How to Invest for Retirement without a 401K

So you’ve decided to forego the big corporation for a small business, or your own business, but now you don’t have access to a 401K plan, let alone a pension.  This doesn’t mean you can’t save for retirement.  There are still ways that you can shelter your income from taxes and have the money you need for retirement.

The first thing to do is to start a personal IRA – either a standard IRA or a Roth IRA.  An IRA is an Individual Retirement Account, which is a tax sheltered account with specific contribution limits designed to encourage individuals to save for retirement through preferential tax treatment.  401K’s were modelled on IRAs – 401K plans just have bigger contribution limits and often have a company match to investments the employee makes – so you get the same tax advantages from investing in an IRA as you do in a 401K.

Contributions to a standard IRA are tax deferred, meaning they reduce your effective income for the year by the amount you contribute, but you then pay taxes on your withdrawals when you are of retirement age as if it were employment income.  For example, if you were in the 15% tax bracket and contributed $1,000 to an IRA, you’d reduce your taxes by $150 (15% of $1,000).  If that $1,000 grew into $20,000 over the next 40 years in the IRA, and you were still in the 15% tax bracket when you retired and withdrew the money from the IRA, you’d then owe $20,000 x 0.15 = $3,000 in taxes on the money.  In the mean time, the money has been allowed to grow for all of those years without the earnings being taxed, allowing you to compound the interest.  The amount you can contribute to a standard IRA and the amount you can deduct depends on the amount of money you make in a year and whether or not you have a retirement plan at work, plus the rules change all of the time, so it is best to check with an accountant or read the rules yourself at the IRS website.  For many people under 50 in 2014, the limit was $5,500, which would be 10% of a $55,000 income.  This is a good start on retirement savings and far more than most people invest until they are in their late forties or fifties, meaning you’ll be way ahead of the game if you fully fund an IRA.  If you’re older than 50, you may be able to contribute $6,500 per year.

A Roth IRA is just like a Roth 401k, where the contributions you make are not tax-deductible, but the money you withdraw is tax free provided you are past retirement age.  Contribution limits are similar to those for a traditional IRA.  (Note that the amount you contribute to a traditional IRA counts against what you can contribute to a Roth IRA, and vice-versa.  Again, call an accountant to get the rules straight and save yourself a lot of money from a costly mistake.)  Mathematically it usually makes sense to invest in a Roth IRA instead of a traditional IRA because you will come out ahead withdrawing your money tax-free at retirement instead of getting a tax break now and investing the taxes you save in a taxable account.  This assumes that tax rates stay about the same and something like a large national sales tax or surcharge on withdrawals isn’t implemented in the future.  I’m less than optimistic about taxes in the future, so I personally use a traditional IRA.  A bird in the hand, so to speak.

One advantage to having retirement savings in an IRA or Roth IRA instead of  a company 401K plan is that you have more investment choices.  With a 401K plan, your company chooses in what you can invest and provides a limited menu of investment options.  Also, the fees for the plan need to cover the costs of the plan plus a reasonable profit for the 401K administrator, so older workers may see a lot of their investment income going to fees to pay for the younger people in the plan who have small account balances, and therefore are probably costing the fund company more than they earn from those workers in fees.  This is a reason to open an individual IRA as well even if you have a 401K and/or a pension plan available at work.

Even with the freedom to choose investments when you invest in an individual IRA, it is best to have the core of your IRA holdings in diversified mutual funds with low fees.  This typically means index funds or index ETFs.  In general fund fees should be less than 0.05% per year.  Holding a large cap fund, a small cap fund, and a bond fund, or just a total stock market fund and a bond fund is a good start.  For more elaborate combinations that can increase your returns, see How to Invest Your 401K Funds.

So what if you’ve maxed out your IRA contributions and still want to save more for retirement?  You can still put money away in a taxable account and invest in index mutual funds or index ETFs.  You will owe taxes from time-to-time, but because these types of funds rarely trade shares, taxes will be minimal and most of your investment will continue to compound.  Be wary about selling shares of your funds, however, to do rebalancing and other maneuvers since that may trigger taxes.  It is better to maintain your desired ratios in your different funds by directing new money to funds that are underrepresented.

You can also achieve tax deferment by holding shares of individual companies for long periods of time.  So long as you don’t sell shares of a stock, and are not forced to sell due to an event such as a corporate buy-out, you will not need to pay capital gains taxes and your investment can continue to compound.  If you do find that you need to sell because the position gets too large or you feel that your money would be better invested elsewhere, you might need to pay a sizeable amount in capital gains taxes.  Any dividends generated by the company would also be taxable, even if you reinvest the dividends.

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.

Instead of Trading Stocks, Invest

Many financial advisers and personal financial pundits will say that you should not invest in single stocks. You need a large amount of diversification (the holding of a lot of different stocks) to lower your risk. Investors should therefore only hold mutual funds, which buy a large number of stocks.

They are right that investing in mutual funds is the safer way to go. History is littered with examples of companies that collapsed, leaving the investors with large losses that they could never make back because the company they had invested in was no longer there. Generally if your company files bankruptcy, you can expect to get nothing for your shares. Management, the workers, other creditors, and the bond holders will take what they can, so there will be a couple of pennies on the dollar leftover for the shareholders if that.

There has never been a holder of a mutual fund who saw his whole investment wiped out, because that would mean hundreds of companies failing at once. If that happened, the whole economy would be imploding and you’d be out hunting squirrels in your backyard to eat. (By the way, this is why the argument that having people invest for retirement with individual accounts in mutual funds rather than having the government-run Social Security program because investing in the stock market is too risky is a really stupid argument. If the mutual funds imploded, there would be nowhere for the government to raise the money to pay Social Security payments either because no one would be working and there would be no corporations anymore!) In general, if you just hold on after a market downturn, you’ll see your investment recover within a year or two. Even better, invest more at these times since the markets generally overreact and under-price things, allowing you to swoop in and get shares in good companies for a great discount.

Still, holding only mutual funds limits your potential investment return. Having a portion of your portfolio in stock mutual funds makes sense since it virtually guarantees you a great, inflation beating return that has ranged from 10%-15% over long periods of time since people have been keeping track. It is where your 401k retirement funds belong, and where your individual IRA funds belong if you don’t have a 401k available to you. Having a portion in bond funds and income funds also makes sense as you are nearing the time when you’ll need the money since then you can generate regular income and not need to rely on selling stocks and capturing capital gains when you need cash.  This is important since you really can’t predict what the markets will do from year-to-year.

Individual stocks, however, can return far more than the markets. Look at companies like Microsoft and Home Depot. If you invested a few thousand dollars in either of these companies in the 1980’s and just locked your shares away in a safe deposit box, you’d be a multimillionaire today. If you put that same cash in a set of mutual funds, you’d have maybe half a million dollars over the same time period. The difference is that a small company can double its earnings and become far more valuable many times over as it grows and matures. An entire market, that includes stocks that grow and become big, others that fail and disappear, and still other that just grow to a certain level and then stagnate, cannot do the same.

The issue though is that many people start to think they are high-power Wall Street Traders and try to beat the markets by shifting from company to company as they hear news, see some movement in the price of a stock, or get a tip from a friend at work. One of the silliest commercials on television today shows a father who talks about the “rush hour” in their home at 6:30 as his kids and wife get ready and head out. He, on the other hand, just sits down at his computer to trade stocks for the day, still dressed in a long sleeve white shirt and slacks to make him appear like someone in high finance.

The truth is you will never be able to beat the markets over the long time by moving in and out of stocks, taking profits and limiting losses. Every piece of news that you hear causes the markets to react before you get a chance to click a button on your computer or call your broker. There are thousands of others out there ready to pounce on the same news. You also won’t be able to find some pattern in the price movements of the market and deftly jump in and out before major events. Most of the time, charting stocks just tells you where you are rather than where you are going. Any reliable pattern indicator that does show something like an inefficiency in the markets that can be exploited is soon discovered and eliminated as everyone piles on. The only way you can actually take advantage of market inefficiencies is through arbitrage, where you find the same stock on two markets at different prices and buy on one market and sell on the other, but professional trading firms with lightning fast computer quickly exploit those opportunities.

The way you outperform the markets is to start thinking like an investor instead of a trader. In other words, thinking like an owner of a company instead of just a stock holder. You find companies that are managed well in markets where they have the potential to grow and make lots of money in the future. You then buy into these companies with the intention of holding them as they grow.

This isn’t a short-term thing where you’ll sell out once you’ve made 20% or doubled your money. This is a long term commitment where you’ll hold on through think-and-thin since you know that brighter things lie ahead. In down markets you know that your company will be able to take market share and become more efficient while competitors go out-of-business. In boom times you can enjoy watching your company grow and expand, but you know that it will get even bigger and more profitable in the future.

This is what it means to be an owner. Instead of acting like someone who bought a few shares on E-Trade, you act like you put $5,000 into your cousin Evan’s garage start-up. You know that you may not get the money back, but you have confidence in Evan and know that he has a great idea and the return you could get would dwarf your investment.

In the next post in this series, I’ll discuss how investing like an owner changes the kind of companies you pick.

I’d love to hear your comments!  Please use the comment form and let me know what you think, especially if you disagree.  You can also contact me at

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.

What is Money?

dollarsThis is a long post – way more than the 1000 words recommended for a blog entry, but please take time to read all of the way through since I think it will be well worth the effort.  I’d also love to hear some comments, particularly from people who disagree.  If you have a way to make a living wage work, I’d love to hear it. – SI

From some of the ideas of how to help the economy, or how to help working people, it is clear that many people don’t understand the fundamentals of money.  When we were young, no doubt we admired the pretty pictures on paper currency and liked the shiny coins that stacked and clanked so nicely.  We were taught that money was something to obtain and guard and value, but what exactly is money?

Money is essentially an “IOU” for work.  You spend an hour doing something useful for someone like picking crops or building a house, and they give you an IOU that you can give to someone else in exchange for them fixing your car or cooking you lunch.  Ideally you should be able to work harder than you need to just meet your present needs when you are young and full of energy, saving up a few extra of these IOUs each year, and then spend them to have others provide for your needs when you are old and unable to work anymore (or just don’t want to work anymore).  If you die before you get all of your labor repaid, you can give the IOUs to your children so that they can receive an equivalent amount of labor as you contributed in the past.  Maybe this is why it is so sad when someone squanders an inheritance, since the person who gave you that inheritance worked so hard.  Read How to Invest a $100,000 Inheritance to learn how you can put that gift you’ve been given to more productive use.

Before money existed, we used barter.  You wanted a new wagon and were a farmer, so you found a wagon maker or someone who owned a wagon they were willing to sell who wanted a load of corn and traded them for it.  The trouble was finding someone who had what you wanted who wanted to trade for what you had.  You might need to trade several times with several different people to finally get what you wanted in the first place.

To make it easier for people to trade for what they wanted, trading posts were established.  There, you could trade whatever you had for the wide variety of things the trading post owner had.  (Note that the free enterprise system was working here – people saw a need for an easier bartering system, so they created trading posts.  They did this to become wealthier, but the way you do this in a free enterprise society is by taking care of the needs of others.  The more people you help, the wealthier you become.)  Owners would quickly learn what their customers needed regularly, so they would make sure to have regular deals with suppliers of those things.  The trading post owner would trade things that were a little less valuable than the things he received so that he could make a small profit to feed his family and provide for his needs since he was managing the trading post rather than out growing food or maintaining his property.  The value he created to his customers from creating and managing the trading post, however, more than made up for the differential in the value of the trade.  They knew they could get just what they needed from the trading post, rather than scouring the country for people who had what they wanted and would trade it for what they had.  The trading post owner created convenience and a time savings, which was valuable to the customers.  If it wasn’t worth the price they were paying, they would have not patronized the store and just traded directly with others.  People would also open other trading posts if they felt the existing ones were too expensive and they could take business away through slimmer margins.

At some point the trading posts probably found the need to issue IOUs rather than trade goods directly.  Maybe the farmers would trade their crops in the fall, but then wait until spring to pick up seed and tools.  Maybe regulars started keeping an account of credit at the stores so that they could come in when convenient and get goods rather than getting everything right when they traded their goods.  Maybe there were also things that were available only during certain times of the year, so people didn’t have things to trade for them when they came in.  People probably started swapping these IOUs with each other when there was something they wanted from someone directly.  That was likely an early form of money.  At some point people probably wanted an IOU that they could use at many stores, instead of just the trading post that issued a particular IOU.  At that point, they may have started using something like pretty shells or bits of gold.  It just had to be something that couldn’t be found everywhere that people knew would hold its value.  It also had to be something that people would work for to obtain even if they didn’t trade it for something else.

At some point precious metals became the standard.  These worked well because they were limited in availability and people wanted them for jewelery and adornment, so people knew they could always trade them.  Countries started shaping these metals into coins and standardizing the quantity of metal in each coin for convenience, but it was still the value of the metal in the coins that made them worth something.  If you wanted, you could always melt the coin down and recover the metal.  Gold was used for larger amounts, silver for medium amounts, and copper for small amounts.  (Note sometimes people would shave a little of the metal off of the coins before they spent them.  This was kind of like counterfeiting since now the coin you exchanged was not as valuable as its face value.)

At times it became difficult to carry around a lot of coins.  To remedy this situation, countries began issuing paper notes that would allow the holder to exchange the note for a specified amount of gold or silver.  This was called The Gold Standard and was very effective.  Because the amount of precious metals were limited, and because the amount of effort required to dig them up and refine them more than equalled the amount of labor the coins and notes represented, the value of money was relatively fixed.  In the US the value of the dollar stayed almost exactly the same from about 1800-1920.  This means that you could work an hour, save up a dollar note, and then trade it to someone 80 years later for the same amount of labor.  There was no inflation!

This all changed in the 1930s in the US when the country needed to repay its debts from WWI.  Rather than cutting government spending and raising taxes, and thereby raising the money legitimately, the government stopped guaranteeing the ability to trade notes for precious metals.  This allowed them to print money without needing to actually go through the effort to procure something of equal value to back it up.  They also confiscated most of the precious metals in the US so that people who held these metals wouldn’t suddenly realize a bonanza, since they knew that those metals would suddenly be worth a lot more dollars than they were in the past if the government started printing money that was not backed up by gold or silver.  When they spent these new greenbacks, there was now currency on the markets that had not been traded for an amount of work equal to its value, but that could be spent and traded for goods and services just like the legitimately earned dollars.  Because there were now more IOUs out there than there were goods being produced, the value of each dollar decreased and the value of gold in dollars increased.

This is called inflation.  To understand the effect of inflation, realize that the dollar that was worth exactly what it was a hundred years before in 1930 is worth one-tenth the amount it was worth in 1930 today.  If you worked ten hours to earn that dollar in 1930, you could now only trade it for one hour of equivalent labor today.  Inflation really is thievery by the government, or at least another tax levied on everyone who holds cash currency (or even money in savings and other bank accounts, since they don’t pay a high enough interest rate to overcome inflation), since it decreases the value of everyone’s money and they therefore lose part of the work they performed in the past.

And this is why the you can’t expect the government to just cover everyone’s needs, or even a few wealthy individuals.  The government could send out lots of checks, but without someone putting forth the labor to cover the value of those checks, the dollars they create decline in value to the point where thousands of dollars must be traded for a loaf of bread.  To put it another way, for every loaf of bread, house, or shirt that someone purchases with the money the government hands out, someone needs to put forth the effort to make that item.  In a functioning economy, you can either have most people working enough to cover their own needs with a few working extra to cover the needs of those who don’t provide for themselves, or you need to have a few people working really hard to cover then needs of a lot of people.  In the latter case, at some point those who are working really hard will just throw in the towel since they are getting nothing in return that comes anywhere close to the value of what they are producing.  They will just produce what they need for themselves.  As more and more people do this,  the amount of goods and services available declines.  You can then have a fist full of dollars, but it won’t buy you anything.

What about rich people?  Can’t they just cover everyone?  Well, people get rich by just getting a little more back than they provide from a lot of people.  They employ people and get a maybe $5 for every $100 worth of goods and services each employee produces.  They trade goods and services to others, and maybe get $2 for every $100 worth of good they sell.  The reason that they become wealthy is that they employ a lot of people and they sell a lot of items.  They become wealthy by providing a lot of jobs and meeting a lot of needs.  If a lot of the workers started receiving more than they produced, (through a minimum wage that was too high, for example,) and if a lot of the people started receiving the items for free, (because they receive dollars from the government to buy things but don’t provide the labor needed to earn those dollars), the wealth the rich person had would quickly disappear.  There would also be no one to take his place because there would be no incentive to put in the hours required and go through the hassle of opening a business and employing people.  You might as well just provide for yourself and do the minimum and enjoy your free time.

So, dollars are only worth something if people are doing something to earn them.  Remember that they are IOUs for goods and services you provided in the past and not some magic thing that governments can just produce at whim.  You also can’t produce $10 worth of goods per hour and recieve $15 per hour just because you need $15 per hour to pay for expenses.  Maybe a few people can, but on average everyone needs to be producing at least as much as they are paid, plus a little extra to cover the business owner and make it worth his time.  The government can produce the paper and the coins, but they can’t produce the loaf of bread or the house.  That takes an effort.

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 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.

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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.

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.