Developing an Investment Plan – Part 2

Ask SmallIvy:  Please send to vtsioriginal@yahoo.com or leave in a comment.

In this post, we continue the theme of setting up an investment plan.  This series started here.

In setting up the plan, time and risk are used to determine the types and allocations of investments. As available time for investing grows, risk should as well. Of course, one’s risk tolerance (as determined by one’s stomach for oscillations) is also involved in the decision.

 The first step in an investment plan is to determine a way to regularly set aside funds build up capital to invest.  A good investment plan will involve regular investment, rather than putting in a sum of money as a one-time thing.  Contributions will be far more  important during the first 10-15 years than they will be from that point forward since by that point the interest from investments will be greater.  Ironically, during the early years people normally have less income with which to invest.

 The best idea is to start out from the beginning living on less than you make and putting aside money for investing.  As salary grows, this amount should also grow.  Using direct deposit to a savings or investment account can help provide the discipline to do this.

The second step is to develop a strategy for allocating assets.  This includes both determining how much will go into each type of assets (stocks, bonds, real estate, etc…) and how aggressive one will be (e.g., whether individual stocks and bonds will be purchased, or if mutual funds will be used).  Having a large number of growth stocks will cause account balance to fluctuate rapidly, but will provide better returns over long periods of time.  Adding a small percentage of bonds will help smooth out the turbulence with only minor reductions in returns.

Once an asset allocation plan is developed, it is time to start purchasing the securities.  This can be done piecemeal – a little at a time – if one does not mind large fluctuations as things are started.  For example, if the plan is to use mutual funds and one has raised $5000 in cash – the minimum needed by the mutual fund company – one might go ahead and purchase the first fund.  If the plan is to have 80% stocks and 20% bonds, one might go ahead and put the next $5000 into the same stock fund (or another stock fund in a different asset category), then put the next $5000 into a bond fund.  Gradually, by adding money to each of the funds as available, one will build a portfolio with the planned investment mix.

The same thing can be done with individual stocks and bonds.  Here a first stock is selected once one has enough funds to buy a reasonable number of shares – normally 100 shares.  Additional shares of various stocks and bonds are then purchased as funds are available.  In this case it is good to have a watch list of about 5-10 stocks.  As funds are available, the stock that is at the best relative price would be purchased.

Once the desired asset mix is attained, it should be loosely maintained by purchasing the necessary funds or stock and bonds as needed to keep the planned ratios.  Some amount of rebalancing should also be done if the ratios get too out of spec by selling some funds/securities and putting the money into others.  This should be kept to a minimum, however, since doing so will like result in capital gains on which taxes must be paid, and also result in commissions and other costs.  Rebalancing should be done at most once per year.

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.

Developing an Investment Plan – Part 1

Ask SmallIvy:  Please send to vtsioriginal@yahoo.com or leave in a comment.

Everyone has seen the late night advertisements. There is a guy standing in a large backyard by a sky-blue pool with tropical flowers and a large stucco-roofed house in the background. Perhaps he has a woman 10-20 years younger than him lounging next to him in a bikini, enjoying the sunny day. They are both probably wearing sun glasses – wealthy people are always wearing sunglasses. He says that he is ready to share the secrets to building great wealth and obtaining economic freedom.

He then proceeds to tell you that you can make a fortune while you keep your day job using his system. It may be a real estate trading scheme. You may be buying and selling penny stocks. Perhaps you are doing multi-level marketing — a technique only a hair different from a pyramid scheme. Maybe you are selling products over the internet for them.  All you need to do is set up an account and then check each day to see how much cash you made. Just sign up for their seminar, which conveniently is coming to the Holiday Inn near you. The price is never mentioned.

Unfortunately, wealth will not come to you from some scheme. If there really were a scheme that could create untold wealth, why would they share it with you? Why not just sell the real estate themselves? Why wouldn’t they set up their own websites to sell their products? If the individuals in the commercials actually are wealthy (and they didn’t just rent out a house for the commercial), you can bet that they got that way off of the fees for their seminars and classes, not from the scheme they are presenting.

Real wealth doesn’t come from a scheme or luck. There is no special secret. Everything can be calculated. It comes from a plan. A good investment plan involves the following:

1. Time.  Growing wealthy requires time.  Do some calculations on compound interest and you will find that very little interest is made in the first few periods, but huge amounts are made during the last few.  Try this experiment: Start by placing a penny in a jar.  The next day place two pennies, the next day four pennies, and so on, doubling the amount each day.  See how much you will be putting in the jar by the end of thirty days.

2. Risk.  Growing wealth requires that risks be taken, because risk is correlated to reward.  This does not mean going to Vegas and betting on red.  It means investing your money in places where the odds are in your favor, but that grow faster than the rate of inflation.  Things like stocks, real estate, ETFs, mutual funds, and bonds.  These investments allow
   your money to earn money and compound, growing as you work so that eventually your portfolio is providing more income than your job.  This is when things really start to happen.

3. Consistency.  Discipline is required.  Money needs to be put away every month into investments.  It doesn’t matter if the market is up or down, put some money away.  If the market falls through the floor, buy all you can.  If the market seems really pricey, perhaps hold back a bit on the side in a money market account, but put some in any way, in case you are wrong.  In any case save some money each month from you earnings.  Consistency is the key.

The first two aspects work together, in that by having more time available, greater risks can be taken.  The third aspect, consistency, is needed to avoid trying to time the market and thereby sabotaging your investments by missing
the big gains.  Remember that plans are done ahead of time when things are calm and thought can be given.  One should be reluctant to change a plan, particularly in emotional times.

In the next post, we’ll get down to the specifics of the plan.

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.

Getting Ready to Invest

Ask SmallIvy:  Please send to vtsioriginal@yahoo.com or leave in a comment.

Cash management for growing wealthy is really quite simple.  While most
people make sufficient income from their jobs to grow wealthy, few
do.  The main reason is that most people waste their money, growing
their obligations each month (the house, cars, watercraft, credit
cards, vacation homes, club memberships) until all of their income is
spent before they see it.  To grow wealthy, a portion of income needs
to be placed in assets each month.  One must increase the amount of
assets he/she has, while limiting in  the amount of liabilities
(things that must be paid for each month).

Before starting to invest, you must get yourself into a state where you are
ready to invest.  Just as important as the buying of stocks is
getting your cash flow such that you are saving money with each
paycheck.  This means:

1. Minimizing recurrent payments.

2. Eliminating debt (especially credit card debt).

3. Setting up automated paycheck withdrawals to investment accounts, or having the
   discipline to write a check each month.

4. Finding assets to invest in.

1. Minimizing recurring payments

Setting up cash flow in the correct way is the secret to growing wealthy.
People who never make any money have recurring liabilities equal to
their incomes.  People who go into debt have liabilities that exceed
their income.  Those who become wealthy save a portion of each
paycheck and gain interest and capital gains from the money they have
saved and invested.  Eventually they start using some of the money
from their investments to buy more investments – then the rate of
growth really accelerates.  It’s like having all of the people at
Google working for you.

To break the cycle of the normal person, look at what bills you have
every month and see if you can eliminate them.  Can you get rid of a
car payment and pay cash for a good used car from a private owner?
Do you really need that health club membership?  Could you jog in the
park?  Can you eat in more often?  Do you really need the Netflix
subscription?  Most of all, can you get rid of debt and stop paying
interest payments?

Any bill that you can eliminate will mean that much more money can go
into investing.  It is tough to build wealth if you have no money
left over after each paycheck.  If you have a lot of bills you need
to pay each month in the form of memberships, clubs and the like, see
if you can get rid of some and instead just purchase the things as
you need them.

Probably the easiest way to prevent having all of your money spoken for before
the month begins is to keep your lifestyle in check when you start.
Perhaps set aside 10% of your paycheck when you start working and put
it in a mutual fund each month so that you will never get used to
having that money to spend.

2. Eliminating debt

When you have debt, not only are you paying for things, you are
paying more than their cost.  If you buy something on a credit card
and pay the minimums, you will pay many times the value of the thing
you bought before you get it paid off.

It takes will power to save up for things, and sometimes it seems
like you really need them now, but if you take going into debt out of
the equation you’ll find all kinds of creative ways to get by until
you save up the money.  Also, the next time you need something, it
will be that much easier to afford it if you are not paying off debt
and you can save your whole paycheck.

3. Setting up automated withdrawals

Investing regularly is the secret to doing well in the stock market.
While the market goes up and down, if you are buying consistently the
price you pay will be averaged out over several different prices.  If
you invest the same amount each month, when the market is low you
will buy more shares.  When the market is high you will buy less.
And because the natural direction of the market over long periods of
time is up, you will do well if you stick to a plan.

4. Finding assets

Assets are items and things that grow in value over time, and generally provide a source
of income, either through their sale or because they pay dividends
or interest.  Initially, the additional income from assets may not
amount to much.  For example, purchasing $2000 worth of stock,
earning an average of 10% a year, would only provide $200 in income
the first year.  But if stock were purchased on a regular basis,
such that $2000 per year was purchased, in ten years that would
provide an income of $2000 per year.  Furthermore, if the proceeds
from the stock were used to buy more stock — reinvested —
compounding takes over.  Eventually, income from assets will exceed
income from employment, at which point one becomes financially
Independent.  Because income grows as the value of assets grows, the
rate of growth accelerates with much more money being earned in
later years than in initial years.  For example, at 10% growth rate
with compounding, assets will double every 7 years.  So in 7, 14,
21, 28, 35, and 42 years $1000 will be worth $2000, $4000, $8000,
$16,000, $32,000, and $64,000, respectively.  Multiply this value by
10 or 20 and you can see why you never want to take money out of a
retirement account.  Note that $32 was made for each original dollar
invested during the last seven years.

So while it may not seem like much initially, start putting away money, accumulating assets,
and stay with it.  Where necessary, some of the income generated by
assets can be used to supplement employment income, but once assets
are purchased, never spend the original capital.  Hold off on getting
that new boat, instead putting the money away, and then when you are
making enough income from the assets you can buy the new boat and
still have the original capital.    It is amazing how quickly wealth
can grow with persistence.

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.

When Do You Need Insurance

Whether it is health insurance, car insurance, home owner’s insurance, or life insurance there is always a salesman on hand.  Some are lizards, some are pitchmen, some are members of your church.  Ask a salesman if you need insurance and he’ll proceed to tell you how you can’t possible get along without it.  Knowing when you do — and don’t — need insurance is an important part of any financial plan.

So what exactly is insurance?  Insurance is a way of shifting risk from oneself onto an insurance company.  In buying a policy, you are paying the insurance company to take on your risk so that if something happens you won’t need to pay for things yourself.

Now obviously the insurance company doesn’t want to lose money, so they do a lot of calculations and run a lot of models to determine just how likely it is that the bad thing will happen to you during the life of the policy.  Based on these calculations, they set the price of the policy such that they will receive as much as they will pay out in claims, plus a little more, for all of the policies they write.

In cases where the bad thing is almost certainly going to happen to you, it is just a question of when, you will actually be paying enough to pay for the event yourself if you save the money.  For example with health insurance, because everyone goes to the doctor for physicals and occasional illnesses, the premiums you pay include an amount that is equal to what you would be paying if you paid yourself for those services.  There is also a high cost service risk – the risk that you will need a liver transplant which will cost $1 million - built into the coverage.  Because most people will not need such an expensive surgery in their lifetimes, the cost of that portion of the insurance is not as expensive as it would be if everyone would eventually have a major surgery.  The insurance company might figure out that the chance was 1 in 100, and therefore you would be paying a little over 1/100th of the cost of the surgery in premiums.

Note that as more routine services are added to insurance, the cost goes up.  Your insurance doesn’t provide free mammograms.  You just pay for your yearly mammogram in your insurance premium.  You don’t get free well-care checkups.  You just pay for them in your premiums.

So when do you need insurance?  You need insurance when the event that could happen would be beyond your means to cover with your savings and investments and still leave you with enough for life’s expenses.  For example, when you a young married couple, you should have enough life insurance to replace the income of each working spouse.  In addition, if one spouse takes care of the kids, maintains the house, or does other such things, you need enough life insurance to pay people to cover those services.  A good rule-of-thumb is therefore that you should have enough term life insurance to cover 10 times your annual gross salary.  For a child care taker, you should have about $500,000 in life insurance to pay for daycare and extended care should the caretaker die.  Note that you should only buy term insurance since the high cost of whole life and other products are not worth the additional savings plan.

As a couple grows older, the kids are out and through college, and you hopefully have been following this blog and are a millionaire, the need for life insurance drops off.  If you have saved ten times the wage earner’s income and enough to pay for the child caretaker, you really don’t need life insurance anymore.  You are self-insured.  Of course, the cost is usually so low for term insurance that you may keep some anyway.

With car insurance, if you were  a millionaire and could pay for someone’s medical bills, you could self-insure.  Unfortunately, since many people who had no money wouldn’t buy insurance, everyone is now required to buy at least insurance for negligence by law.  Paying for insurance to repair your car, however, is optional.  If you have the cash to buy a car to replace yours, you probably don’t need to carry this type of coverage. Of course if the car is old this coverage will be so inexpensive it may be worth buying anyway.

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.

When Buying a House, What Do the Rich People Look?

So when you are driving through town, where do you think the rich people are?  You probably think this is a stupid question.  They are obviously living in those exclusive gated communities with the country club membership, right?  They are probably in those exclusive neighborhoods with the enormous houses and manicured lawns, right?

You may be surprised to learn that those fancy subdivisions are not where you will find the majority of rich people.  As  Thomas Stanley documents on his website, there are about three times as many millionaire families living in houses worth $300,000 or less than those living in houses worth $1 million dollars or more.

The reason lies in the mindset of the millionaire.  He or she doesn’t want to impress people with a house, car, etc….  A person who becomes rich and holds onto wealth has self-confidence and probably could care less about what anyone else thinks.  It is this personal strength that aided him or her in becoming rich.  One becomes rich by purchasing only what is needed – reducing the amount spent on wasting things (items that go down in value and waste away) like clothes, cars, food, and vacations to the minimum.  It is hard to save money away when you’re buying that expensive new car every few years to impress the people you don’t like at work.

He or she wants to hold onto wealth, and the way that is done is by investing money in things that go up in value and require little maintenance.  McMansions will go up in value, but obviously not always, as the last few years will attest.  Often the growth rate in price is about the rate of inflation.  There are only so many people in the market for McMansions, so when you are ready to sell there won’t be that many buyers, forcing you to settle for a lower price.  Well kept but modest homes are always easy to sell because there are plenty of buyers.  By purchasing a home in an established neighborhood, a history of sales prices is also available.  It is better to put the extra money in something like individual stocks that actually grow faster than inflation.

In addition, a large house involves a lot of maintenance.  Buying a large house with a large yard involves large additional costs for roof repairs, painting/siding, yard maintenance, etc….  One can add nice furnishings to a modest house and make it extremely comfortable without increasing the cost of upkeep.  If one really doesn’t need the room, why maintain it?

So who lives in those McMansions?  Probably people who have jobs that pay a lot of money, but whom spend most of it each month on the mortgage, clothes, cars, food, etc….  Search for homes in the Phoenix or Las Vegas areas and just see how many large homes in trendy subdivisions are up for short sale or foreclosure sale.  Putting most of your income into a big house in a fancy neighborhood is too big a risk and one that rich people usually don’t take.

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.