The stop-loss dilemma

This technique enables an assessment of the potential cost if things go wrong. If the investors buy a stock at $100 with a stop-loss price of $75, they know in advance that their maximum loss is $25. There are also other variants which aim to limit the potential reversals of profitable positions. With a trailing stop-loss, the stop-loss price rises in line with the market price. So if the market rallies by $10 to $110, the stop-loss price might also rise by $10 to $85.

The benefits of a stop-loss

It forces an investor to be disciplined. When a position goes wrong, it can cause stress and cloud people's judgement. Anticipating this, and deciding on a stop-loss level in a calm and relaxed manner beforehand, can ensure that an investor will remain objective.

A stop-loss also allows a specific amount of capital to be allocated to each idea. So an investor might be prepared to lose say, $10,000 on a hunch, and say, $25,000 on a firm conviction.

The argument against stop-loss

It doesn't seem very scientific.

Is this necessary if the other risk management ideas are followed?

The choice to cut a losing position is a dilemma.

On the one hand, the positives for managing risk and preserving capital are clear.

On the other hand, if you are confident an investment is a good idea but the price moves against you, perhaps you should be buying more, or at least holding, rather than cutting.

How you may overcome this dilemma?

One discipline which you should use is to value your position regularly using the current market price. A losing position clearly means that something unexpected has happened.

When you invest, have a stop-loss in your mind. If your investment hits the stop-loss level, make a judgement on whether to cut, based on your confidence at the time about the position.

If the loss is threatening to be destructive to your finances, it is absolutely vital to cut. To be at this point, the price must have moved a really long way against you, if you have not bet too much on the idea in the first place.

You must also cut if you are confused about what is going on, or if the fundamentals are moving against you. In these situations, you see the prices go further than expected.

The decision not to cut

There are times not to cut a position, even if it reaches your stop-loss level. These are when two conditions are satisfied:

1. you have the capital in case of further losses;
2. you understand the reasons for the adverse price move, but remain confident that there will be a recovery.

Here it may make sense to hold the position and even to consider buying more. (It is sensible to see the market starting to recover before adding to a position.)

The decision to keep a losing position must not be based on emotion or on any sense of living in hope. You must admit to yourself that things have not gone the way you expected, and that since you have been wrong up to this point, you may well be wrong again. There is an old saying along the lines of 'the market can remain irrational much longer than you can remain solvent'.

Summary

Stopping out is the hardest transaction. No one likes to give up hope. But it is essential in some circumstances. Beginner investors should be especially cautious about mounting losses.

Sometimes you cut a position and then the market recovers. Don't be put off stop-losses by those experiences. The horrible feeling of cutting a position only to watch the price turn and recover is one of the worst for an investor. You are talking about probability and random events, and over time all sorts of good and bad things will happen. You have to look at the long term. Normally after cutting a bad position there is a strangely cleansing feeling - some people say it's a bit like getting out of a bad relationship!

Stop-loss maybe unnecessary for some or many investors if the other risk management ideas are followed.

Qualitites of the successful investor

Drive and ambition are absolutely essential. You won't make it in the financial world if you're lazy.

The risk-taking elements of investing require self belief and genuine confidence. This is particularly important to handle losses. On the other hand, a big ego is a negative because markets cannot be fooled by bravado.

Intelligence and practicality are essential. Intelligence is the ability to sort through a lot of information and to see what is important. There are many educated and knowledgeable people who are not especially intelligent. The ability to use the information is what they lack. An ability to simplify a complicated subject has its rewards.

Above all, you need to enjoy what you do. Financial markets are the most exciting experience imaginable.

A level of optimism like this is important. There is a book by Dr. Martin Seligman, Learned Optimism, which relates the level of a person's optimism to their success. It argues that the most successful people are rational optimists. Optimism relates to an attitude towards risk. Pessimism stops people taking any risk.

Assess risk - and then double it

Risk assessment is not always an exact science.

Occasionally, you hear of investors who have been hit by losses so big that they find themselves "out of the game". The reason is the same in every case: they have not managed their risk.

The most important is to always have a rough idea of how much money you could lose if the markets move against you, and you should be able to withstand that loss if necessary.

Risk assessment is not always an exact science. Judging how much a position can move against you will be nothing more than a gut feeling. It is difficult to be more scientific about it because:

• using history as a guide is not always effective, as the world is always changing.
• even in normal conditions, there is a lot of 'volatility of volatility', as the market goes throught quiet and crazy periods.
• the size of the theoretical maximum loss is all of the investment, because a price can go to zero. But this is hardly expected to happen.
• sophisticated statistical analysis has often proved inadequate, which is why LTCM had come unstuck.

Here is how one investor estimate his maximum loss for each position based on what he feel could happen in a normal environment. A normal environment is one which applies four years out of every five. (For every 5 years of investing, you can expect to meet 1 bear year.)

Step 1: He assumes for risk purposes:

• Blue chip stocks will not fall by more than 25% in the four years out of five. So for every $100 invested in the big names, he could expect to lose $25.
• Smaller stocks are normally more risky. These will not fall by more than 50% in the four years out of five. Therefore, for every $100 invested in a small stock, he was risking $50.

With this estimate for each position, he can simply add them all to get an idea of his total risk ($R). This gives an estimate of how much he could lose in reasonable circumstances - four years out of five.

Step 2: For the one bad year in five, it could be worse than that. The loss will be worse. For this reason, he assumes that he could possibly lose double that amount ($2R).

Step 3: Making some deduction to my total risk. It would be fair to expect that not all of his rainy days will happen together. This is the benefit from diversification. Therefore, he can make some deduction to his total risk if he feel not everything can go wrong at once. (But be careful, some big name hedge funds have come unstuck by underestimating how their positions are correlated.)

To summarise:

This simple and logical technique of risk assessment involves:

• for each position, assess how bad a loss could be in a normal environment;
• double the amounts; and
• add up the potential losses, and take some off the total if it is justified by diversification.

The idea is to be comfortable with the total risk level. It is vital that you could withstand that loss, because a disaster may happen. So simply choose the size of positions so that potential losses are manageable. No market is too risky if the position is not too big.

With the right approach, you should be able to "stay in the game". Do not take too much risk.

Was the potential reward worth the risk?

An investor may be tempted to chase that little bit of extra return on his investment. Perhaps, he may put his life savings into saving schemes that pay slightly more than ordinary bank deposits. However these types of deposits are a little bit more risky. Every now and then they can blow up. It's always sad when these, usually, small investors have lost their savings that way.

Is the higher return worth the risk?


There are many types of investment which pay above market returns. The problem is that every now and then there can be a big crash which can take away the profits and cause losses. These types of investments can give the illusion of being very comfortable when they are doing well. However, there is an asymmetry, because most years they will pay-off, but in a bad year they can be horrendous.

If an investment opportunity looks too easy, it's time to smell a rat.

Everyone is a hero in a bull market

Psychologists have identified that it is human nature to attribute our wins to our skill and our losses to our bad luck. Don't fall for this trap.

With trading and investment, luck often parades as skill, especially when a market is doing well. During a bullish run in the stock market you will often meet someone who is very happy with their ability to pick the right stocks, because they have backed one that has performed well.

But in the same way that a rising tide lifts all boats, even the rusty ones, many stocks do well in a bull market, even if they're nothing special. So the profit may have more to do with favourable big picture events at the time, such as a strong economy or falling interest rates, than with anything company specific. This really means that the person was lucky rather than skilful.

Be mindful of the old chestnut that 'everyone is a hero in a bull market'. As prices went higher and higher, they increased their investment sizes, so that when the crash came they had far more money at risk than they would have imagined just a year earlier. It ended badly. Profits tempted them in, and losses forced them out.

Listen and read very critically

Keep a critical mind when you read or hear market comments. Ask yourself:

• Does the commentator have any track record?
• Are they considering all of the factors?
• If they are pointing to influences which have been present for some time, why should they start moving the market now?
• Are they relying on hindsight?
• Are they hedging their bets?

Be a sceptic. Who is the writer? Don't listen to ill-informed, ad hoc, one-eyed, overpaid, inexperienced, sensationalist, untested, uncommitted and uninvolved people!

It is just too difficult sometimes to have a view. A commentator can gain a lot of respect if he actually said, "I don't know.' He could then continue 'because of the following...' and you know you're going to get a balanced answer. It's brave to say ' I don't know'.

Respect the market, not the experts

The power of the financial markets should be daunting, but many people are not deterred.


Why do people underestimate the difficulty of making money in the financial markets? Here are some main reasons:


1. The experts in the media

2. The widely held belief that many professionals are regularly able to beat the market

3. Some people like to trade the market because they are gamblers - usually with disastrous results.


Experts

The experts in the media promote the idea that markets are easier than they really are. A guy on TV or the newspaper says that the price is going to do this and do that, and it sounds easy. The market can be beaten.

If the media put out a continual broadcast that the market has processed all the information and that the price is right, people would get the message. But they rarely say that.

The experts and media message is that the behaviour of the market can be forecasted. It's a persistent and seductive message, and people think 'ah, I can have a go at that, I can make money out of that'.

You can't blame the average person for following what they read in the newspaper and what they're being told on TV. However, many so-called experts are just commentators or analysts who often don't have any track record and who often, to my ear, don't even make much sense.

Listen critically, rather than just accept what you're hearing or reading. You may be surprised to find that they're not really experts.

The fact that the media and their financial guesswork is entertaining and interesting doesn't necessarily mean that it's the truth.


Most professionals are not outguessing the market

Ever wonder about all the money made by the people working on Wall Street or in the City of London. Surely they know something about markets?

The truth is that very few are successfully backing their views on markets. Most of them wouldn't have a clue what the market was going to do. They make money in other ways, such as commission and mangement fees.

It's not that people working in finance don't know anything - they are usually very good, very smart people. The fact is they're making money out of sales, client relationships and by doing transactions, i.e. facilitating the whole process. They're not actually making money out of successfully predicting what's going to go up and down. They're, therefore, not a reason for you to take up punting cotton futures in your spare time.

Equally, don't be too impressed with your stockbroker just because they sound confident and know a lot of stories and figures. More information does not necessary make the market more predictable. The extra information is probably useless as the price has already adjusted for it - it has been 'priced in'. It's about as useful as playing roulette and knowing whether the roulette wheel was made in Taiwan or Korea.

The critical test is: does the broker make a living out of picking stocks? Probably not. He or she is sitting in their seat because they're getting the fees you pay them to buy and sell on your behalf. It's very easy for someone to have a view when it's with someone else's money.

Speculation is usually only successful when it is in line with the fundamentals

Speculators are often unfairly criticised. The market needs them. Speculators add important liquidity.

Those who invest in small stocks will know. Often these stocks would not have much daily turnovers if it were not for speculators. The longer term holders of these stocks do not buy or sell very often. For those wishing to find buyers or sellers of these stocks, it is a great benefit to have speculators as they are more active.

Speculators also play an important role in taking over risk that others don't want. Wheat farmers, may sell their crop well before harvest at a fixed price for a future delivery date. That way, they can remove the risk that there is a bumper season and an oversupply that forces prices lower.

Speculators are often criticised for pushing prices to unrealistic levels. This argument is flawed. In fact, speculators are usually punished when they do this, because if they are wrong about the real values, they are usually the big losers. The tech boom and bust, where perhaps it was speculators who drove prices to very high levesl, is a great example. Most of them paid very heavily when market prices crashed to a fraction of the higher levels. Though what a great opportunity it was for the more savvy investors to sell near the highs.

So, speculation is usually only successful when it is in line with the fundamentals, and when it is pushing prices to a level that more closely reflects fair value.

Aiming for higher returns without losing your pants!

During the 2007-2209 severe bear market, there were many investors who cashed out of the market, at various stages of the unfolding bear. Many were happy that their capitals were not at risk during the turbulent bear evolving early stages. They were waiting to re-enter the market when it is 'safe' again. Just as they might not have cashed out at the 'right time', likewise, they might not have re-entered the market at the 'right time'.

What defines safety for these investors? They are probably referring to not losing their existing capital. Of course, the safest place was the money market or the fixed deposits. At which point in the bear market will they re-invest into stocks? During the slippery downturn, during the ups and downs, or when the market has turned up convincingly. I suspect many such investors having 'rescued themselves' or 'cashed out' of their stocks will not put their cash back to work until the market has turned up convincingly. This means they would have lost out on the fantastic return of the market during the last 2 months.

Therein is the difference between Warren Buffett and fellow value investors, and the general crowd. They bought at the time when everyone was fearful, probably committing more money into stocks too. The few value investors who spoke on Bloomberg or CNBC during the severe downturn sharing their views that they were net buyers appeared silly in the public eyes when the stocks prices sank further. But events have since proven these value investors to be more right than wrong.

Having a good knowledge of the risk/reward ratio offered by the market is helpful. The safest time to invest is when the market is at its low. This is also the time when the downside risk is small, though not completely eliminated, but the potential for upside gain is high.

Warren Buffett was right again. He asked to 'Buy America' in October 2008 when the US and world market 'fell off the cliff' following the Lehman collapse. For those who have bought following his call, subsequent events should have ensured good returns.

How can we aim for higher returns? Here is another lesson from Warren Buffett on this. What Ben Graham did was to inspire Warren Buffett with his investment strategy of buying bargain stocks that were selling below book value regardless of the nature of the company's long-term economics. This was something Warren Buffett was able to do with great success during the 1950s and early 1960s. But he stayed with this approach long after it wasn't viable anymore - the chains of habit were too light to be felt. When he finally woke up in the late 1970s to the fact that the Graham bargain ride was over, he shifted over to the strategy of buying exceptional businesses at reasonable prices and then holding them for long periods - thereby letting the business grow in value. With the old strategy he made millions, but with the new one he made billions.

As Buffett modified his strategy aiming for higher returns in the late 1970s, we should also regularly re-appraise our philosophy and strategy, through acquisition of appropriate investing knowledge, skills, and its better execution. There is definitely a 'holy grail' in value investing; to benefit from this hugely requires a deeper understanding of its core principles and better execution by the practitioners using proven safe strategies. So far, none is better than Warren Buffett, the accomplished sage. So much has been written on his strategy and method, and we only need to emulate these.

Aiming for safety of capital with a reasonable return was the initial goal. With increasing knowledge and skill, perhaps, aiming for safety of capital and higher returns are achievable. The returns of many investors are compromised by certain knowledge they possess and certain knowledge they do not have. Of course, you may not know what you don't know. Investing is a life-long passion for some. Having a good investment philosphy and strategy is the key. There is constant learning and re-learning. Some knowledge needs to be unlearned. As Warren Buffett said, "The chains of habit are too light to be felt until they are too heavy to be broken."

Also read:
You've Sold Your Stocks. Now What?

Dollar Cost Averaging vs Simple Averaging

There is a difference between simple averaging and dollar cost averaging.

Tan Teng Boo averaged down on a stock and profited. Let us look at what he did.

This was taken from this week's icap newsletter:
"A stock that the i Capital Global Fund invested in plunged around 85% during the 2007-2009 bear market. However, instead of selling as it dropped, we bought so much more of this stock that the cost price plunged around 80% too. By now, the i Capital Global Fund is sitting on a gain of 175% on this particular stock. The reason why ICGF bought so much more was because if it was attractive at higher prices, it is even more attractive at depressed prices since the business fundamentals of the company have not changed. "

What ICGF did. http://spreadsheets.google.com/pub?key=r_MxUHLmwJhsKRpR7JklS1Q&output=html

Simple Averaging

The first point to clear up is actually the difference between dollar cost averaging and simple averaging. What Teng Boo did above was not DCA but simple averaging.

Buffett does not believe in DCA. "It does not make sense investing in stocks when the prices are high." However, Buffett will employ simple averaging, often buying a good stock he likes in large amount when its price is down for no good reasons.

DCA

Those employing DCA should learn its limitations too. It is a way to diversify risk, and is definitely not a strategy to optimise your returns. Various studies quoted that returns from lump sum investing beats those from DCA, 60% of the time.

There are risks too from DCA. If the stock price tanked due to deterioration in its fundamentals, using DCA equates to throwing good money after a lousy company and should not be employed. Also, remember that the same amount used for DCA into a stock is an opportunity cost, to investing in another stock.


The Only Reason to Simple Average or Dollar Cost Average

I did pick up a very important point. It was good to see this advice in print. For those who are investing in good high quality stocks, averaging down can be employed in ONE particular situation, when its price tanked for no good reasons. However, there is still the need to ensure that your good high quality stock's fundamentals have not deteriorated.



To summarise:

There is only one reason that justifies simple averaging or dollar cost averaging - when its price tanked for no good reasons. However, there is still the need to ensure that your good high quality stock's fundamentals have not deteriorated.

If you thought that a stock was undervalued at $34 and without the fundamentals of the company changing, the stock got unfairly beaten down.

An investor put it: "The company and its business have not changed. The only change is its share price got beaten down."

Risks of Dollar Cost Averaging

Risks of Dollar Cost Averaging
by Jim Wang Print Article Email Article Share on Facebook

This is more like a mini-Devil’s Advocate post because of the nature of the idea of dollar cost averaging. Dollar cost averaging isn’t a strategy that is meant to guarantee with any sort of high probability that you’ll generate profits from the stock market, it’s meant as a risk mitigation strategy to help weather the volatility of the stock market. That being said, some people believe that by using dollar cost averaging you can get better returns, which is incorrect and that’s the idea I’ll be tackling today.

The idea behind dollar cost averaging is that you buy smaller lots of a stock until you build up the amount that you truly want, getting a nice average purchase price that isn’t at either the peak or the valley of your period. The stock market is volatile on a daily basis but increasing in the long run so by spreading out your buys you are smoothing out the curve. Proponents advise this because you won’t run the risk of buying your whole lot at a peak thus lowering your total risk involved. This is by no means a guarantee that you’ll generate profits, just that you didn’t pay the maximum price for the share in the period you were acquiring. Now the problem comes when people believe that this means DCA is a strategy for higher returns… it’s not and here’s why.

No Peaks But No Valleys Either
Just as how you didn’t buy your shares at the peak in its price, you also didn’t buy it at its lows either. If you bought one round lot (100 shares) at 10AM, one at 1PM, and one at 3PM, you probably paid three different prices for those three hundred shares and that, of course, guarantees that your average price paid is neither the peak or the valley of the stock during that period of time. If the stock was moving upwards, you paid the least in the morning and the most in the afternoon - which was more than if you bought all three hundred shares at 10AM in the first place. Now, if the stock was falling, you saved yourself the heartache as well but there is no guarantee either way.

Multiples Buys Means Multiple Commissions
Hmmm… who is recommending that you use dollar cost averaging? Could it be the folks who stand to benefit from more trades? If you make three buy orders, you generate three times the fees and commissions than if you made only one buy order! No wonder they recommend dollar cost averaging, it means more money in their pockets.

Lots of Effort
I don’t know of many brokerages, short of something like Sharebuilder where you’re paying a premium otherwise, where you can schedule purchases by time rather than by price (limit orders) and so in order to do dollar cost averaging, you’re going to have to execute those trades pretty much manually, which quit a bit of effort (at least more than making one buy).

So remember, dollar cost averaging isn’t a trading methodology that can guarantee that you earn money, it’s only a way of smoothing out your risk. Once you remember that, dollar cost averaging isn’t all that bad if you’re willing to do the legwork.

The Pitfalls of Dollar Cost Averaging

For example:

I bought 100 shares of Microsoft at $34.00 a year ago, making my investment in Microsoft $3,400 (100 shares @ 34 = $3,400).

Now, suppose today that the price of Microsoft is just $17.00 and I have $3,400 more to invest. I buy 200 additional shares, increasing my total holdings to 300 shares (200 shares @ 17 = $3,400).

Since my total investment is $6,800, my average purchase price is now only $22.67 (6800 / 300).

The Psychology of Dollar Cost Averaging

In our example, we would look at our Microsoft holdings (before dollar cost averaging), and say - this stocks needs to double its price before I can make any profit on it. However, after dollar cost averaging, the stock needs to go up just 5.67 per share before I start to make money. This is a very heartening feeling, and one I’ve done several times. However, if you are averaging just for this warm feeling, then you need to take a hard look at the opportunity costs.

Opportunity Costs of Dollar Cost Averaging

Opportunity cost is what you forgo in order to get something else (economists call it the value of the next best alternative).

For instance, if what I really wanted to do with my second $3,400 was buy Apple stock (trading at $80) instead of Microsoft, the opportunity cost of my decision is the Apple stock. Since $3,400 translates to about 42 Apple shares, the opportunity cost of 200 Microsoft shares is 42 Apple shares.

As long as both Apple and Microsoft grow at the same rate, it doesn’t make any difference to me. It is only when Apple appreciates quicker than Microsoft do I get affected. This is key because stocks that fall tremendously may not rise as much as the rest of the market. The very fact that they fell so much shows that something is wrong with them.

The Only Reason to Dollar Cost Average

There is only one reason that justifies dollar cost averaging.

If you thought that a stock was undervalued at $34 and without the fundamentals of the company changing, the stock got unfairly beaten down.


Should you Dollar Cost Average?

Next time you are tempted to buy more stock to bring the average cost down, ask yourself one thing. Am I doing this for a warm feeling or is the stock a steal at this price?

If you answer this question honestly, you will get it right much more often.



http://investing-school.com/myth/the-pitfalls-of-dollar-cost-averaging/

Dollar cost averaging: Bull versus Bear Markets

Dollar cost averaging: Bull versus Bear Markets

This examines the multiple benefits of dollar cost averaging as a long-term investment strategy.

There are two types of markets: "bull" markets and "bear" markets. Bull markets relate to those periods when the market is trending upwards.

Conversely, bear markets are flat or downward trending. In bear markets, the tendency for most investors is to stay on the sidelines and wait for signs of a market recovery before investing. This makes sense. After all, why invest in a market which is either falling or going nowhere?

The problem, however, is that it is very difficult - many say impossible - to determine when the next bull market is about to start. In fact, it is usually only after many months of excellent returns that a bear market is declared over and a bull market officially in play. As a result, most investors sit on the sidelines for too long and therefore miss out on the substantial gains made at the very start of a bull market.

So, if it is impossible to perfectly time your investment entry point, is it better to invest near the start of the bear market - or wait until after the next bull market begins?

The answer is neither.

Adopting a "dollar cost averaging" strategy during a bear market may be one way to avoid issues of market timing. This is where you invest the same amount of money on a regular basis over a number of years.

There are two performance benefits from this approach.

• Firstly, you are not putting all your money at risk should there be a large market fall early in a bear market.
• And secondly, you are assured that a portion of your money will participate in the early gains of the next bull market.

Here's how dollar cost averaging works.

http://www.zurich.com.au/zportal/cs/ContentServer?pagename=GroupSite/Page/ThreeColumn&cid=1233198359931&p=1159692288459

Lump-sum investing beats dollar cost averaging over 60% of the time

Dollar Cost Averaging versus Lump Sum Investing?

This question actually came up last year, but I didn’t research it very much. My own thoughts were that because the markets trend upwards overall, if you are investing for a long-term period you should get your money in as soon as possible. Sure, you might run into a huge drop, but you could just as easily (in fact more easily) miss a huge rise. But this is too hand-wavy, as scientists would say. I want numbers. So I found some.

Now, wouldn’t it be nice to have a comparison of DCA vs. lump-sum investing for the past 50+ years? We could compare investing $10,000 all at once in January of 19xx, versus using DCA equally over all 12 months of that year. Wouldn’t it be even nicer if we could take into account that any money not used be put in a high-yield interest bearing account?

Well MoneyChimp did just that all the way back to 1950. The result? I used 4.25% rate for bank interest, and over 60% of the time, lump-sum investing beat dollar cost averaging. This result of DCA losing out about 2/3rds of the time is supported by historical back-testing from 1926 in this article from the Financial Planning Association: ‘Lump Sum Beats Dollar-Cost Averaging‘. (Just read the conclusion if you get bored.)

Of course, past performance does not guarantee future results. And DCA would smooth things out if your time frame is really short. I think everyone should consider the facts above and make their own decision. But I bet with the odds, and the odds are that I should invest it as a lump-sum.

Why You Should Calculate Your Net Worth

Why You Should Calculate Your Net Worth

March 13, 2007 @ 12:00 pm - Written by Trent
Categories: Getting Started
Bookmarks: del.icio.us, reddit

In today’s review of the first eight chapters of The Bogleheads’ Guide to Investing, I mention the importance of calculating your own net worth, and in the past I’ve mentioned how to calculate it.

But why is knowing your net worth important? What value does it have? Here are five reasons why you should calculate your net worth.

It provides a rule-of-thumb indicator of your overall financial health. This one number indicates your financial standing at the moment, for better or worse. How you interpret it is up to you.

It puts you in touch with all of your accounts. It’s a great way to regularly nudge yourself to check up on various investments you have and so forth.

Comparing your net worth to earlier net worth calculations lets you track your progress in a very concrete fashion. If you calculate your net worth every month, it can become a clear tracking of the state of your personal finances.

It’s a motivator. For me, it’s my primary motivator. Every single month, I work to make my net worth go up. This means keeping an eye on my spending, working to pay off my debts, and saving up over time for bigger purchases.

It’s easy. Once you’ve gathered up the basic information, you can calculate it in just a few minutes. Add up your assets, add up your debts, and subtract your debts from your assets. Done!

Now that you’re convinced that calculating your net worth is the greatest thing since sliced bread, it’s worth noting that your net worth value does have some drawbacks.

It’s very difficult to meaningfully compare it to someone else. There are so many variables in human life that comparing your net worth to someone else has very little value at all. How does your net worth compare to a child in Bulgaria, for example?

The raw number itself isn’t really all that meaningful - what matters is the change from period to period. Remember this if you are disappointed with your number, and work first on getting that percent change to a good place. If you do that, then you’ll be doing quite well.

Take some time today and calculate your net worth, then do it again in a month and see how it’s changed. You’ll probably be surprised - and you’ll also probably find yourself doing it each month because it’s a really interesting way to track your own progress.

http://www.thesimpledollar.com/2007/03/13/why-you-should-calculate-your-net-worth/

The Simple Dollar Website

The Simple Dollar

Very good website. An excellent resource. Well worth visiting for the many fantastic articles.
http://www.thesimpledollar.com/


I have listed the links to some below:
If You Buy When The Market Is Down, When Do You Sell?
The Intelligent Investor: The Investor and Market Fluctuations
Should You Follow An Investment Strategy If It Makes You Uncomfortable? I Say Never
The Stock Market Is Way Down This Year… Here’s Another Way To Think About It
(A down market isn’t a time to sell. It’s a time to buy. Look at it this way, though. You’re already stuck with this loss - there’s no way of getting out of it. On the other hand, you’re currently holding an investment that’s at a discounted value. If you’re investing for the long term - and if you’re in stocks, this really should be a long term investment - then you need to hold onto that stock, not sell. By selling it now, you’re basically asking someone else to come in and take that discounted investment from you at a nice bargain price. In the end, keep one thing in mind: stocks are a long term investment and if you sell based on what the price is doing today, this week, this month, or even this year, you’re asking for a smarter and more patient investor to take your money. Don’t sell any investment unless you have a reason for selling it, a reason not based on that day’s price.)
Basic Investing In A Down Market (Or Any Time You Feel Nervous)
The One Hour Project: Thoroughly Research A Stock
Mutual Funds Versus Individual Stock Picking: Which Is Right For You?
Two Commenters Disagree: Why Risk Is Interesting
Personal risk vs. Investment risk. What’s the point? Risk comes in a lot of different forms, and different forms of that risk monster scare different people. Any financial move you make has several aspects of risk to it. The key is to find the moves that have the least risk for you, and I think for Tristan and John, those moves in terms of a mortgage would be very different.
What To Do If You Disagree With The Simple Dollar - Or Any Other Financial Guru
Do your own research. I do some posts on basic personal finance analysis and link to other tools here and there - those are so you can look at a piece of advice yourself if you want to and decide whether it’s right and you agree with it. If you don’t understand how something works, ask - if you don’t think a number comes out right in an article, try to figure it yourself. You’ll do nothing but improve your own understanding.
Recognize that no one is absolutely right. Absolute correctness doesn’t exist in this world. If you find yourself completely disavowing someone because you disagree on a point or two with that person, you’re going to have a hard time finding someone who you can talk to, listen to, and exchange ideas with. Accept that no one is absolutely right - including yourself - and be open to new ideas.
Personal Finance Boils Down To Just Two Things…
The Bogleheads’ Guide to Investing: Chapters 1 - 8
Why You Should Calculate Your Net Worth
Nine Reasons I Keep Reading Personal Finance Books

Should I Invest Immediately After a Small Dip in the Stock Market?

Should I Invest Immediately After a Small Dip in the Stock Market?

November 7, 2007 @ 3:00 pm -
Written by Trent
Categories: Investing, S&P 500, Stocks
Bookmarks: del.icio.us, reddit

This week, The Simple Dollar attempts to address challenging questions in personal finance by looking at both sides of the story and figuring out some of the factors you need to look at to make a decision.

Several times this year, the stock market has dipped more than 1% in a single day. If you read the advice of some writers, like in this article by Ben Stein, there is some strong encouragement out there that a dip in the stock market like that means it’s time to buy a broad-based index fund. On the other hand, if you follow the advice of other columns, like this one by Ben Stein, you’ll hear that market timing is bad.

Which is right and which is wrong? There’s not a really easy answer to this one, so let’s look at both sides.

Market’s Down? Buy!

If you look at the long term history of the stock market, stocks go up in value. There has never been a thirty year period where stocks are down, and over the entire twentieth century, the broad stock market increased in value 20,000%. Because of that, it’s reasonably safe to assume that stocks are a lucrative long-term investment.

Now, on any given day, if the stock market drops in value, you can effectively buy in at a cheaper price than the day before. Let’s say you could buy an index fund for $1,000 that included a bit of every stock on the New York Stock Exchange. Then, in one day, the market drops 4%. You can now buy that same share for $960 - it’s effectively a sale!

In other words, buying a low-cost index fund when the stock market drops is the equivalent of buying it on sale. Any time you can buy a solid long-term investment on sale - and it’s all legit - is a deal you shouldn’t pass up.

Ignore Timing and Stick With a Real Strategy

In a mathematically perfect world, the above scenario would be just fine. If the long term trend is up but the very short term trend is down, and you knew that for a fact, you really could clean up on the stock market. Unfortunately, it’s not all perfect like that.

For example, down days on the stock market have different meanings. A day where nothing much happens can be a slight down day, but devastating financial news can be a monster down day. There are all sorts of varieties of individual days on the stock market, and they may or may not be part of larger trends.

Since 1950, using the S&P 500 as an indicator, any random day has a 53.8% chance of being a positive day. There’s also a 54.1% chance that a down day will be followed by another down day and an up day will be followed by another up day. In other words, if you buy on a down day, the odds are better than half that the next day will also be a down day, which means you bought at an elevated price.

The market is effectively random on a day-to-day basis, so playing games like timing the market by buying when the market is down tend to offer not much reward (and often some loss) in exchange for the effort of playing the game. An intelligent investor will simply follow a “buy and hold” strategy or a dollar cost averaging strategy (by buying in at regular intervals, regardless of the market) and sitting back and ignoring the day-to-day changes in the stock market.

My Take

If time were not a factor, it might be a worthwhile endeavor to try the “buy when the market is down” approach over a long period of time. Due to the randomness of the day to day stock market, you wouldn’t gain a whole lot, but you might be able to eke out a small positive return, on the order of a fraction of a percent, over a long period of time (with possible bigger gains or a small loss over the shorter term).

However, the time investment to follow this strategy day in and day out would make it not worth one’s time, unless one did it on a fully automated basis.

To me, market timing makes the relatively volatile investment that is stocks even more volatile and thus not worth the time. I see no problem if you’re about to buy in and jump on board immediately after a down day, but to invest with such timing as a regular strategy probably won’t afford you much serious gain. There is perhaps a tiny gain to be made here, but not a significant one in terms of the time invested. (My comment: Agree totally. That's why I hardly ever queue when I sell or buy a stock.)

http://www.thesimpledollar.com/2007/11/07/should-i-invest-immediately-after-a-small-dip-in-the-stock-market/

Active, Passive, and Portfolio Frugality: Where Should One Start?

Active, Passive, and Portfolio Frugality: Where Should One Start?

March 10, 2009 @ 2:00 pm - Written by Trent
Categories: Frugality, Getting Started
Bookmarks: del.icio.us, reddit


One of the most common ideas expressed in personal finance books is distinguishing between three different kinds of income:

Active income is earned through your active effort - in other words, the money you make from your job. Your paycheck is active income. Income from any side businesses you have is active income. Incidental earnings, like finding money on the street, is active income, too, since you actually had to contribute effort to receive it at all.

Passive income is income that you receive without continual active effort. Income from a rental property is passive income. Book royalties are passive income. A website you set up once, put ads on, and walked away from is passive income.

Portfolio income is income that you receive from your financial investments. Interest from your savings account is portfolio income, as are dividends from your stock holdings or income from selling an investment.

What intrigues me about this division of incomes is that it lines up well with different types of frugality.

First of all, there’s active frugality. Active frugality results from continuous effort and continuous choices to save money. Using a shopping list at the grocery store is active frugality - you have to make up a shopping list each time, but you’re rewarded with the money you save on the shopping trip.

On the other hand, passive frugality is the result of simply not doing something. Choosing to continue to use a crock pot with a broken lid handle is an example of passive frugality. Wearing well-worn socks is another example. Driving your car until it completely breaks down is yet another example. Simply put, you can save a lot of money by simply using things until they’re completely used up.

A third type of frugality is what I’d call portfolio frugality. Portfolio frugality happens when you make an initial investment of time or money into something that will pay dividends slowly over a long time. Installing energy efficient lighting in your home is a form of portfolio frugality. Putting in a programmable thermostat is portfolio frugality. Putting a black cover over the windows in an unused room is portfolio frugality.

From where I sit, most of the negative reputation that frugality gets comes from active frugality (”it seems like a lot of work to save a little money”) and excessive passive frugality (”what kind of cheapskate has holes in their socks?”). Those forms of frugality tend to run more against the grain of mainstream society and meet more resistance from others.

Thus, if you’re getting started on frugality, I recommend trying out portfolio frugality and a few basic pieces of passive frugality. Do things like swapping your light bulbs out, installing a programmable thermostat, and waiting another year or two to upgrade your computer or cell phone.

As you get more and more used to the pleasures of saving money, you can continue to push things until you find your comfort level. Try out higher levels of passive frugality (can’t you get a few more miles out of those socks?) and dabble in active frugality, too (why not make a grocery list before you go? How about cutting out those stops at the fast food restaurant?). Eventually, you’ll find your own comfort level, where you see yourself saving plenty of money but not behaving in a way that makes you feel “cheap.”

Personally, I really enjoy seeking out “portfolio frugality” options. I love doing things up front that continually save me money over the long haul without my active intervention or without any real change in my quality of life.

http://www.thesimpledollar.com/2009/03/10/active-passive-and-portfolio-frugality-where-should-one-start/

How to Manage a Windfall Successfully

Chapter 15 - How to Manage a Windfall Successfully

I didn’t expect it, but one of my favorite pieces of advice appeared in this book: if you get a huge windfall, put it in a short term investment for six months and just think about it and plan carefully what you’re going to do with it.

This is also a situation where you really should have a professional help you, as you’ve just jumped into a completely different investment category and lots of things are available to you.

http://www.thesimpledollar.com/2007/03/14/the-bogleheads-guide-to-investing-chapters-9-16/


Related Posts
The Bogleheads’ Guide to Investing: Overview
The Bogleheads’ Guide to Investing: Chapters 17 - 23
The Bogleheads’ Guide to Investing: Chapters 9 - 16


The Bogleheads’ Guide to Investing is a very detailed “starter manual” for conservative investors. The principles in this book are very fundamentally sound, but are not going to be the foundation for any “get rich quick” scheme.

Before you decide whether or not this is a good book for you, you need to ask yourself what your general investment goals really are.

If your goal is to have a shot at getting rich quickly with a lot of risk mixed in, I don’t recommend this book. You’re better off reading something like Jim Cramer’s Real Money, which is an excellent book for people who are willing to take on some significant risk and dabble in individual stock investment (and even that is fairly moderate risk compared to some investments).

On the other hand, if you’re planning on investing for the purpose of building a stable, lifelong economic backbone, I couldn’t recommend this book more highly. It’s a well-conceived explanation, from top to bottom, of an investment philosophy that will create a life full of steady gains and sustainable wealth.

http://www.thesimpledollar.com/2007/03/16/the-bogleheads-guide-to-investing-buy-or-dont-buy/

Dollar Cost Averaging for better or for worse

Dollar Cost Averaging and Market trend

Here’s the question: is this a good thing? Lots of financial advisors think that dollar cost averaging is the cat’s banana, but I’m not entirely convinced.

Uptrending market: Let’s look at a year in which the value of a stock starts at 100, goes up 10 a month until June (the peak), then stays steady for the rest of the year. You paid $134.94 per share with dollar cost averaging. If you instead bought in at the start of the year with your complete investment, then you paid only $100 per share.

Downtrending market: On the other hand, let’s look at the reverse market: the stock starts at 100, goes down 10 a month until June, then stays steady the rest of the year. If you invested it all right off the bat, you spent $100 a share for stocks now worth $50, but if you used dollar cost averaging on a monthly basis, you only paid an average of $58.66 per share.

Dollar cost averaging is good if you think there’s a good chance that the market will see turbulence or go down. It will reduce the impact of the collapse on your investing. On the other hand, dollar cost averaging doesn’t do so well if the market is going crazy.

Here is how one investor views dollar cost averaging: "Since I think the market is going to be turbulent, but not go up or down a whole lot overall in the year 20xx, I think that dollar cost averaging is fine for me in the short term."

http://www.thesimpledollar.com/2006/12/30/how-im-using-dollar-cost-averaging-for-better-or-for-worse/