Investment Playground.NET

Great! You’ve decided to start saving for an emergency fund. “But where do I put this money?”

You’re looking for a liquid account that earns a return higher than inflation. Your bank’s savings account probably offers one percent a year. Laugh at them and walk away. Look for a money market account that pays the highest rate you can find. Or simply a high interest savings account. Go to http://www.bankrate.com/ to find some of the best rates. I did the dirty work for you as below.

I have an account at http://www.igobanking.com/. A reliable division of Flushing Savings Bank. They’re paying 3.86%, which is definitely the highest I’ve seen, with no minimum deposit. The deposits and withdrawals are seemless and all done online. You’ll get credit to your account within two business days.

WTDirect is offering a great 3.91%. The only catch is that it’s a $10,000 minimum to earn such a great return. Their offer for below $10k sucks - it’s a half percent. But if you want a real nice insurance cushion - here you go. 3.91% will give you $400 after a year - not bad for no work.

Personally - for every dollar I save I like to put it towards earning $1.15. Savings accounts or money market accounts earning one or two percent just doesn’t cut it for me. As soon as I have any money - it’ll go to the best investment for me at that time. But - we still need to plan for life’s many unexpected curveballs. Always have a contingency plan.

This is the part I hate - when every money manager (or blog) tells me to always have an emergency fund of three to six months of your salary - just in case. Why should I save all that money aside when I can invest it? I feel your pain - I’d rather earn ten or twenty percent returns as well. But the truth is - you never know what kind of a curve ball you’ll get. The Consumer Federation of America states that the average family faces $2000 in unexpected bills every year. What about bigger things - you could lose your job tomorrow. Your company could get bought (consolidation is very common in a tough economy). Your furnace could blow tomorrow (it’s been a tough winter). Your car could start to make awful noises as you’re on the way to the bank. Let’s say you want to get married - let’s not let not having enough money stop that from happening. You need to have contingency plans set up every step of the way. That’s why every real investor has a certain portion allocated to cash or bonds. These are low risk and liquid avenues for the just-in-case scenario. Good investments are usually illiquid - this means that you can’t just pull your money out when you need it. If you found a great piece of income generating real estate - good for you - but your money is tied up for years to come.

To start up an emergency fund, start small. Set aside a small percentage of your paycheck and deposit it into a new account. Use automatic deposits into your savings account. $50 per week, $500 per month, whatever you can handle. You should look at your personal situation and say “If I needed some cash all of a sudden - what’s the best amount for me to have on hand?” A few thousand dollars is enough for some people. I wouldn’t suggest anything more than $8,000, and no less than $2,000. Start now and start small - don’t worry if it takes you a few months or longer to get there. If you’re married or have children, you might want a long-term goal of little more. Deposit any one-time extra income you get into the account - a small bonus, a birthday cash gift, your tax return, etc. Once it’s built up - it’s a cushion just in case something happens. Call it a so-you-can-rest-account. There’s not many better investments than those that give you a good night’s sleep.

For the record, I didn’t care too much for Rich Dad Poor Dad initially. It was too basic for me. But after some reflecting, I realized that the general population really needs this basic understanding. The average American essentially struggles to make ends meet - regardless of how much income they make. People with six figure salaries have more bills and debt that they can afford. So in hindsight, cheers to Robert Kiyosaki and the Rich Dad team for some basic and fundamental personal finance lessons.

My very quick summary of the book: invest your money and live by your returns. That’s basically it. We all have steady expenses every month. $300 for car payments, $500 credit card payments, $2000 on a mortgage, etc. What Rich Dad Poor Dad teaches is instead of letting all the monthly bills pile up faster than your income does, you should invest your money and earn a return higher than those expenses. For example - real estate (arguably the best long-term investment even today): if you make a solid purchase of an income generating property. So the property you purchase carries total monthly expenses including mortgage and tax of say $1500. And let’s say you rent it out for $2000, netting you $500 in monthly income. Great - there’s your justification for buying a nice car. So your actual expense doesn’t increase by purchasing this car if done so after purchasing an investment vehicle.

Clear enough for you? Now - just do it five times over to cover your total monthly expenses. It’s hard work - but a great long-term plan.

We all make novice mistakes. So here’s your lesson on how to avoid mine.

Hewlett Packard (HPQ) is a stellar company. They target growth by utilizing their resources appropriately. They can provide print services through their Imaging and Printing division while at the same time offering their computer and IT support. Joint solutions provide revenue to all their divisions. They also derive a ton of revenue from overseas, providing protection from a US economic downturn.

So I decided to research HP as a stock purchase. On November 12th of 2007, the stock took a downturn due to general market malaise which caught my eye - it was down to $47.54 at the close. I was patient and disciplined, and no matter what the stock were to do, I wasn’t going to buy until I completed my research. I started looking at annual reports and shareholder presentations, and I got my hands on some sell-side analyst reports as well. The consensus price target was $56. I was quite confident of this price target - and which such solid management I said this would be a good short term buy. The problem is, by this point the stock was back up to about $52 per share.

Lesson learned: a growth story doesn’t work unless the company is selling at a reasonable price

Sure it’s still a great company, but I bought the stock at $51.95 which was fully valued. If you’re looking for a growth play, be weary of the market that we live in right now. What’s a better option is growth at a reasonable price. Had I followed this GARP rule, I would’ve said “Great company, but not a reasonable price”. And walked away. The stock has fallen 16% in two months since I purchased it, currently around $44. Was this a foolish purchase? No. It was just expensive. If you buy a fully valued stock, it will certainly tank with the market. If you buy an inexpensive gem, the market tanks and your stock comes out on top. I’m not going to sell and realize my loss because it’s still a solid stock to own - but the opportunity cost is that it now has become a long-term play that ties my money up for potentially years.

If you’re in my position, the best course of action is to buy more at such a good price. This is called dollar cost averaging. Meaning, your average price paid is lower than the $52 originally paid. HPQ is releasing earnings tonight after the market close. We’re poised for a gain if they do well, but I doubt it’ll be a 15% gain.

Bottom line - don’t buy anything that’s too expensive, even if it’s a great company.

Investing in the stock market is hard work. Picking a stock that will return profitably is not easy. You’re looking for a good company, with good managers, and undervalued pricing. I buy very few stocks. There’s not a lot out there that’s worth buying, and I’m not a gambler at all. Even if you find a good stock, how much disposable income or savings do you have availabel to you to invest? The typical retail investor plays around with less than $5000, and many people buy and sell with just a thousand or so. There are three problems with this:

1. Commission fees on a percentage basis are much higher than you want to be paying.
2. Absolute returns are much lower than you expect.
3. Forget about the possibility of diversification.

As an example, let’s say you have $1000 to invest, and let’s say you’re investing through Scottrade (the cheapest commission of $7 per trade). Let’s say with your $1000 you buy 19 shares worth of a $50 stock. The stock goes up 10% in the next eight or nine months to $55 per share and you sell. Great move - the market returns an average return of 10% over many decades. But 10% return of your $950 investment is merely $95 - not enough to retire off of. Plus your $14 in buy/sell commission fees eat into that $95 return by 15%. 15% of your earnings are gone! That’s like getting the world’s worst car loan.

And as far as the diversification aspect goes - you’ll need another several thousand dollars to balance your portfolio nicely instead of fully allocated to one single stock (way too high risk).

Bottom line - pay the mere one or two percent fee to a money manager who will invest your money for you. You’re safer and will inevitably have a much higher return.

I’m hearing a lot of talk nowadays about how real estate is “not what it used to be” and is not the place to go to make money anymore. This is a total fallacy.

Every good investment works cyclically. This means that there are good and better times for every investment. Buying into the stock market today is probably not the best investment (risk profile is too high in this market). But it doesn’t mean that the markets have gotten too efficient to make income in. All it takes is time and patience for the markets to retreat to realistically priced levels. As far as real estate goes - there was a time not so long ago when you could throw $10,000 into a piece of real estate and turn around and sell for $50,000 a year later. All the factors driving real estate worked in our favor. Now - it’s the real world. There are still thousands of good real estate investments. However now’s the time that you have to be careful and do your homework before going out and buying everything you can.

Good investments are hard work. The real estate boom we’ve had the last several years can be compared to the dot-com era. Prices of good (not necessarily great) companies were pushed higher and higher on false pretense. People are now talking about how real estate markets will be “hit hard”. Translation - they’re returning to fair value! It’s that simple. Buying a good stock in an average market or a good income generating property in an average real estate market takes work. What is the company’s intrinsic value, what should the stock be selling at, what are the key factors in the company’s growth, what risk does the company face near-term, what is the competitive landscape? OR - what should the property be selling for based on the cash flow it generates, is the property undervalued or overvalued and why, can you buy with equity priced in, what are your expenses estimated to be, what large one-time expenses are forecasted within five years, what are the typical tenant profiles, what risk of non-paying tenants are you exposed to, and what risk can you tolerate? All these questions need to be vetted and asked thoroughly before making any real investment decision. Your answers will guide you to good investments in only average investment markets.

The Fed cut interest rates by 50bp yesterday. If you read our previous entry ahead of the Fed announcement, the market’s response we forecasted was accurate.

Remember - we said the Fed’s 50bp cut was already priced into the market. Meaning essentially, a 50bp cut wouldn’t have much of an effect. What we saw was a knee-jerk buy trigger for extremely quick turnover players and the market rose by 120 points. But alas - true value will always win. The market quickly, within a half hour or less, gave back all those gains, and closed modestly down. Although we forecasted a “modest gain”, it’s always important to find what you feel the true value of your investments and choices will be. You can win two-fold - one is to play the traders’ games on the short end by using true value as your benchmark. The second is just to play value, relax and hang on. It’s going to be one hell of a ride.