Making Money 201? Whoohoo … time to have some fun!

I’ve just loaded 14 new videos into the Vault (click on this link, or check the VodPod Widget on the right hand side of this page for the latest) …

Now for today’s post: Part 2 of a 3 part series on weathering the current financial storm …

OK, so we’re all panicking … at least that’s what the media seems to be telling us as 180 year old investing firms crumble, banks crash and the financial markets are in turmoil, even after a $700 Billion ‘rescue package’.

Time to run for the hills?

Well, if meeting average market returns over a long period is enough to satisfy your needs, read yesterday’s post … click the close button on this page NOW (and, also on every personal finance page / news source hot tip / etc. /etc.) … and, live happy my friend: by the time that you retire, the events of today (and, the two or three more ‘meltdowns’ that you will no doubt live through) will be distant memory and you can only hurt your financial prospects by paying any attention to current events … and, I mean any given set of ‘current events’ between now and the day that you sign-off for ever.

But, that’s not you, is it?

You want – nay, need – extraordinary returns, extraordinarily soon … right?!

In that case, maybe it’s time to listen to our good friend Warren Buffett – The World’s Greatest Investor:

“Occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics is equally unpredictable, both as to duration and degree. Therefore we never try to anticipate the arrival or departure of either. We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”

- Warren Buffett, 2001.

So, does this seem like a time to be fearful to you … or a time to be greedy?

According to Warren, it’s a time to be … greedy: how?

Well, in the current market, everybody knows that cash is king … so, let’s go and make lots more of it!

Before we take off, let’s do a quick ‘pre-flight’ check; do you have your financial house in order?

Let’s see: your 401k has taken a hit, your house has devalued …

… but, you have little credit card or consumer debt, and you are socking away money regularly. So, CHECK.

Great!

Welcome to Making Money 201, which is all about increasing your income through some combination of hard work and risk-taking – the combination that you choose is entirely up to you (and, how ‘steep’ your Number/Date ‘mountain’ will be to climb).

Why do we need more income (besides the obvious!)?

Because, everything financial is on sale right now: stocks, real-estate, loans … the whole box ‘n dice … so, we want to be ‘cashed up’ to take advantage of all the bargains coming our way.

The only problem is ‘market timing’ … take a look at this chart from the Wall Street Journal:

It shows the stock market from 1900 to today, every year across the bottom … but, the right hand side shows a logarithmic (i.e. exponential) scale.

This means that the next move in the market, over a (say) 20 year bull market, will take the Dow Jones from 1,000 to 10,000 … sounds HUGE (and, it is: 10 times your money in 20 years!) … but is ‘only’ an annual compound growth rate of 12%.

The problem, though, is in the RED areas of the chart:

These show the Super Bear Markets – which can be described as FLAT periods in the market that can last 10 to 20 years (if history is any guide) interspersed with volatile short-term up/down movements.

So, I see two possible strategies:

1. Build up CASH

… to be positioned to take advantage of the Next Great Bull Run. Or, maybe we invest in property – I’m sure that we could produce a similar chart.

Here’s what to do: tighten your belt … resign yourself to very limited increase in lifestyle for now … and, take all of your excess income from your full-time business, part-time business, 2nd job, lottery winnings, inheritances, whatever and, buy stocks (and/or real-estate) whenever you can.

Look for bargains in the market (you know, great companies paying good dividends and/or growing profits even now, that have been beaten down to less than 12 to 15 P/E … better is 8 to 10 P/E) and start buying into 4 or 5 of these … and, keep buying! Don’t stop … ever.

This will create your own mini-Berkshire Hathaway, making you a mini-Warren Buffet: you have a ‘cash machine’ (job/s, business/es) and you use it to buy good businesses cheap; then you hold forever. If the price goes down, so what? You simply buy more at the cheaper price as soon as you can afford it. And, if the price of the stock goes up, good fer you, Son … now and go an’ buy yerself some more!

When the market does ride the next wave (one that you will only see in hindsight) you will really see how cheap you got in …

2. Ride the volatility

The first is the ‘safe’ strategy, but will net us closer to 0% growth over the life of the Bear Market than the greater-than-market returns that we need … we need time to ride the downturn and pop out the other end with a basket of great stocks/real-estate assets bought at relatively cheap prices.

But, if you are able to accept some significant risk, there is another way …

Now just might be the time to take a business / trading approach to the market!

In a volatile market, we don’t know from one day/week/month to the next whether stocks will be significantly up or down … but we do know that they will change: often significantly.

This can be an ideal time to speculate with options … but, only with money that you are prepared to lose in the hope that the upside justifies the risk.

Sounds a lot like a business, doesn’t it? Which is why this is an ideal Making Money 201 Income Building Strategy for those who can stomach the ride.

What do I do?

Pick a stock that you like, but that has great volatility … ‘tech’ stocks are ideal for this (AAPL, RIMM, etc., etc.) and buy an equal quantity of PUTS and CALLS at the smallest gap around the current stock price. Sometime during the month, in a volatile market like this, it’s a reasonable bet (at least, I like to think so) that the price will change. If it does – by enough of a margin to pay for the cost of the options – you win!

Of course, you could flip/trade houses, if you prefer real-estate … but, the strategy is essentially the same: add value from volatility and/or sweat to ‘create’ returns in an otherwise generally flat market.

So, if you’re in Making Money 201, why don’t you share with us what you are you doing to not only weather the storm, but profit from it?

The fractal market …

What does this fern leaf and the stock market have in common?

Surprisingly, a lot!

For a start, this is not a drawing or photo of a real leaf … it’s a actually a computer-generated image derived from just a few short lines of computer code.

It’s a ‘fractal image’ – a branch of mathematics that uses randomness (with many similarities to ‘chaos theory’) to describe natural objects so that they look ‘real’ to the naked eye … again, using only a very simple mathematical formula!

The two most interesting things about fractals:

1. They are easy to generate – they are based upon replication of a very simple formula, over and over again. Order-in-Randomness takes care of the rest

2. As you scale up or down the picture looks remarkably similar ….. take the leaf to the bottom right and blow it up to full-size and you will see something very similar to this original image

What does this have to do with the stock market? Well take a look at the following two graphs:

These both indicate movements in the Dow Jones Industrial Average; what’s interesting isn’t the direction … it’s the shape …. they both indicate a random series of up/down movements in a general direction (that, too, seems to change randomly).

The interesting thing about these charts is that they are the same chart (almost)!

One is a 1 year view of the Dow Jones, the other a 3 year view (it should be easy to work out which is which!) …

… you see, as the IBM scientist who ‘founded’ fractal geometry (well, actually revived … it was ‘discovered’ in the late 19th century by a scientist named Julia) in the 80′s discovered, the stock market is fractal.

While the movement is seemingly random, each piece of market movement when enlarged looks very similar to the larger scale movements … so we have up/down movement in the stock market at every scale: daily, weekly, monthly, annually that actually behave quite similarly.

The frustrating thing is this: chaos theory abounds.

Chaos theory says that when systems become complex, a very small apparent change in one variable (i.e. number) can suddenly have a HUGE change on the whole.

It’s why they say that a butterfly flapping its wings in Japan can cause a hurricane in Louisiana …

You can’t think of a system (except in Nature) more complex than the stock market: thousands of stocks make up a market … each one is a real-live business generating revenue, controlling costs, dealing with market/economic/government changes on a daily, or even minute-by-minute basis.

The whole shebang can move up … down … or sideways. But, within each movement is the movement of each company’s stock. The price of each individual stock is fixed by the investors: are they net buyers or sellers in this micro-second (that’s how fast the stock exchange moves)?

Suddenly, one mutual fund executes it’s order to sell Company A and the effect is minimal, either on that company’s stock or on the market. But, on another day a ‘perfect storm’ arises (an announcement by the feds of a change in interest-rates; a war in the Gulf erupts; etc.) and that same sell-off triggers a panic.

Who can predict it?

Nobody … and, that’s the point … look at the charts: do you see anything that looks remotely predictable in that lot?

Do you want to bet your financial future on where the stock market is heading, even for the next 3 years?

I don’t … but, I do know that while the market can (and, does) move dramatically & randomly, there is an underlying force driving it relentlessly upwards:

The companies that make up the market are producing widgets, and inflation is always making the price of widgets go up/up/up (with an occasional, but only short-term pull-back) inevitably pushing their profits (hence stock price) along with it … where inflation goes, the stock market will surely follow … eventually.

But, who can say exactly when?!

So always be a buyer and holder … never a seller be.

Don't let all of those stock investment choices fool you …

People new to the world of finance are often blinded by all the options available for investing in the stock market:

- Direct investments in stocks – but which ones? Growth? Value? Invest far and wide? Or only in a few?

- Trading stocks or options – how to value and trade? Fundamental Analysis? Technical Analysis?

- Investing in packaged products – Mutual Funds? Index funds? ETF’s? REIT’s?

I wrote a post recently that summarized these options; here I simply want to add a little more info …

Investopedia Says:
The building of a factory used to produce goods and the investment one makes by going to college or university are both examples of investments in the economic sense.

This means that the true definition of an investment is something that makes a little money now, or more likely a lot of money in the future.

Therefore, while I say that there are three sensible ways to invest in stocks, there are only two investment methods recommended by Warren Buffet:

1. Buy and Hold low cost, diverse Index Funds (check out Vanguard‘s web-site, and others) – this is a long-term, low risk (if your holding periods are 20 – 30 years) strategy that can help you fund a normal retirement.

“By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals” W. E. Buffett – 19932.

2. Invest in a FEW stocks in companies that are (a) undervalued (b) have a large margin of safety (c) that you love and (d) are prepared to HOLD until the rest of the market decides that they love them, too (at which point you can cash out or keep holding for the long/er term). “I never attempt to make money on the stock market … Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” W. E. Buffett

So, take Warren’s advice: unless you have a strong reason to do otherwise, stick to one – or both – of the only two ways of investing in stocks and, over the long-term you are very likely to outperform all but the luckiest of those speculators out there …

What is the best way for a newcomer to get started in investing in stocks?

I just got back from Omaha, where I attended the Annual General Meeting for Berkshire Hathaway – Warren Buffett’s company – so, it’s timely that I remind you there are only a TWO sensible ways to INVEST in stocks - BOTH recommended by Warren Buffet  – plus one Speculative way:

1. Buy and Hold low cost, diverse Index Funds (check out Vanguard’s web-site, and others) – this is a long-term, low risk (if your holding periods are 30 years) strategy that can help you fund a normal retirement.

2. Invest in a FEW stocks in companies that are:

(a) undervalued,

 (b) have a large margin of safety,

(c) that you love, and

(d) are prepared to HOLD …

… until the rest of the market decides that they love them, too, at which point you cash out and go back to (a).

Anything else is SPECULATING – lots of people have made a ton in trading stocks and options (e.g. George Soros, but he was smart enough to know to quit gambling when you are ahead) – or UNDERACHIEVING such as following the herd and/or buying high-cost Mutual Funds.

You may be one of the few that can succeed in either of these alternative methods … but, please don’t offend the World’s Greatest Investor by calling it INVESTING …

We believe that according the name ‘investors’ to [people or] institutions that trade actively is like calling someone who repeatedly engages in one-night stands a ‘romantic.’ [Warren Buffett]

So, there are only two methods that Warren Buffet would recommend (and one that he clearly would not) – one for the wise and the other for the even wiser - which one would you choose?

_______________________________________________________________________________________________

Well, the ‘news’ of my 7 Millionaires … In Training! ‘experiment’ is finally out … check out my friend, Bill’s post on Money Hacks, then click here to find out more …

The ONLY three ways to invest in stocks … and, some ways NOT to …

So you want to invest in stocks?

And, why not be a bit of a contrarian by getting in now … when the markets are all beat up, and there is doom and gloom around, that’s when most of the money in this world is made … so, if you do want to invest, how?

Well I covered a bit about this subject in a recent post, comparing Index Funds to ETF’s … but, I want to go into it just a little bit deeper:

First of all you need to understand what type of investor you are:

1. Are you a Speculator – living on the edge, trading stocks/options (i.e. gambling) type? Nothing wrong with that - you could be the next George Soros.

If you are, then sign up for some newsletters and courses, such as the Tycoon Report (has the added advantage of being free!)

2. Or, are you a Value Investor - buying cheap, holding for the long term type? Are you the next Warren Buffet? Obviously, nothing wrong with being the world’s richest man, either.

If you are the next WB, then buy yourself a copy of Rule # 1 Investing by Phil Town. It will tell you exactly HOW to value stocks (what measures to use) and WHEN to invest (what indicators to use).

3. If you don’t have the patience for the latter (2.), or the stomach for the former (1.), then buy yourself some units in a low cost Index Fund … keep buying … and, wait!

That’s it in a nutshell …

… but, wait you say … what about:

4. Mutual Funds – too expensive and 85% of fund managers don’t even beat the market

5. Growth Stocks – if you have no special skill or knowledge, what makes you think that you can beat the Fund managers in 4.? You can’t (unless, you are lucky … then you are really just back at 1.).

Did I miss anything?

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When is it best for you to invest?

One of the better on-line resources for investing in stocks is the Tycoon Report … I enjoy seeing it in my In-Box daily (BTW: also check out Tickerhound!).

I was interested to see an article that talked about the three best times to invest; here’s what they said:

To outperform the market, you have to master all the factors that determine when a company’s shares are most likely to rise, not just some of them. It is the combination of indicators, each reinforcing the other, that gives us the most accurate barometer of when and where to invest our money.

One of the topics I cover in detail in the CRISS course is timing or seasonality — the best months and years to make investments in specific markets. Many investors are unaware of facts like these:

• In the 4-year presidential election cycle, market strength is greatest in the pre-election year: the NASDAQ has posted an average 32% gain since 1971 in pre-election years — and the Dow hasn’t had a losing pre-election year since 1939.
• Since 1991, October has been the strongest month for the Dow and the S&P 500.
• For the NASDAQ, the best months are October through January, during which the NASDAQ has averaged 12% four-month returns for over a decade.

 Now, I don’t usually try and time the market according to these (or any other) ‘best time to be in the market’ strategies, because the one time that I do will be THE TIME that the strategy doesn’t work

You know, the papers will say “Market Shock – Dow Jones Plummets in Election Year … first time in over 100 Years … Investor Loses Shirt”.

But, if I am planning to invest AND I have found a stock at a great price in a company that I believe in …

… then it is sure nice to know that the stars are (supposedly) aligned in my favor; but, I’ll probably invest eben if they aren’t.

What are your favorite times to be in the market?

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Making Money 201 – Going for Broke!

If Making Money 101 could be drastically over-simplified as ’saving’; then Making Money 201 is equally over-simplified as being about building your income.

If you were serious about getting your financial house in order quickly, then you probably already did some income building to help you pay debt off quickly while you were working your way through Making Money 101.

Unless you’re a CEO of a Fortune 500 company, or a top professional doctor / dentist / attorney / accountant, then you will need to think about starting a business.

And, to accelerate your business or professional income you may also decide to get into the business of active investing (renovating/flipping real estate, trading stocks and options, etc.).

This is the stage that you get to take RISKS (that’s why you need a solid foundation and plenty of runway … you WILL fail at least once, twice, three times …) because that is the only way to get the big financial REWARDS.

This stage is hard work!

But, it is where you actually sow the seeds that will eventually make you rich …

There are plenty of books and a few blogs around, but most of them are specific to just ONE WAY of making money … the author’s way; some are good and some are lousy.

By the end of this stage you will be earning more than 90% of the US population and will be accelerating rapidly down the runway to financial health … but, spending will also increase dramatically and you will struggle to hang on UNLESS you ALWAYS remember your Making Money 101 lessons about saving!

Paradoxically, you will be the ‘richest’ that you will ever be in your life during this stage IF to you, being ’rich’ means being able to spend lots of money …

… the problem is that your ‘wealth’ is only based upon your income, therefore only lasts as long as your business or job does.

Also, many of the Making Money 101 rules now need to change, as do almost all of the tools ….

For example, dollar cost averaging and index funds are replaced with sensible investment and savings rules and strategies.

You are still far from ‘rich’ …

In fact, you are still Just Over Broke … but, starting to break free!

Dumb Money!

I take issue with the seemingly interchangeable use of the words ‘saving’ and ‘investing’ …

Let’s not confuse buying Index Funds or typical diversified ordinay stock Mutual Funds with INVESTING …

… when you buy a Fund you are SAVING – consider it a long-term savings vehicle, no different to ordinary bank savings accounts, CD’s, and Bonds.

The difference? Effort.

 Buying a packaged financial product is no different to buying any other product: you send away for some information; if you like what you see you fill in the appropriate sales form; you pay your money and receive your ‘product’.

 Hopefully, when it comes to Funds, you make some money when you eventually cash out.

Contrast that with INVESTING:

 You do your research; you look for an underpriced item (in this case, a stock); you purchase the item; you watch the market carefully … and, when the price goes back up … you sell (this could be sooner = trading; or later = long-term-buy-and-hold).

Of course, you could just keep holding for dividends. In either case, you are aiming to MANAGE your holding to MAXIMIZE your RETURN.

Some people call the former Passive Investing and the latter Active Investing … but, if it walks like a duck …

… it is a duck!

BTW: there’s nothing wrong with SAVING … go ahead and buy some Index Funds if you’re not up to the task of INVESTING, even Warren says it’s OK …

The stock market pessimist

I braved the market storm and bought some stocks on Friday (about $700k in Citibank, Coach, Blackberry); for some reason I got bounced out of  Blackberry (RIMM) this morning … I can’t tell, but maybe I accidentally set my trailing stop at 1% instead of 8%?

I must admit, I’m just playing at the moment (see my earlier post: http://7million7years.com/2008/01/27/when-to-bail-out-of-the-market/ ).

Generally, I admit that I am stock market pessimist … always have been … but not any more … maybe!

This is the point in the post where you say: “hang on … when the market was going UP you were a ‘stock market pessimist’ and now that it’s crashing DOWN you’re suddenly a ‘stock market optimist’? Whattup????!!!!”

Let me explain …

Everybody has ways of making (or losing) money that they are most comfortable with … mine happen to include: businesses, property (residential and commercial, buy and hold), and some other stuff that I will tell you about in upcoming posts.

Fortunately, these happen to be the preferred assets of the Very Rich … just dumb luck and good genes on my part … I suspected but didn’t know for certain that they were the preferred asset classes of the very rich (neither did anybody else) until the book that I told you about in a recent post came out (follow the link just under the chart  and read the book exerpt: http://7million7years.com/2008/01/25/how-much-does-it-take-to-be-rich/ ).

So, I was nervous about stocks in general,  until I came across Phil Town’s excellent book on stock market investing called Rule # 1 ( http://philtown.typepad.com/phil_towns_blog/aboutbook.html ). Get it and read it!

The book told me how guys like Warren Buffet find undervalued stocks … I just followed the methodology to find my own favorite stocks (I’ll write a post specifically on this) and played a bit in the market with them.

I only invested $1 mill into 4 or 5 stocks … promptly losing $100k … but, I had the opportunity to learn Phil’s process and put in my ‘tweaks’ (Note to self: delete ‘tweaks’ … sometimes it’s best to just follow the formula).

Some of this was learning, some of this was not following the system exactly, some of this (a lot) was bad timing … subprime just as I was fiddling.

This is not a post that says that you should be in the market now … but SOON (where ‘soon = 1 month => 1 year, see: http://7million7years.com/2008/01/27/when-to-bail-out-of-the-market/ ) … until YOU are sure, there’s nothing wrong with staying in cash (see Phil’s excellent post on this subject  http://www.philtown.com/phil_towns_blog/2008/01/cash-is-good-un.html ).

As Phil says: “Now, go play!” …

When to bail out of the market

What to make of this?

The stock market went up and up – then CRASHED – then went up – then CRASHED … where to next?

Back up? Down more? Big Recession / Big Crash … hmmm, I don’t know … but, neither does anybody else.

Here’s what I do know:

Smart shoppers wait for the Thanksgiving Day sales to buy up the bargains … dumb shoppers buy with the crowds just before Christmas when the prices are marked up sky high.

Same with the stock market … we were leading up to a Stock Market Christmas and prices were sky high … they eventually had to drop, so I stayed in cash and waited …

 THAT was the time to bail out of the market … NOW, it’s Thanksgiving Day Sale time on the Stock Market ….  hurry, hurry, hurry … prices marked down 15% – 20% … even better bargains in finance stocks (remember the sub-prime write-offs?).

So, I am dipping my toes in again … maybe the market will go down again, maybe it will go up … I’m banking on it doing a bit of both with just a little of my money, to see what happens … when I am sure the recession is over (Hint: that will be BEFORE the newspapers publish the official reports, which can be months out of date!), I will be buying up those discounted, quality stocks like nobody’s business!

Want to know how to find ‘good quality’ stocks? Try this excellent book: http://philtown.typepad.com/phil_towns_blog/aboutbook.html )

Not convinced? Hear it from a professional at Friday’s post on the Wealth Tycoon Report blog (I don’t necessarily agree with everything these guys say, mainly because they are stock and trading experts, and I’m not, but this is a GREAT post): http://tycoonreport.tycoonresearch.com/articles/858884874/the-secret-to-investing-like-a-professional

 So, will I be dancing in the streets or crying? Well, I hate to cry, so I’ll only invest now what I can afford to lose (I’ll absolutely hate just dipping my toes in: if the market goes up, I’ll kick myself for investing so little … if it goes down, I’ll kick myself for investing anything at all … but, $$$-wise it won’t help or hurt greatly either way).

 Then, when I am SURE (maybe 1 month, maybe 6 months, maybe 2 years), I’ll grit my teeth and wheel in the big buckets of cash … by then, I’ll be educated, real-world tested (for better or worse!), and prepared!

 You should do the same …