How to Build a Mutual Fund Portfolio – Part 2

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In How to Build a Mutual Fund Portfolio – Part 1 I discussed the basics of mutual funds.  In a nutshell, when buying into a mutual fund you’re pooling your money with other small investors and buying a large basket of stocks.  By doing so you’re spreading out your money so that bad news for one company will not sink your whole portfolio.

Today I’ll discuss how to use mutual funds to build a portfolio.  Let’s assume that you have just started investing and just raised enough money to make your first investment.  With mutual funds, that is between $3000 and $5000.  Let’s also assume that you have a long time to invest – like 20 years or more.

The first step is to select a good stock mutual fund.  Probably the best first fund will be either a large cap stock fund, such as an S&P 500 fund, or a total stock market fund.  When choosing between funds that invest in the same things, select the ones with the lowest fees.  Because mutual funds are buying a lot of different stocks, they end up with about the same portfolios.  Over long periods of time, the ones with the lowest fees will therefore provide the greatest return since you’ll be getting the same markets returns but paying less of your money out in fees each year.  The funds with the lowest fees are index funds since they do not need to pay managers to select investments and they do not trade stocks very often.  To buy into the fund, just send a check to the fund company or send money through electronic transfer online.

Buying into your first fund is just the beginning.  To build wealth, you’ll want to keep contributing money and buying more funds.  Think of it as planting a money tree with dollar bills as leaves.  You could spend your cash from your salary now, but if you plant a few bills and let them grow into a tree, you can harvest the leaves for ever.  You can only harvest a certain number of the leaves each year or the tree will die, but with time the tree gets bigger and you can harvest more.  If you then take some of the leaves from the trees and plant those also, you’ll grow more and more trees and be able to harvest more and more leaves.  You can earn your money once and then spend it forever.

Your initial investment is just the beginning.  Start saving $300-$500 each month.  If you have bought into a total stock market fund, just add money to the fund as you go until you have about $10,000 in the fund.  If you bought into a large cap fund, when you have saved up another $,3000-$5,000, you are ready to buy into your second stock mutual fund.  This time put the money into a small cap fund since that will provide diversification.  Sometimes the large caps will do better.  Sometimes the small caps will do better.  Over long periods of time, the small caps will best the large caps since they have more room to grow.  Which will do better over a period of a few years, however, is anybody’s guess, so you want to bet on both horses.

Once you have about $10,000 in domestic stock funds, it is time to think about diversifying out into other types of assets.  This will help reduce the ups and downs that you see in your portfolio value.  More important, it will ensure you have at least some money in the areas that are hot at any particular time.

If you are nearing the time when you’ll need the money for life expenses, or you just want to have a less volatile portfolio, you should start to put some money into income producing stocks and bonds.  The higher the percentage of growth stocks you have, the greater the level of fluctuations in the value of your account will be, so adding income assets will tend to reduce the heart-dropping falls and help you sleep better when the markets are going south. You will also find that you can have a lot more volatility for not a lot greater return if you have a large percentage of growth stocks.

A rule of thumb for a stock-to-bond ratio, which is really a growth investment to income investment ratio, is to invest your age in bonds.  In other words, if you’re 20, put 20% in bonds.  If you’re 80, put 80% of your money into bonds.  If you don’t like the market fluctuations, add more bonds than you age.  For example, if you’re 40 but worry a lot, have 50% or 60% bonds.  If you don’t mind the fluctuations and want a higher return, invest less in bonds than your age.  In fact, if you are several years out from needing the money (like 20 years or more), you might want to have a very small portion of bonds in your portfolio since that portion of your portfolio will not perform as well as the growth stock portion, so you’ll be giving up several percentage points of return.  Realize, however, that you can expect some large fluctuations in the value of your account, on the order of 40% or more, during big moves in the market like the 2008 housing crash.  You need to have the intestinal fortitude to just hold on for the ride if you choose not to include bonds.  The closer you get to needing the money, the more dangerous being in all stocks becomes since you could lose half the value of your account and take five to ten years to recover.

To add bonds/income assets to your portfolio, you can buy a total bond market fund or perhaps a growth and income fund.  You can also find a managed fund that lists its objectives as “preservation of capital while providing some growth,” since this type of fund would contain a lot of defensive stocks and bonds. Again, however, managed funds would have higher costs, which would affect your return.

Once you have invested enough into a bond fund or an income fund to provide the growth/income ratio that suits your personal taste for volatility, you would continue to add to both positions.  At some point (perhaps when you have about $50,000), you should also consider adding international stocks.  The US is not always the best place to invest, and as I said before, you want to always have some of your money in the places that are doing the best at any given time, so adding an international stock fund to your portfolio is a good move.  Personally I would invest somewhere around one-quarter to one-third of the stock portion of my portfolio in an international stock fund.

Once you have US stocks, international stocks, and a bond fund you could then stay with that mixture of funds your whole life.  You would just add money to the funds as needed to maintain the ratios of stocks to bonds and US to international stocks that you desired, perhaps selling some shares of one and buying shares of another if things got too out-of-balance.  This should be done rarely, however, since it can trigger taxes and also reduces your return because you are driving up costs for the fund.  Some funds also limit the number of transactions an investor can make to dissuade people trying to time the markets.  Really, making a shift once a year at most is fine, while directing new money into the fund that needs propping up the rest of the time.  As you move closer to retirement, shift money into the income funds and/or sell outright and build up a cash position for near-term spending needs.

You can also add some other types of assets to your portfolio as it grows.  See this more as fine-tuning than a necessity.  A Real Estate Investment Trust (REIT) fund diversifies you into real estate, providing both income from rents and capital appreciation from increases in the value of the properties.  You can also invest in convertible securities, which provide both an income and a growth component.  Finally, you can put a small portion of your account into an aggressive growth fund, which will invest in start-ups and other high risk/high reward ventures, or an emerging markets fund, which invests internationally in companies in third-world nations transitioning into second-world nations.  These types of funds will do great some years and really bad during other years.

Probably the biggest thing to remember is that it doesn’t matter all that much.  If you invest in at least a couple of funds that invest in different things, keep your costs relatively low, and generally leave things alone, you’ll do just fine.  The most important thing is to invest regularly and don’t pull the money out to pay for something that will not improve your finances in the future.  Every dollar you invest in your twenties will be hundreds of dollars in your sixties.  It is just a matter of letting it grow into a big money tree rather than pulling it out with the roots when it just starts to bear fruit.

Contact me at, or leave a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

How to Build a Mutual Fund Portfolio – Part 1

One issue for the small investor is getting sufficient diversification.  Diversification is the spreading out of your money over a lot of different companies so that the issues at one company don’t cause a lot of damage to your total portfolio value.  For example, if you put all of your money into two stocks and one of the stocks missed earnings by a wide margin, you might see your account balance drop by 25% as the price of the stock for the company that missed earnings fell by 50% over the course of the next week or two.  There are also companies that suddenly implode due to missing industry trend, fraud by the officers, or the loss of a lawsuit.  As in the case of TransOcean and BP, sometimes they drill a hole in the bottom of the ocean and kill everything in the vicinity.  In that case, even other deepwater drilling operators that weren’t even involved such as Diamond Offshore took a big hit on their share price.

Diversification will not protect you from corrections in the entire market.  For example, in 2008 if you owned only equities you were going to see the value of your portfolio decline by 20-40%.  But then if you held on and didn’t sell you would see that portfolio value return within the next year or two.  If you were diversified out of equities by holding bonds, you would also not have seen as big a decline since bonds held up a lot better than stocks.

The issue with diversifying when you only have $10,000 or so is that you can only buy a few individual stocks before the cost of buying the shares starts to really start to affect your returns.  Typically you would want to buy at least 100 shares of each company to keep costs down, so if the stocks you were buying were in the $30 range you would only hold about three different stocks.  This is not necessarily a terrible thing since you are only risking a loss of $3000 or so should one of your stocks go bankrupt outright, and you have the opportunity of making a much bigger return when you are concentrated in a few companies than if you are well diversified.  Still, if you are not good at picking stocks, you might sit with three losers while the rest of the markets soar to new heights.

Mutual funds make it much easier to diversify.  In a mutual fund, individuals pool their money together to buy a basket of stocks or other assets.  They then get any dividends or interest paid by their investments, as well as any capital gains from sale of securities inside the mutual fund, divided up based on the percentage of the basket owned.  For example, if three people pitched in $100 each and a fourth person pitched in $200 and the mutual fund made $100 from the sale of stock, the first three people would be entitled to $20 each and the fourth person would be entitled to $40 in a capital gains distribution.  Normally the gains are reinvested back into the mutual fund, but taxes may still be due on the gain.  (Warning, if you are holding some funds in a non-retirement account that trade a lot , take a look at the history of their capital gains distributions and be ready to pay about 20% of that amount in taxes each year.  This can be done by selling some of the shares of the mutual fund or saving up other earnings.)

Buying into a mutual fund is fairly simple.  Just go to the website of the fund company, fill out some forms, and then send in a check or make a deposit electronically.  You can also setup automated drafts from your checking or savings account to make regular deposits.  All funds have some minimum required investment to get started.  After that, you can send in whatever amount you wish to purchase more shares.  Not also that some funds allow you to start with a lower initial investment if you setup direct deposit for future investments.

When you buy into an open-ended mutual fund – the type offered by the fund companies – the price you pay per share will be based on the value of the stocks and other assets they hold in the fund, plus any cash they have.  If the value of those assets increases, the price per share will also increase.  For example, if a mutual fund holds 100 stocks worth $20 M, and then those stocks go up in price until the value of the stocks is $40 M, the price per share of the mutual fund will double.  This means that someone buying into the fund then would need to pay twice as much per share.  For practical purposes, however, this really doesn’t matter because you can buy any number of shares desired, even if it is 1.423 shares, for example.  To you it will be sending in specific amounts of cash and then seeing the value of your position increase or decrease as the value of the portfolio the fund company holds changes in value.

Note also that in an open-ended fund, others buying in do not affect the value of your position.  For example, looking back at our last example where four invesors put in $500, let’s say that the fund company used that money to invest in shares of stock.  If a fifth investor then came along an invested $100, he would get a one-sixth share of the assets in the mutual fund (he invested $100 out of the $600 in the mutual fund, so he would own 1/6th of the mutual fund), but the mutual fund would also now have $100 more in cash to invest, so the other investors would not see their share price decrease.  In other words, their share of the pie would decrease but the size of the pie would get bigger by the same amount.

In part two, I’ll talk about specific mutual fund portfolios that could be built to meet different investment needs and explain how to build-up such portfolios.

Contact me at, or leave a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Why Doesn’t Working for Tips Work?

Last week we tried a new place for deep-sea fishing.  I’ve fished several times in San Diego, but this was the first time we went on the east coast.  One thing that was striking was the chocolate-brown water in the waterway.  Luckily we were heading out to the ocean, but that was quite a distance away (about an hour and a half).

The place we went was definitely minimalist.  When we showed up there was just a small ticket booth at a marina on the inland waterway.  When we got to the front of the line, there was no “May I help you?” or even questions of what we would like to purchase.  Just “How many?” since it was assumed we wanted the half day fishing package.  I guess that was the only thing going on at the time, but still it was odd to buy tickets without knowing what we were buying exactly.

On board there were several prominent signs that read, “Crew works for tips.”  I took this to mean that tips were there only wage, but later I got the impression that it was part of their wages.  They also did things like sell cut bait, which was supposed to be better than the standard squid, to raise more money.  This gave the impression of nickel-and-diming for everything, but it seemed like the crew needed to do what they could to make more money.

Morale of the crew was dismal.  With the exception of one crew member, who was really excellent and seemed to be doing everything, everyone seemed to just be going through the motions and doing the minimal needed.  Even the galley, which is where you would think many of the tips would be earned, was rarely manned.  You would think that there would be several people having lunch on the way back and that the crew would be pushing burgers and hot dogs, but it was unmanned even during this critical time.  We actually had to wait a long time for someone to happen by the galley just to buy some chips.  I gave a $2 tip for $4 worth of chips, mainly out of pity.

As we neared the marina, the gentleman who had been doing all of the work went around with the tip jar.  I threw in my tip, probably more than what was deserved given that there was so little service, but I don’t know if other people were contributing much.  On shore there was another charge for cleaning fish, which was reasonable.  Of course in San Diego this was done on the trip back, which would have made sense.  There was certainly a lot of time during the hour and a half ride.

Given how cheap the operation was, I’m guessing that it probably wasn’t a great place to work.  I would put the blame there on the owners, and I’m guessing that the business was probably not doing very well.  People on vacation, or who are out looking for entertainment in general, are looking to have fun with people who are also having fun.  You want to feel like the people around you would be going out for fishing for free if it weren’t a job because they just love it so much.  You want them to be sharing their passion with your kids, making memorable moments.  You don’t want zombies going through the motions.  I’ll bet that if the owners started paying a reasonable salary and started providing some perks such as company parties, they would see their business increase remarkably.

Still, it would seem like working for tips would be a big motivator to provide great service.  If it were me, I’d be trying to get a $20 tip from each group when the trip was over by providing outstanding service from the time they stepped on the dock.  Then again, I’ve never worked for tips, so I don’t really know.  I’m not sure if the issue was that the tips were probably pooled, meaning that you could do a great job but then need to share with the others who were doing nothing.  It could also be that people just don’t tip well, so they would get about the same whether they work hard or do the bare minimum.  If that is the case, people need to start being better tippers and reward good service.  Or maybe the crew didn’t realize that they could do better with more effort.

What are your thoughts?  Do people not tip better for good service?   Do people in service jobs not realize that they could earn more if they put forward more effort?  Has anyone out there had a service job and gotten much better tips by providing great service?  Anyone find that it didn’t really matter if they worked hard or did the minimum as far as the level of tips went?  Anyone find that just being motivated and having fun in these types of jobs makes the people around you happier, which makes the job better?

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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.

Why You Need to Have $6,500 in the Bank for Healthcare, Even if You Have Obamacare

With health insurance, the premium is just one part of the equation.  A small part.  Bigger factors are your deductible and your out-of-pocket maximum.  (There are also other important things like which doctors and hospitals are in your network, but I’ll leave that for another website to cover.)

Many people say they are happy with their health insurance if they are young and healthy so long as their premiums are relatively low.  They say this because they rarely go to the doctor, and therefore don’t really use their health insurance, so the premium is really all that they see.  Many individuals from countries that have socialized medicine say it is great when they are young and healthy.  They are often less enthused when they are old and sick after being told that the surgery that must be done immediately cannot be scheduled for 12 months.  The best insurance plans in Canada pay for travel and healthcare in the US because the waits there are often long.

Still, even for young and healthy people, bad things happen.  You get into a car accident and spend a week in the hospital, complete with lots of x-rays and surgeries.  You have an appendicitis.  You swallow something you should not have that needs to be surgically removed, or fall while you are rock climbing.  Maybe you travel to a foreign country and get a rare parasite like those seen on The Monsters Inside Me.  For women, it can be something as simple as having a child, especially if a surgery is needed due to complications or the baby is premature.

One of the issue with the plans under the Affordable Care Act is that they have really high deductibles and really high out-of-pocket max amounts.  To see how high, check out this article in Forbes.  As you can see, the yearly premiums vary by state, but tend to be between $2000 and $4000 for young people.  For all of those except those in the lowest income brackets, the deductible is $5,000 and the Out-Of-Pocket max is $6350.  This is a lot more than people have for cash-on-hand.

The deductible is how much you would need to pay before the insurance paid for anything.  This means that if you make $30,000 per year or more in most states, you will pay your $2,000-$4,000 premium plus $5,000 before the insurance pays for anything.  If you think this is a lot and that it is very unlikely you will pay out this amount in any given year, you are right.  If you think you would most likely be better off saving up your $4,000 premium each year and just pay cash when you need medical help, you would also be right most of the time.  The only time you would be wrong is if you were unlucky and one of the things I mention above happened when you were 21 or 22, before you had time to save up much money.

The out-of-pocket maximum is the most you would pay in any year before insurance would cover the rest.  Note that this is per year, so if something happens one year and then something happens again the next, or if something happens that requires treatment in different years, you would need to meet the out-of-pocket max each year before the rest would be covered by insurance.  Try not to get sick the week of New Years!

So really, even if you have Obamacare (or really any health insurance nowadays since many plans are converging on the same limits as the ACA), you really should still have about $6500 in the bank at all times just in case one of those freak things happened to you.  You should have even more if you’re in the period of your life where you are having children, or later in life and starting to have more surgeries and procedures.

How will you save up $6500, however, if you’re spending $4000 in health insurance premiums?  The answer is that if you are young and healthy you shouldn’t be spending that much on premiums.  You should be spending something around $1,000 because the chances of something happening to you where you would have costs that exceed the deductible are remote.  The issue is that you are covering all of the people who are older and sicker than you when you are paying your premiums.  You then need to hope that someone will do the same for you when you are older.

There is a better way.  Instead of sending money into insurance companies when people are young and healthy, they could be sending the money into Health Savings Accounts (HSA)s when they are young and letting that money build until they need it when they are older.  They could buy a major medical insurance plan that covers everything over maybe $6,000 or $10,000, which would cost maybe $800 per year, to take care of the times when some freak thing does happen and they end up in the hospital.  In twenty to thirty years most people would have plenty of cash to cover their medical care.  They would also be paying cash, which means those big insurance companies everyone criticizes would lose a lot of their business.

That is one of the odd things about the ACA.  It was passed when people were talking about how bad insurance companies are, and yet it makes everyone send all of the money for their healthcare to the insurance companies!  This leaves people with little money to use to take care of themselves when insurance fails them and doesn’t cover a procedure they need or doesn’t include the doctor they need for their rare medical condition.  People who are wealthy have the money to pay out-of-pocket for better care.  Because of the ACA, those in the middle class will not.

Contact me at, or leave a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Should you Buy Single Stocks?

In some of the funniest radio I’ve heard in a long time, Dave Ramsey (of the Dave Ramsey Show) responded to an emailer’s question, in which the caller asked what she should do with her BP shares, now that they have declined. He screamed into the radio, to paraphrase, “I don’t buy single stocks, because you never know when the company you buy will dig a hole into the bottom of the ocean and kill everything in the vicinity!!!”

For those who don’t know, Dave Ramsey is the author of a series of books and the host of a popular radio show. The theme of the show and the books is getting out of debt and generally getting your financial house in order. Clips can be heard at their website, . He offers great advice on setting yourself up into a position where you can start investing and growing wealth (by getting rid of all of your debt and spending less than you make so you can invest).

Mr. Ramsey’s shuns individual stocks. His investing style is to buy mutual funds. Specifically, he spreads his investments over mutual funds in the categories of growth, growth and income, aggressive growth, and international. He does not buy individual stocks because he believes the risk to be too great. And as he said, you never know what will happen with any one stock you own. It may actually drill a hole in the bottom of the ocean. Or it may just really misread demographics and see earnings implode.

While I do not agree that mutual funds are the only way to go, ownership of only one stock is not advisable, and the number of stocks owned should grow as one’s tolerance for risk declines. To invest in individual stocks, one must understand their behavior and plan accordingly. The price of individual stocks changes rapidly, and sometimes for no good reason. The current price offered reflects people’s feelings about the near-term prospects for the future, what the market is doing, what people expect others to do, where other investments are priced, other events in people’s lives, and recent movements in price. One cannot buy a stock and expect 10% to be added to their bank account year after year just like a savings account. Some years it will double, other years it will fall by 50%. Some years it will move up or down by 2%. Bad things do happen to good companies as well, and sometimes individual stocks fall rapidly in price, sometimes never to recover.

Because of this, placing large amounts in only one stock or even just a few stocks is foolish. There were many retirees from GE who watched their life savings implode along with the price of GE stock during the last recession. If you have large sums of money, you should spread it out over a number of stocks, and even into different sectors and asset categories (stocks, bonds, treasuries, etc…).

For those who do not have a lot of money, however, concentration in a few stocks can be a good thing. If one is a fairly good stock picker, or even picks one huge winner out of five, one can do very well. The difference is that if one has a lot of money, the risk of losing a large sum outweighs the potential rewards that can be gained through concentration. If one only has a small sum to invest, however, it is worth the risk of suffering a loss. If one only has $1000 and it grows at 10% per year, one would only have $2000 after 7 years. It is worth the risk of losing the $1000 for the potential to have $10,000 after those same seven years.

That said, you should be contributing to retirement accounts like 401Ks (10-15% of your paycheck if you want to be assured of a comfortable retirement) and investing that money in mutual funds.  You don’t want to risk your retirement on your stock picking.  You also want to start diversifying into mutual funds as your portfolio value grows.  As some of your positions get large, sell a few shares and buy shares in a fund to start to protect your gains.  The greater the portion of your portfolio that you have in mutual funds, the less volatility (meaning how much your portfolio value moves up or down) you’ll see.  You’ll also be reducing your potential rate of return, however, so holding onto a few single stocks is often worth the risk.  Hopefully you’ll do so well that while the percentage of individual stocks you own declines as you get older, the absolute value will stay the same or even grow because your portfolio will just get that much larger than when you started.

Here are the rules I generally use in determining the maximum size of individual stock positions:

1. Never have more in one position then you are willing to lose. If you cannot afford a loss of $1000, you do not belong in individual stocks. Very few people (except multi-millionaires) could afford to lose $100,000, so positions that grow so large should be split up into smaller positions.

2. On the other hand, make sure positions are large enough that if one is right about a stock, one make’s a good profit. It does no good to be right about a stock that goes from $20 top $40 if one only has $500 invested, since only $500 will be made. Make sure to take large enough positions so that your winners will result in a large return.

3. The more money you have, and the shorter your time horizon, the more diversification you should have. If you have a significant amount of money, or if you do not have much time to recover from a setback, your level of risk should drop. A person who will retire in five years and plans to live off of his savings should not have his money invested such that a drop in a few stocks would affect his plans.

4. Have money that is really needed in the next five-ten years in cash. Again, if you will be retiring soon, there is nothing like having enough to live on for five years in cash. It was sad to hear of so many putting off retirement because of the recent recession. These individuals should have been sitting on a pile of cash such that they could care less about the stock market drop.

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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Dollar Cost Averaging – the Improved Version

Dollar Cost Averaging is a common technique for investing that will result in better results than simply buying all at once much of the time.  In Dollar Cost Averaging (DCA), one invests a fixed amount of money on a regular basis. For example, an investor may put $1000 in a mutual fund every month regardless of market conditions or other factors. By fixing the amount, the effect is to buy more shares when the price is relatively low, and less shares when the price is relatively high; therefore, even if the market stays essentially flat, just moving up and down between a couple of limits, because more shares are bought at the lower prices, the cost basis will be below the average of the price range, so a profit will be made.

DCA can be automated.  Many mutual fund companies allow you to make regular automated deposits from your checking account.  For example, you can set it up where you send $200 every two weeks, right after you get paid, into the fund company to buy shares of a fund that you own.  Because the payments are made based on a fixed time-basis, regardless of what the market is doing, you will be doing DCA.  The nice thing about this strategy is that it is very easy – just set it up once and leave things alone.

DCA is a very automated, easy, no-decision way of investing that is a good approach. It can also be improved upon, however, without a lot of additional effort.  The reason is that while the movement of a stock over any given day are effectively random (you have about a 50-50 probability of the stock ending up or down on any given day), the more a stock goes down the more likely it is to go up, at least eventually.  This is because there is a fundamental value for a company based on the value of assets they own and their ability to make money.  The more a stock goes down in price, the more it needs to increase to return to this fundamental value.  It is very common for stocks to become undervalued during a sell-off as people let their emotions drive them into selling for less than the stock is worth just to get out without further losses.The modification to the dollar cost averaging strategy is therefore to wait for periods where the stock has fallen in price by a specific percentage before making investments. In doing so, a better price will be gained than that gained through blind averaging.

Choosing when to buy in this method is somewhat arbitrary. One could buy when the price falls for three days in a row, or when the price drops by 10% or so. This can be done without following the stock price constantly by setting limit orders 10% below the current price of the stock.  For example, if the stock were trading at $40 per share, a limit could be set at $36 per share.  By making the order “Good ‘Til Cancelled,” or GTC, the order would remain in place for a month and only need to be renewed if not executed within that amount of time.

Obviously a method should be chosen such that the stock can be bought regularly. Waiting for the price to drop by 20%, say, before making a purchase, may result in few shares actually being purchased while the stock climbs to the sky, leaving you behind.  Waiting for a 10% drop might also be too much – perhaps 5% would be a better limit for stocks that are not very volatile (meaning they don’t change in price very much just through random fluctuations).  And that is the danger in using this method.  The big gains in stocks are often had in a few days or maybe a few weeks, then the price will tend to tread water for a while.  If you wait too long for too good a price, you might see the company shoot through the ceiling while you are standing there with your money on the sideline.

In general trying to time the markets is a bad idea.  At least with this strategy, however, you’ll always have most of your money invested – you’re just holding back with the money you are adding to the position.  (I’m not suggesting selling out when the price goes up, just delaying purchases until a drop in price has occurred.)  You therefore won’t entirely miss out on the big gains – you just won’t do quite as well as you would have if you had been buying using DCA, where you bought shares even if the stock was in a big uptrend anyway.

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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Where to Invest $1,000, $10,000, or $100,000 Today

Money magazine periodically has an issue where they discuss what to do with $1,000, $10,000, or $100,000.   I’m always surprised by some of the suggestions, which include thing like this year’s entries, “Rent a muscle car for a day,” or “Take a yoga class.”  There are some good articles on budgeting and investing, but there are also a lot of articles on spending money, often in foolish and frivolous ways.  This month’s issue included an article on the best credit cards.  No one who is wealthy ever got there by earning points on credit cards.

Growing wealth involves investing.  It may be investing in starting a business (something most millionaires did to become wealthy), investing to learn skills to make a better living, or investing in stocks and bonds to make your money grow faster than you can through your own labor alone.  Even the modest $1,000 can turn into a year’s worth of expenses when you retire if you invest it when you are first starting your working career.   So what would I do with $1,000, $10,000, or $100,000 right now? Here are some suggestions.

What to do with $1,000.

  • Put it in a money market fund and keep it as an emergency fund. The next time the car breaks down, you’ll have the cash ready, which means you won’t need to put it on a credit card and start paying out a portion of your earnings in interest..
  • Pay down some credit card debt. This is like investing at 18%, meaning it is like saving $1000 every 3 years.
  • Pay a couple of extra payments on the home. If you make just one extra payment on a 30 year mortgage a year, you’ll pay it off about 8 years early. With a $1,000 per month payment, that is a savings of about $74,000.
  • Put it in a CD and then save up $1,000 to $3,000 more to invest in an index fund or shares of a young growth company. Make this a regular practice and you’re on the path to becoming wealthy.
  • Pick a growth stock trading for under $20 (a young company with a lot of room to grow), buy 50 shares and forget you own it for a while.

What to do with $10,000.

  • Pay off your credit cards. At 18% interest, you’ll be saving $10,000 every three years!
  • Pay off your cars, or buy a couple of 5-6 year old used cars for $5000 each. Not having a car payment will allow you to pay cash for cars from now on if you save up the money you would have been putting towards payments, even after paying for repairs.  That’s how wealthy people have money to pay cash for things.
  • Fund your IRA and that of your spouse. Retirement may be a ways off but you’ll need a lot of money when you get there for necessities and medical bills.
  • Start an educational IRA for your kids. If you’re hoping for your kids to go to college, you need to start saving early. You can put $2,000 per child into an educational IRA that is tax-free for educational expenses.
  • Buy shares of a large cap and a small cap index fund or index ETF. Index funds have low costs, which will make a big difference over time. Buying two sectors of the market reduces volatility.
  • Buy 100 shares each of 3-5 of your top stock picks. Add to these positions over time, gradually diversifying into more stocks and mutual funds as you get older and your portfolio grows.

What to do with $100,000.

  • Pay off any remaining debts, except for maybe the house. Paying off debts increases the amount of money you have available since you are no longer losing money to interest. With rates as low as they are, keeping a home mortgage might make sense to have some money for investing, but there is also no other feeling like owning your home outright.
  • Buy a set of index funds. Include large cap stocks, small cap stocks, real estate (through REITs), and income stocks. Consider international stocks as well. The younger you are the greater the proportion of growth you should have and the lower the portion of income funds.  Bonds also belong in your portfolio, but they are to risky right now due to the low-interest rates.
  • Buy 200-500 shares each in 5 stocks that are the best performing growth stocks in their industries. Keep these positions small enough that you can stand a loss should one of them fail outright.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.