Stock Analysis Example

I was reading a few articles today, and found this one (specifically since it is about Corning Inc. (GLW) which is a holding of mine), but i thought the investment process and things to consider while investing was a good example for those who may be new to investing.  Keep this in mind when things get better…

http://www.forbes.com/2008/11/20/corning-uniphase-bookham-pf-ii-in_pm_1120soapbox_inl.html?partner=yahootix

When?

Not that anyone needs me to tell them what to do, many times people are curious as to what to do with investing, and they ask my opinion.

My opinion after thinking hard over the past few weeks is that depending on your time horizon and risk appetite, (please read that again) I think that now could be a great time to invest in the stock market.  And personally for me over the next couple of weeks, ill be looking for a chance to buy more stocks.  I haven’t yet decided on what form that will take, if ill buy a us mutual fund or an international mutual fund, or buy individual stocks that I have been following.  But, the point is for my time horizon (several years) and risk appetite (4 on a scale of 5, 5 being most risky), there are plenty of companies that are worth owning and who are valuable, especially when you can buy them for so cheap now.  The panic has created an opportunity.

Now here are the risks, so consider yourself properly warned.  We are not in a normal time right now, and we may not have a normal recession ahead of us.   There are a lot of uncertainties about unemployment, house prices, the consequences of the debt held by countries and individuals. How bad will it get, and will we use this opportunity to be smarter.  The market still has the potential to go down, and we still have the potential to experience lots and lots of volatility.  Also, you’ll notice that i am not pointing to any facts or stock valuation evidence.  My conclusion is not a rational fact based opinion, I am instead looking at the emotions and mood of investors and the public and the potential for future.

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Present Value

I have a basic financial concept to share today.  The concept is Present Value (PV) and its brother, Future Value (FV).  I think everyone has a basic inkling of this concept, they just may not apply it to their decisions in a conscious way.

The best way to illustrate the concept is thinking of a friend that wants to borrow money.  Lets say your friend wants to borrow 100 dollars (assume no risk).  What if your friend says that he will pay you back next week, what if he says that he will pay you back in 2 years?

At this point there is another concept that is important to discuss, opportunity cost (the benefit that you give up by making a choice).  In this case, you give up the use of this 100 dollars for 2 years, you are giving up the opportunity to use the 100 dollars now.  If you are saving up for something, you will now have to put that on hold.  If the delay is only one week, its not as of big deal, as if it was 2 years.

Getting back to our topic, would you rather have 100 dollars today, or in 2 years?  If you said today, then you have illustrated present value.  The value today is greater than the same amount in the future.  Now what about 100 dollars today or 150 dollars in 2 years?  Now are you be willing to wait for 2 years?  What this proves is that timing of cash receipts affects the value today.  If you invest 100 dollars today, your hope is that next year you will have more, so if you invest at 10%, you would say that the future value of my 100 dollars is 110 dollars.  The present value of 110 dollars in the future (at 10%) is 100 dollars.  Here is the math behind that.  100 (PV) * (1 + 10%) = 110 (FV).

The implications of future value is not limited to your lending / investing, but also taxes and how you spend your money (because of the opportunity cost).  Because of the investment growth and time, the future value of money today is quite great.  Going back to our math, lets say that you invest 1,000 dollars today, and you are 30 years old.  When you are 65, assuming a return of 0% (spending today), 5%, 8% and 10%, here are the results.

1000 * (1.00)^35(years) = 1,000 dollars (or an old computer, really old).

1000 * (1.05)^35(years) = 5,516 dollars

1000 * (1.08)^35(years) = 14,785 dollars

1000 * (1.10)^35(years) = 28,102 dollars

Which would you rather have? This is a stupid question, but really, what would you give up to get it?  It’s why investment fees are so important to consider, and making sure that money you spend today is worth it to you.

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Inflation Article

There are a lot in interesting articles out there with current finance topics, but here is one that I found.  See what you think, and how it makes you think about your investing for the next couple of years.

http://biz.yahoo.com/bizwk/080818/aug2008db20080815021990.html

Institutional Mutual Funds

In response to a comment today I would like to give a quick summary of Institutional Mutual funds and how they differ from “investor”, “retail” or “open” mutual funds.   What we will see is that the differences are quite small.  But, the differences instead highlight that the two types of funds are intended for different investors instead of a real difference in a fund.

For those who have not heard of institutional funds, lets take the following example, two investors.  One investor (investor A) is very wealthy and has 1,000,000 dollars to invest.  The second investor (investor B) is solidly in the middle class, and would like to invest 2,000 dollars.  As we have talked about before, mutual funds have an annual expense amount (fees that are paid to management company).  If both investors paid a 1% fee, Investor A would pay 10,000 dollars, while investor B would pay 20 dollars.  From a purely practical perspective, the management company has about the same overhead and administrative cost for both the investors, so investor A is paying a lot for the same service that investor B is paying 20 dollars.  So, instead, investor A would rather pay less, and probably shop around to find a better deal.  Now switching sides, a fund management company would rather have one person invest one million than 50,000 people invest 2,000.  So you give the big investor a little bit of a break (they are  still paying a lot if you charge them 0.8% instead of 1%), and you also encourage other big investors to invest with you.

These are the two main differences.  Institutional funds have higher minimum investment amounts (over 10,000 or 100,000), and slightly lower fees, while retail accounts have lower minimum investments (2,000 or less) and slightly higher fees.  The funds are invested in the same stock/ bonds, so there is no difference.

That said, many of you may have institutional funds and don’t even know it.  Many employer 401k plans utilize institutional funds (Each month they combine all the employees amounts and invest one large lump sum into the institutional fund). So be thankful that you are saving money on your fund fees.

Financial Links

There are many financial calculators out there in my opinion you have to know about the underlying assumptions for them to be of any use.  So, I have an idea, I am going to give you a link to the Harris Financial Group site that has more options of financial calculators than you probably have time. My wish would be that you would go to the site, use a few of the calculators, and then let me know the questions you have (eg. what pre-tax return do I expect on my IRA investments? or what is inflation?) As an added bonus, there is even a Financial IQ test. See below for the link.

http://www.harrisfinancialgroupinc.com/index.cfm?type=C&source=calc_hdr.cfm

Also, as long as I am submitting links. I found this interesting page (see below) on the Key Bank website, that has a lot of information on buying a house, the process and different types of mortgage products.  Hope that you enjoy.

https://www.key.com/html/MOL-10.html

Thanks for reading this moneyclamps post!

Market Timing

I realize that everyone may not be in a mood to talk about stocks these days (they are down from the beginning of the year), and if you are like me, you try not to look at your investments but then decide to take a peek and realize that its not looking good.

But, what I have been thinking about is the importance keeping a rational perspective in this environment (where the market may not act rationally all the time).  I’ll suggest what that means to me right now, as I walk through what I personally have been thinking as I talk to others who either want to invest or want to know when to invest.

If you are trying to time the market highs and lows- historically speaking (the last two years) we are at a low point.  It may not be the lowest point we get, just keep that in mind as you think about investing – there is always some risk.

If you are not trying to time the market highs and lows (and unless you are an economic expert – or can tell the future) this is probably your best option.  The key term here is dollar cost averaging.  Dollar cost averaging is a term used to describe the technique of investing on a regular basis (every month for instance).  The advantage of dollar cost averaging and investing on a regular basis is that your purchase price is “smoothed out”.  Under this situation, you don’t have to worry if the market is going down or up, all you have to do is remind yourself that you are investing for the long term and keep investing.  This strategy takes emotion out of trading ETFs or mutual funds that you think are good for the long term BUT may experience some short-term price changes (also known as volatility).  And history (80+ years or so) is on your side as mutual funds/ ETFs that track indexes over that time have been great (on the whole).

So, is now a great time to take advantage of the low prices (keeping in mind that you have a long term perspective).  Or, maybe its a good time to think about starting a regular investment program.

Mutual Funds

Today’s post may be boring for some, but i know that i have explained these investments more than once to people, so here goes.

All mutual funds are not all the same thing. You can have risky mutual funds, and you can have safe (little risk) mutual funds. In fact they can be a lot of things. Also, you can have mutual funds in your IRA, outside your IRA, or in your 401K. A mutual fund is a kind of basket of something, and you invest in that basket. By holding a mutual fund, you are loaning your money to the mutual fund company, and they take your money and invest it in stocks, bonds, commodities, etc.

If the fund for example owns shares of Yahoo, and you hold shares of that fund, you share in the returns that Yahoo gives to fund, but you don’t actually own any Yahoo shares. There are two primary advantages of mutual funds, 1. professional management – someone who you choose selects all the investments and 2. diversification – instead of buying a few shares of one company, you can buy a few shares of a mutual fund, and they pool money together and buy lots of companies.

And for these advantages, you pay a fee (the “Service Fee”)to the mutual fund company (in the range of 0.5% to 1.5% normally).

There are a lot to talk about still, but just two more differentiation points.

Load Funds vs No Load Funds.

No Load funds are cheaper – the fund company only charges the Service Fee. Load Funds, charge a service fee, but also a “Sales Charge” The sales charge is an extra charge that the broker charges you for access to the mutual fund. Moneyclamps prefers No Load Funds.

Equity vs Bond funds

These are two main categories, but there are others. Equities are stocks: IBM, Yahoo, Nike, etc. that you hear about. Bonds are fixed income investments, Corporate debt, and are generally safer than stocks. Moneyclamps does not pick sides between Equity or Bond funds, as each is good for it own objectives. Also, you can have mutual funds that are mixed, some stocks and some bonds. Choosing those depends a lot on what you are tying to accomplish. But for now, just know that there are two big groups to choose between.