One TERRIBLE Piece of Financial Advice You Should Never, Ever Listen To

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Bad Financial AdviceLaunch into any money-related conversation and you’ll inevitably hear the following bad financial advice:

“But it worked for me!”

Those insidious five little words have been used to justify all types of terrible ideas, from buying lottery tickets to over-leveraging your investments to investing every last dime into Apple stock.

Let’s try this one on for size:

Common Sense: “Even if you find an awesome investment, spread your risk by picking a few other investments, as well. Rental properties are awesome, but even if you could make 20 percent cap rates, you should still keep a solid chunk of money in stock market index funds.”

Retort: “But I put 150 percent of my savings in gold in the year 2007 and it totally worked for me. Put every dime in gold! Nothing else! Why bother diversifying when you get the best returns in this arena?!”

Common Sense: “Hold on, you invested 150 percent of your savings?”

Retort: “Yeah, I can take a cash advance from my credit card at 14.9 percent and invest it for 170 percent gold returns! I’d be stupid NOT to!”

Common Sense: “Uh, don’t you think that’s a bit risky?”

Retort: “Hey scardey-cat, if you’re so terrified of risk, why don’t you sew your money into a mattress and leave REAL investing for us tough guys?”

Uh-huh. Right.

Tip: When your opponent has to justify their investing strategy with ad hominem attacks, they’re grasping for straws.

Alright, that was an easy example. Afford Anything readers are an intelligent group. I don’t need to explain this example. You can see why it’s an insane argument.

But let’s look at a subtler example of the “it worked for me” phenomenon. Let’s check out an example in which the counter is uncommon sense.

“But I Sold my Home for $20,000 More Than I Paid!”

UnCommon Sense: “Don’t tie up a huge chunk of your net worth in your home. Your home is NOT an income-producing asset. It won’t stick cash in your pocket each month.

Your money should make money. So live in a cheap home while you deploy your cash into rental properties, stock index funds or other income-producing investments. Reinvest. Lather, rinse, repeat.

“Better yet, buy a small apartment building (like a duplex, triplex, 4-plex) as your first home. Live in one unit and rent out the others. If your neighborhood doesn’t have multi-units, live with roommates until you either have a baby or your mortgage is paid off.”

Retort: “But I sold my home for $20,000 more than I paid for it! So my house IS an investment! It worked for me!”

This is precisely the type of argument you’ll hear from someone who hasn’t crunched the numbers. The people who say it often conflate gross gains with net gains.

The average person doesn’t make very strong net gains on their home value, after adjusting for insurance, taxes, loan interest, repairs, maintenance, Realtor commissions and closing costs. If they’re lucky, most of their net gains can be explained as “inflation plus 2 percent.”

Most people would be better off living in tight quarters and putting the excess money into stocks.

Are there exceptions? Sure. Just ask the people who bought houses in Southern California in the 1970s. But this is the tail end of the bell curve. People have also made millions winning the lottery.

Furthermore, most of the people who happened to buy in 1970’s Southern California shot themselves in the foot by “trading up” continually until the market burst. Many people thought they were different, that they were the exception to the rule, but then they became scared that they’d be “priced out in five years.” So they bought a big home, then lost all their gains.

The best antidote to getting “priced out in five years” isn’t to pay an overinflated price today. It’s to create more wealth. Build your net worth at a rate that’s faster than housing growth. It’s not that tough.

Let’s try another example.

College is Good, Grad School is Better

UnCommon Sense: “You’re not a zombie. So don’t blindly repeat the mantra that college is good and graduate school is better.

“Do the friggin’ math.”

“If you want to be a neurologist, awesome. Take out a six-figure student loan to go to medical school, because you’ll have a rare, high-demand skill that will command you a $225,000+ income.

“But if you want to be a social worker earning $30,000 a year with a master’s degree, think twice before burying yourself with debt.”

Retort: “But I did it and it wasn’t so bad! My student loan payments are only $180 a month. That’s nothing. That’s less than my car payment! And I think the government will forgive my loan in 20 years, anyway.

Plus, I got this job that pays $42,000 a year, and there’s a chance I could get enough in bonuses to make as much as $50,000. There’s no way I could have gotten that without my master’s degree.”

Ouch. This is one of the most common “it worked for me” arguments that I hear. And what’s befuddling is that the underlying message is that it really didn’t work.

$180 per month for 20 years is $43,200. That’s a decent chunk of cash, but it’s not horrifying. People have lost more by buying a house at the wrong price.

What’s worse is the missed opportunity. $180 invested monthly over 20 years is $106,730. That’s a horrifying amount.

But that’s still not the worst part. The real sad news comes from other missed opportunities. Want to start your own business after a few years? Good luck! The rest of us can move into grandma’s basement, mow lawns on the weekends to pay for groceries, and spend the rest of the week building our own graphic design enterprise. Your extra $180 monthly loan payment means you’ll need to mow many more lawns.

“That’s true of a mortgage, too.”

Yes, but you can sell a house.

That’s not the only hang up. You’ll be far less inclined to change careers if you decide your current path isn’t fulfilling. What would you do – go back for a second master’s degree in a different field, racking up even more debt?

You’ll have a rougher time quitting your job to travel the globe. You’ll lose the flexibility to change jobs and take risks. You’ll probably delay buying your first rental property or maxing out your Roth IRA by a few years.

“It worked for me” isn’t always the best path. At best, it’s an isolated data point. At worst, it’s bad advice.




Two Yale Professors Recommend Borrowing Money to Invest. Should YOU??

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Two Yale professors say young people should borrow money to invest in the stock market.

Sounds crazy, I know. Here’s their rationale:

Borrow Money to Invest

Traditional retirement advice says you should invest 10 to 15 percent of your income.

That money should be divided between stock funds and bond funds according to your age. A 25-year-old might want to be 90 percent in stocks, 10 percent in bonds, for example. A 60-year-old might decide to be 50/50 in stock and bond funds.

The problem with this advice, say Yale business and law professors Ian Ayres and Barry Nalebuff, is that 20-year-olds haven’t saved much yet. Fifty- and 60-year-olds have a higher net worth.

So what?

Although a 60-year-old has reduced the percentage of his portfolio exposed to stocks, he has more money exposed to risk – exactly when he’s least able to recover from a wipe-out.

Conversely, the 25-year-old may have 90 or 100 percent of her portfolio in stock funds. But that’s only a couple thousand bucks.

Example:
Jill is 25. She has $2,500 saved for retirement. Ninety percent of that, or $2,250, is invested in stock funds.

Wendy is 60. During the past 40 years, she’s amassed a retirement portfolio of $680,000. Half of that, or $340,000, is invested in stock funds.

When the market drops 3 percent, Jill loses $67. Wendy loses $10,200.

The solution? According to Ayres and Nalebuff, twentysomethings should borrow money to invest in their retirement account.

“It is obvious that you’re not well diversified if you invest $100 in one stock, $200 in another and $300 in a third. You’d have less risk investing $200 in each of the three stocks,” they co-wrote in a column in Forbes Magazine. (They’re assuming each stock is equally desirable).

“The same idea of equal investments applies to investments across time,” they say. “If you have $100 invested in year one, $200 invested in year two, and $300 invested in year three, you have too much exposure to year three and not enough to year one …”

They argue that people borrow money to buy houses, so why not stocks? (Of course, they neglect to mention that you can LIVE in a house, regardless of its market value. You can’t live in a stock portfolio.)

Regardless, the two professors offer an interesting theory. What do you think? Could twentysomethings – counter-intuitively – reduce their risk by borrowing money to invest for retirement?



Why Market Timing is a Terrible, Horrible, No-Good, Very Bad Idea


Let’s chat about the question on everyone’s mind …

What the Heck Is Up with The Market This Week?

Or: Why Market Timing Is a Bad Idea

Investors have been optimistic this year, despite a sagging U.S. housing market, 10 percent nationwide unemployment, and turmoil throughout the Middle East, particularly in Egypt and Libya.

The Dow Jones Industrial Average peaked on Feb. 18 at 12,391, and was holding a respectable — and normal — 12,213 on March 9.

Then the earth shook, and stocks plummeted — all the way down to 11,613 a mere week later, on March 16. The world held their collective breath as Japan, battered by an earthquake and tsunami, sat on the brink of a nuclear disaster. While U.S. stocks took a heavy beating — a fall of 600 points in a week! — it was nothing compared to the merciless sell-off of Japanese stocks. On March 9, the Nikkei was sitting pretty at 10,589. Within a week it was gasping for life at 8,605 — a loss of almost 20 percent.

And now, as time passes and we collectively start forgetting about nuclear Armageddon, stocks surge again — up almost 2 percent today (in one day!), to a Dow Jones average above 12,000 again. (Ah, a return to normalcy!) The Nikkei is back up to 9,206. The MCSI Japan Index Fund (EWJ), a passive fund tracking a huge basket of Japanese companies, is still down almost 12 percent from its high – but has risen 2.4 percent today alone.

(A little note about stock gains and losses — when you LOSE money, you have to GAIN exponentially just to break even. Think about it: you invest $100. You lose 50 percent. Now you have $50. You have to gain 200 percent — double your money — to get back to your original $100.)

Focus on the Fundamentals

So what happened? Why such an enormous swing over the span of a week? None of the fundamentals changed. Every company that lost stock value after the Japanese tsunami — Google, Wells Fargo, Visa — maintains the same fundamentals as they did a week ago. Their skills and talents haven’t changed. Their debt-to-asset ratios haven’t changed. Nothing changed, except that a wealthy nation in the Pacific experienced a tragic and expensive disaster from which they will ultimately recover.

So why the sell-off? Simply put, investors are speculating — gambling — about the future. They don’t know what’s going to happen; no one does. All they know is that there’s uncertainty — and when there’s uncertainty, there’s a chance to make a profit.

So they start buying and selling like crazy. Investors prone to nervousness pull their money out. Investors who love to bargain-hunt pour their money in. Trading volumes skyrocket; firms that charge $7 – $10 per trade start grinning ear-to-ear. For these firms, bad news is great news.

Of course, we live in an automated age, Not all of this buy-sell frenzy is the result of Average Joes at their laptops selling off Sony and Hitachi stocks in $1,000-dollar increments. Much of this frenzy we see isn’t done by people at all, but rather by software algorithms that are programmed to read charts, predict patterns, and make buying-selling decisions based on these patterns. These algorithms don’t take nuclear annihilation and tidal waves into account; they simply look at patterns in stock charts and trade huge sums of money based on raw data. Then Average Joe sees the sell-off on the news and thinks, “Oh man, other investors are getting scared, and stocks are starting to tank — maybe I should move my 401 (k) into cash.”

Stick To Your Guns

Unless you believe in chart-reading and other forms of sooth-saying (perhaps you can read my palm or check my horoscope for more stock picks), you — YOU, the average investor — is best off sticking to your original investment plan:
1) Allocate your assets according to your age and risk tolerance,
2) Rebalance once every year or two, and
3) Leave your portfolio alone.

In the span of the last week, the Dow Jones has crashed from 12,200 to 11,600 and then surged back up to 12,100 (today). If you were to buy or sell based on that frenzy of speculation, there’s a good chance you’d lock in your loss and miss the recovery. If you stayed the course, you’d be fine.

The more you listen to the news, and buy and sell based on what algorithms across the country are doing, the more likely you are to ruin your returns over the long run. Stick to the fundamentals of investing, and have faith in the market to recover from its momentary crashes and surges.

But I want to be part of the action!

Final note: If you have an appetite for risk and gambling — and you really want to get in on the fun! — commit a tiny amount of money to “playing” the market (and treat it like a game!) When the tsunami hit Japan, I bought two stocks: the MSCI Japan Index (EWJ) and Hitachi, Ltd. (HIT), a Japanese electronics maker. I spent only as much money as I’m willing to lose (i.e. not much!), and I consider these purchases to be “fun” money, NOT money for retirement or short-term savings.

Become Filthy Rich By Dividing Your Money Correctly: 3 Rules on Asset Allocation

There’s this phrase called “asset allocation.”

Every time I say it, people’s eyes glaze over. Yawn. Sounds boring.

So let me put this a different way: you can become filthy rich by dividing your money in the right way.

Knowing “the right way” isn’t rocket science … it’s basic. By the end of this post, you’ll know it.

Step 1: Divide Based on Your Age and Risk Tolerance

First, stash 3 months of your basic expenses into an emergency fund. This is NOT an investment. It’s for emergencies only.

Got it? Good.

Okay, now decide how much of your investment money to divide between:

  1. Stocks (mutual funds, index funds, ETFs)
  2. Fixed-income investments, like bonds
  3. Cash and other liquid assets (money market accounts, CDs)

Stocks are volatile. In the short-term, they carry more risk. In the long-run, they make higher returns.

Cash is — well, cash. It’s safe, but it’ll barely keep pace with inflation.

Fixed-income, like bonds, is the happy medium between the two.

How do you decide based on age and appetite for risk? This simple rule of thumb will tell you.

Step 2: Divide your Stock Funds Among These Major Categories

Stock funds – like index funds and ETFs – fall under two major categories: Foreign and Domestic.

Domestic funds are divided into three categories: Large-Cap (big companies), Mid-cap (medium companies), and Small-Cap (obviously, small).

Foreign funds are divided into two categories: Developed Markets (Europe, Canada) and Emerging Markets (Brazil, China, India).

If you love risk:

Then follow this formula for your stock funds (index funds and ETFs):

40% domestic large-cap markets
20 % domestic mid-cap and small-cap markets
30% in foreign developed markets
10% in foreign emerging markets

If your risk appetite is only so-so:

Then follow this formula for your stock funds:

50% domestic large-cap funds
30% domestic mid-cap and small-cap funds
10% foreign developed markets
10 % foreign emerging markets

If risk makes your stomach queasy:

Then follow this formula:

60% domestic large-cap funds
15% domestic mid-cap funds
10% domestic small-cap funds
10% foreign developed markets
5% foreign emerging markets

How do you know your risk tolerance? Take this quiz.

Step 3: Invest your fixed-income funds based on withdrawal time

Bond funds come in three varieties:

  • Short-term
  • Mid-length
  • Long-term.

Make your choices based on when you want to withdraw your cash.

  • 1-5 years: invest the fixed-income portion of your portfolio in a short-term bond index fund. (Remember, in Step 1 you decided what portion of your portfolio would go into fixed-income funds).
  • 5-10 years: put that piece of the pie into an intermediate-term bond index fund.
  • 10-15+ years: stick it in a long-term bond index fund.

I’m simplifying bonds here, because they do get more complex: there are “junk” bonds, “safe” bonds and floating-rate notes. There’s interest-rate risk and coupon payments. It can get as complex as you want it.

But remember: Simple is best, and perfect is the enemy of good.

The longer your cash is sitting in a checking account, the more gains you’re missing. So keep it simple, don’t over-think it, and slice up your portfolio based on this simple, 3-step formula.

Stocks vs. Bonds: The Rule of Thumb

A simple rule that can make you rich.

Here’s an excerpt from the posting 4 Rules that Can Save You $40,000: A Beginner’s Guide to Investing. Click the title for the full story.

Stocks vs. Bonds: The Rule of Thumb

The simple rule of thumb is 110 minus your age = the percentage of your portfolio that shoul d be in stocks. If you’re 35, this means 110-35= 75% of your portfolio in stocks, and 25% in bonds.

If you have a high risk tolerance, increase that to number to 120 minus your age. So if you have the stomach to withstand more volatile returns, and you’re 35 years old, put 120-35= 85% of your portfolio in stocks, and 15% in bonds.

If your risk tolerance is low, drop the number to 100 … so if you’re 35, 100-35 =65% of your portfolio goes to stocks, and the rest to bonds.

What is your risk tolerance? Take this quiz.

4 Shockingly Simple Tips That Can Save You $40,000

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Whew! Writing a guide to saving $40,000 sure sounds like a tall order …

… but it’s not. It’s shockingly simple.

The truth about investing is that it’s not hard or complicated — unless you want it to be.

Sure, you could delude yourself into believing that you’re going to “beat the market.”

You could devote your days to pouring over SEC filings and reports, analyzing debt-to-asset ratios, and comparing the 12-month trailing P/E to the increase in dividends paid each quarter  …

(Eyes glaze over).

… but if you go this route:

  • You’ll take larger risks
  • You’ll be unlikely (over the long run) to make better returns than the market average
  • AND you’ll miss out on life in the process. 

It’s a lose-lose-lose situation.

Which makes my job simple: to teach you the most critical basics, so your money can make money.

Then you can move on to more important things in your life.

Divide Your Money Between Stocks and Bonds According to Your Age.

Here’s a simple rule of thumb:

110 minus your age = the percentage of your portfolio that should be in stocks.

If you’re 35, this means 110-35= 75% of your portfolio in stocks, and 25% in bonds.

If you have a high risk tolerance, increase that to number to 120 minus your age. If you’re 35 and you have the stomach to withstand more volatile returns, and you’re 35 years old, put 120-35 = 85% of your portfolio in stocks, and 15% in bonds.

If your risk tolerance is low, drop the number to 100. If you’re 35, 100-35 = 65% of your portfolio goes to stocks, and the rest to bonds.

Figure out your risk tolerance here: Take this quiz.

Avoid Individual Stocks

Remember that nonsense I was babbling about in the intro … SEC filings, debt-to-asset ratios?

Yeah, I’m trying to forget it too.

Avoid buying individual stocks (Apple, Google) unless you’re willing to spend your Saturday afternoon researching that information.

When I tell you to “buy stocks,” I don’t mean individual stocks … I mean baskets of stocks, such as mutual funds, index funds, or ETFs.

Which leads perfectly to my next point …

Avoid High-Fee Funds.

Pop quiz: What’s one of the biggest investment mistakes investors make?

Answer: Ignoring the fees associated with a mutual fund.

This money silently, quietly seeps out of your portfolio. You never get a bill in the mail. You never pay it upfront. And so you never realize just how many thousands of dollars you pay for a high-fee fund vs. a low-fee fund.

Scenario 1: Let’s say you have $50,000 to invest in your account. You put it in a mutual fund and leave it there for 20 years. But you don’t check the “expense ratio” (a fancy word for “fee”), and as a result, you’re in a fund that charges a 1.19 percent fee — the industry average, according to Vanguard.

At the end of 20 years, you’ve paid a whopping $49,621 in fees.

Look closely at that number — that’s almost the same amount you invested to begin with!! (But you don’t know you’re losing it, because you never have to write a check … this fee is just silently, quietly deducted from your overall portfolio, in small amounts at a time.)

Scenario 2: Now, let’s say you have $50,000 in your account. You put it in a mutual fund and leave it there for 20 years. You DO check the “expense ratio” and find a fund that charges only a 0.23 percent fee.

After 20 years, you’ve paid $10,489 in fees. You’ve saved $39,132.

Stick with Passively-Managed Funds, not Actively-Managed Funds.

There are two types of mutual funds: active and passive.

An active fund is managed by a group of (usually) Ivy League MBA’s who have convinced themselves that they can do what no human being has ever done: consistently beat the broad market average.

In fact, active fund managers are so convinced that they’re smarter, stronger and better than everyone else they’ll charge you a hefty premium to manage your money. (This is where the high fee comes from).

Then — this is where it becomes a horrible deal for you — they collect their hefty premium whether or not they actually beat the market average.

(And, statistically, they don’t).

Put your cash in a passively-managed mutual fund. This is a fund that tracks a broad market — like the Total World Stock Market, or the S&P 500, or the Russell 2000 — without charging you high fees.

What’s an Index Fund?

The king of all passively-managed mutual funds are called Index Funds.

Index funds track an index within the market and deliver returns that mimic the overall market performance.

“They do wha??”

They make sure that your investments perform AS WELL as the overall stock market. No better, no worse.

“Cool, got it. Thanks!”

Want to invest in the entire U.S. stock market at once? There’s an index fund for that. Want to invest in the entire globe? There’s an index for that too. How about investing in the small companies of the U.S.? Yep, there’s an index for that.

If you’re invested in a U.S. stock market index fund, and the U.S. market rises 8 percent, your portfolio rises 8 percent.

With one caveat, of course. You’ll have to subtract a small fee.

This fee — the “expense ratio” can be anywhere between 0.05 percent to 0.20 percent.

Sound bad? No one likes these. But 0.05 percent is much better than paying those hefty 1.01 percent fees that actively-managed funds charge.

What’s an ETF?

Index Funds became so popular that they spawned Exchange-Traded Funds, or ETFs.

This type of fund has grown more in popularity over the last decade than any other fund.

It’s done so for good reason: functionally, it does exactly what an Index Fund does (track a broad index of the market), only it has even lower fees than index funds.

Better yet, ETFs have no minimum requirement (if it’s trading at $25 per share, and all you have is $25, you can buy one share). Index funds, by contrast, have a minimum requirement to get started — usually around $2,000.

The low fees, and the lack of a minimum opening amount, is because ETFs are technically not mutual funds — they’re registered, under the SEC, as baskets of stocks that can be traded real-time throughout the day.

This means that day-traders out there are buying and selling ETFs multiple times a day, hoping to “beat the market” (the greatest delusion in the history of Wall Street).

Those guys who are day-trading, paying fees and commissions with every transaction, subsidize ETFs for the rest of us. That’s why ETF’s have the lowest fees of all. Thanks, dudes!

Here’s the takeaway lesson: The best way to invest in the market is to buy commission-free ETFs. These have low expense ratios, they perform at the market average, and they’re free to buy and sell.

Which ETFs Should I Buy?

This brings us to the topic of asset allocation (otherwise known as “The ONE Thing You Should Know In Order to Get Filthy Rich.”) Click that link to read more …