Financial Literacy

It is difficult for people to understand, appreciate, and benefit from this key principal of saving money: until your savings pile is over $100,000, do not worry about tax gimmicks or risky investing options. Until your savings is over $100,000, then its earning cannot add up to anything of note.

To illustrate: if you have $4,000 in a college savings account for your child and it earns 7% in a year, or $280, it doesn’t add up to anything meaningful. That $280 won’t even buy textbooks for a single term!

So get it out of your mind that growing a savings account solely from compounding interest or capital gains will fund a college education, a home down payment, or a retirement (in under 10 years).

The only element of savings that matters is your contributions, not what it earns. Your contributions will make up +85% of any account balance held for less than 10 years.

(For an account held for more than 10 years, stock market returns will add an ever-increasing amount to the account balance, but it is never steady. The stock market has fallen -20%, -30%, or -40% in a year. The more money you have, the larger account swings you’ll have to endure with the daily action of the stock market.)

When young parents mess around with qualified college accounts like 529 accounts, Coverdell accounts, or other qualified accounts, and then only add small dollar amounts – they are wasting their time, in my opinion. Saving a couple pennies in taxes is never worth your effort. I know someone who has 3 qualified tax accounts for his 3 kids. These accounts are for their college costs, but he only adds $50 a year to them. This is a joke: over the next 15 years this will only add up to $750 per account. This is about 1 month’s rent – not a meaningful amount of money. These accounts won’t accrue to 1% of the total cost of a university education! Over this tiny amount of money, he’s wasting all kinds of time: setting up the accounts, monitoring mutual funds, tax forms, monitoring the rule changes each year, etc. – all over a negligible amount of money.

Another reason to avoid qualified accounts with tax advantages is that politicians are always changing the rules and trying to increase the taxes on them. Just this week, President Obama proposed changing 529 college accounts. Instead of the current tax-free withdrawals, Obama wants to tax any gain, (not at low capital-gain tax rates but at higher ordinary-income tax rates,) in all withdrawals from 529 College accounts. Obama wants this tax increase on college savings accounts so that he can hand the money to other college students who don’t have college savings accounts. A year does not pass without some politician trying to increase taxes on retirement accounts as well.

It is my best advice that you focus on making contributions for large expenses and not worry about investing options or tax implications over small amounts of money for goals less than 10 years away.

Not everyone can afford the minimum balances required by some stock brokerages – $2,500 or $5,000 and up. The problem with small stock trading is that a commission, no matter how small, becomes a big obstacle to profits. For example, $7 commissions is pretty cheap these days and if you buy and sell a stock, your total commission cost would be $14. If you made a small $250 trade then the commissions ate up 5.6% of the trade. If you made a gross profit of 10% then commissions cuts your profit in half; before taxes.

As a rule, I try not to make a trade where commissions are more than 1% of the purchase. So if my commission is $7, then I need to purchase over $700 worth of stock to keep the commissions under 1%.

While zero-commission companies pop-up every once in a while, there is a company, Loyal3.com that allows you to trade stocks with no commissions along with partial or fractional shares. So you could buy $10 worth of a Coca-Cola share, even though the shares are trading at $43 today. Of course, to offer tiny purchases, partial shares, and no commissions, there are some restrictions. But at least you can get into the game of stock investing with very small amounts of money.

Remember, you can purchase stocks that pay dividends. For example, buying $10 worth of Coca-Cola will still pay you dividends that will yield 2.84% per year. There is no bank that is going to allow you to open a savings account with $10 and most will not pay an interest rate over 0.01%. In this case, your $10 in Coca-Cola would be earning 284-times as much money as any bank savings account.

You can setup your account to automatically pull $10 from your credit card each month to make a purchase. This way, you also earn credit card reward points or cash back from your stock purchasing as a bonus.

Loyal3 has some restrictions and disadvantages, but it offers even the tiniest investor an easy way to enter the stock investing arena.

Investments span a spectrum from easy & passive consumption to difficult & active production. On one end of the spectrum is production, where you are creating investments into which others can invest. The other end of the spectrum is consumption, where you are buying into someone else’s investment with little or no knowledge or effort. In between these two extremes is varying degrees of active investing.

Guess which investments pays you the best? The ones where you actively created an investment -or- the one where there are layers upon layers of companies and people in between you and the people doing the actual investing? The closer you are to the investor, or being the investor, the better the investment return. For a couple real examples, putting money into 401(k) mutual funds likely offers the very worst returns and actively investing into a fix & flip residential home may offer you a very high return.

If you want better returns then you need to get yourself closer to active investors, right next to them or possibly become one yourself. For example, who has made the most money from the company, FaceBook? The founder, the initial start-up investors, or the stockholders after the company went public? The later and farther away you are from the active investor the less profit is available to be captured.

How can you find or get close to these investors? It is easy as an accredited investor (someone earning over $200,000 or has a $1 million in investable assets), legally they can invest in anything and entrepreneurial groups are always seeking them out for investment projects. People who are not accredited investors have to do more work to locate investments but you can definitely locate them with networking and/or online research.

Be aware that you need more knowledge and expertise for active investing and you should only invest after you have some education about the investment. What are some investing categories? These could be anything: stocks, currencies, bonds, real estate, venture capital, oil, cattle, gold mining, website turnarounds, jewelry, vending machines, watches, collectibles, just about anything that can make money and you have an interest in learning more about the subject. I recently invested in some computer servers and knew nothing about them 4 months ago. Today, I’m knowledgeable and placed my own servers where they can earn the most money for me on a weekly basis. What subjects do you have an interest in studying to make more money from your investing? Are you willing to learn enough so that you can offer investments to others to make even more active money?

Every financially ambitious person that I know actively trades stocks, stock options, or real estate. They do this on the side or as their primary source of income. While this is a relatively small sample of people, it highlights that active investing, of some sort, is part of the wealth building engine for rapidly piling up money. The question for you to consider is: am I willing to learn more about an investment and then invest in a closer location to the actual investment operator?

There is a great need for education before you consider making any investment, and even more so for an alternative investment. For example, a neighbor bought $15,000 worth of rare gold coins a few years ago. He’d then look at the price of gold each week and was pleased that gold was rising. When the price of gold had risen 50% since his purchase, he went to a coin dealer to sell his coins, expecting them to be worth at least $22,000. Unfortunately, coin dealers would only offer $9,000 for his coins. What happened? He thought he had done everything right? It turns out he bought the coins from crooks (who were long gone) and sold him coins with a true value of $6,000 but they charged him $15,000. He had no education in rare coins and solely relied on the crooks to be truthful – a very costly mistake.

This same story of fraud perpetrated against uneducated investors occurs every day with: rare coins, rare gems, raw land, oil fields, cattle, sunken treasure recovery, high-yield investments, can’t lose penny stocks, anything requiring an “fee up-front,” secret bank trading programs, carbon credits, and many other investments.

In addition to being extremely skeptical about any investment, below are some steps you can take to avoid being scammed:

1. Determine how they found you – is this a cold call or did someone you know pass along your information?
2. Are they licensed? You can then check to see if disciplinary actions have been made against them individually, or their company. Con artists use fake names and businesses that cannot be verified before they disappear with your money.
3. Can you verify all of their claims with a known, independent third-party with a good reputation? A glossy brochure and a slick sales script does not mean it is a legitimate investment.
4. Hang-up on any high-pressure sales approach that takes advantage of your good manners, you want to take your time (or days) evaluating any investment before you part with your money.
5. Never consider an investment in an area where you do not have a lot of education so that you know the correct due diligence to perform.
6. Do not sign any document that you don’t fully understand and never give out personal information or send money before you have thoroughly verified the person, the company, and this particular investment.
7. If there is anything about the opportunity that that cannot be: verified, inspected, audited, proven, or any other due diligence effort – it is either a scam or an unprofessional operation not worthy of your money.
8. Remember there is always another investment coming along, so if this one is not perfect, tell them, “No thanks,” and move on without looking back.

The U.S. dollar has been rising for the last 3 months. When the dollar is rising this frequently pushes down certain commodity prices, like oil and gold, along with currencies like the Japanese Yen and European Euro.

So what are the investing implications for you? There are many but let’s look at a few stock possibilities:

• When gasoline is cheaper, it benefits the poor the most, so they have more money to spend at dollar stores and auto parts stores.
• When gasoline is cheaper then airlines, trucking, and chemical companies become more profitable.
• When gold is cheaper, gold jewelers make more sales.
• When the Yen and Euro are cheaper, wealthy foreign investors buy U.S. real estate to maintain their purchasing power in New York City, Miami, and San Francisco.
• When the dollar is strengthening, U.S. treasury bond interest rates fall.
• There will be less tourism to the U.S.

Anytime there is a market trend or reversal, there are macro-economic shifts that create potential profits and losses. Being aware of these shifts allows you to sidestep some predictable losses and position yourself for investing gains. Once you conclude that a particular industry may benefit from a new trend, then you can begin to narrow down a candidate list of industry stocks to the top two in which you may want to invest.

There are periodic calls for more transparency on mutual fund fees and 401(k) plan fees. However, using the publically available information on these funds proves they still eat chunks of your retirement money.

For example, three of the most popular mutual funds that track the S&P 500 in 401(k) plans took between 12%-37% of your investment balance over 30 years. So instead of retiring with a balance of $150,000, your account will only reflect $94,500; and this is before you pay income tax on your withdrawals.

A study by the Center for Retirement Research at Boston College last month showed that fees from 401(k) plans reduce account balances by an average of 16% over 30 years. This drain is from high fees from passively-managed indexes, not the research intensive actively-managed funds which have even higher fees.

You may be thinking about now, “But my employer makes contributions to my 401(k) plan, that is free money. If I don’t contribute, then I am turning away free money!” Half of all employers do not contribute and of those that do, the average contribution is 3.6% match of the employee’s salary.

Whatever contribution your employer makes, you need to calculate if it is large enough to offset:

• High fees
• Poor performing funds
• The inflexibility of your plan’s portfolio options
• Your other investment and account-type alternatives.

Although many people ask for my assistance in evaluating the 401(k) plan options, I have yet to come across a plan whose employer contributions fully make up for these shortcomings. Doing this math is part of financial literacy that so few people actually map out. If you are financially ambitious, you’ll be better off putting your retirement dollars in some other location with other types of investments. For example, a far better alternative is a Roth-IRA, which offers more flexibility on every front, and has already been taxed. If you earn too much, everyone can contribute to an IRA account and possibly convert it to a Roth-IRA.

The financial-adviser industry is like any other in this respect: there are “experts” and “thought leaders” speaking at conferences with new concepts and ideas surrounding investing. There are investing fads that come and go with each temporary trend in the economy. These fads may start from anywhere: academia, a popular book that investors start asking their advisers about, or a new product category that offers a new feature.

The advice a particular adviser will offer depends upon: the adviser firm’s investment stance, the experience of the adviser, and where he or she gets their financial planning news and ideas.

As an example, let’s pose a question: Should you be invested in bonds? A young adviser may say, “They are offering tiny yields, I’d recommend you stay away.” An asset-allocation adviser may say, “You should definitely have at least 30% of your portfolio in long-term bonds.” A retirement adviser may recommend, “Municipal bonds that are properly insured are very safe and tax-efficient; this is where you should place your bond allocation.” While I might say today, “Yes, interest rates are low – so you’ll get clobbered if interest rates rise. So only buy bonds that you will definitely hold until they mature in the short-term, say 4 years or less.”

The advice from these 4 opinions will have a dramatically different risk/reward impact on your portfolio over time. And remember, this is just one question. There are many questions that need to be answered to complete any financial plan. Some other investing themes currently today include: should you have alternative investments in your portfolio, should you investing be goals-based or cash-flow based, and how often should investment performance be evaluated.

When you have a personal portfolio, you, alone, are the CEO of the portfolio-management team. If you outsource some of this work to others, like financial advisers, you are still fully responsible for what they are doing and need to know how to manage them (and if necessary, replace them). As the CEO, you need some financial literacy and investment literacy so that you can:

• Communicate your goals with any financial adviser that you may employ
• Understand the financial planning fads that may be presented to you
• Keep your portfolio growth on target

Most people are aware that they may be able to make more money by active investing to compound their money, but they immediately reject the idea. Excuses include, “I don’t have the money,” “I’m raising kids,” “I don’t have the time,“ “I don’t know anything about business,” etc. However, there are many opportunities for micro-entrepreneurship that only require the smallest amount of time, effort, money, and commitment.

So I am going to provide a tiny business model that anyone can perform. I learned this model from someone who had been making a few hundred dollars a month for at least 7 years. After his prompting, I even did this a few times myself. This business model is about buying a sheet of stamps directly from the post office, which is in high demand, and then re-selling that sheet at a higher price on eBay. It really is that simple and can be started for less than $15.

The U.S. Post office is continually issuing limited runs of collectible stamps and there are common shortages for the designs that are most desirable to stamp enthusiasts. You’ll need a quick education about which design is rare right now. Sometimes you can find this out online or you could call your local post office to see which designs are selling out the fastest. Now that you have a high-demand design that you want to target, call nearby post offices, or online, to buy as many of these rare sheets as you can afford.

Once you have your stamp sheets, place them for sale on eBay for 20% more than your cost, or whatever markup that similar stamps that are difficult to find are selling at right now; plus shipping costs. After paying auction fees and shipping your sheets out, you should be able to net a minimum of a 10% profit within a week or two.

Granted, earning $1 on a $9.80 sheet of stamps isn’t a lot – but you have a tiny and sustainable business model that you can ramp up to become as big as you want. There are many sellers on eBay doing this right now because the market is so big.

Maybe you have no interest in stamps – that is fine. I know people who do this same tiny business plan with laptops & cellphones, used generators, motorcycle parts, ammo, LED headlights, chainsaws, watches, movie DVDs, and many others. They sell items on Craigslist, flea markets, specialized auction websites, or spend time generating a list of commercial repeat buyers. Whether this is for side-money or a primary source of income, your interests or hobbies likely have some kind of market where you can start earning money as the tiniest entrepreneur.

The stock-investing concept of buying and holding stocks for the long-term is the most well-known strategy. Amateur investors and people with no stocks have heard this strategy and many people starting out want to use this one promoted by financial advisers.

There is a single key component to this strategy that is so important that it makes everything else about this strategy irrelevant in terms of leading to a successful investment. This component is the concept of value. When you are purchasing stocks, are stock values relatively cheap or relatively expensive?

Whether you are investing in stocks, real estate, rare collectibles, or other investments, your investments results will be poorer if you are investing at relatively high prices or better if you are investing at relatively low prices. Although this appears to be self-evident, the difficulty is determining which metrics to use in evaluating whether stocks are relatively high or low.

Some metrics that investors use are ratios that they visually examine for their historical ranges. For example, stock price-to-earnings chart, stock price-to-sales chart, stocks-to-gold, stocks-to-oil, and stock price-to-book value. Reviewing these types of charts will highlight whether your potential purchase or sale of stocks is occurring at a relative bad time or relatively better time.

To emphasize how important it is to understand underlying stock values, and to only purchase when they are relatively low, below are some recent stock market realities that you should know:

• The Japanese stock market is still lower today than it was 27 years ago in 1987.
• The Russian stock market is lower today than it was 8 years ago in 2006.
• The Italian stock market fell in 2008 by 71% and has yet to recover, 6 years later.
• The U.S. had a flash-crash of 9% during a single day in 2010.
• The U.S. stock market fell by 55% during 3 months in 2008.
• The U.S. stock market only recently made a new high from 14 years ago in 2000.

In order for Buy & Hold stock market investing to be a viable strategy for your portfolio, an effort toward evaluating whether the stock market is relatively cheap or expensive must be an ongoing evaluation.

As poor-performing economies of Europe continue to contract, the European Central Bank (ECB) just announced that it will use all available means to increase inflation and stimulate the economy. This means the ECB will initiate programs that will lower interest rates, which makes the Euro currency less attractive to investors. So this latest ECB announcement caused the Euro to fall to its lowest level in a year against the U.S. dollar.

Economies and central bankers around the world move interest rates and currency values that you must consider when purchasing foreign stocks. If a great company in Japan performs well but the Japanese Yen is falling in value, then that currency drop may offset any stock gain that you may have had.

There are two cases when currency valuations are not as important for foreign stock ownership, global commodities and global companies. In the case of commodities, for example, a company in Asia that refines oil, it is the single, global price of oil that will affect the company’s earnings more than the local currency. Since the company is selling an item at a global price, the ups and downs of the local currency have much less net impact to you as an investor. The second situation, global companies that operate on several continents and countries, they normally hedge the currency of sales to their domestic currency. So currency fluctuations happen slower over time as they roll their hedges over a year or more.

Anytime you find an attractive stock outside your home currency, you need to be aware of the potential risk of currency moves that could hurt your investment return.