Investments

Economics / Investments — Comments Off on Inflation Nation: How to Protect Your Purchasing Power
29
Jan 11

Inflation Nation: How to Protect Your Purchasing Power

Let’s paint a new picture of America. Your pay is the same. However, when you go on your weekly trip to the grocery store you see that there are no prices on milk. A guy over the loudspeaker announces that milk is now $6 per gallon. Strangely, a guy bought milk at the same location 4 hours earlier for $5.50 per gallon. You notice that it’s not just milk, there are no prices listed on any item and the guy over the loudspeaker keeps announcing the new prices of certain items. Are you in a bad dream? Perhaps. Or perhaps America is now experiencing something called hyperinflation.

Inflation is the devaluation of a population’s purchasing power over time. All those stories from your grandparents about how they used to get a loaf of bread for a nickel are examples of inflation in action (and you didn’t even know your grandma was an economist.) Hyperinflation is an extreme situation in which inflation is out of control and could even exceed 10% per day! Can you imagine filling your tank up at the beginning of your week and all of a sudden you read that gas is now $8.00 per gallon for the cheap stuff? Hyperinflation causes a general unrest in society, chaos in the streets and eventually even the collapse of governments – imagine the Katrina aftermath in New Orleans occurring coast to coast.

Hyperinflation in Action

Take for example, the famous case of Argentina in 1989 which is summarized amazingly well in the article by John Mauldin titled Catching Argentinian Disease. Mauldin states that the hyperinflation was set off by years of budget deficits and borrowing to fund the government. In1989, no one would lend to Argentina Anymore. As the government still needed to pay its obligations somehow, they fell back on the printing press to keep the government going. As Argentina printed more money to fund itself, the value of the currency plummeted – more supply yields a lower price. Therefore the purchasing power of anyone using the Argentine Peso was demolished. This means that anyone with a savings account denominated in the Argentine Peso was also hurt and their savings were effectively cut down to a fraction of what they had been.

Hyperinflation is an extreme example of inflation, but it illustrates the effects of many years of inflation succinctly. I don’t think the United States is headed for hyperinflation or chaos in the streets necessarily. I do believe that the U.S. government might be expecting inflation to occure and even possibly welcoming it.

The White House Economists and A Hidden Agenda

Many of the White House economists hail from the University of Chicago. White House Chief Economist, Austan D. Goolsbee, has been a professor at UC since 1995. In my opinion, the University of Chicago is the best school for economics in the world and the faculty there is world class. So why is the White House position currently that they see no signs of inflation? Shouldn’t we take the word of the world’s best and brightest economists?

I believe that there is an agenda that the White House has yet to admit to. After all the bailouts which began with the Bush administration and continued with the Obama administration, our national debt has soared. I suspect that the only way to get that debt under control is to inflate it away.

You read above how bad inflation is for savings accounts and purchasing, but we didn’t discuss debt. Inflation works backwards and is actually a good thing for your debt load. Your 100k in credit card debt? Inflated away. Your school loans? Inflated away. The national debt? Inflated away. The amount of the debt doesn’t change (unless it’s indexed to inflation.) Could this be in the plans of the White House? Is this the reason Obama’s top economists don’t see inflation? No one can know for sure. It’s definitely an option.

What Do We Know?

I don’t believe in taking other people’s word for things. I don’t just accept as truths what top economists from the University of Chicago have to say about inflation. Often I get in over my head as the complexities of the many moving parts of some economic concepts are still beyond my understanding (though I will always work to understand them better.) Let’s look for some signs about inflation.

The Proctor & Gamble Quarterly Report

On January 27, 2010, Proctor & Gamble released their quarterly report. The results disappointed as the company indicated that rising commodity prices are squeezing the margins of the company. This means that they are paying more for the raw materials they buy to produce deodorant, detergent and everything else, but haven’t passed those costs on to the consumer. Thus their profit margins are lower.

I can tell you that P&G is a great company with competent and rational management. I can also tell you that competent and rational managers will find a way to eventually pass those input costs on to their consumer. The issue at P&G is that they are a premium brand company. They charge more for the perception that they offer a better product – bottom line is there are cheaper competitors. If P&G just raised their prices without a well thought out strategy, they would lose customers to the competitors. These higher prices will hit the customer eventually.

Research During Your Normal Routine

I noticed a few things just heading to Target and CVS for my day-to-day purchases. The price of my deodorant and hair products have all gone up. Sometimes these changes masquerade as a “multi-pack” or even smaller container at the usual price. Pay attention! Inflation is already here and you need to make moves to ensure your savings and your Investments are protected. Inflation risk is the largest current danger to your portfolio (unless you are that bad at picking stocks – then you might me the largest danger.)

Ways To Combat Inflation

Real Estate

Putting your cash in real estate is one way to combat inflation. The theory here is that real estate will increase in value and give you some protection against the eroding dollar. The rate for a 30 year mortgage is at near record lows and may be a good time to explore a vacation home or an investment home. Also, you need to have realistic expectations regarding your return and your holding period. Please refer to my article The Death of the Starter Home.

Gold

When you hear people say that you “should be in gold” they are referring to a proxy for gold and not a basement full of gold bars or coins from an infomercial. A good proxy for gold is the ETF “GLD.” The reason you don’t want to own the actual gold bars is that it may be impractical, there are security issues and they may be hard to sell or illiquid. Owning the ETF is very liquid as you can buy and sell them through your regular brokerage account.

TIPS

Treasury Inflation Protected Securities or TIPS are bonds offered through the U.S. Treasury and are indexed to the official inflation rate. Therefore, over and above your normal return on the bond, these beauties actually adjust their price to keep up with inflation. Add tips to your portfolio with another ETF: “TIP.”

Commodities and Their Proxies and Other Common Stocks

Adding commodities to your portfolio will also help you keep up with inflation. I like to add proxies for commodities by buying common stocks whose business is energy, mining or farming. I don’t recommend buying or trading futures contracts for the actual commodities. I think a non-professional will get luckyor eaten alive playing that game. Common stocks in general are usually recommended in a portfolio to combat inflation. Though this method is often argued that the common stock is not effective here because companies cannot pass on their costs dollar for dollar to the consumer. I agree in the short-term, but in the long-term they will pass everything on and prices for the consumer will rise.

Inflation is real and it’s already here. Although we probably will not experience the chaos of hyperinflation like Argentina and many other countries across the globe, the erosion of your savings and your retirement accounts due to the inflation will occur. You will not be able to buy what you used to be able to buy for the same amount of money. It would be a shame to sacrifice and save your entire life just to watch your purchasing power evaporate right before your eyes. I am going to go buy more Proctor & Gamble now.

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Investments — Comments Off on When You Should Sell Stocks
25
Jan 11

When You Should Sell Stocks

Every investor will wrestle with the notion of exactly when is the right time to sell shares of stock and every investor will have probably wished they had a few mulligans along the way. The simple answer to this question is that you sell them when they no longer meet your objectives. I know this is vague, but there are many reasons to sell and many reasons to hang on depending on those unique objectives.

Photo via http://www.techiewww.com

Trading vs. Investing

You need to first decide if you are a trader or an investor. Traders generally have a shorter expected holding period and may buy or sell based on expected events or technical analysis (the charts.) Investors usually rely on fundamental analysis and are less concerned with external events. Investors usually pick entry points based on the stock price and the price’s relationship to the intrinsic value the investor assigns to the stock. Most serious investors have been a trader and an investor at different times in their lives and for different objectives. Both methods are widely accepted and used to make money every day.

Technical Analysis vs. Fundamental Analysis

As I stated, technical analysis makes uses of a stock’s chart – a historical record of the stocks price over a certain time period. There is somewhat of a science and a serious art behind performing technical analysis. Traders look for particular patterns in the price action and use this information to predict where the price will go next. Technical analysis is concerned very little with the actual company and is concentrated on the shares. This method is actually trading the individuals and institutions buying and selling the shares more than it is trading the underlying company. The psychology of the masses invested in the shares plays a big part in whether a trader will buy or sell the shares. Admittedly, I use technical analysis on a very limited basis and am far from an authority on the method.

Fundamental analysis digs deep in the company’s financial numbers to make a decision on the future performance of the company. Fundamental analysis is not concerned with who is invested in the company and more concerned with the growth and profitability of the enterprise. Solid accounting knowledge and tools such as financial ratios are essential to the investor using fundamental analysis. An investor with a holding period of forever will most likely pick apart a company’s financial statements to paint a picture of viability investability of a particular company. The bottom line of a fundamental analysis is the stocks intrinsic value – the value an investor places on the shares. If the price of the shares is less than the intrinsic value, the shares are undervalued and should be bought, the opposite is also true.

So When Should You Sell?

Tradable Event

If you are a trader and trading based on a particular event or some other catalyst like the shape of the charts, you sell when either the event occurs or the charts change shape and indicates you take action due to impending price drop. An example of a tradable event may be the earnings press release or the announcement of a merger or acquisition.

An investor should have a holding period of forever. If you buy a stock based on the fundamentals and those fundamentals do not change, there should be no reason to sell. Enjoy the dividends or the growth of the share price derived from the growth of the company. Occasionally the fundamentals will change. Maybe a company announces that they are cutting their growth projections in half. Maybe the company announces some “accounting irregularities’- a term often used when a firm comes under investigation for their reported numbers or maybe worse.

A Shift in the Fundamentals

I owned British Petroleum for over five years when a “small fire” on an oil platform in the Gulf of Mexico was made public (I heard it first from a news agency not the company) in 2010. A few days later, the platform sunk and infamous 2010 oil leak began. I stuck with BP for about another month as they were paying dividends over 6.5% and I loved this nice income stream in my Roth IRA. Finally, I couldn’t take the pain anymore and I sold out. The price continued to drop, but I got out with a decent profit and peace of mind. I didn’t know how bad the incident was going to get and I didn’t know how much BP was going to be on the hook for. I bought BP for the strong balance sheet and that great dividend. I believed that divided would be cut (which it was) and I suspected that balance sheet would take a hit (which it did). There was no visibility in the fundamentals for me and I needed to get out. Granted the company was able to absorb the hit to the balance sheet better than I suspected, but it was time for me to move on. At that time I was moving all my free resources into natural gas – which has paid handsomely since.

Photo via http://www.fooyoh.com

A More Favorable Rate of Return

When performing your stock analysis, an integral part of the process is factoring in your required rate of return (RRR) or hurdle rate. This is the rate of return that you find acceptable for investments of a certain type. For example, you might have a hurdle rate for investments in your Roth IRA than a regular brokerage account because you don’t need to figure in your income tax expense in the Roth. Occasionally, an investment will fall below an investor’s RRR or an alternative investment will be discovered with a higher rate of return. In both of these cases an investor will be advised to sell the lower returning investment and purchase the higher returning stock.

To Bask in the Glory of Your Profits

Some investors feel the need to take profits when they have reached a certain return on the investment. This practice varies greatly from investor to investor. Warren Buffett has been known to sit on his profits for many many years instead of realize them. His logic is such that if it was a good investment 30 years ago, and the fundamentals of the company are unchanged, why realize the gain by selling and have to pay tax? Warren Buffett would not be able to sleep at night because he would be up calculating the lost profits in the future due to the amount he paid out in taxes.

Jim Cramer of CNBC is often heard yelling “bulls make money, bears make money, pigs get slaughtered.” Thus making a case for his belief that you should take the profits and enjoy paying the taxes as your reward for profits well earned. I tend to be somewhere in the middle. I have a trading account where I often take profits and have to pay the taxes. It seems counter-intuitive but, I have a few IRAs where I sell much less and there are no tax consequences to taking profits (at least not this year in my rollover IRA.)

I tend to invest more conservatively in my IRAs because having the benefit of not having to pay federal tax (on the Roth) and deferring tax (on the Rollover) is a benefit I want to hold on to. I don’t want to lose my money in those accounts and not be able to realize this tax advantage.

Deciding when to take profits or cut your losses in the stock market is one of the toughest decisions you, as an investor, will have to make. There are many reasons to sell, many reasons to hold and even many reasons to buy more (not covered here.) Buying is easy because every stock you buy will skyrocket the next day and make you rich beyond your wildest dreams or at least you tell yourself that. Like anything in the investing world it’s always prudent to err on the side of caution, know your objectives and act with conviction. One more hint, once you decide to sell, do not look back and calculate what would have happened if you had made the other decision. This is something investors do to reassure themselves. There is not looking back, only looking forward.

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Investments / Living Life Abundantly — Comments Off on How Your Expectations Are Ruining Your Life
23
Jan 11

How Your Expectations Are Ruining Your Life

Get straight A’s. Graduate from a top ten college. Get a job making at least $X in your exact perfect city. You probably have many expectations for your life. You did not even realize that these expectations were ruining your life and were hindering you from leading a more fulfilling life.

A life spent chasing expectation (or others’ expectation for you), is merely a life running from disappointment and failure as these negative outcomes are the hidden alternatives to our specific expectations. The thought of not achieving these goals is perceived as a failure. What is driving you, your goals or your fear of failure?

In School

I am a big proponent of education. All types of education. Even education for education’s sake is beneficial. If you did not happen to get into your top choice schools, you might view yourself as a failure. A degree is a qualifier not a determinant of future successes – meaning it may get you in the door for an interview or for grad school, but there are many factors that also contribute to your success. Your expectations for your life have gone to hell and you have never even sat in a classroom. Be happy you got into the best school you could and concentrate and doing well with that opportunity.

In Relationships

I have known a few people that refuse to deviate from their expectations of what attributes their significant other should possess. Needless to say, these people are usually single as they cannot recognize a potential significant other through these clouding expectations. Relax and get to know someone for who they are as a complete person before you immediately write them off as not meeting your pre-conceived notions.

At Work

People set career benchmarks. They want to be at a certain place by a certain age. Sometimes it’s all salary and other times they are after a title. Achieving anything less than their expected career benchmark is viewed by them as a failure. A lot of people finally be made a partner at their firm for example, and they have no one to celebrate with because they alienated everyone in their lives to get their title. Keep your career in perspective. Work hard. Look out for new opportunities and make sure you are challenged continually and compensated fairly.

In Your Investment Portfolio

There is not a money manager or retail investor out there that has who hasn’t had a bad year. You have to curb your expectations and be realistic in your forecasts. Sometimes things happen that are out of your control. You cannot let your fear failure and of the riskiness of the markets keep you out of the game. Read all you can about investments. Study profiles of the professional managers. Develop a sound strategy and execute it with confidence.

You need to change the way you think about your life’s goals. Instead of waiting until you achieve one of your milestone stretch goals to take a breath, celebrate the process of working towards them. Recognize all of your efforts towards these goals as successes and let your small successes drive you. It’s the journey not the destination.

Throw all of your expectations out  the window and enjoy the surprises that life throws your way. Allow your expectations for life to be dynamic. Keep your eyes peeled for opportunities that you never considered. Your life will undoubtedly not turn out as you expect it to and that is perfectly ok because that’s how life works.

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Education / Entrepreneurship / Investments — Comments Off on Why Failing Will Be the Best Thing That Ever Happened to You
20
Jan 11

Why Failing Will Be the Best Thing That Ever Happened to You

Winners always win right? Wrong. Every winner is a product of a long line of failures plus an ounce of luck and a pound of persistence. Winning is actually a process which needs to be developed. Part of the process of winning is learning how to fail. Learning how to fail will provide you with powerful lessons to apply to the next business venture or your next trade.

Learning how to fail takes a lot of work. Luckily, failures usually mount quickly, giving you mounds of material to sift through for lessons. When dealing with a failure, it is necessary to pick apart the event to see what went wrong, what you could have done better and what you will do differently next time. The earlier you get on the learning curve the faster you will progress through the necessary setbacks and begin to win.

A loser will not do this.

A loser will quit because the weight of the failure will prove too much to bear. A loser curls up in the fetal position and waits for someone to make it better. They are unlikely to be able to get the loss or failure out of their mind and these thoughts will fester and hinder them from taking future risks – eventually turning them into a bitter loser. A bitter loser will have stern warnings and violent head shakes when conversing with any individual still working on the process of winning.

Obviously, the bitter loser is the worst kind of loser. All optimism for life and an irrational blame game with risk has developed. Avoid a bitter loser at any cost!

Failing is the best thing that can happen to you. You learn adversity, determination and humility – all necessary attributes for a successful life. Whenever someone brags about a life without failure or an investment portfolio without loss, I am always skeptical. Either that person has not ever pushed themselves to be great, never took chances or is dishonest. Maybe this person has never left the cozy confines of their comfort zone.

Living in your comfort zone is a recipe for monotony, average investment returns (at best) and a run-of-the-mill life.

Like any pain in our lives, a failure stings, burns and makes you sick to even think about. These emotions will not last. Only you will know when you are ready to apply the lessons learned and get back on that horse – whether your horse is the stock market, an entrepreneurial venture or a relationship. Accept and embrace failure as a necessary bump in the road and a valuable education. Ask yourself, “what can I learn from this setback?”

Avoid becoming a loser by keeping an open mind to the possibilities that lie ahead for you in the future. Be wiser next time and your failure will make you a better winner in the markets and in life.

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Debt / Income / Investments / Wealth — Comments Off on The Three Pillars of Wealth Creation
18
Jan 11

The Three Pillars of Wealth Creation

If you would like to be wealthy and have not yet been able to acquire wealth, you need to develop habits that support your objective to build it. Once developed, you then need to commit to those habits and to that objective.

People throw around the term “commitment” haphazardly these days. If you look-up the definition of “commit” on Dictionary.com, you will get an assortment of definitions all dancing around giving some sort of obligation or the act of “being committed.” While these meanings are all accurate and some people may think you will need to “be committed” to an institution once you commit to wealth-building, these terms seemed watered-down to me.

There is a huge difference in saying someone committed suicide and someone committed to a marital obligation, for example. When someone commits suicide by leaping from a roof, they cannot revisit and amend the decision on the way down – they are indeed committed to the decision in which they made. Marriage is different. Sure there is an obligation and an expectation that the union will last forever, but marriage can hardly be viewed as a commitment the same way the leap off a building can (but some may argue the outcome is the similar). The difference is the “out clause” which is implicitly or explicitly available to us in most decisions we make in life. With the divorce rate in the United States dancing around 50%, many people have revisited their decision to “take the leap!”

Committing to wealth-building is committing to a way of life and not trying out a new idea or fad that you can easily cease if the wind happens to blow from a different direction on a particular day. Similar successful commitments can be seen in the realm of weight loss. You know the before and after pictures where the individual holds up the big pants? If you read enough of these stories a common theme will emerge. These successful examples made a positive and life-changing commitment to dieting and exercising and have experienced the amazing result you see in the photo of them holding up their big pants.

These men and women developed habits that changed everything they did throughout their day. The way they shopped, the way they slept, the way they went to happy hour, they way they celebrated holidays – there is no realm of their life unaffected.  Committing to building wealth is exactly the same. You will have to develop new habits in the way you shop, where you live, how you eat and every other aspect of your life. The objective is becoming wealthy and living a life of abundance and the before-and-after photo is you holding up a picture of where you dream of being.

Wealth is abundance, but wealth is not necessarily money. Having money and investments throwing off passive income can just be the instrument in which you are able to live abundantly. If you have no debt and some strategic investments paying you an acceptable return, you don’t even need high income to live abundantly and consider yourself wealthy. You can decide how to spend your time! Committing to building wealth is committing to live your life with careful management of what I call the three pillars of wealth creation – debt, income and investments.

Pillars photo by Mandy Dawn via Flickr Creative Commons

Pillar One – Debt

Debt, or leverage, is a normal part of most people’s lives and essential in managing the operations of most corporations. Getting something today and paying for it later is appealing to most people as they gain some pleasure from the purchase and want to experience that pleasure now. The acceleration of their personal enjoyment is a habit people come by innately and it is a negative spending habit that people must drop to be wealthy. Instead of making the decision to buy an item based on the pleasure derived and the time-table in which that pleasure is derived, the decision should be based on the future consequences of the decision to finance the good.

Not all debt is bad. Debt can be used to elevate one’s income (Pillar Two) through the financing of an education. Debt or leverage can also be used to provide the necessary capital for an investment (Pillar Three). Each pillar is inter-dependent on the other two pillars and strategies to increase wealth can be formed by manipulating one, two or three of the pillars. There are many scenarios one can put in play to achieve the objective of building wealth.

Pillar Two – Income

Income is often confused with wealth. If a doctor or a lawyer brings home a few hundred thousand dollars per year, they are often mistakenly labeled as “wealthy” and this is not necessarily true. The most striking example of this large paycheck phenomenon is through the observance of professional athletes. We are all inundated with the headlines every time an athlete signs a new contract for tens of millions of dollars. Then we are all shocked when we read about an athlete’s bankruptcy filing just a few years into retirement. The athlete hit pillar two out of the park (pun intended), but failed to manage the other of the other pillars.

For many Americans, income is a way to keep a roof over their heads and food on the table. They simply do not have the ability to invest as they have nothing left over. Occasionally, they even need to use credit cards to cover these basic human needs – which trigger a downward spiral of hopelessness and despair. Income and debt need to be mastered before one can begin to learn about investing. Often times, a highly-paid professional with a large house and a nice car also works just to pay the $5,000 mortgage and the lease on the Bentley. A plumber with a savings account that lives under his means will have a higher net worth that the highly-paid professional.

Pillar Three – Investments

Investment is the management of accumulated wealth. How many lottery winners go bankrupt because they are so unbelievably ignorant on investing they blow two-hundred million dollars on solid gold telephones and diamond-crusted golf balls? I am being a tad facetious – but only a tad. The hard part is getting the nest-egg built up enough to have to consider the investment pillar. On the other hand, I cannot really blame someone who is the third generation in his/her family just working on not going too far into credit card debt and trying to increase income. These negative habits are learned and passed from generation to generation. Most people are completely unaware of investing and in their realm. To them, there are only two pillars.

Saving is not investing. Saving is setting aside cash for some future purchase and attempting to earn as much interest while you wait. Savings will eventually be spent.  Ideally, investments have no timeline. You should plan on never spending the principal used to make your investment. Occasionally, you may sell an investment for strategic reasons and invest the capital in a more optimal investment, but you should not shift that money to anything that is not an investment of acceptable return. You should plan on spending only the interest or dividends spun off of the investment to make your money last.

For even diligent savers and investors, reaching this investment utopia will not happen. Even in retirement, a portion of the principal invested may have to be spent to support the retiree’s lifestyle. The reasons for not reaching this pinnacle are many and depend on an individual’s age and a myriad of other contributing factors, but the concept is sound and to be committed to building wealth means being committed to this objective and being committed to this objective you need to develop habits that support this commitment in every aspect of your life.

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