… but, you can catch AJC on this blog tomorrow and on ajcfeed.com LIVE next week on Thursday @ 8pm CST (9pm EST / 6pm CST) !

Last month I wrote a post ‘busting’ the myth of diversification (and, did a little follow-up segment about it on my ‘live show’ @ AJC Feed).

As expected, I got some ‘for’ and ‘against’ comments … including this comment from Ramit Seth who writes the great personal finance blog I Will Teach You To Be Rich:

Well ….

… Ramit’s very blog is called I Will Teach You To Be Rich … no if’s and but’s about that. So, unless my definition of ‘rich’ is way off …

[AJC: basically, it’s to be able to live the Life of Your Dreams when you Need to live it, and without working … for most people, I’m guessing that’s going to take more than 120% of their current salary and sooner than 65 … if that’s not you, then sign off now]

But, nobody said that you have to “try and beat the market” instead of diversifying 😉 It’s not binary …

What I am saying is this:

a) if you ARE satisfied with ordinary outcomes then don’t stuff around with fancy investments, picking stocks, picking funds, etc. Do the sane thing: go for the ‘guaranteed’ 30 year return of 8% (or, take a ‘gamble’ that you will indeed match the average 30 year return of 11%, if you prefer) via a broad-based, low-cost Index Fund

b) If you ARE NOT satisfied with ordinary outcomes then what choice do you have? Find SOMETHING that you CAN make money out of and DO IT … it could be stocks; business ventures; blogging; real-estate; trading; options; flipping; MLM; working 5 jobs; whatever rubs the skin off your knuckles … [Ramit and I share at least a couple of these ‘interests’ – not together … yet!] …

But, you are going to HAVE to do it (and get BLOODY good and LUCKY at it) … or, go back and read (a)

Remember: the objective isn’t to make money in stocks (or RE, or whatever) … it’s to make money …

… to support Your Lfe’s Dream – whatever that may be; however much it may require!

Can I get any clearer?

The best way to give up your ‘day job’ is to watch my Live Show this Thursday @ 8pm CST (9pm EST / 6pm PST) at http://ajcfeed.com ….

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Yesterday I mentioned an interesting article from the Tycoon Report, that talked a little about ETF’s. The same article gave a great summary about using options as a hedging tool …

… but, watch for the subtle difference in using two different types of options to do essentially the same thing … one relatively benign, the other can put your whole financial house at risk!

Here’s what the article had to say:

What strategies to incorporate now in the market to increase your return and decrease your risk? The market and the economy have been ugly lately.  [Just two of these] best strategies for this type of market are:

1.  Selling Call Options –An investor who sells calls believes that the price of the underlying stock (or ETF) is going to remain stable or decline.
 
    Remember when selling calls that:

•  Your maximum gain is the premium received

•  Your maximum loss is potentially unlimited

•  Your break-even is the strike price plus the premium received

2.  Buying Put Options –An investor who believes that the price of a stock is going to fall would buy a put option on that stock (or ETF), etc.

    Remember when buying puts that:

•  Your maximum gain is the strike price minus the premium paid.

•  Your maximum loss is the premium paid.

•  Your break-even is the strike price minus the premium paid.

Now, I’m not really an options trader – so don’t ask me for any ‘power strategies’ on this – read the Tycoon Report instead … it’s free!

But, I do know that selling naked calls is a dumb move … you can be liable to cover the entire stock purchase if you are ‘called’ and your downside can be theoretically infinite! Tycoon Report says:

If the call writer (seller) is uncovered (naked), and does not own the underlying stock, the potential loss is theoretically unlimited, since there is no ceiling on how high the price of the stock may rise. 

Why ever do it … particuarly when Buying a Put essentially produces the same result for absolutely minimum risk?!

For those who aren’t familiar with them, don’t just dismiss Options out of hand, the power of options is that they allow you to control a whole share/stock (well, usually you have to buy them in ‘lots’ of 100) with only a small ‘down payment’ known as a premium. Depending upon the option, you can gain the entire upside of the transaction …

… let’s say you buy a call on a stock that moves from $10 to $15 …. VERY OVERSIMPLIFIED: you might get the entire $5 increase just by putting up the, say, $0.50 per share ‘premium’ … 10:1 on your money. Not bad!

The problem is that the same works in reverse: if you sell a call on a stock that moves the wrong way (in this case you are ‘betting’ that it will go down … but the price skyrockets, say, from $10 to $50, you are in a whole world of hurt, because YOU have to come up with that $40 per share and give it to the guy who bought the Call Option from you!

Here are the FOUR BASIC OPTIONS for investing in options [pardon the pun]:

Here are times when I think it is safe to use Options:

1. When you have bought the actual stock (say, 1,000 shares of Apple, Inc. – Stock Symbol: AAPL), but are worried that they might drop, even though your are fairly certain that they are about to skyrocket (still sounds like speculating to me). Then you might buy 10 lots of Put Options, which (for a small premium that you essentially ‘lose’) will protect you against a price drop: you get to sell them to the sucker who sold the Put for the agreed price (usually, what you paid for the shares BEFORE they tanked … nice!).

In practice, I only buy stocks that I think are undervalued, will go up over time (I don’t really care when), hence am quite happy to hold on to – if I get caught in a down market, I will likely hold if I happen to get caught out. More likely, I will have already traded out of it using technicals (i.e. black magic and witchcraft … it’s little more than that), and use a Trailing Stop Loss to help protect me if the stock should fall.

I happen to prefer carrying the risk of a sudden and catastrophic crash rather than paying the small’ish premium for the Put. But, could equally recommend buying the Put. Personal choice, I guess.

2. When I own a stock that I think will trend up over time … isn’t that all of them 😉 … but, not dramatically so, then I may Sell a Covered Call (means that I also own the underlying stock), which is almost like ‘renting’ the stock out to somebody else for a few days/weeks and getting a small premium. Surprisingly, unlike selling the deceptively similar so-called ‘naked’ call (where I don’t actually own the underlying stock) this is a super-low-risk strategy … low, in that you don’t see yourself losing money.

In actual fact, you can lose money when the share goes up higher than the sell price that you set on the call and you have to hand them over to the buyer, while watching the price shoot up even further – to his benefit, not yours! So, it works best with a stock mildly rising in price (of course, the market is not always stupid and reflects volatility in the price of the option).

3. When you are retired and want to shift most of your money into nice, safe, boring inflation-protected Bonds (TIPS from within a tax-shelter; certain MUNI’s outside), but still want a little ‘gamble’ on the stock market. Then, why don’t you allocate, say, 5% of your portfolio and Buy some calls over a whole of market ETF (I know, I know … just yesterday I said that ETF’s were yada yada yada … this is a Making Money 301 wealth-preservation strategy; that’s a whole different enchilada to what we were talking about yesterday!)

… but, before you even think about 3. (a) buy a copy of Zvi Bodie’s excellent book for retirees: Worry Free Investment and (b) see a financial adviser (this is your whole future, we’re talking about).

Now, this wasn’t meant to be a primer on Options, so forgive me if I cut a few corners … I just wanted to let you know where I would consider them …

For today’s entry in my Videos on Sundays series I thought that I would take a recent video from the archives ….

It was cut from my last ‘live feed’ taken from my hotel room in Sedona, Arizona … one of the most beautiful places on this planet: Sedona itself, not my hotel room! 🙂

If yuo want to see more, check out the archive of videos from my AJC [live] Feed Thursday night chat shows, the AJC Vault. Here is the key to unlock the vault …

Do you have an Emergency Fund?

To me, an ’emergency’ is usually something like a problem with the house or car, losing/changing jobs, or a health problem. These are all real and can all take significant chunks of cash …

… but, if you can reasonably forecast their likelihood up front (i.e. you have a family member with a known or suspected ‘condition’; a crappy house/car/job; etc.), then they’re not ’emergencies’ – in my book, they are ‘time bombs’ – and you should be budgeting/saving a specific amount to cover the expected cost + a margin of safety, as best you can.

They are not ’emergencies’ for the sake of this post …

… they are the unfortunate realities of your life and you need to prepare for them properly – even if it has to come at the short-term ‘expense’ of your Investment Strategy.

No, what I am talking about is the ‘lucky majority’ who have good jobs, homes, cars, health – besides partying VERY hard to celebrate our good fortune – how much of an Emergency Fund should we have?

1 month? 3 months? 6 months? More?

OK, let’s bust the myth of keeping 3 to 6 months cash sitting in an Emergency Fund!

Never had one, don’t want one … and, if I was to keep one, it would have 2 years of income sitting in it (in a mixture of redeemable bonds, cash in various currencies, and gold coins/bullion) so that I could run and survive “when the [insert disaster of choice: Russians/Arabs/WWIII] come”.

So, does that mean that I don’t have cash?! Hell no … it’s just that it’s not for emergencies … it’s for investing. And, as I said, when I was still building my wealth, I never kept an emergency fund.

We did keep cash surplus for unexpected bills, etc. but never more than a month or two of income … at least, not for long … here’s why:

What happens if no emergencies crop up in the next 5 years?

If you had $10,000 sitting in an Emergency Fund (e.g. CD’s) you would have earned nearly $1,700.

If you had $10,000 sitting in an Index Fund you would have earned nearly $3,500.

What happens if no emergencies crop up in the next 10 years?

If you had $10,000 sitting in an Emergency Fund (e.g. CD’s) you would have earned nearly $4,200.

If you had $10,000 sitting in an Index Fund you would have earned nearly $10,000.

What happens if no emergencies crop up in the next 20 years?

If you had $10,000 sitting in an Emergency Fund (e.g. CD’s) you would have earned nearly $11,000.

If you had $10,000 sitting in an Index Fund you would have earned nearly $33,000.

Get the picture …. that’s a $22,000 ‘premium’ to cover a possible emergency!

It gets better ….

What if you had committed that $10,000 to a deposit on a $100,000 house? Over 20 years, it would have increased your Net Worth nearly $200,000 !

So, are you willing to pay a $200,000 premium for an insurance ‘insurance policy’ against an emergency?

But, what would I do if an emergency arises:

1. If it’s a ‘planned’ emergency of the kind that I mentioned before, I would borrow against the house, or sell down my stocks ahead of time and put the money aside well ahead of expected use.

2. If it’s an ‘unplanned emergency’ then I would already have taken a HELOC against my home – and, in the event of such an emergency, I would simply draw against it, and put in place a plan to pay it back.

Sure it will cost interest, but that’s the gamble that I took – even if it takes me 5 years to pay it back, the interest bill will pale against the increases that I made by investing those funds (and will continue to make, when I get the debt paid off and my feet back on the ground).

Warning Advanced Strategy: What do I do?

Well, I always pay cash for my houses, but then I take out as big of a HELOC as my wife and bank will allow me (usually more than 50% of the equity that I hold).

Then I draw down the full value of that HELOC and invest in individual stocks (an Index Fund is a fine alternative for the purposes of what we are discussing) … if I happen to need the money for an emergency, I sell off all or part of my investment and divert the HELOC borrowings to that use. So far, I haven’t had to. 

Loss on the stock? That’s market timing, which is why this is an ’emergency strategy’ only …

… the key is not to take a certain hit on your finances for the possible loss in an emergency. Equally, it means not sticking your head in the sand, and having a contingency plan in place i.e. a way to deal with emergencies if they do crop up.

I wrote a little ‘Saturday Post’ that I thought wouldn’t get a lot of attention … after all Saturdays and Sundays are the ‘crash days’ for bloggers … at least they seem to be for me.

You see, those are the days that the WordPress.com Stats Graph takes a nosedive and I begin to wonder where all the readers have gone …

… then on Monday, there you are again (for some reason Wednesday and Thursday are the peak days), usually in even greater numbers than before.

Anyhow, the post was just about some of the mistakes that I had made … with the biggest mistake, by far, being not starting early enough in both my business-building and investing careers.

By coincidence, and I didn’t mention it at the time, I suffered a huge paper loss with one of my investments just as I was writing that post … enough to send most people into a foetal position, never to recover!

Even in the face of that loss, I didn’t see the need to alter a single word in that post: I still maintain that ‘time loss’ (i.e. not starting early enough) cost me far, far more … but, because I did start eventually, this loss whilst huge is nowhere near catastrophic to my personal financial situation … a mere blip on the chart … sick, I know. But, true 🙂

Anyhow, Alex weighed in on that post with one of the longest, most honest, and most interesting comments that I have ever received on my blog … so, Alex (with your unwritten ‘permission’) I decided to elevate your comments, unedited and unabridged, to the lofty status of Guest Post:

I enjoyed this post very much. I’m young, and yet through your blog and other sites, I come to realize what I’m making a lot of mistakes too. I should have been a lot richer than I am today, had I not been too greedy and gullible.

My mistakes were:
1. I never had a set goals that I wanted to achieve. I went to college, straight-A for 2.5 years, because my parents paid a fortune for me to go study. Had I known what to focus on during that time, I WOULD be already rich.

I programmed a classified ads website for my college literally overnight. It was a lot of fun and caught on buzz at the school. My friends and the administrative staff (including the deans) loved it. The bookstore hated it for I let students trade textbooks by passing them. But I failed to make a single dime out of the site. I didn’t have a goal to start with. Another project for the sake of working on something exciting at first. Then after the excitement dies down, the reality kicks in. I let the site faded to nothing. Who benefited the most from my service was this one couple working at the college. He was able to sell his microwave for $35 (he thought it would be junk) and kept mentioning it when he met me.

I was there when FaceBook first started. Friends asked me that did I program Facebook too? I was there when Rube on Rails began to take off. I was there when Ajax was the kid on the block. I was there right before the spectacular financial run-ups before the credit crisis. I was there a lot of the times, and yet all I did was to be a casual observer.

My mistake was that I was not aware of the world around me at a level where I could get richer. And I didn’t have enough knowledge to understand and see what course of action I would do next.

2. I was greedy and gullible.
3rd and 4th year in college, I got hooked to trading Forex. I “invested” in prediction service. I bought the service for $2,000, on my credit card (if you search around, probably my name would show up, asking about forex…). I was a dirt poor international student, making ~ $7/hr! All I could think of was to bite the bullet, buy this service, make $20,000 from Forexso I had enough money to propose to my girlfriend at the time.

Things turned sour. I lost money in forex. The service gave out garbage signals at … 3am. My creditcard debt was like $3,000 just from this stupid service. I called them up to cancel andbecause I already signed the contract, they refused to refund me the $1,000 I haven’t paid (those guys splitted up the payments so I can fit on my cards!). I was too nice to give them a finger and get my money back. Afterwards, I experienced life of a debtor: ashamed, got called by collection agency at least 30, 40 times a day. My credit score, until now, is still at the “poor” level because of those late payments to the CC companies 3 years ago.

I remembered 2, 3 months after the whole thing about Forex died down for me, I opened up one of my paper-trading accounts. I had a 3000-pip run up (paper-profit!) for a trade I forgot to close.

The moral of this mistakes: don’t gamble on other’s people money. I was borrowing against my future incomes and placed bets on things that were too good to be true. This was bad greed.

3. I never have a mentor or know anybody that can told me: this is how you can think and focus your actions so that what you do will bring more wealth to you.

After college, I read “Think and grow rich”. The book didn’t crack my head too much at the time. I was still with the “casual observer” mindset. Fresh off college, I worked 60, 70 hours a week, making HALF of what I’m making now, hoping one day I would see the day light. Literally, my job was on 2nd shift. I worked from 4pm to 12pm, got home, worked another hour or two, then went to bed, woke up, worked from 9am to 3pm, got ready, then off to work again. It was like that for 8 months straight. I paid up all my CC debts and other responsibilities. If people tell me they are seriously in debts, have no way of re-paying what they owe, well, they will have to try to work harder and more hours. There’s no way around it. That’s why debt is slavery.

Then I started to really think where I want to be in life. Sort of a mid-life crisis for a 22 year old guy. I had the chances to talk to *quite a few* millionaires (AJC, that includes you also ). I kept thinking: what makes them so different from me, how could they get so far ahead financially while I was stuck here, barely making enough money to pay my dues. I begin to walk down the path of entrepreneurship. For the lack of money, I have a mindful of ideas, and now, a determination to work my way up. Now it is really to “think and grow rich.”

It took me 2 years to come to realize my first financial goal: a number to reach when I’m 30. I will keep working 12, 13, 14 hours a day until I reach my goal. I will keep thinking, learning, asking questions, finding answers. I will continue making more mistakes, but each time, I’ll be a bit wiser and more determined to go forward.

Learning from my mistakes, here are how I keep myself from repeating the same mistakes:

– Never get into credit card debt. Ever.
– Surroundmyself with people of the same thinkings. I have to be in the right environment to grow and learn faster.
– Talk to people who has actually done it, e.g. getting rich so I can learn from them. Surprisingly, once I had told myself to do this, I started to know a lot more millionaires!
– Fake the mindset of successful people until I make it. Having the determination to achieve the dream.
– Work harder and smarter. If I work 8 hrs/day to make other people richer, I will have to work more than that for myself in order to go charging forward.
– I need to have enough money in case I see an opportunity, plus I have to prepare a cushion of cash as a safety net to fall back to, if I happen to fall down in this entrepreneur path. I will certainly get right back up again, but having a cushion will be much better and give me a warm feeling inside.

I wanted to write more, but it’s time to work on my project

AJC, thanks for sharing with us your experience!

No, Alex, thank you for sharing with us your experience!! 

20/20 Hindsight is a wonderful thing … but, the important thing is that you learned from your ‘mistakes’ (I prefer to call them your ‘first swing at the ball’) and quickly moved on.

Alex, is an immigrant to the USA, he is here without family, without a support network, yet he is incredibly gifted in what he does and has a mind chock-full of ideas … Alex is definitely a guy ‘on the way up’.

Anybody else feel like sharing? Please feel free to comment as long/short as you like …