Merry Christmas

I'm taking the week off to celebrate Christmas. I wish you all a very merry one.

Paying Less for Books: Part 2 – Money Saving Tactics

I am a bibliophile. I prefer holding a book in my hand while I read. I like to own books. I like to look at them on my shelves and recall their main points or stories.

Because it’s important to minimize the cost of the books I buy, I’ve developed a strategy and tactics to substantially reduce the price I pay. The strategy is patience. I put books I’m interested in on a list and wait.

Several good tactics are based on the strategy of patience.

First:
As time passes I validate my interest in the books on my list. About half of them I eventually delete from the list without buying; I’ve lost interest in them or my interest is insufficient to justify the money or the time to read them

Second:
I wait for the mass-market paperback edition. I use this tactic for most of the novels on my list. A typical hardback novel lists for around $30. The mass-market paperback typically lists for around $8.

Third:
I have a Barnes & Noble membership providing a 10% minimum discount on any B&N paperback or a 20% minimum discount on hardbacks. As a member, Barnes & Noble sends me a discount coupon at least once a month for an additional discount on anything in the store. The additional discount ranges from 10% to 25% with 15% discount coupons being normal.

The B&N discounts are cumulative not additive. That is, they take the 10% membership discount and then they take the 15% coupon discount on the balance; instead of adding the 10% and 15% coupons and taking a 25% discount once. This process reduces the total savings, but it’s still a good deal.

Fourth:
I shop the remainders. Book sellers, including B&N, deeply discount books that fail to meet their sales expectations or to make room on their shelves for newer issues. Sometimes, books on my list show up on the discount displays. When they do I snap them up and still take the 10% B&N membership discount. On those occasions when I buy books on impulse, they’re almost always on the discount shelves.

Fifth:
I shop the used books on Amazon.com. When the mass-market paperback edition is published, the remaining hardbacks are discounted, especially by the used book sellers on Amazon. Even with a $4 typical shipping & handling fee, the total discounted cost of used books on Amazon often drops below the $8 price of the paperback edition. I’ve bought several books at a discounted price of $0.01 plus the $4 shipping & handling.

The combination of these tactics – based on the strategy of patience – enables me to buy the books that I really want without busting the budget.

Link to Other Topics in the Special Report: Cutting Expenses

Paying Less for Books: Part 1 – Patience and Making a List

I am a bibliophile. I read – a lot. And I prefer holding a book in my hand while I read. Oh, I read email and email newsletters and articles and blogs on the internet. But, when I hold a good book in my hands my attention span is much better than when I read from a computer screen.

I like to own books. I like to look at them on my book shelves and recall their main points or their stories. Because I like to own books it’s important for me to minimize their cost and so, I’ve developed a strategy that substantially reduces the price I pay for most books.

The key to my strategy for paying less for books is patience. I rarely buy books impulsively. I keep a list of desirable books on my pocket computer with a duplicate of the list set up as a “Wish List” in Amazon.

When I discover a book I’m interested in I add the title and author to my list. Then I wait. Right now my list contains 83 titles; evenly split between fiction and non-fiction.

The easiest way the list saves me money is when, after some time has past, I realize that a particular title doesn’t interest nearly as much anymore. It no longer seems worth the money to buy it or the time required to read it. And so, I delete it from my list.

This is the ultimate fate of half of the books I capture on my “Wish List”.

The passing of time also permits other money-saving tactics to come to fruition. Tactics to be discussed in future posts.

Link to Other Topics in the Special Report: Cutting Expenses

Covered Call Options: Part 3 – How to Analyze a Covered Call Option

Writing a covered call option is the least mysterious and arcane black magic technique of options investing. It’s simple enough that I’ve done it myself and made a few bucks.

My analysis for writing (selling) a covered call goes like this:

1. Select a stock with at least 100 shares in my portfolio that has active options trading; for example Southern Copper – ticker symbol PCU.

2. Determine the minimum price I would be willing to sell PCU if my covered call is exercised.

3. Go to my on-line broker’s web site and look up the “options chain” for the stock – PCU.

4. Choose a selection of PCU call options at acceptable striking prices and several expiration dates (near term, three months out, and six months out).

5. Get the price quotes (bid price or last price paid) for each option.

6. Calculate the profitability of each option applying my broker’s option commission structure. I use an Excel spreadsheet for this analysis.

7. Choose the most profitable option in the selection.

8. Final gut check on the striking price and the price for which I’m willing to sell the option.

9. If I decide to set a price for my covered call option different from the price quotes used in my analysis then plug my price into my analysis model to check its profit.

10. Place the trade order thru my on-line broker.

After that, you wait for the call to sell. If it sells, you wait for it to expire or be exercised. If it expires, you can start the process over and sell another call. If it’s exercised then you have just sold your stock at the option striking price.

After you place the sell order for the covered call you will either sell the call earning the exact profit you calculated or you will not sell the call - you will have lost or gained nothing.

If you sell the call the only risk you take is the possibility of having to sell your stock for a price less than the market price at the time the call is exercised. If you chose a striking price that gives you an acceptable return then the worst case is you miss making a bonus profit on the sale of the stock.

Here is an analysis of a real selection of PCU call options:

My broker’s commission structure is as follows. A $9.20 commission is charged per trade or transaction. In addition, $0.75 is charged for each contract. In this example all of the potential trades analyzed are for one contract so the total commission in each case is $9.95.

The price is the price per share so 100 shares at $0.65 per share is $65.00 – this is the amount the buyer will pay me for selling the PCU AH call. $65 less the $9.95 commission yields my profit of $55.05. If the market price rises above the $40 striking price per share then the option would probably get exercised. Since my current cost basis (the average price I paid for my PCU shares) is $21.04 per share, I stand to make a profit of $18.96 per share or $1,896 for my 100 shares - less my broker’s commission on the stock sale of $5.95.

I chose these specific call options because their striking prices are above the current $36.40 market price for PCU and, since I’m not really interested in selling my PCU shares, I want to reduce the probability of being forced to sell the stock. I also want to ensure that if I’m forced to sell I get a price I’ll be happy with.

The number of contracts offered makes a difference to the profitability of covered calls because of the option commission structure. The same analysis is shown below using four contracts per transaction.
On the PCU AI call you see the difference in profitability due to the increased number of contracts. When one contract is sold the profit is $0.05 but when four contracts are sold the profit jumps to $27.80 – considerably more than four times the original profit.

You also see that a more profitable single contract is less affected by the commission structure when the number of contracts increases.

Another consideration is the expiration date. The more time allowed before the expiration date the higher the probability the stock price will rise above the striking price. Of course, if the stock goes down the option will expire. If you want to sell the underlying stock before the option expires, you will need to buy the option back at the current market price.

Writing covered call options allows you to lock in a profit with the risk of possibly missing out on some bonus profit if the underlying stock goes up above the option striking price.

Links to Other Topics in the Special Report: Covered Call Options

Covered Call Options: Part 2 - Definitions of Option Terms

Covered Call Options: Part 2 – Definitions of Option Terms

Options are mysterious and arcane - the black magic of investing – primarily because they have their own language. The language of stocks and bonds is more than most people want to try to master. Options seem to be a completely different language – not a mere dialect of investing but something completely different. As such, they are intimidating.

I’m not an expert investor – let alone an expert options trader. But I’ve dabbled in the covered call enough to understand the basics; and, enough to want to learn more.

So, here is a short vocabulary in options – enough, I hope, to let you make an informed decision about the usefulness of covered call options to your personal investing.


Option (or options contract, or contract)
A binding contract in which one person promises to sell and deliver to another person 100 shares of the common stock of a specific company for a specific selling price. The contract is valid for a specific period of time and after the designated end date the contract is void. The buyer of the contract is not required to exercise his rights under the contract but the seller of the contract is required to deliver as agreed if the buyer exercises the contract.

Expiration Date
The expiration date is the specific date on which the options contract will become void. The buyer of the contract must exercise his rights under the contract before the expiration date because on the expiration date he loses those rights. All options contracts have an expiration date.

Underlying Stock
The underlying stock is the 100 shares of the specific company for which promises to buy or sell are made in the options contract. All options contracts have underlying stock.

Striking Price (or strike price)
The striking price of the options contract is the price at which the underlying stock will change ownership if the options contract is exercised. All options contracts have a striking price.

Call (or call option, or call contract, or call options contract)
A call option is an options contract in which the seller of the option promises to sell the underlying stock to the buyer of the option.

Put (or put option, or put contract, or put options contract)
A put option is an options contract in which the seller of the option promises to buy the underlying stock from the buyer of the option.

Covered Call (or covered call option, or covered call contract)
A covered call is an options contract in which the seller of the call option actually owns at least 100 shares of the underlying stock.

Naked Call (or uncovered call)
A naked call is an options contract in which the seller of the call does not own at least 100 shares of the underlying stock. If the options contract is exercised, the seller of the call must buy shares of the underlying stock in order to deliver them to the buyer of the call option – and yes, people actually do this.


These are the definitions you will need to understand the covered call. Using these definitions, the next post will review how to analyze a potential covered call to determine if you can expect to make money on the trade.

Links to Other Topics in the Special Report: Covered Call Options

Special Report: Covered Call Options

Links to Other Topics in the Special Report: Covered Call Options

Covered Call Options: Part 1 - What Are Covered Call Options?
Covered Call Options: Part 2 - Definitions of Option Terms
Covered Call Options: Part 3 - How to Analyze a Covered Call Option

Covered Call Options: Part 1 – What Are Covered Call Options?

Options are mysterious and arcane. They’re the black magic of investing. Few understand them and fewer make money with them. But there is one straight-forward class of options and the way to use them to make money is clear – writing covered calls.

Writing a covered call means selling to someone else an option to buy your stock. A single covered call options contract gives the buyer the right to purchase 100 shares of your stock in the specified company (the underlying stock).

Since not all stocks have options contracts, the first requirement to sell (or write) a covered call option is that you must own at least 100 shares of a stock for which options are traded. So check with your broker to see if options are traded for your stock.

When you have at least 100 shares of a stock that has options trading, your next task is to determine your broker’s commission structure for writing covered call options contracts. My broker charges a flat rate per transaction plus a surcharge for each 100 share contract in the trade. This has the effect of reducing the cost per contract on multiple contract transactions. I have only used one broker for selling covered calls so I don’t know if this commission structure is standard. In any case, you need to determine exactly what your broker will charge.

The commission structure is very important because the prices of options contracts vary all over the place and you want to be sure that when you sell your covered call you make enough money on the sale to pay the commission and a profit large enough to make it worth the trouble

The next post will review some basic options definitions.

Links to Other Topics in the Special Report: Covered Call Options

Flexible Spending Accounts: Part 2 – Calculating a Safe Contribution

If you aren’t participating in your Flexible Spending Account, you’re literally giving money to the Internal Revenue Service unnecessarily. Still, if you go overboard on your contributions you can lose money

Start calculating a “safe” flexible spending account contribution by listing everything you spent out of pocket on health care last year. Capture the description and out of pocket expenditure for each line item. Classify each item as covered or not covered and repeatable or not repeatable.

Example Expense List:

Annual physical exam; $25; covered; repeatable
Blood work for physical exam; $25; covered repeatable
Semi-annual dental exam; $30; covered; repeatable
Emergency room; $150; covered; not repeatable
Aspirin; $12; covered; repeatable
Multivitamins; $10; not covered; repeatable
Band-Aids; $4, covered, repeatable
Nail Clippers; $3; not covered; not repeatable
Wrist Brace; $7; covered; not repeatable
Shampoo; $4; not covered; repeatable

Covered expenses include co-pays for medical, dental, and vision office visits, lab work and tests, and any hospitalization or emergency medical expenses. Out of pocket expenses for prescription and over-the-counter medications are covered as are prescription and over-the-counter medical devices and supplies.

In general, if you incur the expense to heal, cure, or control pain then it’s probably covered. If it’s a “wellness” expense - like vitamins, food supplements, or exercise equipment - it’s probably not covered unless your doctor wrote a prescription ordering you to incur the expense.

Total the annual amount twice – once with all covered expenses and once with only those covered expenses that are repeatable.

Example (using the Expenses List):

Total of all covered items = (25+30+150+12+4+7) = $228
Total of covered & repeatable items = (25+30+12+4) = $71

Odds are good that your list will be much longer and the totals much higher than the example– but let’s continue to use the Example List.

Next, you need to know your approximate income tax rate. You can calculate an estimate of your income tax rate from last year’s Form 1040. Look up your actual tax paid and your adjusted gross income from your Form 1040.

Example Form 1040 Information:

Tax Paid = $10,000
Adjusted Gross Income = $40,000

Then divide the Tax Paid by the Adjusted Gross Income ($10,000/$40,000 = 0.25) then multiply by 100 to convert the result to a percentage (0.25 * 100 = 25%)

Example Income Tax Rate = 25%

Example “Safe” Contribution:

If you now divide the Total of covered & repeatable items ($71) by your Income Tax Rate subtracted from one (1 – 0.25 = 0.75); so $71 divided by 0.75 = $95. The result ($95) is the amount greater than the covered repeatable amount that you can contribute with nearly complete safety.

It is likely that there will also be covered non-repeatable expenses in the coming year and taking a conservative guess at them will allow you to increase the safe contribution. You may even plan non-repeatable expenses; for example, the purchase of glasses or perhaps laser eye surgery. The cost of planned expenses can be directly added to the safe contribution figure.

Once you have a year or two of experience using your flexible spending account you can simply adjust your contribution up or down based on experience.

There’s really no excuse for not getting started.

Link to Other Topics in the Special Report: Cutting Expenses

Flexible Spending Accounts: Part 1 – Saving Money with Flexible Spending

If your employer offers a flexible spending account, and you aren’t using it, you’re literally giving money to the Internal Revenue Service unnecessarily.

Many employers offer flexible spending accounts in their benefits package. These accounts are structured by federal law to allow payment of most medical-related bills using “before tax” money.

Unfortunately, the law creating flexible spending accounts also requires money that is left in the account at the end of the benefit year to be forfeited by the employee. This feature scares off many would-be flexible spending account participants. They’re afraid of losing money.

There’s really no excuse for the law to require the forfeiture of excess money. Any reasonable person would allow the excess to roll over into the next benefit year.

Nevertheless, even if you don’t spend all the money in your flexible spending account you can still save money overall depending on your income tax rate.

For example, if your income tax rate is 30% and you contribute $1,000 to a flexible spending account; the $1,000 contribution in subtracted from your gross wages before tax is applied. Since your taxable income is $1,000 less, your income tax will be $300 less (30% of $1,000).

So, by contributing $1,000 to your flexible spending account you save $300 on your income tax return. If you end the benefit year having used only $800 leaving $200 forfeited in the account – you’ve still saved $100 net. The tax reduction gives you a fair amount of flexibility that increases as your tax rate increases.

If you contribute $1,000 and:

1. Your income tax rate is 35% then you have a net savings from your flexible spending account as long as the forfeited amount is less than $350.

2. Your income tax rate is 25% then you have a net savings from your flexible spending account as long as the forfeited amount is less than $250.

3. Your income tax rate is 15% then you have a net savings from your flexible spending account as long as the forfeited amount is less than $150.

4. Your income tax rate is 0% then you have no net savings under any circumstances.

Still, if you contribute $2,000 to a flexible spending account but have only $800 in qualified medical expenses then you have a net loss of $600 ($1,200 forfeited less $600 tax savings assuming a 30% tax rate); a very undesirable outcome.

Flexible spending accounts are an easy way to save money on your income taxes – even if you forfeit a smaller amount at the end of the benefit year.

The topic of the next post will be calculating a “safe” annual contribution to your flexible spending account.

Link to Other Topics in the Special Report: Cutting Expenses

Structuring Your Simple Portfolio: Part 5 – Simplicity in Rebalancing

Simplicity is the key to your success in investing to achieve a comfortable retirement without becoming a financial expert.

1. Simplicity in investment portfolio
2. Simplicity in account types
3. Simplicity in making account contributions
4. Simplicity in increasing annual contributions over time
5. Simplicity in rebalancing your portfolio

Simplicity in investment portfolio and simplicity in account types were discussed in Part 2 of this series. Simplicity in making account contributions were discussed in Part 3. Simplicity in increasing contributions was discussed in Part 4; and next up – simplicity in rebalancing your portfolio.


5. Simplicity in Rebalancing Your Portfolio

Target Year Mutual Fund
If your simple portfolio consists of one Target Year Mutual Fund, rebalancing your portfolio is as simple as it can get – you simply don’t do it. The managers of the Target Year Mutual Fund handle the asset allocation and rebalancing for you.

They take into account the number of years remaining until your fund’s target date by gradually increasing the percentage of bonds and decreasing the percentage of stocks held by the fund. All you have to do is keep adding new money to the account.

An Equity Fund and a Bond Fund
If your simple portfolio consists of an Equity Fund and a Bond Fund, rebalancing is a task you should do periodically.

In Part 2 of this series, I suggested an allocation of 60% to your Equity Fund and 40% to your Bond Fund. This is a very conservative asset allocation and if you use it you may choose to keep this allocation permanently.

Set up an annual rebalancing time. For example, rebalance your portfolio every year immediately after your birthday or immediately after Labor Day. It doesn’t matter what date you choose except that you should commit to a date and actually do the rebalancing on schedule year after year after year.

To do the rebalance simply:
1. Determine the value of both of your funds and their combined total value.

2. Calculate the percentage of the total represented by each fund.

3. Calculate the excess value in the fund that exceeds the target percentage.

4. Exchange the excess value into the fund that is below the target percentage.

Example:
1. Your scheduled rebalancing date is the day after Labor Day (no one knows why you chose that date). On that day your 401k account says that your Equity Fund is worth $35,000, your Bond fund is worth 30,000, and the total value of the 401k is $65,000.

2. $35,000 is 53.85% of $65,000 against your target asset allocation for the Equity Fund of 60%.

3. $30,000 is 46.15% of $65,000 against your target allocation for the Bond Fund of 40%.

4. 46.15% is 6.15% greater than your Bond Fund target allocation.

5. 6.15% of $65,000 is $4,000.

6. Move (exchange) $4,000 from your Bond Fund to your Equity Fund.

7. After rebalancing, you have $39,000 in your Equity Fund (60% of $65,000) and $26,000 in your Bond Fund (40% of $65,000).

8. That’s it – you’re done for this year. Do it again the day after Labor Day next year.

Investing for your retirement can be simple. In this series, we’ve explored two of the very simplest portfolio structures. If you have no interest in learning more about investing or no time to devote to such study, these simple portfolios will do an adequate job of accumulating a comfortable retirement nest egg over twenty or more years depending on your annual contribution amounts.

The sooner you get started, and the more you contribute each year, the better your results will be.

Link to Other Topics in the Special Report: Structuring Your Simple Portfolio

Structuring Your Simple Portfolio: Part 4 – Simplicity in Increasing Contributions

With a simple portfolio and a simple strategy you can successfully invest and achieve a comfortable retirement without becoming a financial expert.

Simplicity is the key to success.

1. Simplicity in investment portfolio
2. Simplicity in account types
3. Simplicity in making account contributions
4. Simplicity in increasing annual contributions over time
5. Simplicity in rebalancing your portfolio

Simplicity in investment portfolio and simplicity in account types were discussed in Part 2 of this series. Simplicity in making account contributions was discussed in Part 3; next up – simplicity in increasing contributions over time.

4. Simplicity in Increasing Annual Contributions Over Time

A simple and painless way to increase your 401k contributions is to save a portion of every raise you get.

For example; assume you started with a 3% payroll deduction to your 401k. A year later you receive a 3% raise; so you increase your 401k contribution percentage from 3% to 4%. You keep the balance of your raise to increase your lifestyle a bit.

The following year you get another 3% raise and you increase your 401k contribution by another 1% from 4% to 5%. After 10 years, your 401k contributions are up to 13%.

You can continue this sequence until you are contributing the maximum allowed by law and still increase your standard of living every year – just not as much as the entire raise would have supported.

On the other hand – if you start early enough - your retirement will be not only secure but very pleasant.

Similarly, if your simple portfolio is in a Roth IRA, you can set your account transfers at some initial amount and increase the amount with each pay raise.

In this case, you will deal in actual dollar amounts – not percentages of your pay.

For example; assume your initial account transfer to your Roth IRA cash account is $100 per month. For the first year you contribute $1,200 and then you get a raise of $200 per month.

You will increase your transfer into the Roth from $100 per month to $200 per month and pocket the other $100 of your raise. Don’t forget to increase the monthly buy (exchange) amount so the money actually goes into your simple portfolio and doesn’t accumulate as cash.

The following year you contribute $2,400 to your Roth and you get a $300 per month raise. So, you increase your account transfer into the Roth from $200 to $350 and pocket the remaining $150.

The next year your contribution is $4,200 – closing in on the maximum allowed $5,000 per year contribution.

When you get your next raise you increase your transfer to $416.66 per month and contribute the maximum $5,000 per year – until the legal limit is increased, then you will again increase your contribution.

Successful investing for retirement can be simple.

The next post will discuss simplicity in rebalancing your portfolio.

Link to Other Topics in the Special Report: Structuring Your Simple Portfolio

Structuring Your Simple Portfolio: Part 3 – Simplicity in Contributions

There’s a lot to learn and know about investing. But, you can successfully invest and achieve a comfortable retirement without becoming a financial expert. With a simple portfolio and a simple strategy you can succeed.

For beginners, and for the uninterested, simplicity is the key to success.

1. Simplicity in investment portfolio
2. Simplicity in account types
3. Simplicity in making account contributions
4. Simplicity in increasing annual contributions over time
5. Simplicity in rebalancing your portfolio

Simplicity in investment portfolio and simplicity in account types were discussed in Part 2 of this series; next up – simplicity in making account contributions.

3. Simplicity in Making Account Contributions
Absolutely the simplest way to make contributions to your simple portfolio is through payroll deductions to your employer’s 401k plan.

When you establish your 401k account you will also choose a percentage of your gross income that you want to contribute to the plan. Then every payday an amount equal to the percentage of your gross pay (before taxes and other deductions) for that pay period will be withheld and contributed to your 401k account.

The contributed money will be allocated to the chosen investments of your simple portfolio. In the case of a Target Year Mutual Fund 100% of your contribution will be applied to the mutual fund. If you are using an Equity Index Fund and a Bond Index Fund your contribution will be allocated to each according to the allocation percentages you chose when you set up the account.

In Part 2 of this series, I suggested an allocation of 60% to the Equity Fund and 40% to the Bond Fund.

Some employers automatically enroll new employees in the company 401k plan with a pre-selected portfolio and a pre-selected contribution percentage.

Don’t count on that, though. And, even if your employer did enroll you automatically, check it out and make sure your enrollment conforms to one or the other of the simple portfolios.

If your simple portfolio is in a Roth IRA you don’t have the option of contributing through payroll deductions. So, you have to create an effective substitute. The way to do that is:

A. Have your pay direct deposited to a checking account
B. Set up a weekly, monthly or twice monthly automatic transfer from the checking account to your Roth IRA cash account.
C. Set up a monthly purchase of your chosen simple portfolio investment(s) using the money in the Roth IRA Cash account.

Each investment option under the Roth IRA umbrella is assigned its own account number. Cash contributions will probably have to be initially received in a cash account or money market fund which will be one of the investment options under your Roth IRA umbrella.

Then, you will buy or exchange into the Target Year Mutual Fund (100%) or into the Equity Index (60%) and Bond Index (40%) Funds from the cash or money market account.

This is more complex to set up but your bank or Vanguard account representative will do the heavy lifting if you ask.

In either simple contribution scenario above, once you have the payroll deductions or account transfers set up, the whole thing will run on automatic pilot. Just read your monthly and quarterly statements to ensure everything is still running and to watch your balances grow.

Successful investing for your retirement can be simple.

The next post will explain simplicity in increasing annual contributions over time.

Link to Other Topics in the Special Report: Structuring Your Simple Portfolio

Structuring Your Simple Portfolio: Part 2 – Simplicity

Investing and personal finance is so complicated. There’s just too much to learn and know and research. I don’t have time for it. Besides, it’s boring!

I used to think that. I put off investing for retirement for years because of it. And after I started putting money in a 401k plan I borrowed from it and even took early withdrawals paying the income tax and the 10% penalty.

The amount of information and the risk can be overwhelming. But you don’t have to be a financial whiz kid to be successful. You can accumulate a sizable nest egg for a comfortable retirement with a very simple investing strategy. If you start young enough you can retire wealthy and retire early.

For the beginner, and for the uninterested, simplicity is the key to success.

1. Simplicity in investment portfolio
2. Simplicity in account types
3. Simplicity in making account contributions
4. Simplicity in increasing annual contributions over time
5. Simplicity in rebalancing your portfolio

1. Simplicity in Investment Portfolio
Absolutely the simplest investment portfolio is the Target Year Mutual Fund. This is a mutual fund managed with an objective of moderate growth and mitigating risk by asset allocation suitable to the time remaining before you retire. The fund manager does the asset allocation for you and as the years pass and the target year gets closer the manager reduces the percentage of the fund invested in stocks and increases the percentage in bonds.

Most 401k plans offer a selection of target date funds. Also Vanguard offers a series of target funds with target dates in five year increments starting with 2005 and ending with 2045. They are called “Vanguard Target Retirement 2045 Fund” with the actual target date substituted for “2045” for each fund.

The second simplest portfolio consists of two index mutual funds. Index funds are structured to closely match whatever index they are named for. The two funds in the second simplest portfolio are a total stock market index fund and a total bond market index fund. Vanguard offers both and they are highly regarded. Look for “Vanguard Total Stock Market Index Fund Investor Shares” and Vanguard Total Bond Market Index Fund Investor Shares”.

You will have you manage your asset allocations yourself and rebalance annually. But a simple asset allocation of this simple portfolio is 60% in the stock market index fund and 40% in the bond market index fund.

401k plans rarely offer index funds; if yours does use it, if not, substitute the offering closest to “large cap equity or stock fund” for the stock market index fund. And for the bond market index fund substitute the 401k offering closest to “bond fund or income fund”.

2. Simplicity in Account Types
The simplest account type for your simple portfolio is your employer’s 401k plan. If your employer has one, enroll in it. Many 401k plans, but not all, match a portion of your payday contributions. That’s free money, so if there’s a matching amount you should contribute at least enough to get your employer’s full match.

When you enroll in your 401k plan, select your simple portfolio using the guidelines described in section (1) above.

The second simplest account type is the Roth IRA. To set this up you must choose a brokerage or mutual fund company. For this purpose I recommend Vanguard.

When you set up your Vanguard Roth IRA you will also select the Vanguard mutual fund or funds for your simple portfolio using the guidelines described in section (1) above.

Investing for your retirement doesn’t have to be complicated – it can be simple.

The next post will explain simplicity in making account contributions and simplicity in increasing annual contributions over time

Link to Other Topics in the Special Report: Structuring Your Simple Portfolio

Special Report: Structuring Your Simple Portfolio

Links to Topics in Special Report: Structuring Your Simple Portfolio

Structuring Your Simple Portfolio: Part 1 - Introduction
Structuring Your Simple Portfolio: Part 2 - Simplicity
Structuring Your Simple Portfolio: Part 3 - Simplicity in Contributions
Structuring Your Simple Portfolio: Part 4 - Simplicity in Increasing Contributions
Structuring Your Simple Portfolio: Part 5 - Simplicity in Rebalancing

Structuring Your Simple Portfolio: Part 1 – Introduction

In the Asset Allocation series I advised choosing non-correlated investment classes for your portfolio; that is assets that don’t go up or down at the same time. I also recommended some specific asset classes. But you don’t invest in asset classes. You buy specific things. You buy shares in a mutual fund, common stock shares, bonds, gold coins, rental houses, government or corporate bonds. And, you buy them in specific types of investment accounts.

In this series, “Structuring Your Portfolio”, I will introduce various types of portfolios suitable for average people. From the very simplest portfolio structure to fairly sophisticated structures for people who enjoy the process of investing and want to make a hobby of it.

I can not make you a professional. I’m not a professional investor myself. Mostly, I’m a self-taught hobbyist amateur. Because I’m self-taught (lots of books, lots of free newsletters, and lots of trial and error) and a hobbyist, I think I can help you get started and help you improve your investing skills and your results.

Before deciding what to buy we should think about where our financial assets will reside. Even this bit can get complicated, but for most people the choices come down to these:

1. 401k (or equivalent) account administered by your employers

2. Traditional IRA accounts administered by a bank or brokerage company

3. Roth IRA accounts administered by a bank or brokerage company

4. Taxable accounts administered by a brokerage company

5. Bank accounts administered by a bank

6. Real assets administered by you

Each of these possible homes for your investments has certain advantages and disadvantages; characteristics largely created and defined by the federal government. The key features of each investment account type are described below. There are many minor features of each type that I’m not going to cover, so these descriptions are not comprehensive.

401k Accounts
401k plans are “tax deferred”. A percentage of your overall (before taxes) wages or salary is deducted from your pay every payday. You choose the percentage and you choose which of the limited number of investment options your payroll deduction buys.

Tax deferred means that you don’t pay income tax on the amount you contribute to the 401k account. You also don’t pay income taxes on any capital gains (increases in the value of the investments you bought) as long as the value stays in the 401k account.

In the end, you do pay income taxes on the money you withdraw from your 401k account – that’s the deferred part.

Traditional IRA Accounts
Traditional IRA’s are also tax deferred. Money you contribute up to the legal limit (currently $5,000) is tax deductable. Since your employer is uninvolved in your IRA the money is reported as income on your W-2 form, but you deduct it from your gross income when you file your income tax (Form 1040). If you withdraw money before you are 59 ½ years old you will be taxed at your normal rate plus 10% of the amount withdrawn early.

You neither report as earnings nor deduct the gains as long as the money remains in the IRA account. But, like the 401k, you pay income taxes on the money as it is withdrawn from the account. If you withdraw money before you are 59 ½ years old, the same 10% tax penalty applies as in the case of an early 401k withdrawal.

Roth IRA Accounts
Roth IRA’s are tax free instead of tax deferred. Contributions to your Roth cannot be deducted from your income tax for the year you made the contribution. But once money is in the account it will never again be subject to income tax even when it is withdrawn.

Taxable Accounts
Taxable accounts are not protected from income tax in any way. You may choose to purchase specific assets that have certain tax advantages, but the account itself conveys no tax advantage. They are typically not covered by any federal insurance program.

Bank Accounts
Like Taxable Accounts, Bank accounts have no tax advantages. They are protected from loss up to $250,000 per account by the Federal Deposit Insurance Corporation.

Real Assets
Real Assets are things like gold coins, $100 dollar bills, houses, or collectables. The only tax advantage is whatever break you get on your income tax rate for a capital gain as opposed to your rate for regular income. Rather than collecting interest or dividends on these assets you frequently must pay for insurance, storage, or maintenance.

Each of these investment account types could have a place in your portfolio of assets and you can use more than one or even all of them. It depends, as most thing do, on your inclinations, your desires, your expertise, your disposition, your age, your risk tolerance, and your financial net worth.

Link to Other Topics in the Special Report: Structuring Your Simple Portfolio

Asset Allocation: Part 4 – Risk Tolerance

In Part 2 of this asset allocation series I assumed 25% allocations for each asset class in the example portfolio. Selecting the target asset allocations for your portfolio is not a science – despite the “Risk Tolerance” surveys and formulae offered by many financial planners.

There are some basic concepts you should consider when setting asset allocations:

1. The closer you are to retiring the greater the allocation of your total assets to “safer” asset classes and the lower your allocation to “risky/aggressive” asset classes.

2. Money you expect to need within the next five to ten years (depending on which financial planner you listen to) should be held in cash or cash equivalents; money market funds, Bank CD’s (certificates of deposit), or laddered bonds (not bond funds).

3. A large enough allocation must be made to more aggressive asset classes to keep up with inflation because the average woman who retires at the age of 62 will live another 25 years; the average man another 20. Many will live 30 years after retiring and some will live 40. In 30 years even moderate inflation rates can be devastating to the value of your portfolio.

4. Emergency funds must be held in cash or cash equivalents that can be withdrawn quickly without penalties.

5. If allocations are too lopsided in favor of any asset class rebalancing will have little value.

6. You have to sleep at night. If your investments keep you from sleeping change your allocations to favor safer asset classes.

Planners advocate allocation plans that vary all over the place. I’ve read advice for twenty-somethings to be 100% in growth stocks. At the other extreme, I’ve seen advice that everyone, regardless of age, should be 50% in stocks and 50% in bonds.

Here’s my advice:
1. Have some money in cash, have some money in bonds, have some in stocks, have some in gold, and have some in real estate. Each of these asset classes should be at least 10% of your portfolio value and none should exceed 70%.

2. Your emergency fund is not part of your portfolio. It should be 100% cash and not count as the cash portion of your portfolio.

3. If you are within five years of retiring you should start building up the cash portion of your portfolio so that on the day you retire you will have enough cash in your portfolio to cover your expenses for five years – after subtracting expenses you plan to pay with money from Social Security, a fixed pension, or income from an annuity.

4. Within these constraints, design your portfolio to grow to meet or beat inflation not counting the new money you will invest – but with asset allocations that let you sleep at night.

5. Rebalance your portfolio annually – perhaps around your birthday.

6. Reconsider your asset allocations annually. You’re getting older and you may be getting wiser.

Risk tolerance and setting asset allocations is more art than science regardless of the research and the formulae used by financial planners.

Links to other Topics in the Special Report: Asset Allocation

Asset Allocation: Part 3 - Rebalancing

Having a mix of uncorrelated asset classes in your portfolio tends to protect the portfolio from downturns and to limit the gain from upturns in any asset class. Asset rebalancing is a powerful tool to improve your overall results.

Most financial planners recommend rebalancing annually. Others have data showing portfolio gains are higher when it is done less frequently – every two or three years. Yet another recommendation I’ve seen is to set gain or loss targets and rebalance only when one of the targets is attained.

Whatever rebalancing frequency is used, the act of rebalancing is the same. You choose an allocation percentage in advance for each asset class and, when you rebalance, you sell enough of the class that is above target to bring its actual portfolio percentage back to its target.

On the other side of the transaction, you buy enough of the classes that are below target to bring their portfolio percentages back up to target. For a portfolio in which you’re still investing new money, you can rebalance by buying only the asset classes that are below target.

When you periodically rebalance, you systematically sell investments that are up in value while their prices are high; and you systematically buy more of the classes that have declined in value while their prices are low.

The old truism is that the essence of investing is to buy low and sell high. Unfortunately, most people don’t have the self-discipline to execute that advice. Plus, nobody knows when the price has stopped going up until it goes back down. Nor do they know when the price is hits bottom until it goes back up. Consequently, most people invest by emotion and often buy high and sell low.

Asset rebalancing makes the “buy low, sell high” discipline much easier to live; you just move the money from one asset class already in your portfolio to others using pre-set rules for the transaction timing and amounts.

I’ve seen data that indicate regular rebalancing over many years increases the final portfolio value by 30% to 100%.

Asset rebalancing improves your investing results in a portfolio of uncorrelated asset classes.

Links to other Topics in the Special Report: Asset Allocation

Special Report: Asset Allocation

Other Asset Allocation Topics:

Asset Allocation: Part 1 - Introduction
Asset Allocation: Part 2 - Asset Classes
Asset Allocation: Part 3 - Rebalancing
Asset Allocation: Part 4 - Risk Tolerance

Asset Allocation: Part 2 – Asset Classes

Asset Allocation is kind of like putting your eggs in several baskets and giving the baskets to people who take different routes to Granny’s house. The trick is to choose high quality baskets and to choose routes so the Wolf can’t intercept more than one basket.

The value of your investment portfolio should be divided among several different asset classes. Examples of asset classes are cash (bank or money market accounts), U.S common stocks, U.S. preferred stocks, U.S. corporate bonds, U.S. government bonds, commodities, international stocks, international bonds, and real estate. This is an incomplete list but covers the classes most commonly considered and bought.

Asset class subcategories include large cap stocks (big public companies), small cap stocks (relatively small public companies), growth company stocks, value stocks, and dividend paying stocks. Subcategories frequently overlap with a single company falling into more than one category.

Asset allocation is not just diversification. Diversification refers to owning multiple stocks or bonds with the objective being to protect your wealth in the event one of the companies you are invested in becomes worthless. To be sure, asset allocation also provides the protection of diversification. The difference is that in asset allocation you intentionally invest in asset classes that tend to increase or decrease in value independently from one another.

For example, usually as the price of stocks go up the price of bonds go down. The same is true of cash and commodities – when one goes up the other normally goes down.

Nowadays, there are ways to invest in commodities and real estate through stocks, ETF’s and mutual funds so even a modest portfolio, like mine, can take advantage of asset allocation using a variety of asset classes. A sample portfolio might consist of shares in an Extended Market Mutual Fund, a Total Market Bond Fund, a REIT (Real Estate Investment Trust) Fund, and a Precious Metals Mutual Fund. The allocation percentages might be set to 25% for each class.

The sample portfolio might behave in the following ways under the specified market conditions:

1. Conditions - slow economic growth with low inflation:

a. Extended Market Mutual Fund increases slowly
b. Total Market Bond Fund is stable and paying consistent dividends
c. REIT Funds increase slowly
d. Precious Metals Mutual Fund declines slowly

2. Conditions – slow economic growth with high inflation:

a. Extended Market Mutual Fund is stable
b. Total Market Bond Fund declines
c. REIT Funds increases rapidly
d. Precious Metals Mutual Fund increases rapidly

3. Conditions – recession with low inflation

a. Extended Market Mutual Fund declines
b. Total Market Bond Fund increases
c. REIT Funds decline
d. Precious Metals Mutual Fund is stable

Ideally, one or more asset classes will go up regardless of the market conditions. By itself, this kind of an asset mix will tend to preserve the value of the portfolio protecting it from big declines and also preventing big increases. A powerful tool to improve this result is “rebalancing”.

The next post will explain portfolio rebalancing.

Links to other Topics in the Special Report: Asset Allocation

Asset Allocation: Part 1 - Introduction

Financial Planners seem to talk about asset allocation all the time. They recommend percentage allocations to various investments (usually different mutual funds) based on some assessment of your “risk tolerance”.

Usually you end up buying some shares in a “large cap growth” fund, a “large cap value” fund, a “small cap” fund, an “international” fund, and a “bond” fund. The percentages vary with your age and your “risk tolerance”.

Asset Allocation is kind of like parceling your eggs out into three to six different baskets, giving each basket to a different person and instructing each person to take a different route to Granny’s house. Most of the baskets will get to Granny and miraculously, each basket that arrives at Granny’s house will have more eggs at the end than it had at the beginning of the trip.

Like most people, my first exposure to asset allocation was sitting down with a Financial Planner who was armed with a “Risk Tolerance Assessment Survey” and a “Financial Goals Survey”. I filled out the surveys and several days later a “Personalized Financial Plan” was delivered to my doorstep filled with monthly saving and investing targets, asset allocation percentages for each of the recommended mutual funds, and of course, Life Insurance.

It was a decent plan and I promptly filed it away where it would not likely see daylight again for several years. My budget couldn’t be squeezed enough to do half of the Personalized Financial Plan and the guy was obviously trying to sell life insurance so I did nothing. That was a mistake.

If I had done even a little of the investing portion of the plan I would be much wealthier today - some thirty years later. But I was young, foolish, over-confident, indestructible, ambitious, and over-whelmed by the whole “asset allocation” thing – plus suffering from sticker shock.

I can’t help you with the young, foolish, over-confident, indestructible, and ambitious parts. But I can help with the “over-whelmed” part and the sticker shock part.

The Asset Allocation trick is to choose high quality baskets and to select the various routes to Granny’s house so the Wolf can’t intercept more than one of them.

In Part 2, I’ll discuss selecting the routes – that is – selecting different types of investments that are poorly or even negatively correlated.

Links to other Topics in the Special Report: Asset Allocation

Dollar-Cost Averaging

“Dollar-Cost Averaging” is one of the most commonly known and understood investing strategies. But everyone hears about it a first time, even you.

When I first heard about dollar-cost averaging I was attending a financial planning seminar in Killen, Texas. I was a young married Army Lieutenant with a mortgage but no children. The seminar was sponsored by Fidelity Investments.

A round wooden disk with the letters “TO IT” printed on one side in bold black letters was found on every chair when we arrived. After pitching the benefits of systematically making monthly purchases of the Fidelity Destiny mutual fund the presenter concluded the seminar by telling us that we had no excuse now that he had given us all “a round to it”. Then he scheduled home appointments with many of us, including me.

In the end, I signed up. For two and a half years a monthly allotment was automatically deducted from my Army paycheck and invested in the Fidelity Destiny fund. Because of the systematic dollar-cost averaging of my fund purchases and because I waited another two years before selling my shares this was my first, and for many years my only, successful investment. It was successful despite a 20% front end load which means 20% of every monthly purchase was skimmed off and given to the sales person (the seminar presenter) as a commission.

So what is this magic “dollar-cost averaging”? It is simply the fact that the price of your chosen investment instrument will fluctuate and if you make regular equal dollar amount investments in the same financial instrument you will sometimes pay a high price and sometimes you will pay a low price. When the price is high you buy fewer shares but when the price is low you buy more shares.

Because the average price you pay is always less than the highest price your investment risk is reduced. You will not inadvertently put all of your money into your investment at the highest price, nor will you get an accidental windfall by putting everything in at the lowest price.

For most people, like me then and now, dollar-cost averaging is not an intentional strategy. It is the result of a payday saving plan – like contributions to a 401k account.

However, if you happen to have a lump sum to invest, remember dollar-cost averaging and consider using it to put your lump sum into one or more investments using multiple purchases over an extended time period. Markets will fluctuate. What goes up must come down and what comes down is likely to go up. But don’t think you know what the market will do tomorrow. Sometimes you will be right. Sometimes you will be very wrong.

Emergency Fund

“Save for a rainy day”. Everyone has heard it but few do it.

For many years my emergency fund was my credit card. When – not if – something bad happened I charged what was necessary on my plastic and then tried to pay for it over the next few months.

But when you spend pretty much what you make every month, paying off a credit card is difficult. Even making those pesky “minimum payments” takes a bite out of your “budget”. And consistently making minimum payments is a sure-fire way to stay in debt forever.

Worse, Mr Murphy invokes his infamous law and more financial emergencies (i.e. life) happen before you’ve paid off the first “emergency”. Your credit card bill grows and your ability to pay it off shrinks.

The best way out of this mess is to avoid it. Pay Mr Murphy before he invokes his law. Squeeze your budget for the “minimum payment” money before it must to be paid to the bank. If you pay Mr Murphy by putting that money in a savings account every payday then, when Murphy’s Law is invoked for you, the bill will already be paid. All you have to do is move the money from the savings account to the people who provide the products or services needed to correct the problem.

Note that it is now a “problem” not an “emergency”.

Financial planners recommend that you save enough money in an emergency fund to cover your expenses for three to six months. This is supposed to sustain you after a job loss until you land another job. That’s a good target although I think twelve months of expenses is an even better target. But whatever the target, don’t let the size of the number discourage you from starting.

Any positive amount is better than zero. Mr Murphy’s law covers a lot more than job losses. $500 in an emergency fund could go a long way toward repairing your car so you can get to work next week.

The key is to systematically put some amount away for Mr Murphy every payday. The more you accumulate the more you insulate yourself from the effects of Murphy’s Law.

Mr Murphy WILL BE PAID. Life happens! The only open questions are; (1) Will you live your life or will life happen to you? (2) Will the bank pay you or will you pay the bank?

You determine the answers by choosing – or not – to create and grow an emergency fund.

Airline Flight Vouchers

If you are flexible, you can occasionally pick up a windfall of several hundred dollars in the form of an airline flight voucher.

In July, while returning from a business trip, the flight I was booked on for the last leg of my trip home had to switch airplanes. Apparently, the originally scheduled airplane had a mechanical problem and the replacement airplane was equipped with fewer seats.

Consequently, the airline asked for volunteers to take a later flight. My traveling companions’ carry-on luggage was already stowed in the cargo compartment of the DeHaviland commuter plane so they could not volunteer. My bag was checked and I was pretty confident that even though it would arrive before I did that the airline would hold it for me. And, since I had no pressing schedule for that afternoon I raised my hand.

In exchange for waiting in the airport for two more hours I took home a $300 voucher good for any flight on that airline as long as I make the reservation within a year of the issue date.

My wife and I plan to use the voucher to reduce the cost of a future vacation trip.

Picking up a flight voucher is an uncommon event. But, there were about 50 people on that flight and most could not or would not volunteer. I could and did because I was flexible enough to adapt to the revised flight schedule.

Link to Other Topics in the Special Report: Cutting Expenses

Shell MasterCard

We buy gasoline for $0.12 a gallon less than the posted price at every fill-up.

Our local Shell station usually has the lowest price for regular un-leaded gas in our community. Occasionally though, the Sheetz station down the block beats their price. But whether our Shell station is slightly higher or slightly lower than Sheetz we still get the best prices in town buying gas from Shell.

Shell Oil has a partnership with MasterCard that benefits Linda and I with a 5% rebate on all gasoline purchases made at any Shell station. With the current $2.40 per gallon price for regular un-leaded we get a discount of $0.12 per gallon.

The posted price is charged to our card then the rebate is calculated and automatically applied to our statement the following month.

It works. It’s reliable. And, since we use the Shell MasterCard for nothing else; and since we use it for all gas purchases, it’s easy to track our expenses and rebates.

Buying gas using the Shell card is like getting $15 cash in the mail every month.

Link to Other Topics in the Special Report: Cutting Expenses

Choice Privileges

Occasionally, not often, I travel on business and my employer pays my travel expenses including normal hotel charges.

Many people take advantage of business travel to stay in expensive hotels and dine in expensive restaurants. I make these occasions a win-win for me and for my employer by choosing Choice Hotels who’s well known brands include, Sleep Inn, Comfort Inn, and Comfort Suites. These mid-priced accommodations are generally less expensive than rooms selected by my colleagues; reducing the travel expense for my employer.

However, Choice Hotels has a “loyalty rewards” program they call Choice Privileges. I have a Choice Privileges account and every time I stay at a Choice hotel I’m credited with 10 Choice Privileges points for every dollar of invoiced cost (not counting taxes). So, a typical one-night stay at a Comfort Inn at $79 per night will earn me 790 Choice points.

In addition, Choice Hotels frequently runs promotions in which they offer 10,000 to 14,000 bonus points if you stay in three different Choice hotels within a 30 to 90 day pre-defined period. The catch with the promotions is that they must be different hotels, so when I have a two-day event scheduled I have to check out of one hotel and into another (sometimes across the street) in order to qualify for the bonus points.

It’s worth the hassle though. I’ve already taken a couple of free hotel stays by using some of my accumulated Choice Points and I now have enough in my account to cover the five day vacation Linda and I are planning for next month.

A win-win business travel situation for me and my employer allows my wife and I to eliminate the cost of accommodations from our vacation budget.

Link to Other Topics in the Special Report: Cutting Expenses

Unclaimed.org and Missingmoney.com

I really got a check for $192.

Back in 1979 I moved from Round Rock, Texas – just north of Austin – to Kokomo, Indiana – north of Indianapolis. When I hit the road leaving Round Rock and Texas behind, I stopped by the Savings and Loan to close out my small savings account. I don’t remember the exact amount but it was less than $100.

Unfortunately, it was a Saturday and the S&L was closed. So I drove north to Indiana thinking that I would return in a year or two and close the account then. In 1979, there were no personal computers; no on-line banking; and very little banking by mail. Banks largely kept “banker’s hours”.

Three years later I traveled back to Texas. As I drove through Round Rock on my way to San Antonio I stopped at my old Savings and Loan to close the account. With my “passbook” in my hand I walked up to the door and noticed that the name on the building was different.

That worried me slightly but I didn’t think it would make a difference. It did. The new owners didn’t take over the S&L’s business; they just bought the building. For the remainder of my time in Texas I kept my eyes open for another branch of the S&L and I looked for it the phone book. But, the old Saving & Loan was no where to be found.

In my mind, I wrote off the money as a mistake and a lesson.

Thirty years after I moved away from Texas my wife, Linda, heard a discussion on the Clark Howard radio show. The topic was finding lost money through the web sites “Unclaimed.org” and “Missingmoney.com”. I visited both sites and looked for my name in every state I’ve lived in. I found it in Austin, Texas and in Charlottesville, Virginia and I applied for both claims.

I’ve not received a response for the claim in Charlottesville, but two weeks ago I received a check for $192 from the Texas claim. It turned out to be the money I’d left behind at the old Savings and Loan plus thirty years of compounded interest.

Recovering $192 cost me 20 minutes and one first class stamp; one of the claims was made on-line and the other was mailed.

Link to Other Topics in the Special Report: Cutting Expenses

Cutting Expenses – Introduction

You can cut your household expenses without destroying your lifestyle. You can make room in your budget to put money away for retirement; for emergencies.

There are easy things you can do to reduce your expenses and free up cash for saving and investing. The links below will take you to very specific things that my wife, Linda, and I have done or are doing. You may not want to do them yourself – but they work.

Additional links will be added as additional topical posts are added to the blog.

Links to Other Topics in the Special Report: Cutting Expenses
Airline Flight Vouchers
Choice Privileges
Cutting Your Bills Down to Size
Flexible Spending Accounts: Part 1 - Saving Money with Flexible Spending
Flexible Spending Accounts: Part 2 - Calculating a Safe Contribution
For My Next Car I Paid Cash
Going Out on the Cheap
Mortgage Refinance
Paying Less for Books: Part 1 - Patience and Making a List
Paying Less for Books: Part 2 - Money Saving Tactics
Renting Cars for Road Trips - Part 2
Renting Cars for Road Trips - Part 1
Shell MasterCard
Tankless Waterheaters
Timeshare Sales Pitch Weekends
Unclaimed.org and Missing money.com

Inflation Protection – Part 7 – Summary

Inflation is coming. It might be next year or the following year but it’s coming. You “get ready” for inflation by moving money into assets that increase in nominal value as the currency inflates.

Assets that have proven successful in protecting wealth from the ravages of inflation in the past include:

• Gold (and silver) – bullion, coins, jewelry, ETF’s, mutual funds and gold mining stocks; I invest in a precious metals mutual fund.

• Oil (and natural gas and coal) – ETF’s and mutual funds, and the common shares of refinery, exploration, oil service, integrated oil companies, limited partnerships, and royalty trusts; I invest in the common shares of exploration, integrated oil companies, and partnerships. The key for me is consistent and growing dividends.

• TIPS (Treasury Inflation Protected Securities) – bonds, ETF’s, and mutual funds; I invest in a TIPS mutual fund.

• Consumer Staples – ETF’s and common shares; I invest in the common shares of consumer staples companies with consistent and growing dividends.

• Commodities (agricultural products and minerals) – ETF’s mutual funds, and common shares; I invest in the common shares of one mining company.

There are other ways to hedge against inflation. The important thing is to choose a strategy you believe in that that fits your personal risk tolerance.

But remember, inflation is coming – get ready.

Links to the Inflation Protection Special Report
Part 1 - The Need
Part 2 - Gold
Part 3 - Oil
Part 4 -TIPS
Part 5 - Consumer Staples
Part 6 - Commodities
Part 7 - Summary

Inflation Protection – Part 6 – Commodities

Commodities generally trend upward with inflation. They are especially risky, however, because they are very sensitive to supply and demand imbalances.

Precious metals and fossil fuels such as gold and oil are special classes of commodities - I discussed them in previous posts. Some manufactured items, passive integrated circuit chips for example, are sometimes called commodities. But generally a commodity is a direct agricultural product (think wheat, corn, and cattle) or a mineral (think copper, aluminum, and iron).

As with oil, you can invest in commodities through futures contracts, a contract to take delivery of a specific amount of material on a specific date. Futures contracts are for pros. Unless you are a commodities professional or you run a farm or a mine – stay away from them.

A more reasonable way for an individual investor to get involved in commodities is to buy the stocks of agricultural or mining companies. Shares of limited partnerships and trusts for mining and forestry companies are also available on the stock exchanges. And, finally there are ETF’s (exchange traded funds) that specialize in commodities. Commodities provide inflation protection at a higher risk than other strategies.

I own common stock in one mining company, Southern Copper (ticker PCU), and shares in one mining trust, Mesabi (ticker MSB), for my own account. MSB is a steady high yield dividend payer. PCU pays a dividend that varies wildly with fluctuations in the price of copper. And, although copper fell along with everything else recently, I expect it to go back up as demand in China increases.

Still, I consider PCU my riskiest inflation hedge as well as potentially the most rewarding.

Links to the Inflation Protection Special Report
Part 1 - The Need
Part 2 - Gold
Part 3 - Oil
Part 4 -TIPS
Part 5 - Consumer Staples
Part 6 - Commodities
Part 7 - Summary

Inflation Protection – Part 5 – Consumer Staples

The broad stock market has not done well when inflation was higher than 5%. Some companies, however, thrive under high inflation conditions; companies with “pricing power”. These companies raise their prices as their labor and material costs increase. They are, therefore, able to maintain or even increase their margins.

Because consumers are unwilling to delay these purchases, companies that produce consumer staples such as food, toilet paper, shampoo, toothpaste, and pain relievers are generally able to raise their prices with inflation. The stocks of consumer staples companies tend to outperform the market because their profit margins are relatively secure and their earnings and dividends go up along with the general inflationary trend - or even faster.

Many firms are unable to raise prices without triggering a significant fall in demand for their products; the broad stock market, consequently, lags behind the consumer staples companies. Automobiles, home appliances, restaurants, home electronics, and books are examples of products consumers are willing to delay buying when the price goes up. Companies producing these “discretionary” items are squeezed. If they raise prices, volume goes down. If they don’t raise prices margins go down.

Many firms experience the volume-margin squeeze. That’s why most mutual funds, including index funds, generally do poorly in an inflationary environment.

Today some ETF’s (Exchange Traded Funds) specialize in consumer staples companies. I’ve never bought them because I don’t trust their stock picking. If a company makes consumer staples it’s included in the fund regardless of the soundness of the underlying business.

I prefer to buy shares of individual consumer staples companies with a track record of paying and increasing dividends. My favorite consumer staples stocks are Proctor & Gambol (PG), Johnson & Johnson (JNJ), and 3M (MMM). I own shares in all three companies.

The common shares of good quality consumer staples companies can be expected to keep pace with inflation whereas the broad market indexes do poorly when inflation is high.

Links to the Inflation Protection Special Report
Part 1 - The Need
Part 2 - Gold
Part 3 - Oil
Part 4 -TIPS
Part 5 - Consumer Staples
Part 6 - Commodities
Part 7 - Summary

Inflation Protection – Part 4 – TIPS

Lending money to issuers of fixed debt securities when inflation is high is a prescription for certain losses at the prevailing inflation rate. So why would I lend my money to the United States Treasury when I expect inflation to pop sometime in the next several years?

The answer is TIPS, Treasury Inflation-Protected Securities. TIPS are US Treasury Bonds with contracts that call for increases in the bond principle based on the movements on the Consumer Price Index (CPI). The interest rate is fixed but when the principle is adjusted the actual semiannual interest payout moves up and down with the principle.

The face value at the time the bond is issued is an absolute floor on the principle of the TIPS Bond. If inflation has increased the principle since the bond was issued the bond principle can fall if the CPI falls but it can fall no further than the original face value.

I have heard that the Treasury cooled on new issues of TIPS. If true, it is itself a signal that the United States Treasury expects higher inflation and wants to sell conventional bonds for as long as they can get away with it.

TIPS can be purchased directly from the Treasury or in the open market. In addition, they are packaged into specialty TIPS mutual funds and ETF’s.

I chose to buy TIPS through the Vanguard TIPS mutual fund for my traditional IRA account. If you buy TIPS in an IRA the principle appreciation is under the IRA account’s tax protection. However, if you buy TIPS in a taxable account the IRS requires payment of capital gains tax on the inflation induced increase in principle.

TIPS bonds offer low risk inflation protection for your principle and the interest income derived from it.

Links to the Inflation Protection Special Report
Part 1 - The Need
Part 2 - Gold
Part 3 - Oil
Part 4 -TIPS
Part 5 - Consumer Staples
Part 6 - Commodities
Part 7 - Summary

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Inflation Protection – Part 3 – Oil

In 2008 the price of a barrel of oil topped out at $147. So far in 2009 oil bottomed at $34 per barrel and then rose to $71.

Before the financial crisis changed everything, many people talked about the “peak oil” thesis. This is a prediction that world-wide oil production has reached its all time past and future peak. And, since world-wide demand for oil continues to rise the price of oil must go up to balance demand with supply.

We have since discovered that demand and the price of oil can go down – drastically. Nevertheless, the underlying equation remains intact even though short term fluctuations in demand can and do result in price fluctuations.

Several arguments speak in favor of using oil and natural gas as protection against inflation. In the long term the “peak oil” thesis is valid. Global demand is expected to continue increasing especially in China, India, and Brazil.

Even though more oil is discovered everyday it is discovered in increasingly more difficult and expensive to recover places. Because the costs of new oil & gas production are increasing; temporary decreases in demand that cause a fall in the oil price make marginal production projects uneconomic. They are then cancelled or abandoned. This automatic reduction of supply puts a floor under the price of oil.

Oil markets world-wide are priced in US dollars. When the dollar inflates relative to world currencies the price of oil in dollars goes up, even if the price remains stable in other non-inflating currencies.

Some will argue that alternative energy sources will reduce oil demand, but alternative energy sources are not yet commercially viable. They will likely first become commercially viable for generating electricity. It may be many years before they significantly replace oil.

If you choose to use the oil and gas markets to protect yourself from inflation there are several ways to do it. (1) You can buy oil futures contracts, contracts to take delivery of a quantity of oil at a set price sometime in the future. I strongly advise against this approach. (2) You can buy the common stocks of companies in the oil and gas business such as exploration companies, production limited partnerships, refiners, vertically integrated oil companies, and oil service companies. Or (3) you can buy energy sector ETF’s or mutual funds.

I’ve chosen to own shares of exploration companies, production limited partnerships, refiners, and integrated oil companies; all companies that pay significant dividends in addition to giving me the opportunity for share price appreciation as the price of oil rises.

Links to the Inflation Protection Special Report
Part 1 - The Need
Part 2 - Gold
Part 3 - Oil
Part 4 -TIPS
Part 5 - Consumer Staples
Part 6 - Commodities
Part 7 - Summary

Inflation Protection – Part 2 – Gold

During every commercial break on television and radio you hear ads from companies offering to buy your gold jewelry or sell you gold coins. “Experts predict gold will double!” “Gold is the perfect way to diversify your portfolio.” “Now is the time to own gold.” Is it all hype or hope?

If there is an extended inflation, the price of commodities will inevitably rise. Gold and silver have thousands of years of history as a reliable store of value. When people are worried they feel better holding gold.

There are many ways to participate in the markets for gold and silver. You can buy and take physical possession of gold jewelry, gold coins, or gold bars (bullion). You can buy gold ETF’s (Exchange Traded Funds) that give you part ownership of a store of gold bullion in a bank vault somewhere. You can buy the common stock shares of gold mining companies. Or, you can buy shares in mutual funds or ETF’s that specialize in gold, silver, and platinum mining company shares.

Which method you choose to connect to the gold market depends on your comfort level with stocks and mutual funds and on just how bad you think things might get.

Personally, I don’t think the economy will collapse leaving the survivors reduced to subsistence farming and barter. I am convinced, however, that inflation is coming sometime in the next three years. As a result of my conviction I’ve invested a portion of my retirement fund in a precious metals mutual fund.

I find physical gold too awkward to buy and sell or to use as money. I thought about buying gold ETF’s but in the end I settled on a mutual fund that invests in gold and silver mining companies.

I’m content with my choice. It pays dividends and annual capital gains distributions and it is leveraged to the price of gold. The underlying mining company stocks go up faster than the price of gold goes up; they will also go down faster if the gold market turns down.

My way is not the only way nor is there a “best” way to own gold. This is a case where you must indeed “work out your own salvation with fear and trembling.”

Links to the Inflation Protection Special Report
Part 1 - The Need
Part 2 - Gold
Part 3 - Oil
Part 4 -TIPS
Part 5 - Consumer Staples
Part 6 - Commodities
Part 7 - Summary

Inflation Protection – Part 1 – The Need

Inflation is coming. It might be next year or the following year but it is coming. The Federal Reserve is creating money out of thin air to the tune of billions of dollars each day. The money the Fed creates will eventually reach the general economy and cause prices to rise.

Government spending has risen dramatically while revenues have fallen 34% year over year. The Obama administration predicts a recovery starting in early 2010. However, they also set the “worst case” scenario for the bank “stress test” at 8.9% unemployment in a recovery starting in late 2009. The Federal Reserve is now forecasting 9.4% unemployment by the end of 2009 and continuing to rise to around 10.5% before declining.

The administration promises to reduce spending in 2010 and to raise taxes everywhere on everything.

They want to create a carbon use tax also known as “cap and trade” that will increase the cost of doing everything that uses energy – virtually every human activity. Some estimates peg the carbon tax cost at an average of $3,000 per family. Make no mistake families will pay this cost through increased prices of goods and services.

They want to create a “value added tax” (VAT) on all economic activity. VAT taxes are commonly used in Europe. They are sort of like sales taxes that are applied at every level of production and consumption – unlike American sales taxes that are applied only at the retail level. A 10% VAT would increase the cost of everything a family purchases by about 10%. So a family that spends $30,000 a year would experience about $3,000 in increased prices of goods and services as a direct result of the VAT. It would also increase the administrative costs of running a business by requiring all companies to collect these taxes.

The recently announced increased CAFÉ standards for automobiles are estimated to add $1,300 to the price of an average new car.

Plus, the administration says it will allow the Bush tax cuts expire in 2011. That will effectively increase income taxes on the average family by about $1,500 per year.

Why am I talking about tax increases in a piece on inflation? Because increasing taxes will, I say again, will slow economic growth; perhaps enough to delay the recovery for years. A delayed recovery means that new taxes will fail to produce the predicted revenue. This will result in continuing deficits that must be financed through borrowing and the creation of ever more money.

Inflation is coming – get ready.

So, how does one “get ready” for inflation? By moving money into assets that will increase in nominal value as the currency inflates - more to come.

Links to the Inflation Protection Special Report
Part 1 - The Need
Part 2 - Gold
Part 3 - Oil
Part 4 -TIPS
Part 5 - Consumer Staples
Part 6 - Commodities
Part 7 - Summary

Tankless Waterheaters

In 2005 Linda and I built our house. We hired a General Contractor and presented him with a floor plan and specifications we had painfully developed, tweaked, and negotiated over the previous two years. In 2003, during the planning phase we renewed our acquaintance with Roger, a man in North Carolina who had recently completed construction of his new home.

Roger took us on a tour of his home pointing out the many features of which he was justly proud. The feature that made the biggest impression on me was his Rinnai tankless waterheater.

Back in 1980, I read about and tried unsuccessfully to find these devices for heating water on demand instead of keeping a reservoir of water hot all the time. I was excited to see one in use in a real home. I quizzed Roger and he gave me the name of his plumber and the plumbing supply shop where the Rinnai was purchased.

When it came time to spec out our new house the Rinnai tankless waterheater was on the list. The installed cost of our Rinnai was about double the cost of a good quality standard water heater but there are two huge benefits.

You never run out of hot water. If two people are running the hot water at the same time you still have the problem of one demand stealing hot water from the other. But the tank doesn’t run out of hot water and there is no waiting time to allow the tank to heat up to temperature.
The propane only burns when hot water is actually being used. I estimate we saved enough propane over the past three years to more than pay the difference between the Rinnai and the cheaper standard water heater.

By the way, the wait to get hot water actually delivered to the faucet after it is turned on is the same as the wait for hot water to arrive at the faucet from a standard tank.

We love the Rinnai and we are very pleased with our decision.

Links to Cutting Expenses Special Report
Cutting Expenses - Introduction

Mortgage Refinance

With interest rates down across the board recently Linda and I have been looking for an opportunity to reduce our monthly payment by refinancing our 6.25% 30 year fixed mortgage.

In recent years many people refinanced mortgages to cash out some or all of their home equity. They effectively started over on their mortgages with the same or higher monthly payments. I was surprised by the number of loan officers who expected me to take equity out of our home. Our objective, however, was a lower monthly payment in case our income becomes jeopardized by the on-going recession.

4.875% to 5.125% interest rates on 30 year fixed mortgages have been available for months - but the quoted closing costs from the various lending institutions were in the $5,000 to $7,000 range. We were unwilling to pay that much.

One day a colleague mentioned that he had just closed on refinancing his home with a 15 year fixed mortgage at 4.5% and $2,000 in closing costs. I jumped on that and called his loan officer at BB&T Bank to see what he could do for Linda and me.

The BB&T loan officer was working 14 hour days seven days a week refinancing mortgages. There was a reason for that.

BB&T was able to put together a 30 year fixed refinance for us with a 5.0% interest rate, zero points, and closing costs of $4,500. $2,500 of the closing costs were effectively rebated by the return of escrow from our previous mortgage company and the fact that no mortgage payment was due in the month of closing (May) or the following month (June). More than half of the $4,500 closing costs consisted of interest paid to the previous mortgage company for the month of April, the prepaid interest to BB&T for May, plus setting up the new escrow account at BB&T. so the rebates were near one-to-one replacements of these charges. This left us with a net closing cost of about $2,000.

We rolled the $2,000 net closing cost into the new .mortgage. Even so, our total monthly payment was reduced by $133 per month; this despite a coincidental increase in our homeowners insurance and the required escrow.

Instead of allowing the extra $133 to trickle away we will continue making payments of the old payment amount and apply the difference to paying off the mortgage early.

Links to Cutting Expenses Special Report
Cutting Expenses - Introduction