If You Had a Million Dollars

What would you do if you had a million dollars?  Sure, you could do all of the silly things mentioned in the BNL Song.  Most people would say they’d go on vacation or buy a fancy car or two.  While a million dollars is not that big a sum anymore, it is still a substantial amount?  How substantial?

Well, let’s say you are working an upper middle class job and earning about $80,000 per year.  If you had $1 million invested in a set of mutual funds, you could withdraw about $80,000 per year from the funds without the balance going down (on average- some years you’d make more and some years you’d make less), even taking inflation into account (the return on stocks is between 10 and 15%, so figure you could take 8%, leaving the rest to deal with inflation).  This means that you could retire and still receive the same income without working another day in your life.

Maybe you don’t want to retire though.  With $1 million in the bank, you have an effective income of about $160,000 per year, $80,000 from salary and $80,000 from interest and capital gains.  Because a lot of the money in capital gains would be growing tax deferred (you wouldn’t owe taxes unless you sold the shares or the mutual fund you were holding did so and distributed the earnings  – or reinvested them for you).  You could therefore receive $160,000 per year effectively but not pay taxes on part of the income for years until you sold the funds.  If you die, much of the money could even be left to heirs without ever paying taxes on it.  That’s better than a $160,000 salary.

With that extra income you could take a lavish $20,000 vacation each year and still reinvest $40,000.  You could buy a house for someone every couple of years.  You could pay the salaries for a couple of people at a local non-profit.  You could send a child to a private school and pay cash each year, all without seeing your principle value decrease.

If you decided to simply live on your salary and reinvest it all, you would have $2 million in only about 7 years.  Then $4 million seven years after that.  It grows fast – getting the first million is the hardest part.

So what’s the point of this rambling post?  There are two, actually.  The first is that it is worth the sacrifices in the beginning to save and build your pipelines.  At first others around you will seem to be better off and living the good life, but if you wait you’ll have all that they have and more.  Plus, you won’t need to work for any of it while they’ll need to work extra to pay for the interest on the credit cards and home equity loans they used to pay for their lifestyle.

The other point is that if you invest your millions, rather than spend it all as many lottery winners do, you can have your cake and eat it too.  Even if you blow your entire year’s earnings travelling the world or giving out $100 gifts to strangers at Christmas time  (and how cool would that be), you’ll have another $80,000 sitting there waiting for you the next year.  That’s how people who stay rich do it.

 Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

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

Preferred Stocks

Preferred stock is often issued by a company for a special purpose.  For
example, if a company wanted to gain enough money for building a new
plant, they might choose to issue preferred stock.  Preferred stock
might also be issued as compensation to directors or others.

The exact nature of shares of preferred stock are specified when they
are issued.  In general shares of preferred stock do not represent
ownership as do shares of common stock.  Often holders of preferred
shares do not have the right to vote in election or on other matters.

Despite the lack of ownership, preferred stocks carry many advantages to
common shares.  Holders of preferred shares often receive a higher
dividend than holders of common stock; however,  the dividend for
preferred shares usually is fixed when the shares are issued and does
not rise as earnings increase as will dividends on common shares.
Another advantage is that holders of preferred shares often have
precedence over funds of the corporation.  For example, dividends of
preferred shares are usually paid before those for common shares.

Some preferred stocks are also convertible.  This
means that the shares can be converted into shares common stock.  For
example, if IBM were to issue some convertible shares, they might
specify that each ten shares of preferred stock could be converted
into one share of common stock.  Because of the possibility of
conversion, the price of the preferred stock will tend to rise if the
price of the common shares rise.  In our above case, the price of the
preferred shares will likely never be less than 10% of the price of
the common stock since 10 preferred shares can always be converted
into  a share of common stock.

Preferred stocks are normally suitable for wealth preservation and generation
of income.  Their higher yields and preferential treatment when
allocating company funds tends to prevent them from falling as
rapidly as shares of the common stock.  In the case of convertible
preferreds, the investor will also have the chance of receiving some appreciation since the price will tend to increase –  although not as rapidly – when the price of the common increases.

 Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

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

Asset Allocation and Risks in Investing Depend on the Investors Time Frame

The third concept affecting risk and return is time frame. Time frame is the amount of
time an investment is expected to be held.  Purchase of high
volatility assets would be nothing more than gambling if one were
planning to invest for a few months or a few weeks.  Likewise, buying
lots of shares of a single stock for a short period of time is very
risky.  It has been shown that one would actually do better picking
stocks throwing darts at the financial pages than by trying to select
them when the period is a year or less.  This is true even if
professional money managers are doing the picking.

Because stocks are volatile, it is difficult to predict price over short periods of
time, between one and three years.  Remember that the prices for
shares presented by the market are not necessarily rational at any
given time.  Stocks that are overpriced can continue to rise.  Those
that are dirt cheap can get cheaper.  Even if one buys shares in a
great company, the general market sentiment can cause the price to
fall and stay down for short periods of time.  There is also
manipulation, various trading strategies, and all kinds of random
events that can affect prices over the short-term.  Maybe you’ll buy
that great stock and then the founder will decide to unload a bunch
of shares and buy a house.

It is much easier to predict stock prices over long periods of time because the price will
eventually follow the fundamentals.  In addition, stocks have a
natural tendency to rise as the economy grows and earnings increase.
Returns on stocks over long periods of time have averaged between ten
and fifteen percent — much better rates that most other
investments.

Also, buy buying shares regularly, rather than putting all of one’s money in at once, one
can also lessen the effects of market fluctuations since more shares
will be bought while prices are low than when they are high.  This
process, called “dollar cost averaging,” is a popular and
effective technique.

So the allocation of assets into bank accounts, bonds, stocks, real estate, and other
investments is highly dependant on time frame.  For those with only a
few years to invest, the money should be safe in a bank CD despite
the terrible interest rates.  For those who are saving for retirement
and have decades to let the money grow, the money must be in assets
with more return than the bank or inflation will decrease the actual
value of the account each year.  Ironically, many in 401K accounts invest only in bank CDs, not wanting to take the risk of investing in stocks.  Over a lifetime, this will make the difference between an account with a few hundred thousand dollars and millions.

 Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

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

Stocks for Growing Wealth

One can grow wealth more quickly if income is allowed to compound. Likewise, businesses will grow more quickly when they are reinvesting most or all of their profits in the business.  One could have one
pizza restaurant and take home the profits each night.  If the business is successful, the profits may provide enough income for a family’s necessities for several years (the successful restaurant,
like shares of stock, is an asset).  If instead of taking home all of the profits, however, some of the money generated by the restaurant was  used to expand the restaurant, add other touches that would
bring in more people, or purchase the land and building to open a second restaurant, the income generated by the restaurant would grow with time.

When a business is young and there is a lot of room to expand, the value
of the business can grow quickly if most of the profits are reinvested.  This is why many young companies pay little or no dividend.  Because there are a lot of opportunities to expand the
business, it is better for the company and the shareholders to use the cash flow for expansion and acquisition of competitors.

Young, rapidly expanding businesses can have a very high rate of return, but
are also more risky than larger, more established businesses.  If they expand too rapidly, make a bad acquisition, or simply misread the market the effect on profits will be much more severe than it
would be for larger businesses.   Larger businesses can have many product lines and are in many different regions, while smaller businesses typically just have a few product lines and only a few
locations.

Because of the their opportunity for rapid growth and expansion, small, young
companies that pay small of no  dividends are great for growing wealth.   Because they are more risky and the rate of growth in any given quarter or year is uncertain, they are not good for maintaining
wealth or generating income.  For example, if one invested in Amazon in the late 1990′s, one would have seen the value of one’s shares grow several hundred percent over then next few years.  A similar
investment in a bank CD would have only returned a few percent per year.

If one were relying on the investment and selling shares periodically for current income, however, one would have been in for a nasty shock.  In the early 2000s, when the internet bubble burst, the value
of Amazon fell through the floor.  One would have been lucky to even sell the shares for what one originally paid if they were bought on the way up.

For the investor who didn’t need the money right away and could actually buy more shares after the fall, this would not be any great tragedy.  In fact, the value of the shares has recovered and even grown a bit
above their value in the late 1990s (since Amazon is now actually making a profit to justify their stock price).  The income investor, however, who needed the money each year and could not wait for the
recovery, would have had to sell at low prices.

Stocks suitable for growing wealth have the following characteristics:

1. They tend to be young companies or companies that have undergone a
   radical transformation (a large new business line or a huge
   restructuring in which many assets and liabilities were shed).

2. They have a lot of room for expansion.

3. They are able to grow profits substantially each year.

4. They pay little of no dividend.

5. They have little or no debt.  They have a lot of cash flow from
   current operations that allows them to grow and make acquisitions.

6. They have the ability to perform research or test new product lines
   using cash flow from current operations.

 Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

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

How to Invest with Small Weekly Money Installments

Dear SmallIvy,

I would like to put aside some money each week to invest.  What is the best way to invest money in small amounts?

Thanks,

Chuck

Dear Chuck,

Unfortunately buying stocks directly is best done with relatively large amounts – on the order of $2000-$5000 at a time.  This is because brokerage fees generally have a minimum and those costs will severely hurt returns if investing a few hundred dollars at a time.  If one buys lower priced stocks – those trading in the $5-$15 range one can get away with investments of $500-$1500 at a time, but this limits the companies available. Buying stocks at less than $5 per share is generally not recommended since most stocks in that price range have encountered some serious problems and are more suitable for value investing, which is not the strategy I recommend.

There are really two options for investing smaller amounts in stocks regularly (this assumes one does not want to save in a money market fund until $2000-$5000 is saved, buy some shares, then repeat, but would rather be actually buying stocks with the small installments) .  That is either to buy mutual funds or use a dividend reinvestment plan. 

Many mutual funds, such as those offered by Vanguard, allow relatively small initial investments – on the order of $3000-$5000, and then allow you to send in whatever amount you wish after that.  Index funds are recommended due to their low fees and because very few managed funds beat out index funds over time due to their higher fees.

The strategy using funds would be to save up and buy into a mutual fund (again, $3000-$5000), then start sending in the regular smaller deposits after that.  Some companies even allow direct deposit so you don’t even need to worry about sending a check.  Once the account balance builds up, say to the $6000-$10,000 range, you can then sell some of the original mutual fund and start investing in other mutual funds as well, to increase your diversification, or start buying individual stocks with some of the money. 

It is the belief of this blog that if you buy the right type of stocks – stocks that are solid, best-or-breed, steady growth companies – and are willing to hold them for a long period of time to reduce timing risk, you can beat out the mutual funds and market in general.  This results in greater fluctuations in account value, however, than holding mutual funds.  Those with weak stomachs will therefore find holding some portion or the entire portfolio in mutual funds a better choice.

The other strategy is to use dividend reinvestment plans.  These allow investors after the original investment through a broker to buy shares directly from the companies as well as buy additional shares with dividends.  Most companies that offer these plans are large, well-established companies.  These companies tend to be stable with steady income streams.  Unfortunately, they also tend to only deliver returns at about the rate of the market or a little slower since they have already largely reached their full market size. 

In this strategy, a stock would be selected and purchased, then regular payments sent.  When the position was sufficiently large, say $5000, one would sell half of the shares and buy a second company with the money, continuing this process until about 5 companies were held.

At some point the account would grow large enough to shift from a pure growth strategy, which buying small numbers of individual stocks is, to one designed for growth and some asset protection.  This is done through diversification – spreading the investments out over several stocks.   At that point some of the money would be shifted into mutual funds or Exchange Traded Funds (ETFs) since that is the easiest way to diversify.  Again, index funds of broad market ETFs are recommended.  Remember never to have more money in one stock than you are willing and able to lose.  Even strong, stable companies like GE can see their share price drop by 90% or more in short periods of time.

Regular investing is the key to growing wealthy.  If one can put things on autopilot and make putting money away part of each months activities, one can do very well.

Regards,

SmallIvy