Understanding Inflation And How To Protect Yourself From Its Effects

Understanding Inflation And How To Protect Yourself From Its Effects

We almost always have some inflation, meaning wages and prices increase which helps job creation and economic growth. The absence of inflation is deflation, which means declining prices and could cause or worsen a recession as businesses lay off workers.

For years, we have had low inflation with relatively stable pricing, largely due to the Federal Reserve’s efforts.  However, the low inflation levels could change as our economy rebounds from the pandemic. To find higher rates, you have to go back to 1990 when inflation was 6.1%. Double-digit inflation was more common in the 1970s, with its peak at 13.3% in 1979.

The Federal Reserve’s Monetary Policy’s Actions

The Federal Reserve has dual goals: maintaining relative pricing stability and sustainable economic growth with full employment. In the Great Recession and in March 2020, due to the pandemic-related economic downturn, the Fed steered towards accommodative monetary action to drop their fed funds rates to the lowest levels of zero-to 0.025% to stimulate the economy. 

Chair Powell and the Fed intend to keep interest rates low through 2022 and have said they would be more tolerant of inflation rates that exceeded their 2% target. There is a reasonable possibility that we will see higher inflation soon.

Will The Fed Stick With Their Accommodative Policy?

Despite their intentions to stay with an accommodate policy, the Fed’s policy mandate is to adjust their stance to changing information. The 10-year Treasury note’s yield has been rising and could signal higher inflation expectations. The Fed has tools to combat high inflation such as raising interest rates. 

It is not clear if the Fed will change gears but we can prepare ourselves. Should inflation increase to moderate levels above 2%, there are ways to protect ourselves from the potential erosion of our money. Moderate inflation may provide some benefits. You need some level of inflation to promote more spending.

Reasons Why We May See Higher Inflation

  • The Fed intends to remain accommodative for a while, with lower rates and liquidity.
  •  A potential $1.9 trillion fiscal support for those businesses and households in need is on the table.
  • The number of people getting vaccinated is rising, which may help boost the economy.
  • We are saving more with the latest US personal savings rate remaining high at 13.7%, about twice the rate seen in 2019.
  • Credit card balances at the end of 2020 reflect the largest yearly decline since 1999, reflects consumer spending is down.

These factors, if combined, may unleash consumer spending to kick up our economy and contribute to higher inflation. Offsetting these factors is high unemployment levels staying stubbornly high and may keep inflation low for now.

With low inflation, it has been difficult for anyone to earn any income in a low-yielding environment without taking on more investment risk. For investors with 60/40 retirement portfolios investing in stocks and bonds, respectively, some have shifted more significant proportion into stocks.

Investors will need to seek assets that are at least keeping pace with rising inflation. Holding cash in savings and checking accounts are suitable for liquidity purposes.  However, their safety feature will diminish as their values erode with rising inflation.  Later on, we have a list of investments that can protect you during a higher inflationary environment.

What Is Inflation And How Does It Affect Your Buying Power?

The definition of inflation is a steady rise in the general level of prices of goods and services. For example,  a gallon of milk cost $1.57 in 1975 rising to $2.20 in 1985 as a result of high inflation in the 1970s to early 1980s. It now costs $3.61 in 2021. The changes in prices are due to inflation, not scarcity. 

As a result of inflation, your purchasing power, the amount of goods and services that one’s income will buy, goes down. When prices rise, purchasing power declines, usually falling by the reciprocal amount of the price increase. Your paycheck may stay flat or go up more slowly, leaving you with less money. Union members may be an exception as they receive a cost of living wages as part of their contract.  

Calculating of Inflation

The US Bureau of Labor Statistics calculates inflation monthly using the consumer price index (CPI). The CPI is the best measurement of changes in prices of all goods and services purchased for consumption in urban households. This index tracks a market basket of food, transportation, housing, health care, and entertainment, broken down into over 400 subcategories bought by end-users.

The CPI is a cost of living index with a starting reference point from 1982-1984 as the base period of 100. The CPI for January 2021 was 261 reported on February 10, 2021, the cost of living would have risen 161% since the base period [(261-100)/100= 1.61 of 161%]. If car prices rose 15% over the past five years, you may be paying $34,500 for a car that had cost $30,000 ($30,000 x 1.15%).

Economists tend to look at sequential (quarter-quarter) or year-to-year changes in the CPI. The most recent sequential rise in January increased by 0.3%, and up 1.4% since a year ago. These price increases confirm the low inflation we have had since the Great Recession began in 2007.

The Purchase Pricing Index, or PPI, is similar to the CPI but measures wholesale prices from raw material through the production stages. When PPI rises, the higher costs often are passed on to consumers.

Low inflation has stymied returns from the low inflation environment from low-risk income-based investment portfolios as we discussed here..

What Contributes To Inflation?

There are various factors that may influence inflation.

Higher Demand

Demand-pull inflation occurs when total demand for goods and services in an economy outpaces supply. In the early 1970s, a strong economy caused oil prices to rise and pushed up inflation to 12% in 1974. Strong consumer demand for goods and services could result in higher spending leading to higher inflation.

Increase In Production Costs

A different way of rising prices than demand-pull can come from increases in production costs without higher demand is known as cost-push inflation. Higher production costs can come through increased wages, raw materials, depletion of natural resources, droughts, or higher taxes. Businesses are not always able to pass these higher costs onto consumers.

There have been conflicting views on whether raising the federal minimum wage to $15 per hour would cause inflation. One side of the argument points to wage hikes which have been slow to come for many employees, and therefore, increases are overdue. Wage growth often leads to a more robust economy.

However, the pandemic-related recession has caused high unemployment that has crippled many small businesses. Many believe that we should have an improved economy and higher employment before raising wages.

Natural Disaster Shortages 

Prices can rise when shortages in goods and services associated with natural disasters such as severe weather conditions, droughts, floods, fires, or avian flu. These disasters impact manufacturing plants, businesses, and residential areas. These unpredictable events may put temporary or long-term pressures on the production of goods, causing inflation due to scarcity.

In 2010, British Petroleum’s oil spill was the largest marine disaster in the Gulf of Mexico, causing higher gas and seafood prices. This area accounted for one-third of all seafood consumed in the US. About 40% of the Gulf waters needed to be closed to commercial and recreational fishing due to the spill.

Government Overspending

The US budget deficit has been rising from already high levels since the pandemic to counter the economic downturn. A government budget deficit occurs when expenses outpace revenues, not unlike the household budget.

Multiple fiscal stimulus packages related to hardships caused by the pandemic have been essential to provide funds to businesses and unemployed workers. This boost to government spending has required the US Treasury to raise capital and increase money creation by printing money. Both US Treasury and the Federal Reserve have increased money supply to increase liquidity and keep the financial markets calm, but a higher money supply typically leads to higher inflation.

Higher Prices From Higher Demand Post-Pandemic 

Many businesses lost revenues during the pandemic because of social distancing needs. As more people are vaccinated, our economy may rebound from strong demand in travel, entertainment, dining out, and going about life more normally. We may see some prices go up with increased demand and pressure to recoup lost revenues.

Different Kinds of Inflation

The various forms of inflation that are most worrisome are stagflation, deflation, and hyperinflation.

Deflation

Deflation is when there is an overall decrease in the cost of the economy’s goods and services. When price declines are minimal, consumers may spend more. When deflation is more pronounced, we may demand less, expecting more price declines. Businesses, anticipating lower spending, will cut production to prevent swelling inventories, and layoffs may result.

This deflationary scenario is considered the opposite of inflation and its evil twin. The Federal Reserve uses a 2% inflation target as part of its monetary policy, preferring low inflation to deflation. Deflation can send an economy into a recession or a worse downturn, causing layoffs.

Stagflation

Stagflation refers to a stagnant economy reflected in high unemployment and high inflation simultaneously. This problematic situation, spurred by an oil shock, lasted from the early 1970s into the early 1980s and was challenging to resolve. 

Hyperinflation

Hyperinflation has not been around for a while. The closest the US experienced hyperinflation was during the Civil War, and I think that is where everyone wants to see it, that is, in history. Between 1921 and 1923, the Weimar Republic, Germany’s government, experienced hyperinflation rising over 300%!

Relationship Between Inflation And Interest Rates

Inflation and interest rates are not the same thing, but they relate to each other. There is a tendency for interest rates and inflation to have an inverse relationship. When interest rates are low, it stimulates economic activity, and inflation rises. But, when interest rates are high, consumers slow spending, the economy slows, and inflation declines. It takes time for the economic changes to take place.  

Investing For Protection From Inflation

As an investor, you should have a better understanding of inflation so that you can protect yourself from its effects. Some investments keep better pace with rising inflation than others. Real or physical assets often appreciate at or faster than inflation, and can provide better returns for investors. It is helpful when investing to understand the economy as we discuss here.

Money Market Securities

Cash and cash-equivalent securities make poor investments in a low-yielding environment. However, when inflation rises, the annual percentage yield (APY) will increase. Seniors have been clamoring for 5% CD yields which do not currently exist. Should inflation rise to higher levels, having cash to investing in money market accounts that are FDIC-insured will be a desirable place.

Build CD Ladders

The six-month CD rate hit a high of over 17% in March 1980 when inflation was 14.8%. I don’t think anyone wants to see inflation reach those levels or expects inflation of that magnitude. However, you can build a CD ladder to take advantage of rising APYs offered by the banks and credit unions.

You can start with short-term periods such as three or six-month CDs as inflation rises, lengthening their maturities as high inflation stabilizes, locking in nice returns. CDs are a less risky way to earn higher returns, especially if inflation is over 5%.

TIPS And Other inflation-indexed Bonds

Currently, bonds at fixed rates do not yield meaningful returns. However, bonds with variable rates are worthwhile investments in rising inflationary environments.

Treasury Inflation-Protected Securities, or TIPS, are issued and backed by the full faith of the US Government. They are considered the safest security, most liquid,  and rated AAA for the highest quality. Holders receive interest income twice per year at a fixed rate. These securities are an excellent way to diversify your portfolio for the least risk among other inflation hedges.

As inflation-protected securities, TIPs provide investors with a guaranteed real rate of return. The principal of TIPS increases with inflation and decreases with deflation measured by the CPI. At maturity, you are either paid the adjusted or original principal, whichever is greater. Like all Treasury securities, TIPs are exempt from state and local taxes.

Municipal Inflation-Linked Bonds

 Like TIPS, investors can buy municipal (munis) inflation-linked securities that track CPI and adjust the bond’s principal. These securities can keep pace with inflation better than a municipal bond without this feature.

Compared to TIPS, munis do not have backing from the federal government, are less liquid, and its ratings vary by municipality.  Funding purposes are to build roads, schools, airports, or infrastructure projects. To offset its higher risks, holders of muni bonds are tax-exempt from federal income taxes.

Corporate Inflation-Linked Bonds

Corporate bonds may have inflation-linked features, similar to the other bonds, adjusting to the CPI changes to better pace with higher prices. These securities tend to have higher risks that vary by the quality of the corporation. These bonds are less liquid than Treasury securities (every investment is!) and don’t have any tax-exemption benefits for their holders like Treasuries or municipal securities.

Variable-rate bonds have floating interest rates for coupon payments. Municipal and corporate bonds may have this variable feature that is adjusted to the current money market rate for their interest rate.

Gold

Gold is an inflation hedge and offers diversification for any investment portfolio. As a physical asset, gold is in limited supply. Central banks own gold in their portfolios as part of their foreign exchange reserves.

Gold prices were up 25% in 2020, among the best-performing assets. You can buy gold in its physical form as bars or coins. Typically, gold doesn’t pay dividends. However, some gold mining stocks pay dividends (e.g., Newmont and Barrick) individually,  as gold miner ETFs or SPDR Gold Shares or GLD, the bullion is in a fund.

Silver is an inflation hedge with a lower price point, attractive for retail investors.

Commodities

Commodities are not just pork bellies. As an inflation hedge, it is a broad group with many different products you earn and store. There are three main categories:

  •  Agriculture commodities include food, meat, timber, and cotton.
  • Energy has crude oil and its refined products.
  • Metals categories are largely precious metals and industrial metals.

As the price of the commodity rises, the product that contains the commodity will likely rise. When aluminum or steel prices rise, manufacturers may pass on the higher costs to consumers.

Real Estate Investment Trust or REITs

Real estate property makes excellent investments when inflation rises, but it may require work to maintain. A REIT is a company that owns and operates income-producing real estate. There are many different REITs for equity, retail mortgage, health care or hospitals, and data storage, providing diversification for any portfolio.

They generate stable income from above-average dividend yields. That’s because REITs are required to distribute at least 90% of their taxable income to shareholders annually.

Common Stocks

Stocks, as an asset class, have historically provided returns that beat inflation. They are a sturdy investment for the 60/40 investment portfolio, with inflation-indexed bonds likely to do better when there is higher inflation.

Certain sectors may perform better than others. Energy stocks, much like the commodity itself, are often inflation hedges. Financial stocks earn better income margins on loans in times of inflation, and healthcare insurers have performed better when higher inflation appears.

We already mentioned REITs and gold stocks as a worthy area to invest in if inflation rises. Let’s add Dividend Aristocrat companies for inflation protection. They are represented by stocks that raise their dividends consistently for at least 25 consecutive years. There are different stocks in various sectors and are available as ETFs.

Another way to invest in stocks is to buy the S&P 500 index as a fund or ETF for inflation protection and diversification. If you choose to purchase stocks individually or as a sector, you may want to avoid utilities, consumer discretionary stocks, or companies with debt-laden balance sheets, like United Rentals.

Final Thoughts

Many are suggesting that higher inflation is on the horizon over the next few years. That may be as we haven’t had meaningful inflation since 1991. Higher inflation, so long as we don’t have stagflation or hyperinflation, is manageable. There are several investments that are attractive as inflation hedges for protection.

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7 Deadly Sins Of Investing And How To Avoid Them

7 Deadly Sins Of Investing And How To Avoid Them

In Seven, the neo-noir thriller, detectives David Mills and William Somerset (played by Brad Pitt and Morgan Freeman) track down a serial killer who uses the seven deadly sins as a motif in his murders. Investing may not be as lethal as a serial murderer. Here, we discuss the seven deadly sins of investing,  how they may impact our stock performance through destructive mistakes, and how we can avoid them.

What Is Investing?

Investing is a way to potentially grow the amount of money you have. The goal of making investments is to buy financial securities and hopefully sell them at a higher price in the future than what you initially paid. A saver can become an investor by giving your money a chance to work for you.

Investing is the best path to achieve wealth but it’s not a straight road. Unlike saving, investing involve some risks that could cause you to lose money.  You need to understand these hazards so you may be able to mitigate them. Investors purchase stocks and bonds with long term goals, unlike traders who have short term plans.

We can lose money when investing leads to emotional behavior or bad habits. Start investing as early as you can so you can earn money on top of the money you already earned, called compounding returns. Stay focused and purposeful so you can avoid behavioral biases which often play a detrimental role. Using financial discipline when investing can help you to achieve success

The seven deadly sins passed down from the Catholic Church of the Middle Ages may cause investors to perform poorly as modern examples for each deadly sin. The seven deadly sins are lust, gluttony, greed, sloth, wrath, envy, and pride.

1. Lust

When thinking of this deadly sin, I can’t help thinking about Jordan Belfort, better known as The Wolf of Wall Street. Belfort, or what we see of him, nearly defines every deadly sin. For that reason, he and the movie based on his memoir is pure entertainment and instructive for those who lust after sex and money.

As the first deadly sin, lust is a strong craving or intense longing such as sexual desire. It can also mean hunger for money. From an investor’s point of view, falling in love with your investments can be hazardous. Heavily favoring one stock may result in too much concentration risk in your portfolio.

Overexposure To One Stock Poses Concentration Risk

Take the example of Gur Huberman’s “Familiarity Breeds Investment” study in 2001, which involves ATT’s (“Ma Bell”)1984 breakup. When ATT split into the 7 Baby Bells, its shareholders received equal amounts in each new company.

Huberman found investors tended to retain a disproportionate amount of shares in their local Bell company. These individual investors held as much as $10K-$20K of a single stock, a higher concentration than the typical stock holding in a US household’s net worth.

Overexposure to one stock poses more significant risks to your portfolio that can sneak on you from slowing fundamentals. Investing in the company you work for is common for many people. However, if you have substantial ownership of shares where you work for and in your investment and retirement accounts, you have too many eggs in one basket. Instead, you need to diversify your portfolio with different stocks, industries, and asset classes.

2. Gluttony

Gluttony is the overconsumption of eating and drinking. We have all been there, gorging ourselves over an excellent meal, and feel our regrets afterward. Dante refers to this sin as “excessive love of pleasure.” We may be engaging in gluttony by overindulging our funds into less liquid investments without leaving a cash balance to buy stocks in a correction or pay off debt.

The recent excessive trading of GameStop shares by retail traders to shake up Wall Street seemed to be foolhardy, if not reckless. Sending that stock into the stratosphere caught everyone’s attention before coming back to earth but may have been costly.

Diversification, Asset Allocation, and Rebalancing

Alternatively, some people hoard their cash in a savings account, which generates little interest income, especially in this low rate environment. Investors need to be careful in allocating money into investments and having funds for emergencies, debt pay-offs, and retirement.

The antidote to gluttony is purposefully investing with strategies that embrace diversification, asset allocation, and periodic rebalancing.

3. Greed

“My name is Jordan Belfort. The year I turned 26, I made 49 million dollars, which really pissed me off because it was three million a week.”

The Wolf of Wall Street

“Greed is good…Greed, in all its forms, greed for life, for money, for love, knowledge, has marked the upward surge in mankind and greed.”

Gordon Gekko, Wall Street, the movie

Greed is not good, but it is very prevalent in the world of investing. The Wall Street (“the Street”) culture is all-consuming. It breeds greed and the need to make more than the person next to you. Not everyone working on the Street is greedy, or a criminal but temptations are there as they are everywhere.

The definition of greed as a sin is an intense and selfish desire for something of value, referring to wealth, material possessions, power, or food. Trendy investments are often collective greed that may become long term losers. Stock manias reflect “irrational exuberance,” a phrase used by then-Federal Reserve Chair Alan Greenspan when he commented on stock’s higher asset values than fundamentals warrant.

Bubble manias of the past–Dutch tulips, South Sea, Japan’s real estate and stocks, dot-coms, housing– should provide historical context to fear and greed in today’s markets. We hear about overbought markets but justify our purchases in SPACs, bitcoin, Tesla, Nio, so we aren’t left out of some of the apparent winners.

Lock-In Some Profits

How can we better deal with our greed, so we don’t become a casualty of fickle markets? No one gets hurt taking some profits off the table. I sell a small percentage of my gains regularly, usually, after a stock rises 20%-25%. This way, I may avoid my winners blowing up, an experience I have in my past.

Recognizing the need to be rational when investing is essential. It means doing your research, or if you feel you don’t have the time, are too emotional, or don’t have the inclination, you may be better off finding a financial professional to advise you in your best interests.

Take heed from another respected investor, Warren Buffett, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” There is a Fear and Greed Index (FGI) that measures investor sentiment for those opposing emotions daily, weekly, monthly, and annually. Too much fear can send stocks down, while greed indication may push stocks up.

4. Sloth

Why do they have to pick on this cute animal known for moving slowly and spending most of its time upside down in trees? As a deadly sin, sloth translates to an absence of interest or not exerting oneself physically or mentally. Said another way, it is the avoidance of hard work and perseverance, or simply laziness.

We can usually spot sloths who are lazy about physical exercise. However, investing requires cognition or understanding of what you are doing with your money. 

Laziness can hurt you when you are jumping into stocks without rhyme or reason. A slothful investor may under-invest or spend too little time reviewing one’s portfolio. Investing is not a “set it and forget it” activity. Investors may mistake the buy and hold strategy as akin to that. The buy and hold strategy means that you have a long-term perspective, but you need to adjust your portfolio for new or changing information.

Be Aware of Biases At Work

Making investments requires research. Even if you are planning to use a financial advisor, research is necessary. You still need to find a person or team that works to understand your financial goals to work with you on your financial plan.

Slothful people may be prone to procrastinate over making decisions. The status quo bias occurs when someone may be resistant to change. The endowment effect is similar, but it occurs when someone places a higher value on what they already have. Shortly after my parents passed away,  I inherited stocks, such as ATT and IBM, conservative names appropriate for their portfolio but not necessarily mine. Yet, I held on to their stock picks as an example of an emotional bond that was irrational.

How To Avoid A Slothful Nature?

If you intend to monitor your portfolio, recognize the need to be proactive in having diversification, taking some profits, and making adjustments as warranted based on changing company fundamentals. There are many different kinds of low-cost index funds that have other purposes of fitting your investment strategies. For example, you may look at target-date index funds that may appropriately adjust holdings based on your age.

Automation

You can automate your paycheck by allocating a certain amount or percentage to go into retirement savings, so you don’t have to remember to contribute to this account regularly. It is essential to use your paycheck to make it easy to make investments, save money, and pay bills.

Consider talking to a financial planner to help you with your financial goals and make investments for you.

5. Wrath

“Heeere’s Johnny!”

Jack Torrance, off-season caretaker in The Shining

There are many images of wrath, but Jack Nicholson’s character comes to mind. Wrath is defined as uncontrolled feelings of anger, rage, vengeful, and even hatred. Jim Cramer’s very rational rant in 2007 (and transcript) as the financial crisis was unfolding, but the Fed Chair was not yet cutting the fed funds rate or adding liquidity to the markets.

When the stock market becomes volatile as it did during 2007-2009 and in March 2020, we have wrathful states that pose dangers for any investor. We become angry at bad decisions for keeping stocks too long or selling them too fast as many jumped to do as the stocks sold off in March in the shortest bear market in memory.

GameStop As An Example of Irrational Buying

Retail traders who may lack experience may seek greater risk than they can handle and make irrational buying decisions.  We saw some recklessness as buyers were bidding GameStop shares up to crazy prices beyond their poor fundamentals.

It seemed as though traders were trying to punish short-sellers such as hedge funds by engaging in combat. Stories of young investors who took out costly loans to buy shares at exorbitant prices are heartbreaking. We wrote a letter to young investors you can read here.

Studies suggest that anger may increase our risk-taking. Don’t be reckless and engage in using leverage like margin trading.

Avoid anger and other emotions when making investments. The market doesn’t hold grudges, know how to be vindictive, or have a memory from day-to-day.  Investors need to make adjustments for changing circumstances.

Learn From Mistakes And Use Discipline

Learn from your mistakes to not sell as the market is plummeting unless you need liquidity. Stay rational by not impulsively trading or investing. Give yourself some discipline by selling a losing stock after it drops 7%-8% to avoid a more significant loss. Consider taking some profits off the table to lock in those gains.

6. Envy

Have you ever felt envious? Of course, you have. Envy is a feeling of resentful longing often brought on by someone else’s possessions, better standing, or luck. Envy often leads to conspicuous consumption to match those around them at work or in the neighborhood. The phrase “keeping up with the Jones” may mean buying a new car or a boat to fit in with other people around you.

Investing circles may envy those who are “killing in the market” when they share their wins in the most trendy stocks or funds. What they may not be telling you is about the mistakes they have made in the past. At one time, people envied Bernie Madoff’s clients for above-average returns, and we know how that movie ended.

Herd Mentality Bias

Merrill Lynch may still refer to its financial advisors as its “thundering herd,” but following or copying the herd is a negative sentiment. In behavioral finance, herd mentality bias refers to the investors’ tendency to follow what other investors are doing in the market.

Think of dot-coms, GameStop, or popular acronyms for groups of stocks such as “FAANG,” standing for Facebook, Amazon, Apple, Netflix, and Google, before it changed its name to Alphabet.

It is not always the wrong move for individual investors to buy rising stocks that reflect heavy trading volume. Sometimes that is a healthy indicator of institutional buying, and it is painful to go against the smart money crowd. However, it will financially hurt when large investors start shedding stocks in their portfolios.

Don’t Chase Hot IPOs

Individual investors, who typically do not have access to new issues, often seek the hot IPOs after pricing in the primary market. The average first-day pop in the post-IPO stock is 20%, but hot names have shot up 80%-100% or more. Six months later, many of these stocks have fallen below their IPO price as the aura on these stocks is gone, a casualty to weaker fundamentals than expected.

Instead of being envious, learn about investing, risks, and develop strategies that work for you. Remember that Madoff’s returns were fictitious. It is in our nature to compare ourselves with others. However, you cannot be sure that you are looking at anyone’s full picture. Don’t waste your energy on envy.

7. Pride

“Details of your incompetence do not interest me.”

Miranda Priestly, The Devil Wears Prada

Pride or extreme pride is hubris, a Greek cousin to pride. Hubris means self-confidence, arrogance, and corrupt selfishness. One who has hubris irrationally believes they are better, superior and has excessive admiration of their self-image. Having this kind of pride is a self-destructive vice, especially harmful when you are an investor.

It is hard to work for someone like Meryl Streep’s Miranda Priestly, who always desires to be right. As an investor, the need to be right can hurt your ability to make money.

You may hold on to a losing stock and an unrealized loss rather than admit you are wrong. The justification for holding on to the stock is that it is only a loss on paper until you sell it. However, a 10% unrealized loss can widen if fundamentals warrant it. Loss aversion bias is the tendency to prefer avoiding losses to acquiring gains.

Overconfidence Bias

Another bias is overconfidence, which means having an egotistical belief in your investing acumen. It is challenging to perform better than the market averages, but those who are overconfident tend to operate with the false comfort they can perform well.

Instead, having a fear of being wrong in many investing situations can help you stay on your toes. The best investors avoid overconfidence and consider worst-case scenarios as medicine to remain aware of downsides in the market. They recognize that there is much that you cannot control about the market.

Avoiding The 7 Deadly Sins With These Investing Rules

To recap some of the ways you can avoid the investing pitfalls associated with the seven deadly sins:

Avoid concentration risk by diversifying your portfolio and do asset rebalancing.

Be aware of the emotions and behavioral biases that impact our decisions.

Don’t dump stocks during times of market turbulence.

Buying hot IPOs post-pricing is not a good idea, as there will be a better time and price to do so. 

No one gets hurt taking profits off the table to lock in gains.

Don’t engage in reckless strategies such as short-selling or using leverage to buy stocks.

Use automation to move money more quickly from your paycheck to contribute to your savings, retirement, and investment.

 

Final Thoughts

When investing, you may have run into the seven deadly sins that can impact your performance. Counter each sin, often wrapped in emotion or biases, with purposeful investing to avoid common mistakes.

Thank you for reading! If you found some value in this article, please share it with others. Consider joining The Cents of Money community by subscribing and getting our weekly newsletter.

 

 

 

Money Isn’t Everything! These Values Matter

Money Isn’t Everything! These Values Matter

According to my grandmother, “Poor or rich, money is good to have.” We need money to pay our living expenses and support who and what we care about most. Raising a family or taking care of our parents requires funds for health care, education, and the opportunity to enjoy the beauty of life. It can help us make a difference in the lives of others through giving.

Without money to pay our bills or invest, we may fall short of achieving our life’s goals and having financial security, independence, and freedom.

Money Isn’t Everything!

Money isn’t everything. It has its limitations. Obsession over money and wealth is unhealthy, mainly when it controls your life. It may prevent us from ever being satisfied with our life by continually needing to compare ourselves to others. Money matters because it is the tool we need in the absence of bartering. However, many things are more valuable and can help us achieve our full potential. Focus on those values that make you content. Review the values listed on Maslow’s hierarchy of needs. Self-actualization is the pinnacle of our self-fulfillment needs.

As individuals, we each have our list of personal values that give meaning to our lives. These values shape our personality, behavior, and attitudes. How often do we reflect on those traits that make us who we are? It is an excellent exercise to do to make sure you are going in the right direction. Since we serve as role models for our children, we need to be sure we send the signals we want them to see. They are worthy of us doing a check on our values and beliefs, which make us tick.

What We Value, Besides Money

 

1. Time Is A Precious Resource

Time is money, but it is so much more. If there is inequality in money and wealth, we have the same limited time. You can’t borrow or lend time at any cost. Anyone who loses family and friends knows the tragedy of time running out.

You can’t buy time unless you can pay someone to do a task for you, which may temporarily free you to do other things. But you can’t buy time in a permanent sense, no matter how much money you have.

Time is our most precious resource. As such, spend your time with people you most enjoy being with or doing what you most desire. Don’t waste your time; use it in productive ways.  Think in terms of daily accomplishments and whether you have achieved what you wanted to do. Like money, invest your time meaningfully. Find ways how to improve your time management skills here.

2. Manage Your Energy Wisely

Somewhat related to time is how we manage our energy. Energy affects our physical, mental, emotional, and spiritual well-being. We all have limits to what our mind and body can do. What is personal energy or power? It is the amount of effort or strength you are willing to devote to people, things, or challenges in your life.

There are people in our lives who are delightful. We get a good boost from spending our time and energy with them. Other people may deplete our energy through negative behavior or attitudes. In this challenging year, the pandemic has weighed on our lives by making it difficult to see our friends and families. We may have saved time and energy by working remotely, but we lost the uplift from seeing people in the office. Indeed, driving to work may give us the power of the bridge, separating our home from our jobs.

3. Your Health Is Our Vital Asset

We can’t take our health–physical, mental, and emotional-for granted. Yet, we often do this by not taking as good care of our body and mind as we can.  What is your health worth? Like time, it is priceless and precious. Eating healthy, daily exercising, and getting a good night’s sleep shouldn’t be hard to do. They are good habits to incorporate into your mindset. Even short daily movements have helped me loosen up considerably.

Recently, I complained to a friend about being more stressed about more things lately. He recommended several meditation sessions to try out. A few of the sessions were particularly helpful, so I work on those. Changing up your routine with good habits can be stimulating. 

I look forward to reading at night, playing music that fits my mood, and understanding my emotions better.

4. Family,  Friends, And Community

“First be a person who needs people. People who need people are the luckiest people in the world.”

Bob Merrill, lyricist Sung by Barbra Streisand

We need our family and friends for their love, affection, companionship, and to validate us. I come from a tiny family where friends were family and family were friends. The pandemic experience has required us to social distance for safety reasons. However, we have grown tired of this pandemic and staying apart from people we love. Human beings just don’t enjoy isolation. We thrive when we are with other people who are essential in our lives. They contribute to our sense of belonging, comfort, and self-worth and add to our lives’ meaning.

Community And Colleagues

Apart from family and friends, it is your community and your neighbors. Community is where you live and your colleagues at work. Work and community are spheres where you may meet new friends. We recently moved from a big city to a small town. We changed communities just before the pandemic is the ideal time for you to meet new friends. Our kids are fortunate to have met and formed relationships with good friends when they were at school. Those relationships have carried over to online and social media.

5. The Right Life Partner

Choosing the right partner you want to spend your life with is easier said than done. Only after years together can you look back and say you are fortunate to find someone to be with until you are old and gray. When you are in your 20s, how do you know if you both have the same interests, intellect, and standards?

You don’t. However, by loving one another and finding someone with who you can connect easily, learn from, trust, respect, and grow, you have the making of the right life partner.

My Life Partner

Speaking of myself, Craig and I connected instantly in what feels like a lifetime ago. We have similar interests, enjoy each other’s company. Challenges are in every relationship but knowing how to deal with each of them matters. Craig has always been my incredible support, and we both learn from each other when we have different interests or opinions. I feel lucky that we have built a tremendous enduring bond that has remained strong through the high demands of having active teens and two dogs.

6. The Virtues of Work

“Choose a job you enjoy doing, and you will never have to work a day in your life.”

Mark Twain

It has been my great fortune to find meaningful work most of my career. Every individual should explore what kind of work they most enjoy doing. For some, it is working with their hands to craft a tangible product. Many feel rewarded by helping others, while a significant number prefer making lots of money to afford a luxury lifestyle. To each, their own goals and road to success.

I have always found challenging work to be enterprising and energizing. Working has allowed me to grow my knowledge and skills outside of my home. With so many people unemployed these days, I feel blessed to have a job that will enable me to teach remotely. The virtues of working are plentiful. Work adds meaningful dimensions to your life besides compensation. I have learned new skills, expanding my knowledge, cultivating my career and reputation. Read more on the virtues of work here. 

7. Love of Learning

“Anyone who stops learning is old, whether at twenty or eighty. Anyone who keeps learning stays young.”

Henry Ford

By being a lifelong learner, you can look at the world with fresh eyes. Learning can be formal, informal, or casual. You don’t have to learn in the classroom to pick up knowledge. Most of our education comes from outside of an academic setting. Picking up new information or realizing an original thought can give new highs and optimism. Whether you are learning for a career, hobby, or personal growth, never stop learning. There are only benefits to be found in lifelong learning.

Keep your brain healthy by find activities you enjoy and challenge yourself. There are so many resources and ways to learn. I have overcome some of my anxiety by improving how to cook, updating my tech skills, working on crossword puzzles, writing better, reading books I may have shied away from, and more. Chess is one of those games that I have genuinely wanted to learn how to play.

The Queen’s Gambit

I was fascinated by watching The Queen’s Gambit recently. Netflix’s series is a story of an orphan, Beth Harmon, who aspires to play chess in the male-oriented competitive world of the 1950s and 1960s. I played chess (poorly) with anyone who would play with me (only my brother) when I was in grade school. However, I would watch these intense chess players while strolling through Washington Square Park in New York City. It was so cool! Playing chess may have eluded me, but it has always sparked my interest in learning.

8. Protect Your Reputation

“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”

Warren Buffett

Buffett’s quote on reputation is priceless. Your reputation is your brand, whether it is for a business or you. I cannot understate the importance of how you are regarded by your social circles, at work, and in your family. Reputation is your character and quality as judged by people. It forms the basis of respect and the currency of your worth. Cultivate traits like honesty, integrity, honor, and strong morals that should be in the workplace and your life. Manage your online presence for the quality of your character you are conveying.

The ruin of your reputation usually comes more quickly and efficiently than its establishment. It can be due to a lapse of ethical conduct or doing something legally questionable. Don’t post on social media without considering potential negative ramifications.

Rule of Thumb For Questionable Posts

If you are unsure, use the rule of thumb for questionable posts. That means first considering what others–friends, family, colleagues, your current or future employers–may think.

Words, photos, videos, or anything that are reflections of you and your values may last in cyberspace for all time. Protect your reputation carefully but not at all costs, which may make it harder to restore. Even now, you may already have some questionable items that may cause harm to you in the future. For example, you may want to pull that drinking contest you won with a trophy filled with bourbon, even if it is a relic of your past.

9. Experiences Over Possessions

Having experiences top buying things most of the time for me. Unique experiences tend to be more memorable and pleasurable. Traveling by camel in the desert, ziplining, and whitewater rafting bring tremendous rushes to our adrenaline. 

Studies have shown experiences bring people more happiness than do possessions. In their 2014 study, psychologists Matthew A. Killingsworth and Thomas Gilovich found it wasn’t just the experiential purchases (money spent on doing) that provided more joy than material possessions (money spent on having). The joy of waiting in line for the experience gave participants enduring pleasure as well as consumption. Millennials are known for their preference for spending on experiences, but boomers also favored experiences in this study. 

In a 2018 study with the Center For Generational Kinetics, Expedia found 74% of Americans prioritize experiences over products. Travel tops the list of experiences that make us happy the most. Of course, these results were before the pandemic when we were able to take trips. As a result of the pandemic, experiential purchases such as traveling, concerts, and movies, have declined. No doubt, the experience economy and sharing it with others has suffered as well.

10. Find Your Passions

Passion is a powerful emotion defined as a strong feeling of enthusiasm or excitement about doing something. Your passionate interests maybe those areas of topics, skills, or activities that excite you. Being passionate is often beyond a mere interest in something and can be an internal energy source. Like experiences, you are more engaged and engrossed in the activity or learning more about it.

Finding your passion in your job or career can motivate you to improve your performance. You don’t need to work in a position that directly aligns with your interests, but there could be an overlap between your work and other activities. Being excited about interests outside of work has its benefits. It allows you to develop new skills, meet new people, and expand your personal growth in a more balanced way.

For many years, I collected coins as a hobby, starting with Indian Head pennies, which led to my interest in the history of Native Americans, which I still am engrossed in today. Later, my husband and I became serious collectors of 18th Century American furniture and art, learning about American history.   I am always fascinated to know what passions other people have in their lives.

11. Gratitude and Empathy

“He who receives a benefit with gratitude repays the first installment on his debt.”

Seneca

Expressing our thanks to all those we love and appreciate can help us live better lives—both the givers and the receivers of our gratitude experience many advantages. Our happiness rises, we feel healthier, stress declines, and it helps us cope with a range of negative emotions. Gratitude is our moral barometer and, when genuinely given, boosts our energy. Expressing gratitude is good for our finances as well.

Gratitude has been studied extensively in the past two decades. As such, gratitude is a “gateway’ to other positive emotions– joy, pride, motivation, and wonder.

A Shared Role In Our Brain

Gratitude is on par with empathy. Empathy, a relatively new term, is defined as the ability to understand and share another’s feelings. Having the ability to understand and share the feelings of another is empathetic. Scientists have linked gratitude and empathy because there is an exact role played by each in the medial prefrontal cortex  (MPFC) part of the brain. That part of the brain helps people set and achieve goals and contributes to a wide area of functions.

Feeling grateful and empathic are enduring values that produce benefits for the giver and receiver.

12. Financial Security

Sooner or later, I wanted to get back to money as the value we share with those mentioned earlier. Achieving financial security provides peace of mind when your income can cover your expenses; after having saved for emergencies and your retirement. Financial security requires adopting good habits that can support your lifestyle while you work toward financial goals. Becoming financially secure means not worrying about credit card debt because you pay your bills in full and will not pay interest charges. 

The importance of feeling financially secure allows you to have flexibility and freedom to control your life. Financial security means different things for different people. For me, it means working at a job for less pay but feels more rewarding when teaching college students. I feel fulfilled at the prospect of sharing what I know with others. Being able to schedule my time better helps me to face the needs of my family better.

Final Thoughts

Money isn’t everything, but it matters when you don’t have enough to pay your bills. Besides money, there is much to value in our life. We should protect, honor, cherish and nurture these values for giving meaning to our lives.

Thank you for reading! If you found this of interest, please share it with others. Consider subscribing to The Cents of Money and receive our weekly newsletter.

 

 

 

 

 

 

A Letter To Young Investors On This Market Frenzy

A Letter To Young Investors On This Market Frenzy

Dear Young  Investors,

This stock market has been fascinating, exciting, and mesmerizing, but I fear a trainwreck is coming. When GameStop’s stock value rises to $34 billion from nearly $279 million a year ago, and its fundamentals are still weak, this move is not rational. I want you to understand why and I have tips to share to minimize risk. There appears to be no reason for this stock to climb as it had. None of the analysts or the company management are signaling a positive change.  

 Market frenzy is not new, but the Reddit forum, Wall StreetBets, and its influential power are a way of making recommendations. This new tactic may pose significant risks, not just to the hedge funds but to the marketplace itself. Already we have seen fallout such as Melvin Capital. This hedge fund lost 53% from its short-selling in January. They are a professional firm that should understand the perils of short selling.

My sympathy and concern lie with the young and inexperienced investors. They may lose their motivation to invest for lack of trust in the financial markets. I applaud the higher participation of young retail investors and hope for their investing success. We explain what is happening and provide helpful investing rules and tips to minimize risk later on in this letter.

Higher Retail Participation

 I have a gray hair or two, but in my experience, I have not run across the message board and retail traders recommending aggressive purchasing several out-of-favor stocks (GameStop, Koss, AMC, American Airlines) to the moon. Social media’s influence on the financial markets, specifically Reddit WallStreetBets, and now the more than six million members, powered several stocks–Bed Bath & Beyond, Koss, GameStop, AMC–to extraordinary heights as these companies’ fundamentals remain poor.

The Reddit forum peppers its board with new Wall Street lingo. Terms like “yoloed a stock” translates to  “you only live once.” It means that you should make a significant investment in that stock. For more on traditional Wall Street jargon, you can read our post here.

Who would have thought we would see such volatility in Gamestop and other stocks as retail traders rage against hedge funds in positions of the longs against the shorts, the traditional vs. new breed in this David vs. Goliath saga. I am sure some institutional investors are riding this horse alongside the retail traders. 

Is there stock manipulation in this activity? Stock manipulation occurs when there is artificial inflation or deflation of security prices for personal gain.  I don’t know that anyone would be surprised if that is happening. I am sure the SEC, and its eventual head, Gary Gensler, are watching closely. 

How Will This Market Frenzy End?

Who or what is responsible for the market frenzy, and how will it get back to normal, if ever? We have seen this story with different stock names before, and we will see it again. It will be a learning experience. There will be books to explain it with hindsight and at least one movie to entertain and educate us. “Wolf of Wall Street” will pale next to this new story.

I will try to explain what is happening and make sense of it, although it is a moving picture. I will always encourage you to understand the stock market, its risks, and how to reduce them. You need to invest responsibly. Investing remains the best path to wealth.

In recent years, the industry changes have seen new entrants like Robinhood enabling young and inexperienced retail investors to access the financial markets. Is Robinhood the villain or the victim? They have had to raise substantial capital to facilitate activity.

Increased retail participation is a good thing, but investors need to understand the market risks and use financial discipline. 

As an investor and an ex-Wall Streeter (I was an equity analyst at Drexel Burnham and UBS), I have seen my share of events (e.g., Long Term Capital, dotcoms, WorldCom, and subprime mortgages) that caused extreme market volatility. Financial markets are regularly subject to volatility, but the (GameStop) frenzy seems quite different and more extreme. People always get financially hurt, sometimes devastating so and this time will not be an exception.

GameStop

The astronomical rise to an irrational high of $483 (thus far) in GameStop (GME) in January 2020 was surprising given its rational $4.21 stock due to its poor fundamentals. Comparisons to Blockbuster in the then-emerging Netflix era are apt. GameStop, brick & mortar retail business selling video games and consoles during COVID, is not a recipe for success. My teen son downloads his games now. GameStop was once our favorite destination, but that was years ago.

A year ago, the shares traded at $4.21 per share with a $279 million market cap. With its fundamentals declining, GameStop has been a target for short-sellers, notably by hedge funds. Reddit forum has driven stocks to record levels initiating short squeezes (explained below) on institutional investors. Quotes from WallStreetBets are helpful to understand the movement to affect stock prices. 

This frenzy is more significant than the GameStop action, which has spread like a contagion to several other stocks, including AMC, Bed Bath & Beyond, American Airlines. Stock and options traders, many Robinhood customers, have collectively used their influence via WallStreetBets, a Reddit forum, to support GME’s price.

Since the start of 2021, GME has been hugely volatile, going up 600%. According to S3 Partners, short-sellers have lost $5.05 billion, resulting from short squeezes. Let me explain these terms, so you can better understand short-selling and short squeezes.

Short Selling And Short Squeezes

Traditionally, when you buy a stock, you hope the stock up above your purchase price, and you have a profit. Short-selling is a bet that the stock will decline, and you will buy the shares by borrowing the shares, speculating you can buy them at a lower price in the future. It is an advanced strategy and should be done only by experienced traders who will hedge with call options.

A short squeeze occurs when a stock, like GME, rises sharply, forcing short-sellers, who expected GME to fall, to have to buy shares to minimize their losses. If many traders are doing the same thing, it places upward pressure on the stock price.

Hedge funds heavily shorted GME. Its short interest was $5.51 billion, up from $276 million a year ago. The percentage of GameStop’s float (e.g., regular shares available to trade) sold short was 139.57%! That is an obscene number. The GME situation is ongoing, pinning the WallStreetBets traders against hedge fund companies or David against Goliath (the hedge fund companies). The facts are not fully known.

Even My Daughter Gave Me Advice

What was scary for me was a conversation I had with my daughter, Alex, this week. Alex is bright, a terrific student, but she doesn’t know much about the stock market or care. She surprised me when she asked if I owned any shares of GME or any of the pumped-up stocks. When I assured her that I didn’t, as she turned from me as if I were a loser, she said, “But, Mom, you could have made so much money!!!!” I love making money, but I do try to limit my risks.

So, this letter is also for my kids, Tyler and Alex, my college students, and of course, my readers!.

How Did We Get Here?

 

The Democratization of The Stock Market

More retail investor participation in the financial markets did not happen overnight. The household distribution of US stock ownership has been unequal for a long time. 

According to US Census, in 1952, only 4.2% of the US population owned common stock. A 2020 Gallup Poll reported that 55% of Americans hold stocks, but the ownership is mostly the wealthy. Based on net worth, the top 1% own the vast majority of stock market value at 88.1% as of 4Q2019.

In early 2020, with market downturn associated with coronavirus, many young first-time investors signed up for new accounts at online brokers, traditional and Robinhood. That trend of increased young investor participation will hopefully continue unless the GameStop phenomenon ends badly.

Reduced Barriers To Entry

There have been reduced barriers to entry driven by deregulation, technology, reduced cost, and increasing competition. Competition emerged first in the brokerage industry with discount brokers and online brokers.

Robo Advisors

The rise of smartphones drove investors to innovative and disruptive digital services. Robo-advisors such as Robinhood are investment management companies that use computer-generated algorithms and potentially human-based advisory services to develop a stock portfolio. Their products are stocks, funds, options, gold, cryptocurrencies, all available at zero commissions, lower management fees, and no-to-low minimum requirements.

They serve young and first-time investors with easier access to low-cost investing via trading apps on an equal playing field. These fintech companies have fully digital platforms with easy to use interfaces, sophisticated trading tools, and research resources.

Robinhood

With at least 13 million customers, Robinhood is among the largest online investment platforms for stocks, options, and cryptocurrency trading. They don’t require their customers to have a minimum of money in their amount, so they cater to all people, not just the wealthy.

Robinhood attracts scrutiny from the SEC, Congress, and the public. They have increased their educational resources for beginning traders and investors. It is not clear how effective that will be in reducing risks associated with speculative trading.

Their average customer is in their mid-20s, with significant Millennial representation. Due to the madness occurring in the markets, Robinhood has restricted transactions in several stocks to closing positions only and raised their margin requirements as of this writing. CEOs Vlad Tenev and Baiju Bhatt asserted that many of their customers use Buy and Hold strategies with a long-term perspective.

Are Young Investors Taking On Too Much Risk?

Retail investor participation has grown in recent years. Many people began investing during the lockdown as sports, entertainment, and gambling establishments closed.

As a college professor, I encourage my students to begin investing in the market through the Stock Market Game. Some already have Robinhood accounts and are trading stocks, options, and cryptocurrencies. Investing in stocks, which typically generate higher returns than bonds, is the best path to achieving wealth. Higher returns come with higher risks that you need to understand to mitigate those risks.

8 Tips For Young Investors

 

1. Get Your Finances In Order First

Never invest money in the market you can’t afford to lose. Before investing, make sure you can keep your lights on by paying the utility bills. Your finances should be sufficient to cover your necessary living costs for a reasonable time. Don’t use your rent money to trade or invest. Instead, set some emergency money aside.  

2. Can You Explain Your Strategies?

Don’t take wanton or reckless risks by engaging in strategies you don’t understand. I know people have FOMO (fear of missing out) when they see their friends make a ton of money by adding many risks. Learn through YouTube Channels and resources available to you to understand the downsides in any stock trading or investing.

If you bought X stock, could you explain its fundamentals and why it is attractive at current valuations to a friend or colleague? I am talking about a 30-second pitch, but it is good practice to know why you are investing.

3. Don’t Use Leverage Through Margin Buying

Buying or trading stocks on margin is a significant risky move. When buying shares in a company, you may use some of your own money and borrow the rest from your broker.  People use margin buying to make higher profits through the added leverage. By paying only a small portion of the total amount, investors amplify their purchasing power. However, it doesn’t always work in your favor.

Essentially, you are borrowing money or using leverage to pay for your investment. Margin calls are an extension of credit, with your securities acting as collateral. Typically, you can borrow up to 50% of your intended investment, and your broker has a 30% margin requirement, although it can vary.

A Margin Requirement Example

Mary will borrow $25,000, buying  $50,000 of stock ABC. Under normal circumstances, If ABC drops 30% to $35,000=($50,000 x .30). Mary’s equity is now  $10,000 = (35,000-25,000 borrowed). Her broker’s margin maintenance requirement of 30% rears its head, meaning Mary needs to have $10,500 in her account= (35,000 x .30), requiring her to add $500= ($10,500-$10,000) for the margin call. 

The risks you may face are largely out of your control. When the market becomes volatile, brokers may raise margin requirements to as high as 100%.  A few brokers, including Robinhood and Interactive Brokers, raised margin requirements to 100% on specific volatile stocks like GameStop and Bed Bath & Beyond. You either can satisfy their requirement or sell the shares. If your stock has plummeted, and you don’t have the liquidity to meet the margin call, you must sell the shares.  

4. Short-Selling Is Complicated

For experienced traders and investors, short-selling has its merits, but there is no place for inexperienced traders or investors. A stock’s value may decrease for many reasons, including lower revenues and profits, product failures, or increased competition. Short-selling has been in the press, especially related to GameStop, which has a very high short interest and brought out a swarm of retail traders who have sent GameStop in the opposite of where the short-sellers want it to go. Watching the market volatility reminds me of the dangers of short-selling and margin buying strategies.

A short sale of a stock involves selling a stock you don’t own. Therefore, you have to borrow the shares to sell them on the market, speculating that the share price will decline. The short seller must replace the shares at a later date. As you borrow the stock for the short sale, this trade requires margin, but it requires a higher amount because there is no collateral, as we discussed.

The Fed requires all short sale accounts to have 150% of the implementation’s short sale value. This percentage is a minimum, but the broker can adjust the requirements upward.

An Example of A Short Sale

Let’s say you believe GM is overvalued at its current price of $35. You’ve done research (hopefully!) and found out the company will generate lower revenues than the consensus believes due to potential product recalls. You call your broker and arrange to borrow 100 shares of GM at $35, or $3,500 selling price, and the broker sells those shares.

A few months later, GM shares drop to $27, so you instruct your broker to purchase 100 shares at that lower price, or $2,700. These latter shares are given to the brokerage firm to repay the borrowed stock.  You pocket $800, or the difference between $3,500 and $2,700.

A Short Squeeze

This example is simple and straightforward. Imagine a transaction with GME and shorting 10,000 shares at $5 per share, or $50,000, expecting GME to go to $3 per share. Instead, GME shoots up to $300 per share, and days later, it is worth $3 million. There have been instances of short selling disasters. For example, when a company gets a higher buyout which lifts its shares. The GME situation is different for the messaging boards and how the traders collectively pushed up several companies’ stocks.

Use Call Options

Short selling is not for the faint of heart. You can limit your risks by using call options to hedge against a possible rise in the stock. Without an option, you are opening yourself up to unlimited losses. Targeted hedge funds (e.g., Melvin Capital) lost billions on GameStop, and they have experience. What makes young traders believe that they can handle these risks?

I have not engaged in short selling, which would mean I would want a stock to go down. However, some short-sellers provide valuable insights by uncovering stocks that may be overvalued or fraudulent. Short-seller Jim Chanos haunted the shares of Enron in 2001 by uncovering Enron’s accounting scandal.

Day Trade Is Challenging

The stresses of day trading are very high. Traders rapidly buy and sell stocks throughout the day, hoping to make more profits than losses. Unfortunately, many make more losses at first. They tend to borrow money, buy money on margins, and requires access to capital.

There is a low chance of success in earning an income as a day trader, yet it is a challenge to do this only on a part-time basis. It may sound exciting as you can do it from your home, but there are costly technology needs and a good stomach to handle the pressures. Swing trading is an alternative that has some similarities to day trading but is usually is done over a more extended period and not your full-time job.

When the market gets volatile, don’t bail by selling all your stocks. 2020 was an extraordinary year for many reasons. It was a year in which the stock market proved its resilience.

From its February peak to  March 23rd bottom, stocks dropped nearly 34%. However, the S&P 500 index resulted in a 16% gain for the year and a 44% gain for the NASDAQ. Imagine if you sold your shares on March 23rd?  Many people did sell, learning a lesson about holding on to stocks during market volatility.

5. Buy And Hold Strategy

I am not a short-seller and don’t use leverage or day trade for fear of taking on too much risk. I have made some poor choices through the years, such as selling stocks too early, being too greedy, not having enough patience, or buying a stock I didn’t understand. My investment strategy is more deliberate buying and holding onto fundamentally strong stocks for the long term.

This strategy has some advantages like compounding, lower capital gain tax rates, and waiting out the turbulence and dips, or buying more stock for dollar-cost averaging to reduce my basis. Compounding is an excellent tool to grow your wealth in retirement and taxable accounts exponentially. That said, you do need to use financial discipline. 

6. Take Some Money Off The Table – Don’t Be Greedy

It is a good idea to sell some stock to lock in a 20%-25% gain. I have learned the hard way, watching my stocks climb as if going up were inevitable, losing money in dotcoms and elsewhere. The old Wall Street saying remains close by with these words, ” Bulls make money, bears make money, pigs get slaughtered.” If you have some big gains from GameStop, you probably want to lock that in even if you will pay the higher tax rate.

On the other hand, if a stock is not working as you thought, it may be time to admit a mistake. Consider limiting your losses by selling the stock after it is down 8%. You want to revisit its fundamentals as something may have changed for the worse.  It hurts a lot when you see a bigger loss in a stock you still own. Often, cognitive biases, such as loss aversion, prevents us from giving up on one of our losers.

7. Diversification Minimizes Risk

Concentration in one stock is risky. What if you yoloed, and put a significant amount of your money in GameStop, and it suddenly dropped precipitously. It did that when Robinhood restricted GME and other stocks but removed the restriction when they received criticism. If not GameStop, it could be another stock name that becomes angel but then loses its wings.

Diversify your portfolio is a way to minimize risk. I buy stocks outright, but I remain diversified by buying index funds and ETFs. As you build your wealth, you should make sure you have diversified with other assets, including money markets, bonds, real estate, and gold. 

8. Don’t Gamble Or Speculate Without Some Knowledge

Investing in the markets is a way to use your earned money to make more money than you lose. Don’t gamble your hard-earned dollars on anonymous tips or speculate without trying to understand its risks and rewards.

As I wrap up this letter, I believe you can find success in investing and find ways to make it fun and rewarding. Don’t get sucked into strategies that won’t benefit your finances. As you make more money, you can use your generational influence to make societal changes through work and charity. You don’t have to make money to do good in the world. Don’t get discouraged when you lose money. Make that a learning experience.

Final Thoughts

The unusual market activity prompted by social media-driven calls to buy stocks to counter heavily shorted stocks borrowed by institutional investors is dangerous. It serves as a reminder that investing is never a sure bet. There is a generational opportunity for young people to participate in the financial markets.

I hope that they are rational investors that use common sense and discipline to stave off potential losses. It will be a shame if these investors are vulnerable to losses and are mistrustful of the financial markets as some of these traders engage in possible revenge strategies.

Thank you for reading! If you found value in this article, visit us at The Cents of Money for other such reads.

 

 

 

 

 

How To Talk To Your Kids About Money

How To Talk To Your Kids About Money

“Poor or rich, money is good to have.”

Leah Eliash Kaufman, my grandmother

I worked in my parents’ housewares store after school, weekends, and summers. From the age of 12 until I got my first full-time job after completing college, I helped out my parents. It was a family obligation, and I was not paid but got a wealth of knowledge running an up and down business.

Mom and Dad did share their values about money. My mom was mostly frugal, particularly when we had difficult times. My friends came from modest means as well, but they always seemed to have more than me. They had the latest toys, trendy clothing, a new bicycle, and a new car later. We rarely went on vacation because the store was open six (and sometimes seven) days a week.

Memorable Lessons Passed On

While I didn’t have a ton of material things, my parents did pass on life lessons about the importance of education, working hard, and giving back to the community. They also encouraged me to set up a bank savings account, invest in stocks, pay more with cash than borrow, and quickly pay off debt. 

My mom was never able to go to high school though she wanted to be a lawyer. Circumstances prevented her from moving ahead. She was so savvy about money, investing, and running an ultimately successful business.

Are We Rich?

As a mom, I feel her influence, especially with my kids, now in their teens. When they were younger, one or both accompanied me to the college finance classes I taught. That opened the door for my husband and me to have some early discussions about money with them.

I always asked my mother when I was a young child, and my kids have asked us, “Are we rich?”

According to Charles Schwab’s 2019 Modern Wealth Survey of Americans ages 21-75, you are wealthy if your net worth is $2.27 million.

However, the amount varied by generation:

Gen Z         $1.49 million

Millennials  $1.94 million

Gen X         $2.53 million

Boomer       $2.63 million

Those surveyed said that 72% based their definition of wealth on how they live, and 28% considered wealth on the dollar amount.

The average US household’s net worth is $692,000, skewed because the super-rich pull up the number. A more realistic number is the net worth of the median US household, which is $97,300.

The truth is the majority of Americans need help in better managing money with these statistics:

  • Only 38% have an emergency fund
  • 59%  live paycheck-to-paycheck
  • 44% carry a credit card balance at medium to high teens interest rates
  • On average, we spend almost $500 per month on nonessentials

For these reasons, we, as parents, have an essential role in fostering our children’s attitudes and adopting good financial habits.

Here are 10 Ways To Talk To Your Kids About Money:

 

1. Start to teach them early.

Conversations with your teens about anything sensitive can be awkward, especially about money. According to a 2018 T. Rowe Price survey, 66% of parents are reluctant to discuss money matters with their children. Only 21% of the kids recall their parents speaking about money at least once a week.

Speaking to children about finances takes some of the mystique out of money for them at an early age. It is more comfortable for parents to talk about savings, giving them a head start in math. Explain how the bank holds money for people and explain how it lends money. This will begin a conversation about financial literacy, leading to developing money management skills.

I did take my kids at a too-early age to an ATM to take out money.  My daughter, Alex, got too excited and wanted to try pushing buttons to get some money. She also gave $10 to a friend in her pre-K class for being her friend. It was her tooth fairy money. Luckily, his mom tipped me off. We talked to her about how that money goes into the bank to grow into more money.

2. Wants versus Needs

As they got older, my kids became accustomed to asking for and expecting everything.

It is tough to teach “needs” and “wants” when your 8-year-old says that he needs a smartphone. His friends had one for a long time. We began to set money limits by giving money for after school for the whole week. They learn something about allocating more money for the days they have plans with friends.

Spending money is a neglected topic for many. When kids see us spending money on big-ticket items like a 65″ TV screen, I usually share my thoughts with them with examples. 

We took a vacation with the kids, and when I was eyeing a decorative bowl,  my son Tyler was upset with me for buying something and not limiting myself. He asked me, “if I needed it?” I thought about the bowl and realized I had one just like it. I passed on the bowl and let him know he helped me make the right decision.

Teach your children to shop wisely and not to be impulsive about spending. Emphasize need, quality, and price.

3. The Dangers of Credit Cards Versus Debit Cards

Having credit cards are a big responsibility for everyone. Credit card debt is toxic to all to carry large balances. Parents should speak to kids about the difficulty of mounting debt if you don’t pay your credit card balance fully. Parents are having their children become authorized users on their cards at an early age. Many banks do not restrict age, allowing a 10-year-old who may not be truly ready to have one.

Parents should use this opportunity to allow their children to learn to take care of cards by getting debit cards. Reasonable spending limits can encourage to make choices. Parents should talk to kids about what to use the cards for and when to use cash. A debit card is an excellent way for your kids to acclimate themselves to using a card with care. 

Related post: A Guide To Your Child’s Credit Report: Pros And Cons

4. Financial Education For Your Family

The T. Rowe Price study found the effectiveness of financial education in the home or school were both falling short.

Most young adults who received some financial education in school are more likely to have a budget, emergency fund, be good with money, and have a retirement account. However, 34% said that their parents have more influence than schools on financial habits. 78% of young adults who received financial education had it in the 12th grade or later.

Encourage your children’s active participation in family matters that concern them. For example, they can make their case about the allowance they will receive, participate in family budgets for items you are shopping for like school supplies, clothes, and vacations.

Parents should enlighten their kids regarding their attitudes about money management. These are essential skills. For example, discuss getting another car. They can discuss why they may prefer to buy a new or used car outright versus taking a loan or leasing a vehicle.

Saving Money

If your goal is saving money, give your children reasons why buying a used car is better. A new car depreciates about 20% on average as soon as you drive it, plus most new cars lose some value in the first year. Along with these savings, you may pay less for sales tax, insurance, and registration fees.

Parents are in the best position to model responsible behavior about money. Once kids make some money on their own, parents should require their kids to save for their car when they begin to drive.

Still, the problem may go beyond parents’ reluctance to discuss money matters. Parents may be lacking in some areas of financial literacy themselves. It is a good idea to learn about money and to invest together as a family. I often talk to my kids about a favorite stock I own and why I still like it. They ask for updates at times.

5. Be Honest With Your Mistakes

We all wish we did everything well. The truth is that we make mistakes. We want our children to do better than us in education, making money, and managing money. If you have made money mistakes, whether it was taking on too much debt and paying it off or not having enough liquidity at times, share that with your kids.

We bought a lot of art and antiques at probably peak prices before we had kids. Frankly, I developed the bug to buy 18th-century Federal furniture and other collectibles, but it doesn’t contribute to retirement savings.

6. (Kiddie) Roth IRA

My mistake in buying antiques, although beautiful, is that antiques are less liquid than other assets when you want to raise money. This realization does allow me to discuss retirement savings with my Generation Z kids. Studies show that this generation is more aware of the need to set up IRA accounts early. Teenagers can contribute to a Roth IRA up to the amount they make from eligible employment.

If my son Tyler earned $2,000 as a camp counselor or at the movie theater, he can invest all or part of the $2,000. If kids invest all of it, parents can’t contribute up to the current maximum of $6,500 in 2021. Contributions to Roth IRA is limited to Tyler’s earned income of $2,000. If your teen is under 18 years, typically the age of majority, they are minors, and a parent has to serve as a custodian.

While it would be great for your teenager to contribute as much as possible to a retirement savings account, even a portion of their earnings would be a great start. The lesson for them is the growth of their contribution is tax-free and will benefit from compounding returns over the decades.

7. Investing In 529 Plan

As parents, you should set up 529 savings accounts for your children’s college education as early as possible. Your children may not even be walking or talking yet, but that shouldn’t stop you from beginning to save for your children’s future with tax-deferred dollars.

It is way too early to know if they will go to college. However, getting an early jump may allow you and your children to reduce the need to take on debt. If you haven’t opened an account yet, involve your children when you open the account and explain it to them. It is good to know that saving early may reduce the need for student debt later on.

8. Showy Social Media…Keeping Up With The Jones

Our kids are growing up with smartphones. They are continually interacting with their friends, reading about restaurants and vacations they have gone on, shopping for trendy clothes, shoes, and bags. They are exposed to many different lifestyles at a much earlier age than we as parents have been.

It is “Keeping Up With The Joneses” on steroids. Social media has led to many conversations after we recognized our kids looking a little crushed at times. They would point out that their friends were getting more things than they were.

An Example

Our son, Tyler, was on X-Box playing Fortnite with his friends all the time. Most of the kids were buying “skins” which are costly (up to $20 per skin), an expensive endeavor if you splurge for 60 skins.

We didn’t want to have to pay for this unnecessary game expense on an ongoing basis. We had to sit down with our son to explain that every family has different resources and spending patterns.  Some families make more, and some families make less. He gave us good feedback.

Weeks later, his group of friends moved on to another game.

9. Share Family Values versus Sharing Your Salaries

Discussing salaries are a complicated topic, requiring thought. Most families are uncomfortable discussing money in general, and even more so sharing their salaries. About 30% of families do not earn a regular paycheck. Besides, what does that figure tell your children? Often, it is an abstract number. Salary is different than your take-home pay because of the taxes you are required to pay.

Some say that revealing your salary is an essential part of educating your children about finances. It may help your children by being open and build trust in your relationship. Explaining how your take-home pay relates to your household expenditures could help your kids make your budget more transparent.

 A Better Life Lesson

Others say that salaries are personal information and children do tend to share everything. How do you explain your salary differences, or do you have to do so? 

There are many variables to discuss money without necessarily sharing your specific earnings or net worth. They prefer to know what you do for a living, do you like your job, and you will always have one.

It is better to share what you value, such as your family, friends, how you live, spirituality, and your beliefs. Learn what they value as well.

10. Charitable Giving

“To whom much is given, much shall be required.” KJV

It is never too early to involve your kids in giving to important causes to the family. It is a way to talk to your kids and find what their interests are. They can put aside some small amount and physically drop it in a box at a local shopping center or send a check. The point is to have them recognize they have social responsibilities larger than themselves.

Final Thoughts

Communicating openly and clearly with your children about money will help them grow more financially confident. It will strengthen their bond with you and earn their trust about financial literacy, a topic you don’t generally talk about with others. Their increased comfort with you will help them with important money management decisions they will need to make, such as college, career, buying an apartment or home.

Related Post: Why You Need An Emergency Fund (And How To Invest It)

What is your experience in speaking to your children about money? What works and doesn’t work? We would like to hear from you!

 

 

 

 

 

 

 

 

 

Best Personal Finance Tips You Should Know

Best Personal Finance Tips You Should Know

This time of year is always a good time and place to see where you stand regarding your financial goals. Build and strengthen financial habits to achieve financial success. Use these personal finance tips as a checklist to become more financially organized at the beginning of the year. No matter what your situation is, your financial success doesn’t happen without work. Careful planning, often with professional guidance, requires that you look at a wide range of your finances and how you handle money.

We cover major tenets of personal finance and relevant tips you should know to have better financial health and success.

Evaluate Your Monthly Budget

Track your monthly income and expenses. Break your expenses into fixed or non-discretionary expenses and variable or discretionary expenses by category on an excel spreadsheet. Think of your budget as your household’s income statement. Your budget will help you to control your spending.

Use the 50/20/30 budget rule as a rule of thumb. Essentially, you are allocating your after-tax income into three budget buckets:

  • 50% of your spending are for your needs, notably housing, utilities, groceries, car payments and other needed fixed or non-discretionary expenses.
  • 20% for savings that can be used for paying down debt, emergency fund, and  investing or combination.
  • 30% are for your wants, that is discretionary or flexible spending for entertainment, vacations, and shopping. This what is left after your allocations are made for priorities, notably needs and savings.

Adopt a disciplined strategy as early as possible when you have fewer items to track. Use budget apps readily available or create your own excel spreadsheet.

Update Your Net Worth

Keep track of your net worth which is your household balance sheet. To calculate net worth, add all of your assets that you own less all liabilities that you owe. When you are young, you may have more liabilities because you are just starting out and may have college loans. However, over time, through accumulation of assets that grow at rates faster than your debt, you should have amassed comfortable net worth.

Net worth is an important benchmark to compare against your short and long term financial goals. Are you where you want to be in your 20s, 30s, 40s and thereafter? The fastest way to build wealth is through good financial habits that require saving, spending less, managing debt wisely and investing.

Build An Emergency Fund

Save for emergencies in a separate account that is readily available money. A common mistake made is not saving money for unexpected events like losing a job, pet surgery or a flood in your basement. Plan for 6 months of essential living costs to take care of rent, mortgage, uitlities, credit card bills and any other fixed monthly costs. Make sure your emegency fund is liquid in either cash or cash-equivalent (also known as money market) securities.

This fund should be used for emergency purposes not necessarily your wants for a high priced vacation. If you like to travel a lot, it may be worthwhile to have a separate vacation fund to set aside for those purposes.

Make Savings Your Mantra

Spend less than you earn so that something is left over to put in savings. Part of your savings should be allocated to investing. Growing your money in investment accounts is your best path to a comfortable financial life and to achieve wealth. Alternatively, spending more than you earn will result in more debt.

Automate your finances from your direct deposit paycheck so that some portion goes into your emergency fund, 529 college savings and retirement savings. Even with automation, review your amounts periodically. It is easy to set up withdrawals from your earnings and forget about it. However, you may be able to afford higher amounts than what you set up initially and can sock some more money away now.

College Savings Planning Should Be Started Early

Set up a 529 college savings fund as soon your newborn arrives. There are several ways to save for college besides a 529 plan like a Coverdell Education Savings Accounts and UTMA. Saving for college early gives you a headstart in growing funds through the power of compounding  while enjoying deferred tax benefits. Virtually all states have their own plan though you are not limited to your home state. There are a variety of funds to choose from including target date funds.

Retirement Savings And Earn Company Match

Save for retirement as early as possible. By setting money aside early you benefit from compound growth, that is, interest on interest. You may defer tax payments or reduce tax costs long term. Learn how your employer-sponsored 401 K plan works with respect to matching contributions which can be quite valuable. A company 401 K match may be a certain percentage like 6% of your salary with the firm matching dollar for dollar (or 100% which is generous) or something less of the amount you saved.

These contributions are like “free money” so don’t leave these dollars on the table. Open up a Roth IRA account to complement your 401 K retirement plan. You want to max out these amounts. Invest this money in a variety of investment choices offered by the plan.

Don’t delay savings for your 529 plan or retirement plan because of you are overwhelmed by the various options. Opt-in to a plan. You can make changes later on.

Health Care Savings Accounts

Find out if you have a flexible savings account (FSA) or a health savings account (HSA) available through your employer. Both plans can help you purchase qualified healthcare costs through pre-tax earnings contributions. The HSA is available either through your employer or if you are self-employed. You cannot have both plans.

The FSA plan sets lower contribution limits than HSA, and if you don’t use it by year-end, you forfeit what’s left in the account. The employer controls the FSA, while the individual controls the HSA.

The HSA plan has higher contributions, covers a broad range of medical expenses, and is more flexible. Unlike the FSA, it does not have a “use or lose” feature. Instead, if you don’t spend the remaining amount that year, it rolls over. The HSA is portable, so if you leave your company,  you can bring the account. You can earn interest on your HSA like any savings account. However, if you use those funds on unqualified items you will pay a penalty, and, if you are below 65 years, you may need to pay taxes as well.. 

Managing Debt Wisely

Pay your bills on time and in full so that your balances are not being charged interest. When you pay only the minimum amount required by the credit card companies, you are paying far more in interest for what you charged on your card. Give your cards a rest until you can pay it all every month.

Use shorter borrowing periods for car, student loans and home loans to lessen the interest amount.The shorter the time frame on your car,  home mortgage or student loans, the lower your total respective cost will be  Yes, you are paying more per month but over a shorter period of time. Perhaps you can increase your down payment.

Know your respective interest rates, fees, penalty rates and terms on all borrowings: mortgage, car, student loans, and credit cards. When interest rates decline as they did in 2019, refinance your rates.

Use Credit Cards With Care

Credit cards provide an essential convenience and help us to build our creditworthiness. However, if you only pay the minimum on those balances, you are incurring high interest rates on what you owe. This is when compound interest becomes your enemy, and you are paying interest on interest. Keep your balances as close to zero as possible.

Use cash more when possible. It can be a motivator to spend less and help us negotiate lower prices when bargaining. You feel the burn instantly as to seeing it on your monthly bill.

When using payment provider services like Venmo and Zelle, know the differences in your liabilities. Credit card holders are usually liable up to $50 for unauthorized charges if you report your card as stolen. User protections for P2P vary so check carefully for coverage.

When working on debt payoffs, eliminate debt with highest interest rate first. I understand the psychological benefits of the snowball method and if it that is an effective motivator for you, go for it.

Avoid payday loans should go without saying. however, if this is your only choice, work with a financial counselor as soon as you can.

Control Your Spending

Comparison shop for everything you buy or sign up for: groceries, clothes, cars, homes, applicances, and services such as financial advisors,  insurance, banks ,credit cards. Be as informed as possible about points, rewards and cash-back offerings that encourage more spending than necessary.

Negotiate when and wherever possible. This goes for shopping and the interest rates on loans. However, learn to negotiate for higher compensation as well.  Opportunties are sometimes waiting for you to be more proactive in the bargaining process.

Know your wants versus needs. You don’t need everything to survive. Many items we say we need are really wants we desire like a long vacation or luxurious clothes.

Don’t go grocery shopping without a detailed list. This was a game-changer for us when my husband would come home with loads of unnecessary items all the time. Use per-unit pricing to compare items. Find coupons online.

Window shop with friends and buy when alone.

Be aware of numerous biases playing with your decision making.

When car shopping, buy certified pre-owned cars which have been completely inspected, repaired and may have original factory warranties remaining on its life. Do your oil changes and maintenance check ups as required.

Building And Managing Your Credit

Review your credit report periodically. It is available for free from AnnualCreditReport.com on an annual basis. You can also get one free report every 12 months to review your credit reports from each of the credit bureaus: Equifax, Experian and TransUnion. Then you can review your report more often especially when there are issues.

If and when you find errors, have the issues corrected as quickly as possible. Here’s how you do it.

Your creditworthiness is essential for more than just borrowing. Your prospective employer, landlord, utility provider and potentially significant other may want to know how you handle money too. By the way, background inquiries are usually soft inquiries that do not affect your score. However, hard inquiries happen when you are signing up for a new credit card or trying to refinance your mortgage loan  and will negatively  impact your score.

Know how the five key categories impacts your credit score. Your FICO scores are based on the following percentages:

  • Payment History – 35%
  • Credit Utilization – 30%
  • Length of Credit History – 15%
  • Credit Mix – 10%
  • New Credit – 10%

 

Your Child As Authorized User

Parents can help their children build up their credit by authorizing them as users on their cards. Think carefully about your own credit score. If it is low, it may actually hurt their score and defeat the purpose of being on your card. Know your child’s age and maturity, their ability to be responsible and setting up spending limits. There are virtually no age limits so it is up to parents to decide when their child is ready to have access to a credit card.

Yes, it is worthwhile for kids to get a credit boost. However, make sure you are not exposing them to fraud or identity theft, one of the downsides of children having a credit card. You will need to monitor their credit report along with yours.

Before getting them a credit card, talk to your children about money, spending and saving as a means to convey the need for good financial habits. The card is for their needs, not for paying for their friends’ needs and wants.

Raise Your Credit Score

The better the credit score, the lower your borrowing rate and the better on getting credit card deals regarding rewards and cash back. There are a variety of ways to raise your credit score or avoid inadvertently lowering it.

Don’t close any credit card accounts as this will ding your score. Instead, put these cards in a safe place like a drawer and don’t use them.

Keep your credit utilization rate well below 30% of total available credit. It may be beneficial for you to open an home equity line of credit(HELOC). If you have equity in your home you can take out a line of credit up to that value. This will expand your available credit, improving your utilization rate.

Certain programs are becoming popular that may help you boost your score for free or a low monthly amount. For example,Experian Boost, launched in late 2018 counts on time household payments for services such as telephone utilities tpwards your score. RentTrack And Rental Kharma report on time rent payments to credit bureaus.

If you have poor credit or in need of building up your credit, apply for a secured credit card as a means of boosting your creditworthiness. Become an authorized user on a close family member’s card for a period of time.

Applying To College

Fill out FAFSA, Period

If you are seeking funds for college, there is no downside to filling out the FAFSA (Free Application For Federal Student Aid) form other than your time spent. The form is necessary for federal loans, grants, work study programs and merit based scholarships. Don’t lose these opportunities by bypassing FAFSA. Federal loans tend to have better loan rates than private loans.

Be aware of your respective terms, grace periods, due dates and repayment options. Automate where possible so you don’t miss any payments. Try to target paying back your loans in a shorter time frame than the standard 10 year terms especially if you get bonuses or are getting nice raises.

Consider community or two year colleges which can be cost effective, for those who wish to work while going to school or want an interim step.

Save Money In College

When in college, look for ways to save and make money. College students tend to be better budgeters and track spending based on having less money to spend. As students living in a close environment, you are sharing similar tight money circumstances over the four years at school. College students eat ramen noodles, take public transportation and enjoy more experiences.

Keeping up with the Jones comes later on, after you get your first job and start making money. Try to remember your frugal days at college. Resist lifestyle inflation by having  good financial habits.

Understand Your Company Benefits Plan

Whether you are working at your first job or at the same firm for years, review your company benefits package. What may not have been of interest to a 20 plus year old, may be desirable now. Companies are increasingly adding to their compensation plans that can be customized for your life stage. Among the standard benefits plans are retirement plans, health care insurance, tuition reimbursement, insurance, flexible spending accounts (FSAs) or health savings accounts, paid vacation, sick time, medical or family leave.

You may need to add more coverage to parts of your benefits offerings such as life insurance. Typically, companies provide you with a starter package which will likely not be enough protection for a growing family. Company plans vary and may be a good reason to choose between two competing offers.

How To Start Investing Early

You can only reduce spending and save so much. Learning how to invest is the best way to outpace inflation, save money for college tuition and retirement, and accumulate wealth. According to a Gallup poll in 2019, 55% of Americans own stocks either individually, in mutual funds or in retirement accounts. This rate is below pre- 2008 recession levels of 62%.

Inflation refers to increases in prices resulting in reduced purchasing value of money. As prices go up say 2%, your money will get less units than it did in prior periods. Through  investing in stocks, you can better maintain your purchasing power. Stocks  tend to generate better returns (based on higher risks) than other securities, outrunning inflation. Stocks grow at a compound growth rate of 9% over the long term (over 90 years), though 2019 has been a banner year with S&P index, including dividends,  registering one of best gains since the 1990’s at roughly 30%.

Stock Market Games

Playing a simulated stock market game is a great way to learn how to invest and get familar with relevant terminology without losing real money. There are a number of free games  available and easy to set up that mirror realistic trading and investing with friends, family or on your own. Many of these sites have tutorials, videos and articles to educate you on the basics and provide strategic tips.

Start Investing With Small Amounts

Put small amounts  like $25-$50 per month into your investment account that you can afford to lose. That is, don’t invest your rent money. Starting small is a good way to get started as you gain a better understanding and confidence. Many large online brokers have lowered or eliminated commissions and initial minimum amounts designed to encourage small investors. Be aware that there may be management fees on your balances.

Buy Exchange Traded Funds or ETFs  which do not have minimum requirements, are available at low fees and provide you with diversification. Most mutual funds require a minimum initial investment between $500-$3000 and higher. For beginner investors, that may be a steep amount. You have many choices of ETFs and low cost index funds. Start with Vanguard’s offerings.

Some Investing Basics

When you begin buying stocks, have a long term outlook. Although commissions are reduced, you can realize better returns with long term investing (over a year or more) rather than trading. There are tax benefits when holding a stock more than one year by way of capital gains and capital losses.

Have some discipline strategies in place for when you should sell or exit a position. If you have a stock that is up 20%-25%, it is a good idea to sell a portion of your gains. A useful rule is “bulls make money, bears make money and pigs get slaughtered.” That is, don’t get too greedy.

Another good rule when investing in stocks, courtesy of Investor’s Business Daily (a great resource!) is to always sell a stock if falls 7%-8% below what you paid for it. The premise of this principle is that by selling at that level you are capping your downside potential. It has worked well for me. On the other hand, another strategy investors use is to buy small portions of stock initially and then buy opportunistically at lower prices to reduce cost basis of your stock.

I consider that all investors, including beginners, should have a basic knowledge about the Federal Reserve and their impact on interest rates, money supply and financial markets. We a have a primer on the Fed for those who want some insights.

Compound Growth And CAGR

One of the most important terms in finance to understand is compound growth. It can work against you when you are referring to a long term debt such as a fixed mortgage when you are paying interest on interest which increases your loan. Here, when investing, it can work in your favor when you are referring to the growth rate of your investment in your portfolio. Keep in mind, while stocks have above average returns, they have down years which can be sharp like during the 2008 recession.

The most accurate way to calculate returns is the compound annual growth rate or CAGR which smooths out returns over a longer period of time. Investors like to compare CAGR S&P 500 index (commonly referred to as “the market”) to their savings account or to that of a specific mutual fund or to their portfolio. This how investors can see how they are doing relative to the market. The formula for the compound annual growth is here. Thankfully, there are CAGR calculators to use.

If you are investing without a financial adviser, you need to do research. There are a lot of publicly available resources available to learn about the company and its businesses, its industry and its risks. You need to understand trends in the market. Expect stocks to be volatile and they may bounce back quickly after a fall in the market. BLOG POST

Diversification And Asset Allocation

Diversification of your stock holdings is important. Don’t put all your money in one stock or one sector of the industry. That is a recipe for greater losses. The best way to achieve diversification is through buying ETFs or low cost index funds which contain baskets of different securities. You want to minimize your risk as best as possible based on your own tolerance.

Not only do you want to have different stocks in your portfolio, you should aim to have different types of investments. This can include money markets, Treasury, municipal and corporate bonds, foreign securities and real estate. You can use ETFs and mutual funds to gain diversification within each asset class. Asset allocation is a means of diversifying these different investments. How you allocate your assets is based on your preference, age and lifestyle. Use a financial advisor or planner to talk through your planning and goals.

How To Choose A Financial Advisor

Meet with a financial planner or advisor to review your financial goals periodically and discuss how to achieve them. A financial planner does much more than selling you securities. Look for someone with a CFP designation. However, that should not be your only criteria. You should feel comfortable with this person and/or team.They should understand your household’s financial situation, lifestyle and your plans regarding children and college, career, retirement, insurance needs and estate planning. Here is how to choose a financial advisor.

Protect Your Family Financially

We love our families. Take proper steps to financially protect them. Providing financial security–besides making a good income, saving, paying off debt and investing– requires protective measures like buying essential insurance coverage and estate planning.

Insurance Coverage Is Essential

Your employer may provide you with some types of insurance as part of your benefits, including life, health and disability but often it is not enough. As your family grows you need to make sure you are adequately covered to take care of your family’s essential living costs and their future plans, including college. There are 8 types of insurance that you need to have proper coverage: auto, homeowners, renters, life,  disability, health, long term care, and  umbrella insurance.

Estate Planning

Prepare for the worst for your family’s sake. There are a number of steps to take for estate planning. Create a will and/or trust according to your wishes. You also need advanced medical directives and a living will as essential documents for your loved ones and health care providers.  Most people resist dealing with estate planning as a difficult topic. However, not dealing with it may leave your loved ones in a confused state during their time of grief. Think of estate planning as a plan of action that you are taking for your family.

Review And Update Your Designated Beneficiaries

An effective and efficient way to distribute our assets is by designating our beneficiaries outside the will through our bank accounts, insurance policies and such. Many of our assets are nonprobate property. As such, they are transferable to survivors by contract immediately upon death rather than under a will.

The advantages of contract transfer over the distribution of assets by a will are less time, cost and more privacy. Transfers to loved ones by a will could take 6 months-1 year if probate is not required. If contested in court, the distribution could take longer. Even worse, your will would be made public through court documents. At a minimum, be aware of the need to have designated beneficiaries for all assets. Review and update your beneficiaries based on life events such as having a new child or other necessary changes.

Invest In Yourself

Education does not end at the schoolhouse door. Embrace learning so you can master skills that are valuable to you. Read more and acquire knowledge so that you are competitive at work, have wider and diverse social circles and can teach others. Avoid procrastination which can be costly and cause unnecessary mistakes. Use time as the precious resource it is so that you may live everyday to its fullest.

Final Thoughts

To achieve financial success in life you need to have a game plan combined with good financial habits. Measure how you are doing with a review of your budget and net worth. They are key documents that help pinpoint where there may be some improvements needed. Financial planning should be discussed among family members. Calculate certain financial ratios, benchmarking your financial health. These ratios are tools designed to evaluate financial strength. As a companion to this article, see our post: 18 Financial Ratios You Should Know.

We hope this has been helpful to you. Thank you for reading and share it if you found it as valuable. Let us know what your thoughts are! Wishing you much prosperity and health in the coming year!

 

 

 

 

 

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