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New Technologies
by by Ted Williams, NOCCC - March 26, 2001 at 23:48:45:
The meeting was opened by Cathy Grammer Margolin. She announced our 25th anniversary will occur next month. Be sure to attend our gala party on April 1 at Chapman University. Cake and beverages will be served. Our president, Terry Warren, announced that nominations for the election of NOCCC officers and board members may be made by sending an email with your nominations to Terry at twarren@alumni.caltech.edu.Presentation This presentation summarized my investing experiences. I hoped that my experiences may have been of some interest to you, but they did not constitute a recommendation of any security, product, or company. NEVER accept any advice or recommendation, including the information provided here, without first performing your own independent verification. The complete presentation is available on my web site at www.tlwilliams.net if you wish to find out more about any of the subjects summarized here. The presentation started with some basics and then turned to some more involved investing strategies for those who have the interest and time to devote to taking a more active role in their investments.
Overview—The essential ingredients to investing is time, money, and a willingness to take on some risk. Discipline is required to stick with your investing strategy through the ups and downs of the market. One strategy that has been successful for me is both simple and effective:
1. Eliminate debt, especially unsecured debt.
2. Participate in tax sheltered retirement plans (401Ks, 403bs, Roth IRAs).
3. Invest regularly over a long period of time.
4. Invest part of your money in a low cost index fund, such as one of the Vanguard index Funds.
5. Invest part of your money in a low cost bond fund.
6. Invest part of your money in FDIC insured instruments such as CDs (Certificates of Deposit) and MMFs (Money Market Funds).
7. To reduce risk (but with lower gain), increase the portion of your investment in MMFs and CDs.
8. To increase your gain (but with more risk), increase the portion in stock growth funds.
9. Put all of the money that you will need in the next few years into CDs and MMFs. Just invest regularly in a good mutual fund and forget about it. As the time that you plan to spend some of your investment approaches, move a portion of your investments into CDs and MMFs.
Do NOT do any of the following:—
1 Try to anticipate when the market will rise or fall. You will get in or out of the market at just the wrong moment.
2 Switch funds. Just invest and forget.
3 Buy and/or sell stocks, bonds, etc. except when you have more money to invest or if you are approaching a time when you plan to spend some of your investment.
4 Withdraw earnings from a retirement plan or IRA early.
Needs at Retirement—One purpose for investing is to provide funds for retirement. A maximum withdrawal of 3 5% per year from an investment account can be tolerated without exhausting the investment prematurely. For example, $500,000 is required for an annual retirement income of $20,000 (based upon a 4% withdrawal per year. Stocks Stocks are an ownership share in the company. Historically, the price of stocks in general have risen (discounting the effect of inflation) by 7.2%. This return is more than double the average yield of bonds, CDs or MMFs. Unfortun-ately, extended periods have elapsed when the price of most stocks have fallen dramatically. Bonds A corporate bond is an IOU from a company. The bond has an interest rate, a maturity date, and a face amount. When the bond matures, the company promises to pay back the full amount of the bond. In addition, half the specified interest is paid on the bond every six months. If the bond is callable, the company may choose to pay you back early (this will happen if interest rates drop). A bond held to maturity is worth exactly the face amount (unless the company goes bankrupt, in which case the bond may become worthless). You may sell a bond on the open market, but there are transaction costs, mark ups, and the value of the bond my be lower (or higher) than the value at maturity. CDs (Certificate of Deposit) A CD is much like a bond. It is an IOU from a financial institution, such as a bank or a credit union. At the end of a specified term (usually 1 5 years) the bank will repay you the full amount of the CD plus a specified interest accrued over the term of the CD. If the bank is a member of the FDIC (Federal Deposit Insurance Corporation), you are guaranteed by the US Government to be repaid the face amount of the CD (up to $100,000) even if the bank goes bankrupt. Thus, the risk associated with a CD is less than with a bond. If the CD is callable, the bank may choose to pay you back early if it is to their advantage (your disadvantage). Risk Investments have more or less risk where the risk is that you will lose some or all of your original investment. Higher yield investments have higher risk and vice versa. There are several sources of risk:
1. Capital Risk. Stocks may fall in value. Bonds may default. In either case, you may lose all or a portion of the money that you invested in stocks or bonds.
2. Interest rate Risk. If you choose to sell a bond, the value of a bond is subject to changes in the current interest rate. If you hold a bond to maturity, the interest rate risk is avoided.
3. Inflation Risk. The buying power of a $1.00 may dwindle over time. The higher the rate of inflation, the faster that the dollar will lose value.
The following table shows the effect of the above risks on the investments described above:
Investment Capital Risk Inlation Risk Interest rate Risk Average Return (inflation adjusted) Money Market None Minimal No 2% CDs (FDIC) None (<100,000) Yes No, (unless callable) 3% Corp. Bond Yes (defaults) Yes Yes (if sold) 3.5% Stocks Yes (large) Yes No 7.2%
Coping with Risk Risk can be controlled by asset allocation. If you put 100% of your savings in CDs, Treas-uries, and MMFs your risk will be limited to inflation risk. At the same time, your average return will be limited to about 2% 3% after inflation. On the other hand, if you invest in stocks, your risk will be higher, but your return will be better than any other option (stocks did better in 80% of all 10 year periods). Of course, you can choose some middle ground in between these extremes.
Taxes State and Federal income taxes can take a huge bite out of your profits. Some rough guidelines on the taxes for a taxable account:
1. Interest earned on CDs and bonds are taxed as ordinary income.
2. Corporate tax is paid by the company on any dividends. Then, the recipient of the dividend pays taxes again. (If these earnings become part of an estate above the deductible amount, the same dividend is taxed A THIRD TIME.)
3. If a stock or bond appreciates in value, the increase in value is taxed as ordinary income if it is held less than twelve months. The increase is taxed as a capital gain if it is held for twelve months or more.
4. Earnings in a Roth IRA are not subject to Federal income taxes.
5. Taxes on earnings in a traditional IRA are deferred until the earnings are with-drawn.
6. A mutual fund account may be subject to substantial taxes that you have little or no control over. Stick to funds with a low turnover (< 50%) to reduce your tax liability. The turnover rate for a fund is included in the prospectus (under Financial Highlights).
Roth IRA It is hard to over-emphasize the advantages of a Roth IRA. Everyone who is not taking advantage of the Roth IRA (who qualifies) is missing a great opportunity. For those under 40 years of age, the Roth IRA is a simple and effective way to guarantee a comfortable retirement. Check out the following sites for more information:www.senate.gov/~finance www.schwab.com www.rothira.com The benefits are enormous. Qualified withdrawals (first house, disabilities, at age 59.5) may be made with no penalties and no Federal income taxes (state tax may apply). The amount that you contribute (but not the earnings) may be withdrawn at any time. Refer to the links mentioned above for the rules on conversions. Even at 2,000/year a 10 year old can accrue millions of dollars by the age of 60!
Computer aided Investing The presentation mentioned several ways that you can use your computer to help you make better investments. Here are a few web sites (in alphabetical order) that were mentioned: www.aaii.org
American Association of Individual Investors. An organization that helps individual investors. They have local clubs and lots of useful literature.
www.bankrate.com—finds the best rates for CDs (Certificates of Deposit) and MMFs (Money Market Funds).
www.better investing.org—all about investment clubs. www.bondresources.com lots of info on bonds.
www.buyandhold.com—a stock broker that facilitates a buy and hold strategy.
www.fool.com—lots of advice on investing. Includes a variety of portfolios.
www.gomez.com—rates companies including stock brokers.
www.goodmoney.com—scroll down to select forums, lists of stocks
www.hulbertdigest.com—Rates financial newsletters.
www.investinginbonds.com—advice on bonds from the Bond Market Association.
www.morningstar.com—rates mutual funds, ETFs (Exchange Traded Funds), and stocks.
www.moneycentral.msn.com—select investor, quotes, options to get detailed information on option prices.
www.netstockdirect.com—lists 1600 plans with information about each.
www.quote.com—investment tools, message boards, stock and mutual fund information.
www.ragingbull.com—message boards, financial news, quotes.
www.realassets.org/social_investing/—social investing basics, using screens.
www.rothira.com—a very comprehensive site on the Roth IRA.
www.schwab.com—good info on investing, including information on the Roth IRA
www.senate.gov/finance—official info on the Roth IRA.
www.sharebuilder.com—provides services similar to a stock broker.
www.valueline.com—lots of stock information. The Hulbert Digest rates their Portfolio I as one of the few portfolios that outperforms the S&P 500 stock index over an extended period.
www.etrade.com—a low cost stock broker
www.scottrade.com—a low cost stock broker that sells mutual funds, stocks, bonds, etc.
www.treasurydirect.gov—a very low cost and safe way to buy treasury bills, treasury notes and treasury bonds.
www.vanguard.com—offers low cost mutual funds.
www.wsj.com—lots of investing information.
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