Warren Buffett has written a very interesting and timely article in the New York Times today. For those unfamiliar with Warren Buffett, he is one of the world's greatest investors, having made his fortune in the stock market. He now runs the corporate conglomerate Berkshire Hathaway.
In the article, Buffett compares the current budget deficit to those of years gone by. As a percentage of GDP it's twice the previous non-wartime record. It gone up to 13% where the previous high was 6%.
He also points out that US net debt has risen from 41% to 56% of GDP and questions at what point the country's credit rating will be put at risk. Sooner or later other countries will perceive the United States as credit risk if debt levels keep rising.
Lastly Buffett discusses the risk of rising inflation as a result of all this. All of this debt must be financed and with the prospect of the Government printing more money, inflation may soon follow.
From an investor's point of view, it begs the question how do we protect our investments from inflation? I will write more about this in the future.
Click the following link to read Warren Buffett's op-ed piece entitled The Greenback Effect.
I'm a big fan of the returns the big Ivy League endowment funds have been able to produce over the years. Yale has been able to produce a compound return of almost 16% over a 20 year period. Harvard produced a compound return of just over 14% over the same time frame. So it is with interest that I study the asset allocation of these funds each year.
However, as a small investor, I've always felt that I was unable to replicate the asset allocation of these endowment funds. They have been reducing these exposure to listed equity investments in recent years thereby making more difficult for an investor like myself to approximate what their investment portfolio contains.
But just recently, I read an article on the Kiplinger website (The Ivy Endowment-Fund Portfolio) where a simple portfolio is put forward which aims to copy the diversification and risk management techniques employed by the ivy league schools. The best part is that because the portfolio is composed of 10 exchange traded funds, the average investor like myself is able to buy these ETF's directly on the stock market.
The diversification achieved and low cost of using ETF's in an investment portfolio have been discussed at length many times the world over so I wont go into the arguments again here. Suffice to say that I'll be taking a closer look at the asset allocation recommended in the article to see whether it's worth incorporating some of the investment ideas into my own portfolio.
There are different approaches to saving money. Whether it's saving for a short term goal or saving for your retirement, people go about it in a variety of ways.
I admire those who have a set amount which they put aside each week (or each month) before they spend any money. I call these people conscious savers. It's a regular savings plan. The money is normally deducted from their pay or taken out of their bank account at the beginning of each period.
This sort of approach works for these people because there is a risk that if the money is not put aside immediately, it will get spent. It's a smart move and it lends itself to better long term planning, whether that planning relates to reducing debt or investing for the future or saving to buy a house or whatever.
Unfortunately, I'm not that disciplined. In fact my approach is the exact opposite. I tend to pay all of the bills and spend what I need to each month and only at the end of each month does what's left over get added to our savings.
Fortunately, that works for us. We don't have extravagant tastes and lead a fairly middle of the road existence and our income has always been such that we've been able to add enough to our savings each month to pay off all of our debts, including our mortgage and accumulate a reasonable investment portfolio that will someday become the foundation of our financial freedom.
Despite our success in the past at just following a saving what's left over approach, I do wonder whether a more conscious approach would put us further ahead over the long term. Maybe the extra financial discipline would enable us to save that little bit extra and help us reach our financial goals earlier.
The downside, as I see it, is that we may feel more constrained at living this way. There may also be more stress on our relationship if we attempt a more rigid approach to our personal finances.
Some personal finance blogs discuss at great length the benefits of reducing your debts and cutting your cost of living. The reason is that this will free up more of your money to be saved and invested for the long term. This is perfectly rational reasoning and should be the first step to getting your personal finances in order. But it's only one side of the equation.
I was recently browsing through the Startup Nation Home-Based 100 winners. It's a list of 100 of the best businesses which are run by people in their homes. Reading some of the stories reminded me that as well as reducing your monthly expenses, increasing your monthly income is a way to improve your financial position.
Most of these businesses stemmed from very simple ideas. The founder identified a niche and worked out how to fill it. Many of these business owners were just following their passion and now they get to do what they love for a living. How good is that?
A number of these businesses also had very low startup costs and started as way just to earn a little extra money.
I bet many of us have at least a couple of ideas like this inside us. With just a little time and effort maybe you could get a small business up and running just like these people. Who knows where it could lead?
Central to the subject of personal finance is the concept of living within your means. In a nutshell, to live within your means is to spend less money than you earn. It's a basic concept which I'm sure most of us know and understand but for whatever reason we occasionally (or sometimes frequently) like to ignore it.
So many of the basic problems we all face with our money can be traced back to a failure to live within our means. High debt levels and minimal or non-existent savings are manifestations of the problem. And while you might be confident that you can make the repayments or borrow more money to cover any short-term cash flow problems, what if the unexpected happened.
In the current economic climate, the reality is that more people are losing their jobs. If you've managed to save some money and at least establish and emergency fund, you'll have a cash buffer if the worst happens. But if you've spent everything you ever earned (and then some) and suddenly you find yourself unemployed, would you be able to make ends meet?
Escalating credit card debt is a sure sign that you are living beyond your means. If the balance outstanding on your credit card is growing from month to month, it's probably time to take a step back and have a close look at your finances. How much money do you earn and how much do you spend? Be realistic about it. Remember if you're not saving any money and your debt levels are rising, there must be a shortfall somewhere.
Prepare a budget. Note down for a couple of months how much money you've spent and on what. You will probably be surprised. I know I am each time I go through that exercise.
Building wealth the old fashioned way requires you to establish a habit of saving. You'll be amazed at how quickly $50 or $100 put aside each week into a savings account will add up. Or alternatively, an extra $50 or $100 paid off the credit card will soon have it paid off and will free up the cash that was going in interest payments for use on other things.
You have your budget in place. You're spending less than you earn. You've started to save money on a regular basis and you're starting to accumulate a handy little pile of cash. So what's next? It's time to start thinking about another very important part of personal finance - investing.
Investing is the mechanism by which you will make your money grow. It is the act of buying assets which will grow in value and/or produce income over the years to come. Investing your current and future savings at a reasonable rate of return will help build wealth in order to reach your future financial goals.
But how do you get started with investing? Today I'd like to discuss a broad group of investment strategies which advocate a relatively simple and hands off approach to investing.
While most us us have heard of legendary investors like Warren Buffett, there is a theory floating around which says that the average investor wont do anywhere near as well as Warren Buffett. In fact they will struggle to beat the average because the average itself is made up of a bunch of average investors. Even more importantly, just to earn a return equal to the average should be considered a success.
This is where approaches put forward by The Coffee House Investor and others come to the fore. In a nutshell, they advocate the use of asset allocation and low cost Index Funds or Exchange Traded Funds (ETF's) to build your investment portfolio. Asset allocation is used to diversify across asset classes thereby spreading risk and reducing volatility. Index Funds and ETF's are used as a low cost way of ensuring an investor captures all of the return of a particular asset class - this is the very idea behind index funds.
You can see some of these types of portfolios in action at the Lazy Portfolios section of the Market Watch website.
Or for a more in depth discussion of the Ultimate Buy & Hold Portfolio from the Lazy Portfolios mentioned above, read The Ultimate Buy-and-Hold Strategy by Paul Merriman at FundAdvice.com.
The stock market is plummeting. I can't believe the turnaround in investor sentiment in the last year or so. The Dow was over 14,000 just 18 months ago and now it looks like it might go down below 7,000 again. I know the economic outlook is not as rosy as it used to be but has the underlying value of the companies which make up the Dow really halved?
You could well argue that the stock market was overvalued 18 months ago and that it's really just approaching fair value now. I can't claim to be an expert on valuation of equities markets so this may well be the case - but even if it is the case, it still food for thought.
A patient investor who's willing to hold onto some cash when markets are racing out of control, will eventually be rewarded with better value. And that's where we are now. Stocks are on sale - they're 50% off.
Now I wont pretend that I'm not worried about the financial crisis. I have no idea how bad it will get or how long it will last. But I suspect that in 5 or 10 years time stock market investors (particularly value investors) will look back at this period as one of the best buying opportunities of a generation.
Having said that, I think investors should tread warily. I would stick to companies in sound financial shape - low debt and strong cash flows. And be prepared to see the market price of your investment continue to fall. But take comfort in the fact that it's almost impossible to pick the bottom and that you're still buying a quality business for half of what it sold for less than 2 years ago.
I should point out that I'm an private investor managing only my own money. I'm in no way qualified to give financial advice. You definitely should not take any of what you read on this blog as personal financial advice. See a professional. I could be spectacularly wrong - maybe the world really is coming to and end.
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