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.
I find that personal finance and money is no different to any other area of my life. Planning and goal setting are essential in enabling me to reach the outcomes I aspire to.
With the arrival of the new year, now is a good to revisit some of your goals and maybe set a few new ones. In this post I thought I would outline some of my personal finance goals for 2009.
Diversify My Income Streams
Like most people, my main source of income is from my day job. I have a modest portfolio of investments, mainly in the stock market, which produces some income as well. But this investment income is not yet enough to cover our family's expenses. I would like to reduce my reliance on full-time employment by growing my investment portfolio and perhaps diversifying into other areas.
Starting a small business is in the back of my mind as well. But ideally the set-up cost would need to be low and it would need be something I could run on a part-time basis initially. This is really nothing more than an idea for now.
Cutting Our Living Expenses
Last year I made some headway on this front, but I haven't been as diligent as I could have been. I've been going through our household budget and looking at how we can save money on the big-ticket items. It's surprising how much money you can save if you're willing to shop around for the best deal. Negotiating also helps.
Tidy Up My Investment Portfolio
The stock market investments I hold have held up reasonably well through the recent financial turmoil. As you would expect the prices have fallen from their highs but by and large they are in pretty good shape financially. However, I tend to be a collector of stocks and as a consequence the number of securities I hold tends to become a little unwieldy. I need to trim down the number of holdings to a more manageable number.
A little while back, in my post about building wealth, I mentioned that I thought it was important to re-invest any income derived from your investment portfolio. It is an example of the compounding effect at work. Today I'd like to share my thoughts on dividend reinvestment plans (sometimes referred to as DRIPs). Dividend re-investment is touted by many a being a great strategy for growing your investments over the long term.
What Is A Dividend Reinvestment Plan?
When a company declares and pays a dividend, investors would normally receive that amount in cash. Under a DRIP, an investor can opt to forgo the cash payment and instead receive the equivalent amount in company stock.
As an example, if you own 100 shares in a given company and that company declares a dividend of $1 per share, you would be entitled to a cash payment of $100. But if that company offered a dividend re-investment plan and you decided to participate in the plan then you could take the $100 in shares. If the company's stock was trading at $50, you would receive 2 shares under the DRIP.
Advantages Of Dividend Reinvestment
Participation in these schemes allows an investor to acquire more stock an a company without paying brokerage fees. This means it can be a low cost way of increasing your ownership of an investment. Even though only a small quantity of stock is accumulated each year, this can add up over a number of years.
To make it more attractive, some companies offer stock in their DRIP's at a discount to the current market price (around a 5% discount or so). This can make the plan an even more cost effective way to add to your holdings.
Disadvantages Of Dividend Reinvestment
The main issue I have with these plans is that you may not necessarily be investing your funds in an investment which represents the best value at any given time. I like the idea of re-investing the income from my stock market investments. It creates a compounding effect whereby the amount reinvested increases the income the following year and so on. But I like to choose where I invest my hard earned cash. I prefer to take all of the income received over a given period then plow it back into the opportunity which represents the best value at that time, or perhaps even invest in a new idea.
Another thing to consider is the additional paperwork required. You will need to track each purchase for tax purposes. As your portfolio starts to grow and the number of holding increases, you will need to track the issue of shares twice or sometimes 4 times per year for each holding.
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.
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