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.
When you put your money into a savings account at the bank, it is on the understanding that you will earn some interest on that deposit. It's your reward for letting bank use your money for a while. Alternatively, you could say it's the cost a bank incurs when borrowing your money. Dividends are a little bit like interest but with a number of subtle yet important differences.
A dividend is a payment a company makes to its owners (stock holders) out of any profits it makes in a given period. Dividends are normally paid either quarterly or half-yearly.
While the interest you receive on your deposit in a savings account is typically agreed up front (ie. the interest rate is advertised), the amount a company pays out in dividends is a little more fluid. The payout may fluctuate from year to year. If the company is successful, the the amount will normally go up each year. However, when profits falls, so does the dividend - and if things get really bad, there may be no payment at all.
Another thing to consider about dividends is the chance of capital appreciation (or capital loss). In order to receive a dividend, you must first buy stock in a given company. You may consider this to be the equivalent of making a deposit in a bank savings account. However, when it comes time to take your money back out again, there can be a big difference between a bank and a shareholding.
With a bank account, you would expect to receive back the same amount of money as you deposited, plus your interest (not withstanding the present economic climate). But with a stock market investment, you need to sell your shares to get your money back. And for this, you will be at the mercy of the markets. Stock prices may have gone up - but as we have seen over the past year, they can also go down.
Now it's is not all down and gloom with dividends. History tells us that provided you invest in good quality stocks for the long term, then your dividends, along with some capital growth, will exceed the interest you could get in the bank. Just be aware that a much longer time horizon is needed. Most investment professionals recommend 5 years or more.
Dividends are payments a company makes to its shareholders out of corporate profits. It is the income you receive for investing in the stock market.
Typically the returns derived from equity based investments like stocks take the form of capital growth (through a rising stock price) and income through dividends.
It's important to note that not all companies pay dividends. Newer companies and those experiencing high growth may decide to re-invest all of their profits back into the business. This may be a better outcome in the long term as it will grow the value of the business. But income investors want the cash now (or at least on a regular basis) rather than at some point in the future.
A convenient way of expressing this income component of return on your stock market investment is as a dividend yield. It's calculated by dividing the amount of the dividend by the price of the share. So a stock trading at $20 which pays a dividend of $1 would have yield of 5% (1 divided by 20).
But don't worry too much about the maths. These yield figures are available in the business section of most newspapers and on all of the finance and investing web sites (like Yahoo Finance and others). Using this figure, you can then compare the returns on offer for various stocks and get a rough idea of the relative values involved.
You can also compare the dividend yield to the interest rates available on the various bank savings accounts and other income investments. Just be aware the buying stock is not the same as putting money in the bank. The risks involved are much greater - you're not comparing apples with apples.
I firmly believe that a personal or household budget is one of the fundamental building blocks when it comes to the subject of personal finance. A budget allows you to see clearly where your money comes from and where it goes. This is the very first step you need to take if you want to get in control of your finances.
Having said that, I've been a somewhat sporadic user of a budget as a personal finance tool. What I tend to do is prepare a budget and satisfy myself that my income does indeed exceed my planned expenditure by a sufficient margin to meet my savings goals.
What invariably happens then is that once I'm comfortable that my spending habits are roughly in line with the budget, I tend to neglect it until another (normally financial) event triggers me to go back and re-visit it. And that's what happened recently.
My wife has recently quit her job so it means we're down to one income. While it means a more relaxed family life for us all, it also requires a little more attention to the financial details of our lives. So in keeping with tradition, this event has prompted me to go back and update our budget.
The good news is that we still have an adequate difference between income and expenses to allow us to meet our savings goals. But the lower level of income caused me to cast a slightly more critical eye down the list of expenses to see where we could potentially save a little extra money.
Starting with some of the larger annual outlays, I fairly quickly identified 2 or 3 items which deserved closer attention. Adding together our phone and internet bills made it one of our larger regular expenditures. A little research quickly identified a number of better deals available to us for these services. In the end we chose a VOIP option in combination with our internet service. The cost is now roughly half what it used to be.
I plan on tackling some of the other larger expenses in the near future. I'm sure we could get a better deal on some of our other services if we shop around a little.
What prompted this cost cutting exercise was the preparation of a budget. It forced me to have a look at all of our expenditure in one place rather than in dribs and drabs as they actually occur. And we're seeing the benefits already.
Most of us go into debt at some point in our lives, either by choice or out of necessity. It might be a car loan to finance the purchase of your dream car. It could be the mortgage you need to buy a home for you and your family. It might even be the credit card debt you build up each month (and hopefully pay off within the interest-free period).
But I'm surprised at how many people I've met who have got their personal finances in a mess through the imprudent use of debt. So today, I'd like to put forward some ideas of how you can use your capacity to borrow for good rather than evil.
What Is Bad Debt?
In general, any money which you borrow to buy something which goes down in value could be considered bad debt. This might include so called lifestyle-type assets like expensive cars or consumption items like clothes and food. Money borrowed to finance a vacation would fit into this category as well.
Your credit card is quite often one of the main accomplices in racking up unhealthy debts. This is because credit cards are normally used to buy everyday items - food, clothes, going out to dinner and so on. Then when the balance on the card is not paid off at the end of the month the problem is compounded. At interest rates which often exceed 20%, this is a very costly exercise.
What About Good Debt?
Ideally, the only time you would borrow money would be to buy an asset which appreciates in value or produces income. The total return from the ownership of the asset would need to exceed your borrowing costs in order to advance your goal of building wealth.
An example might be investing in real estate. You would expect to receive some income from such an investment which would help service the interest payments. In addition you would hope to see some growth in the value of your investment as well.
One of the key features of a personal finance plan is the section aimed at building wealth. And investing in the stock market can be a great way to accumulate wealth over the long term. And there are plenty of options to help you get started. You don't need to go out and buy a heap of shares straight away. In this post I'll examine some of the ways you can go about investing in the stock market.
Get A Good Adviser:
First off, find yourself a good adviser. The adviser could be a financial planner or a stock broker or even your accountant. This person must be trusted and must know you current financial situation well and understand what you future financial goals are. Finding the right person is especially important when you're just starting out. A financial planner could be useful if you're looking generally at investments as part of your overall financial plan. A stock broker is more useful when you're looking at making specific stock market investments.
Mutual Funds:
But you don't need to jump straight in. Rather than holding stock of individual companies, you may like to invest via a mutual fund. The managers of these products pool investors' funds together and buy a range of different stocks. One advantage of this approach is that you can achieve a level of diversification even if you don't have much to invest. In fact an investment in one mutual fund may gain you exposure to the stock of 60 to 80 companies or even more.
One thing to be aware of however, is that even though you're spreading the risk across different businesses and industry sectors by using a mutual fund, you are taking on specific risk associated with that mutual fund. Make sure you do your research before choosing a fund and get professional advice if need be. Another way of mitigating the specific risk is to consider buying more than one fund. It's all about eggs and baskets.
Investment Clubs:
This is something I've not yet tried but I'm quite interested in. An investment club is a group of stock market investors (or any sort of investors I guess) who pool their resources - both financial resources and brain power. The idea is that each member of the group contributes funds to the club and the members meet on a regular basis to make investment decisions.
To my way of thinking this has a couple of advantages. By putting your money together with others, you'll collectively have more buying power. This means you can diversify your investments more broadly. Instead of being able to buy stock in one company every one or two months by yourself, you may be able to make two or three purchases each month as part of a club (or even more depending on the number of members).
The other advantage is that you'll be making joint decisions. This means there will be more ideas on what stock you could buy and more people to filter out the poor ideas. Collectively you should be able put together a good stock portfolio over time.
The main disadvantage I can see is that because it's a group thing, you'll need to make sure it's a group of like minded people. Do they all share your investment philosophy? Are they long term investors or short term traders? Will their preference be value stocks or growth investing? And the more people involved, the harder it will be to gain a consensus.
Invest Regularly:
Whatever method (or methods) you choose, my preference is to invest regularly. It's like a regular savings plan. And by spreading your investment activities out over time you can avoid putting all of your money into the market at the very top. Detractors of this approach would argue that you will also avoid buying at the bottom of the cycle as well - thereby not buying as cheaply as you may have. There is some merit in this argument, however, timing the market is notoriously difficult so I'll leave the decision to you.
What is an emergency cash fund and what does it have to do with personal finance?
What if you lost your job tomorrow? What about if your car broke down - or your fridge or washing machine. Would you be able to cope with this unplanned expense without undue financial stress? Would you need to borrow money at some exorbitant interest rate to cover the cost until the next payday?
An emergency savings fund is a store of cash or cash buffer put away to cover life's emergencies. No matter how well we plan things, life will always throw unexpected situations at us. This is where the personal emergency fund money comes into play. By having this extra cash put aside, you will be able to meet these challenges without the stress of trying to come up with extra cash at short notice.
There are almost endless possibilities when it comes to unforeseen financial emergencies. Here are some you might like to consider:
- Breakdown of an important household appliance like a refrigerator,
- A medical emergency,
- Loss of employment,
- Car repairs,
- House repairs.
Some of these situations may require you to come up with hundreds, if not thousands of dollars at short notice. If you can't come up with these funds at short notice, what are your options? In the worst case scenario, you may have to borrow money from a short-term money lender (think cash advance, payday loan or something similar) at very high interest rates. If you have a credit card, you may be able to use that, but once again you may face a steep interest bill. If you're lucky, you may be able to borrow the money from friends and family. However, not everybody is this fortunate, and even those that do have this option may prefer not to go down this path. Borrowing money from friends or family can place undue stress on relationships. So how do you get started with an emergency cash fund?Hopefully, you're in a situation where you're able to save some money on a regular basis. If you currently aren't saving any money, I would suggest you review your personal financial situation. You may need to cut back on your spending - have a look at your expenses and think realistically about what you can do without. Start with your discretionary expenses. Assuming you are putting aside a little money each week or month, this is the money you should be putting into your family emergency fund. Set yourself a target (say $1,000) and concentrate on putting this much aside over a number of months. This should be your top priority and all of your saving efforts should go towards this goal until you feel you have enough put away. It's important for this money to kept separate from the rest of your finances. You will need to resist the temptation to dip into it for special purchases - that new large screen TV or the holiday. Even worse, you don't want it to be frittered away on everyday living expenses. You need to make sure that the funds will be available should the need arise. Remember, it's for emergencies only. How Much Is Enough?I mentioned a figure of $1,000 earlier. This figure is somewhat arbitrary. I think it's a good starting point and is far better than not having an emergency fund at all. But I would suggest that most people would need more than that. How much more? Well the consensus seems to be about 2 - 3 months pay (or even more). It will depend very much on your personal circumstances though. Factors to consider include the following: - How many dependents do you have?
- How much if any health or medical insurance do you have?
- How secure is your job?
- What are your monthly expenses?
A young single person with no dependents could obviously get by with a much smaller emergency fund than a married couple with 3 dependent children and a mortgage. Consider each of the likely scenarios and work out how much you would need to meet the unexpected costs. For example, you may allow $1,000 for a replacement refrigerator. You may also consider $2,500 to be enough to cover any major car repairs. And you may think that 2 months would be long enough to seek alternative employment, and if your living expenses are $2,000 per month then you would need to put aside $4,000 to cover this eventuality. In the above example, you might like to set the amount for you emergency fund at $4,000 as this is the greatest figure out of the scenarios you have considered. It's unlikely (but not impossible) you would encounter all of the above situations at once, so I would just make sure I have the most expensive one covered. Where Should You Keep Your Emergency Cash Fund?Because in the event where you need to make use of your emergency fund you will need access to the money at short notice, I would suggest you keep it in cash or a cash equivalent. This means an at call savings account (maybe on online savings account to maximize the interest you can earn). Or you may want to consider a short dated term deposit or CD (certificate of deposit). The main thing to remember is that should you need to call on your emergency fund, you will most likely need the cash in a matter of days. Many personal finance experts may consider an emergency fund to be an inefficient use of your resources. In some cases this can be true, but it will depend on your personal circumstances. In my next post, I will discuss more advanced concepts in managing your emergency cash fund.
Are you trying to get your personal finances organized? This article will help get you started.
Lots of people have good intentions when it comes to personal finance - they just don't know where to start. And it's not always easy. Everyone's situation is different - there's no one-size-fits-all solution. You may be in a situation where you have trouble making ends meet from week to week. Or you may have a decent income coming in each week but never seem to have any money left at the end of the pay period. There are even those among us who have managed to save a little money but are not sure what to do next.
Take Stock Of Your Personal Finances Now!
The first step you need to take is to work out where you are now. This is essentially establishing what you financial position is now. What are your assets and liabilities? How much income do you have each month? How much do you spend?
What Are Your Assets?
This can be a tricky question. How do you work out what an asset is? The simplest asset to identify is cash in the bank. Next will be any investments you have - stock market, real estate, retirement fund and so on. Then, if you own (or have a mortgage over) your own house you might like to include this next.
Now comes the gray area. Some personal finance books will tell you that lifestyle purchases like cars, boats, televisions and stereos are not assets. They argue that these "assets" wont appreciate in value and in many cases will have very little resale value. And in the worst case scenario, they may have high maintenance costs associated with them. I'm not going to say whether or not you should include these things in your list. I tend not to include them, but it's up to you. You should be going though this exercise (establishing your financial position) on a regular basis and the most important thing is to be consistent over time in what you record.
For each of the assets you've listed, assign a dollar value. For financial asset (like cash, mutual funds and stock market investments for example) this will be easy. For other things you may like to record the purchase price. In cases where the monetary value of the asset diminishes quickly over time, you might like to allocate a value based on how long you've had it and how long you think it will last. Better (and easier) still, just don't include it as an asset. Consider it as an expense - like a night out or a weekend away.
What Are Your Debts?
This should be a little easier than the assets - as most lenders will remind you frequently of how much money you owe them. Write them all down. Include any money owing on your mortgage, personal loans, car loans, credit card debt, student debt, store cards and so on. Now write the amounts next to them.
Do You Owe More Than You Own?
The next step is to add up all the values you allocated to all of your assets and write down the total. Now add up all of your debts and write down the total. Now the moment of truth - subtract your total debt figure from your total assets figure. What do you get? Is it a positive number or a negative number.
If you got a negative number, don't panic. At least we know where we stand. You should be happy that you now have a basic idea of your personal finances and how they stack up. Knowing how much net debt you have will give you something to focus on. Each month, you will want to try to reduce the deficit of assets to debt. You may not improve every single month, but overall you want to see a steady improvement over time.
If you subtracted your debt from you assets and got a positive number, well done. Don't become complacent, but you must be doing at least something right to be in that position. Either though hard work or maybe just good fortune you are ahead of the game - but by how much? Or maybe a better measure would be to look at the total interest you are paying on any debts you may have, then compare this to your income. You may have more assets than liabilities, but are you moving in the right direction?
In my next article I will be looking at what our next step should be. How does our income stack up against our expenditure? Please come back tomorrow to read the next article in the series on personal finance basics.
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