proposes increasing the required Social Security Taxes and expanding that program.  Given that the current trustees of Social Security – Congress – have done so poorly with the 12.4% of income they get, why would anyone propose putting 25% or 35% of pay into that system?  If something isn’t working, is the solution to double down and assume things will change?

Instead, how about we educate people on how to invest in a 401k?  Maybe have people read blogs like this one.  Even Mr. Yglesias does a good job of proposing how one should invest in a 401K at the end of  in his article.  It really is as simple as 1)Put 10-15% of pay away, 2) Spread it out over 3-5 funds that cover a wide range of assets (growth, aggressive growth, international, growth and income, and maybe bonds or REITs), 3) Buy the lowest cost funds you can, 4) Don’t move things around more often than once a year, and then only to rebalance the account so that you have roughly the same percentage of your money in each fund, and 5) Five years before retirement, either increase the amount of income producing assets held to lower volatility or start selling assets to raise enough cash to pay for expenses beyond your income for the next five years. (Basically one year’s worth of cash should be raised each year, so you have five year’s worth of cash at retirement.)  That’s really it.  Now you have been educated.

-A Small number of highly compensated folks now have lucrative careers offering bad investment products to a middle-class mass market based on their ability to swindle people.

I’ll admit that there are bad investment products, but for those in 401K’s that means making 5-8% per year versus 10-12%.  Social Security returns maybe 1% if you live long enough to collect, assuming the program continues to survive.  I would hardly call this “swindling.”  Still, with a little bit of education, people could do a lot better.  Not really that much education – maybe a book and a blog or two.  I would suggest perusing Boggleheads once in a while instead of watching videos on YouTube and updating Facebook and Pinterest.

Central in the theme of his article is that earning money is evil and being poor is noble.  It may be true in a Third world country where the people who are rich get that way by taking from the poor (and diverting funds from America and other first world nations meant to go to the poor to the armies and the palaces of the dictators).  In America, however, there is generally benevolence involved in getting wealthy, since earning money requires meeting the needs of others.  People who are honest and provide things that are worth more than the amount they charge do well.  People who swindle others don’t stay in business long.  Beyond meeting the needs of people directly, this also results in the generation of all sorts of excess goods and services that then improve the lives of the poor.

In America most poor people have color televisions, cell phones, cars, apartments, plenty of clothes and plenty of food.  In many countries they don’t have running water, food, or toilets.  There is a shortage of toilet paper for almost everyone – both for the middle-class and the poor – in Venezuela right now.  But you can bet that the leaders of the country who so nobly take from the rich and the middle-class under the guise of helping the poor don’t want for a roll.

Finally, if people are willing to sacrifice some luxuries now to fund their 401K’s and learn just a little so that they can invest correctly, the 401K also provides a way for middle-class people to become rich in one generation.  If their children then continue the practice of saving and investing from there they can become ultra-wealthy in two generations.   The 401K encourages people to save for retirement.  It also puts the money in a place where it can’t be taken and used for other things – either by the people contributing to the plan or by Congressmen who want to spend the money on pet projects.

No, Mr. Yglesias, 401k’s do not “suck”.  Social Security “sucks.”  Communism “sucks.”  Socialism “sucks.”  401k’s are the best shot people have at a dignified retirement.  And if Social Security had been structured as a private account like a 401K 90 years ago, investing separately in a 401K would not be necessary because everyone who worked would have plenty for retirement from their Social Security accounts.  Instead they are facing the bankruptcy of Social Security in a few years, and a continuation of meager benefits from that program even if it does survive.  They therefore need to fund yet another account to enjoy a dignified retirement – and you would deny them even that.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

How Many Shares Should You Buy?

One of the best pieces of advice I ever got in a book came from Spooner’s Do you Want to Make Money, or Do You Just Want to Fool Around?  Spooner pointed out that a big mistake many people make is not buying enough shares of a stock they like.  They may do great research, pick a great stock, and buy at the right time, but they buy so few shares that what should have been a big winner turns into a nice but modest gain.

For example, they may buy 100 shares of XYZ corporation at $20 per share.  If XYZ does really, really well it might be at $60 within a year.  Our investor picked a great stock – up 200% in a year!  And yet, our investor made $4000.  Not really life changing.

Spooner instead recommends buying 500 shares or even 1000 shares.  This would be a large position in our $20 stock – now $10,000 or $20,000, but the same 200% gain would be a gain of $20,000 or $40,000.  Something that would make a difference when compared to other income.  A good stock pick could be a new car or tuition at a state university.  It could be a new kitchen or a boat.  (Boat = a hole in the water people throw money into.)

I looked at my portfolio and found that I was doing just what Spooner said.  I had several 100 share positions.  Whenever I made $1000 I would sell and be glad.  I would also have the occasional $2500 winner, but there were also some $800 and $1500 losers here and there.  At that point I decided to become more serious about my investing and buy larger positions.

Now I tend to concentrate my individual stock picks in a few, larger positions.  If I want diversification, I may then allocate a portion of my portfolio to index funds.  For example, if I had $40,000 to invest, I might put $15,000 into an index fund or two and then buy maybe 500 shares in three stocks in the $20-$25 range.  I would pick stocks in different sectors, for example, retail, technology, and healthcare, and pick what I considered to be the best stock in that category.

I would get into these stocks in stages.  I might buy 200 shares at first, then wait a few weeks or months, waiting for a good dip.  Then I’d buy another 200 shares, and then do the same thing for the final 100 shares.  I might be watching all three stocks, buying the one that looked the best during a given time period.  This way of wading in helps out psychologically since if I buy a stock and it goes down, I think “Great – it’s at a discount!” instead of “Whoa, did I screw up?”

I am then at an advantage to the mutual fund manager.  I can pick my top three stocks because I only have about $25,000 to invest.  The manager has a couple billion to invest so he needs to buy all kinds of stocks he really doesn’t like.  I can also sell a position when I want without worrying about effecting the price.  The manager may take weeks to unload a position since he has so many shares to sell.

Now before jumping in with both feet, realize the risks.  If I pick badly, like the CEO takes all the corporate money and goes to Mexico, I could see my $20 stock crater to $2 and lose $9000 of my $10,000 position.  Even if I just pick a stock that sits there for ten years, I may give up all sorts of appreciation that I would have gotten if I had just put the money in index funds and tracked the market.

I accept this risk, however, since there is a large potential payoff and I could sustain a loss of $9,000 without jumping off a building.  My rule of thumb, however, is to never have more in one position than I could stand to lose.  If I did well and saw a position grow to $40,000, I might very well sell half of the shares.  I would also keep saving money and buying more shares, adding additional stocks when the positions reached 500 or 1000 shares.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Reduce Your Taxes through Proper Money Management

Understanding tax planning is very important for the investor.  By setting up accounts correctly and thinking about the tax consequences when making trades one can save a lot on taxes.  Conversely, do things wrong and it can cost you a lot in taxes.

Before we continue, understand that I am an investor, NOT A CPA OR FINANCIAL PLANNER, and therefore you should check and verify what I am saying.  Every situation is different and I’ve found that an hour or so every few years with a CPA is well worth the expense since they can help you out with planning for your individual situation.  Take these as general tips to reduce or limit your taxes.

1.  Take a long-term perspective to limit your taxes in your taxable accounts and maximize the compounding of your investments.  If you are frequently trading in a taxable account, the short-term capital gains you rack up can have a big effect on your taxes.  Because you are paying out taxes each year you lose the ability to compound and make money on the cash you are paying in taxes each year.  If you buy a stock and hold it for ten or twenty years, you have a huge taxable capital gain in the end but you will make money for years on the money that would have gone to taxes.  This can easily increase your total return by 2% or more each year.  For this reason, your taxable accounts should be full of growth stocks that pay little or no dividends, index funds, and the like.

2.  Place income stocks and assets in tax deferred and tax-free accounts.  Assets like bonds and REITs that pay large dividends should be placed in IRAs, 401K’s, and other accounts that are tax deferred or tax-free.  That way these assets can compound without a tax bite being taken each year.

3.  When you take a loss, look for a gain.  When you take a gain, look for a loss.  If a stock purchase doesn’t work out, think about selling some shares of a big winner.  Likewise, if you sell a stock with a big capital gain, think about selling one of the losers in your account.  This way you can write the loss off against the gain and reduce your taxes.  You can also write some ordinary income off against a loss from investments (but the amount is limited) and carry losses into future years if you don’t have enough income to write the whole loss off against.  See your accountant for the details here.  Note that you can’t buy the shares of the loser back within 30 days (or buy shares of the loser 30 days before you sell it) or it is considered a wash sale and you can’t deduct the loss.

4.  Think about delaying gains into future years.  Think about taking losses in the current year.  The general rule is to delay income into future years and bring losses into current years.  This means selling loser before the end of the year and waiting until after the new year to sell winners.  This is not always the best choice, however.  For example, if you know you are going to have a big gain or a raise next year, you may want to delay taking a loss into the following year.

5.  Pay deductible expenses in the current year.  Just as it is good to take losses in the current year, it is good to take deductions in the current year.  Pay your property taxes before December 31st even though you may have until March.  Likewise, pay deductible investment expenses like account fees before year-end if you can.

6.  Think about tax-free investments, but do the math.  People sometimes seem overly eager to save money on taxes.  They continue to pay a home mortgage they could pay off because they can deduct the interest even though they are paying $10,000 in interest each year but only saving $2500 in taxes.  They rush out to shop on a sales tax holiday even though they are only saving 8% that way.  Many tax-free investments just don’t provide the return that taxable investments do.  Be sure to do the math and make sure the tax-free status is worth the low returns.  Also remember that capital gains from stocks are tax deferred until you sell, so a portfolio of stocks that you only tap gently for a little extra income is very tax efficient by itself.

7.  Never do things just for taxes.  While it may seem nice to save on taxes, I’ve seen many investments drop quickly, wiping out any gain that would have been made by avoiding taxes when people try to get too cute.  If you have a stock with a big gain and it’s time to sell, you might very well lose 30% on the whole position waiting to save 25% on half of it.  Perhaps the worst example I’ve seen was from an article I read in the Wall Street Journal after the dot-com bubble burst in 2000.  A woman who was one of the early employees in a dot-com company became a millionaire when her shares of company stock went public and jumped several hundred percent.  Rather than sell some shares to make improvements on a house she wanted to do, her broker convinced her to take a loan against the shares to avoid the capital gains taxes.  When the shares fell through the floor, not only had she lost the millions she made, she ended up owing about $400,000 on the loans!  Consider taxes, but don’t let them drive your investment decisions.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

The Covered Calls Expire this Week

For those following my covered call writing saga, we’re coming down to the wire.  The calls I wrote on BJ’s Restaurants expire next Friday.  Since this is the last week and they are “in the money,” meaning that they are above the price the person who bought the calls can purchase them for, chances are good that they will be purchased this week.  It would probably happen at the last minute, but because they are American style calls, it could happen at any time.

As I always seem to find when I deal with options, there was one point where I could have jumped out if I’d been very deft and done well.  A few days after I sold the calls the share price of the stock dropped down into the low $33 range and the calls went from $1.40 each to $0.25 each.  I could have made maybe $0.90 per call after brokerage fees in only a few days – not bad.  The question at that point, however, was whether the stock would stay down, or go down further, in which case they would expire worthless and I could save the brokerage costs by staying put.

Of course, the stock instead rallied over the next few days, pushing the price of the calls back up somewhat — although not as high as they were — and making it likely that the stock will be purchased.  This isn’t a terrible thing.  I purchased the shares around $31 per share, so I’d make a nice profit and get to keep the proceeds from the calls.  I’m just not sure I want to sell at this point, so I’m looking at my options (pun not intended).

At Friday’s close, the stock was at $36.53 per share.  The May 35 calls I wrote were at $1.66 per call.  Note that their price is getting pretty close to the difference between the stock price, $36.53, and the strike price, $35.  Because there is not a lot of time left before they expire, the time value of the options is decreasing towards zero. (Time value is the value of the options beyond the difference between the current price and the strike price due to the fact that the speculator may be able to make money by purchasing the options and using the leverage they provide to make bigger percentage gains than they would by simply buying the stock.  The closer you get to expiration, the less likely that is to happen.  Another way to think about this is as the premium you pay for insurance that you will be able to buy the shares for the strike price.  Like any insurance policy, the less time the policy covers, the less valuable it will be.)  With only a week to go, the stock will probably close above the strike price on Friday, although this stock does move quite a bit so there is a chance it will not, especially if the rally we’ve been having falters.

Here are my options:

1) Hold pat and let the shares be purchased for $35.  I would make a profit of about $4 per share plus the $1.40 premium on the options.  I confess I would kick myself if the stock then proceeded up to $40 per share or something, although I do have additional shares.  I would be happy though if they fell back into the low $30 range where they had been trading and I could buy them back for less than for what I sold them.

2) Buy the options back, take a loss on the options, and hold the stock.   I could buy a set of May calls to offset the calls I wrote and close the position.  At $1.65 each I would take a loss of $0.25 per option plus a couple of hundred dollars in commissions, but this would be less expensive than selling the shares and then buying them back again.

3) Roll the options into June or July.  The June $35 calls are currently selling for $2.05 each and the July calls are selling for $2.55.  I could buy back the May calls and then write the June or July calls.  This would net an additional $0.40 per call for the June calls or $0.90 for the July calls, before commissions.  After commissions it would probably be $0.20 and $0.70 per call for the June and July calls, respectively.  This would be a good move if the stock stagnated and especially if it fell since the premiums I would receive would offset part of the loss from the drop in share price.  Given the big gains stocks have made this year, that might be a good move since they may be due for a breather.  Then again, if the stock continued up, I’d have an additional month or two to  wait while my short position grew ever bigger.

4) Roll both out in calender date and up in price.  I would write July $40 calls and buy back the May $35 calls.  The July $40 calls are selling for $0.40 per call, so this premium, combined with the $1.25 per call I received when I wrote the May $35 calls would just cover the cost of buying back the May $35 calls.  If the stock continued upwards, I’d be able to make an additional profit until the stock crossed the $40 mark.  If the shares fell, however, I really wouldn’t have any additional protection.

Right now I think I’ll go ahead and let the stock get sold.  As I’ve said, I have additional shares beyond those on which I wrote the calls, so if the stock keeps climbing I will make a nice additional profit, so things wouldn’t be so bad.  If the stock falls back down, I can use the cash I got from the sale to buy more shares at a lower price and maybe write some additional calls.

I can’t help thinking though that I’d have been better off just holding the stock.  If the shares sell at $35, I will make a profit of about $400 per 100 shares from the appreciation on the stock plus $125 per hundred shares from the options, for a total of $525 per hundred shares.  If I had just held the shares, I could sell them for $36.53 per share right now and make about $553 per hundred shares.  I would probably be feeling differently if the shares had stayed below $35 per share since I’d be getting some income despite the fact that the shares were going nowhere, but it seems like I can usually do better just holding the shares.

My father used to say that if your broker sends you a Christmas card, you’re trading too much.  It seems like writing covered calls results in trading too much, often generating more for your broker than you receive.  Then again, maybe the way to look at them is a way to lower your risk, much like buying bonds.  You give up a bit in potential return versus holding a basket of growth stocks outright since your gains will be limited when stocks are going up, but you feel better when stocks are stagnant or going down somewhat since you either make a decent return (better than bonds) or don’t lose as much.  Theoretically you could do better writing covered calls than you would holding index funds since the potential returns are around 20 to 25%, versus 10-15% for the market in general, but it seems like holding individual stocks – the right stocks – provides the best return.  The problem is finding the right stocks.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Some Clever Wall Street Sayings and Expressions

Traders and investors over the years have come up with some clever expressions.  Today I thought I’d share a few.

Bulls make Money.  Bears make money.  Pigs get slaughtered.

This one makes the point that you can make money either betting with the market or betting against the market in a short sale.   People who get too greedy, however, especially if they start to use a lot of leverage, can really lose big.

How to make $1 million trading options.  Step 1, start with $2 million.

At one point I thought I could actually trade options and make money despite the fact that 90% of options end up worthless.  I was buying index puts and calls and a few equity puts and calls.  Somehow I ended up losing about three times as much as I had planned to risk.  At least my taxes were low that year.

A dead cat bounce.

The idea is that if it falls far enough, even a dead cat will bounce.  An expression used for a stock which has fallen far and then experiences a small rally.  Usually it falls back to its past lows after the bounce.

Trying to catch a falling knife.

It is often tempting to buy a hot stock when it is falling in price.  You will usually find, however, that just because it seems cheap compared to where it was doesn’t mean that it won’t get cheaper.  I usually wait until after the dead cat bounce and then plan to wait a few years to see anything happen.

The shoe shine boy indicator.

When people wore real shoes, there were plenty of shoe shine boys around.  When the shoe shine boys started buying stocks and giving stock tips, experienced traders knew it was time to sell out because the rally was way overblown.

The Curb.

The nickname for the American Stock Exchange.  Named so because it started out when traders began exchanging stocks on the curb outside of the New York Stock Exchange.

 

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.