Buffett Quote Series #1

So I haven't posted in almost a month now mainly because I've been pretty busy with school work.  I thought I'd try to do a series of posts on something I've been wanting to do for a while which is talk about some of the great quotes from one person I admire greatly (along with many others), Warren Buffett.  Here is the first part of my series with two quotes I pulled.

What's Your Allocation?

Studies have shown that a very large driver of variation in returns for portfolios is derived from different asset allocations.  Focusing on having the right asset allocation can help improve your returns on investment over time and is a more reliable driver of returns than either stock picking or market timing.  There is often much debate over any "ideal" asset allocation as it differs among individuals.  I'll just go over some of the general themes and rules of thumb on how to think about asset allocation.

How to Effectively Save for Retirement

I've talked about the 401(k) and the IRA separately before, but I thought I'd do a more consolidated post comparing the two.  There are two main types of accounts that you can use to get tax advantages to save for retirement and they each come in two forms.  The two main types of accounts are 401(k)s and IRAs and the two forms are traditional and Roth.

Falling Investor Confidence

With the end of the month finalizes the DOW's worst May since 1940, dropping almost 8%.  With worries in Europe turning toward Spain recently, market volatility has increased.  Facebook's IPO disaster recently also helped reinforce investor fears in risky assets leading to more risk aversion and avoidance of stocks altogether.

Sell in May and Go Away

There is a saying in the investing community to sell in may and go away, referring to selling your stocks and staying away from the market for six months before buying back in around October or November.  The reason is that historically, the six months following May tend to underperform the six months leading up to it.  In both 2010 and 2011, the stock market peaked at the end of April and it looks like this year has been the same.  For 2012, April had been the shaky month but the S&P 500 had increased about 11% until the end of April.  And since then, the market has fallen around 6%.

Buy Fear and Sell Euphoria

I can't quite remember this quote originated, but I quite like the idea of "buying fear and selling euphoria."  It goes along with Warren Buffet's quote: "You should try to be fearful when others are greedy and greedy when others are fearful."  It essentially means when other investors worry and sell their assets in a panic, the people who buy and hold tend to do very well.  When everything is going great and people are putting all their money into the markets, those who get out tend to take advantage of the higher prices and do very well again.  This past year, the markets have been very fearful with all the volatility but those who were greedy and bought when everyone else was selling would be sitting on some gains right now.

End of the Year Losses

Merry Christmas everyone and thank you for supporting me in reading my blog.  While you open those expensive family presents you bought each other (which hopefully you have budgeted), I thought I'd end this year with an educational post about what almost everyone does near December 31st: take capital losses to offset any capital gains or some income.  The reason why you would want to offset capital gains or income is to save on taxes.

The Market

What do people mean when they talk about "the market?"  When they say the market is up 200 points, what exactly are they referring to?  If you hear this terminology, but never knew exactly what it referred to, this is the post to read.

Optionshouse: The Cheapest Way to Invest

Buying Direct

There is an alternative method to buying stocks from a broker.  Investors can try to buy stocks directly from a corporation through a DSPP (Direct Stock Purchase Plan).  For some companies, the commission that you pay is $0.  This allows investors to slowly add shares of a company to their portfolios over time without having to build up a sum of money to purchase all at once (otherwise, you'd be paying a very large percentage of your investment in commissions).  There is usually a fee to sell shares, but hopefully, the stocks you pick for buying direct are for the long-term.  Some companies do have fees to buy shares, but they are generally less than broker's depending on the company.  Most of the ones who offer a DSPP are blue chip stocks like P&G or Microsoft.  You can find a company's DSPP plan if they have one on their website under the investors tab.  Or you could probably google search it.

TradeKing Review

Have you already decided on a broker yet?  If not, let me make a recommendation for TradeKing.  As I discussed in my earlier post, when I started I went out to look at discount brokers.  I wanted to minimize the cost of commissions for trades so I first compared prices.  I'll say upfront that TradeKing is definitely not the lowest out there.  I believe Optionshouse has cheaper commissions for both stocks and options (more on this financial derivative later) but TradeKing had a better reputation of customer service as well as a referral bonus.

Your Orders, Sir?

This is going to be a very brief introduction to the types of orders you can make in order to purchase stocks and other similar securities like ETFs or mutual funds.

First off, if you look at www.google.com/finance or any other financial webpage, you can usually see the real-time (or close to real-time) prices of the stock market during trading hours (9:30am-4pm EST).  If you can imagine it, try picturing yourself walking in a supermarket.  As you go down one aisle, the stock aisle, you see all these different products and the price tags of each one changing every couple seconds by some cents.  This is kind of what the stock market is like during trading hours.  Prices fluctuate up and down.  Usually, big changes happen in between market hours so prices open (the price the stock begins the trading day with) at a much higher or lower price than the previous close (the price stocks ended yesterday's trading day).  Sometimes, when big economic reports or earnings reports come out, you can see a large spike or drop in a stock price in the middle of a trading day.

So how does this affect you?  Obviously, the price you buy or sell stock is very important.  There are several different types of orders that you can use with your broker: market, limit, stop, stop limit, market on close, and some other more complicated ones.

How To Buy Stocks?

I've talked a lot about why you should invest in stocks, especially if you are looking over a long time horizon, but you may not know too much about the process.  There are a couple ways to actually purchase stock, but I will mainly look at the primary method for most ordinary investors: a stock broker.

The two types of stock brokers are full-service brokers and discount brokers.  I am personally most familiar with discount brokers, but I will mention what I do know about full-service.  Full service brokers often charge a higher premium for their work and generally offer more in terms of research, financial advice, retirement planning, tax tips, etc.  Full service brokers include Edward Jones, Goldman Sachs, and Merrill Lynch.

Discount brokers, on the other hand, charge a much cheaper commission and offer a much simpler product.  The most important difference is the price: discount brokers are usually around 1/20th the cost of full-service brokers.  This makes them much more attractive for investors who do not want full financial planning service and instead want to just put some money into stocks, bonds, etc.  Discount brokers include TradeKing, Zecco, Optionshouse, Fidelity, and Scottrade.

The Feeling is Mutual

So you've read about why you should invest in stocks and the handy ETF security, but you're probably wondering what those mutual funds that you hear here about really are.  A mutual fund is a pool of money collected from investors and put into different stocks and other securities of different asset classes.  Sound familiar?  It should.  Mutual funds are very similar to the ETFs we just talked about.  However, instead of tracking a specific index, mutual funds are actively managed by money managers.  The main goal is to give smaller investors access to professionally managed, diversified portfolios which would be more difficult to create with a smaller amount of money.  By pooling together money from many people together, the fund makes it easier to invest it many securities.  However, students and investors should be aware of the fees that mutual funds have which often eliminate much of the gains you can make from such an investment.

The ETF

We have talked about the benefits of diversification before.  This technique should be used in your overall portfolio and within each asset class in your portfolio (meaning you should have a mix of stocks, bonds, etc. and diversification within stocks, within bonds, etc.)  If not, you might end up with the diversification they have in the cartoon.

So since we are on the topic of stocks, I am going to be introducing the exchange traded fund (ETF) which is an easy way to diversify your stock holdings.  The ETF is a security that tracks an index (a basket of different stocks or other assets) but trades like a stock.  You get the ability to buy it like a stock or short sell it and some of the advantages include lower fees than mutual funds (which we will talk about later).

What's in a Stock?

So you were convinced enough by my earlier post on why stocks to put some money in?  But you don't know what to look for in a stock?  Especially in bear markets when the economy is going down and stocks as a whole drop in price, it is important to pick good stocks.  In bull markets, it is still important but a little less so since generally stocks as a whole will go up.

There are several features that you should pay attention to when picking a stock.  These include the P/E (price over earnings) ratio, market capitalization, and return on equity.

The Short Sale

Okay, so the stock market might not be as random as this cartoon, but it does show that sometimes the market moves irrationally.  Again, I would like to reemphasize holding stocks for the long-term since most of the short-term fluctuations in price are unpredictable.  You will definitely experience a lot more volatility the first few months after purchasing a stock than when you look at time horizons of several years.

We went over last time that you can make money off the dividends and the capital appreciation of the stock.  Of course, this assumes you are purchasing a stock outright.  There are ways to make money when stocks fall as well.  I wouldn't recommend this method because of a few reasons, but it is a tool every investor should be aware of.  First of all, let's start with the basic proposition for how to make money on the change in price of stocks.

Why Stocks?

The stock market is a pretty popular place to put your money.  If you have ever seen the news, a section is usually dedicated to how the stock markets moved that day and many people have investments in various companies.  But first of all, why does the stock market exist?

Companies usually get listed on the stock exchange as a way to raise money.  Individual investors have the opportunity to give companies money in the hopes that the company is able to use that money in a solid business plan to make more money.  However, this is only in the case of an IPO (initial public offering) where a company first sells shares to investors.  During the normal day-to-day trading on the stock exchange, however, people buy or sell shares of stock to one another.  There are instances where the company may initiate a stock repurchase to buy back its shares when they think their shares are undervalued, or priced too low, but for the most part the counter-party to a trade is another investor (or fund manager, etc.).

Stocks and Bonds, What?

So you have some money saved up, probably from disciplined budgeting, and perhaps it's in your bank account.  What do you do with it now?  You are earning a little bit of interest, but you really want to see your hard-earned money grow, have it reproduce more of itself for you and take a little bit of the responsibility for your financial stability.  What can you do with it?  There are actually a lot of options available to you.

I'm fairly certain almost everyone has heard of stocks and bonds, but probably many college students don't know what they are or how to utilize them.  Please read the disclaimer at the bottom of my website as nothing I say will constitute financial advice.  I will try to state mostly facts and observations as well as give my own opinion, but if anyone reading this blog is actually thinking about putting money into any of the places I will mention, please do your own research to make sure any investments you make are right for you.  For this post though, I will be mainly defining a lot of these asset classes.

First of all, what are stocks and bonds?  First, let's look at the question of equity versus debt (stocks are a form of equity and bonds, debt).  Equity is ownership in something.  When you buy a stock, you are becoming a partial owner of the company and purchasing ownership.  Debt, on the other hand, is similar to the loans we have talked about for credit cards and banks.  When you buy bonds, you are loaning money to the entity on the other side.  If you buy government bonds, you give the government money and get a bond (a certificate that says the government owes you some amount of money) in return.

What is the difference in how these assets earn you money?  With equity, the value of your ownership depends on the performance of the company.  If you take some time to follow the stock market, you will see that it fluctuates day to day.  You can earn money through two avenues: capital appreciation of the stock (you buy the stock at one price and sell it at a higher price) or dividends (similar to interest you earn on debt).  For debt, you earn interest either when you get your principle back at the end of the term or as a stream of payments up until the end of the term.  It is kind of similar to how you pay interest on your credit card balance if you don't pay it off in full, except when you buy a bond, you are the one getting paid as the lender.

Bonds and debt securities are considered safer securities than stocks and equity because you are guaranteed your money back (depending on how reputable the bond issuer is).  Stocks do not have to guarantee a dividend and the value of a company can drop pretty steeply with some bad news.  However, with greater risk often comes greater reward, which I will discuss more in depth in my next post.