Step3 Prophet

Some random thoughts on stocks

I"m reading a book right now called "A random walk down Wall Street" by Burton G. Malkiel. I highly recommend it to anyone interested in directly investing in the stock market. The author's basic premise is that it's a losing game if you try anything other than a broad investment strategy such as a total market index fund. All his talk about the behavior of stocks (and stock investors) has got me thinking about the nature of stock. The following are some random musings on my part.

The whole premise of stock investing is that over time stocks go up in value. This has been shown to be true since stock markets began, but the amazing thing is that they go up in value faster than just about anything else around! The value rises exponentially, at an average rate of 9% per year(historically). Thats astounding. Consumer price inflation rises at about only 4% per year. I wonder why there is a disconnect between the two. The value of most everything else rises much more slowly than stocks.

Inflation itself is a tricky beast. Why does the price of everything go up over time? Because people think it does! Sounds crazy, but it must be true. The value I get from, say, a can of tuna doesn't change from one can to the next. The amount of work to produce that can of tuna doesn't change appreciable either. But over time, I pay more for each can I buy. I think it stems from people wanting more, which also explains why prices rise exponentially.

Corporations want more profits, so they raise the price of their goods slightly. A free market would punish those who raise prices by producing competitors who sell the same goods at a lower cost, which I guess is a driving factor in keeping the inflation rate down. However, everybody desires more money for their goods and services. Employees want a better salary so they go the firm that pays the most. Delivery drivers want more compensation for delivering the goods, workers want more for producing the goods, and construction companies want more for building the factories. The increases are relatively small each time, but over years they compound and thus we have inflation.

Why does the cost of goods rise exponentially vice linearly? Because of the way humans perceive difference. For example, if you were in a store and needed to buy item selling for $15, and you knew it was selling for $5 at another store, you would go to the second store. But what if your where buying a plasma television, and saw it at the store your were in for $1010 and the other store for $1000. You probably wouldn't bother. The difference is that your mind perceives the first item at a 66% discount, while the second item is at a 1% discount. People are geared to perceive the relative difference, not the absolute difference. If you  made $30,000 a year, and got a $1000 raise, you would probably be quite pleased. But if you made $70,000 and only got a $1000 raise, you would probably be ambivalent or even displeased( because it isn't keeping up with inflation!)

Oh well, just be glad we aren't Zimbabwe. According to wikipedia the current inflation rate as of April is an extimated 165,000% and they just issued a $50,000,000 dollar note(US $1.20)

Still, I wonder what drives stock values up more quickly than other prices. If it weren't for stock splits, some of the older companies would be priced right out of individual investors range( such as  Berkshire Hathaway, which closed today at $127,200)

Moving accounts

I've been thinking about moving my Sharebuilder account over the Zecco for quite some time now. I stopped my automatic investments with Sharebuilder awhile back, and any new money I wanted to direct into stocks has been through Zecco because of the zero commissions aspect. When I fist signed up for Zecco I considered doing a brokerage account transfer from S->Z , but at the time there was no incentive. It would have required mailing in paperwork and waiting for more than a month for the brokerages to sort things out. Now though, with Zecco's change in policy such that only accounts > $2500 get free trades, I have a better incentive. On Friday I did a little research into making the switch. I was halfway into filling out the forms for the transfer when I had a few questions(The instructions where non-existent). Turning to the internet for help, I discovered fellow finance bloggers who had made this transition before. Particularly The Sun's Financial Diary was useful since he detailed each step of the process, and brought to my attention the fact that Sharebuilder charges a $50 fee for account transfers. Since I had no free cash in my account, shares of my stock would have to be sold to cover the fee along with the partial share that I own since Zecco only transacts with whole shares. On the other hand, sharebuilder does charge to close an account.

So my plan of action now is this: sell all my shares at sharebuilder for a $10 fee on real time orders, take the money from the sale and transfer it to Zecco( through my checking account), where I can buy the same stock or any other one I please. The downsides of this plan are the trade fee (which is less than an account transfer fee since I only have 1 stock), and any tax consequences I might incur. Since I first bough this stock a little over a year ago, some of my sale would be taxed at the long term capitol gains rate, and some at the short term(< 1 year) rate. However, because or recent down turns in the stock market, my sale of this stock should result in a net loss, which may be favorable to me on my tax return next April 15(Probably not by much). Since I've never sold any of my investments before this will be an interesting exercise.  I'll have to figure out my cost basis, and how the sale will actually affect my taxes next year. My loss will probably be about $300 dollars, so not to big an effect either way. Slogging through IRS publications is not my idea of a good time, but it looks like I'll become acquainted with publication 550.

The cheapest way to invest long term

I said in an earlier post I'd cover the absolute cheapest way to invest, so here it is. The answer is Zecco and ETF's. How so you ask? Well, ETF's are exchange traded funds, basically mutual funds that trade on the stock exchanges just like any other company's stock. The basic structure of an ETF allows for very low fees , somewhere on the order of 0.25% or less for all of Vanguards funds. The ETF is usually cheaper than the actual fund if you were to buy it from the company. Considering the average mutual fund expense ratio is 1.4%, you are paying 4-6 times less for an ETF. So why are mutual fund companies still in business? Brokerage fee's.

To buy an ETF, you must go through a broker just like any other stock transaction. Even with the rise of the discount broker you pay $4-$7 per transaction, which translates into 4-7% of a monthly $100 investment. Sharebuilder is your best bet for dollar cost averaging using ETFs, as long as you are putting in $200+ per month to keep the investment cost ratio down. So how does Zecco fit in?

Zecco is a company that offers zero cost commisions(hence the name zecco) on regular stock transactions if you meet there requirments. Right now that mean >$2500 invested gets you 10 free trades a month. Less than $2500 and you pay $4.50 a trade. Once you meet the minimum cash limit, suddenly ETF's become cheaper than mutual funds due to the low expense ratio. Since the goal is to accumulate wealth, you won't be selling anytime soon, and the $2500 will be met with in year, or two.

Over a 30 year period, the difference between even 0.15%(Vangaurd 500) and 0.07% (Vangaurd Total market ETF) can be $3000 for every $10,000 invested. The only drawback right now is that Zecco does not offer an automatic investment program. You can open an regular or IRA account, but you must make the stock purchase every month yourself. If have the discipline to do this, you can save big in the long run, but until they offer an alternative, I'm sticking with Vangaurd mutual funds, because you just can't beat having the money taken out automatically. Still, I use Zecco to play around with stocks small time. Check them out at Zecco.com

Words of Widsom from my father(he's a pretty smart guy)

Today is a guest post from my father. He wanted to emphasize a few points about saving for retirement

He Says:

"I would recommend that one first invests in a 401(k) up to the
company match limit.  You can't beat an instantaneous 50% (or in some
cases 100%) return on investment.

Next, I would invest up to the max limit in a Roth IRA.  This is
especially true for those who are early in their career.  Early on,
you're not making much and your marginal tax rate may be, for example,
10-15%.   The fact that you must use after-tax dollars is not a big hit
early in one's career.   And 40 years from now, if they have followed
your advice, the income they derive from investments might be
substantial.   Sure is nice to be tax-free....

Next:  if any of your 401(k) is paid in company stock, diversify at your
earliest convenience.   The law now allows you to do so.   All of my
company match is in Crane stock....and at least once a year I go in and
transfer it to a different diversified equity fund.

After that, it gets a little hazier.   I continue to fund my 401(k) to
the max because I am so fortunate to be in a 25% tax bracket now.  It
makes sense for me to shield income now, as I don't expect to make
nearly so much in retirement.  Also, in true couch potato fashion, it's
just a mindless way to invest.   I never see the money, so it doesn't
get spent.   The downside of 401(k) investments is they are not
accessible until retirement, or you pay a 10% penalty to access the
money.   So it's not for everyone."

Thanks for the advice Dad. He also recommends (and so do I) the Scott Burns articles. He's a writer for the Dallas Morning News where He answers questions and has common sense financial advice for the average person. Check it out at Assetbuilder

The simplest way to save for retirement

I think many people who are just starting to work for the first time have questions about how to save for retirement. There are about a million different ways, and you can spend a lot of time researching what to do with your retirement money. For people just starting out who don't want to put a lot of time and effort into, there are some simple things you can do.

Option A: Go with the company plan. This is good especially if your company matches funds. Example: you put in 6% of your paycheck toward retirement, the company matches that, and you have doubled your retirement savings with no extra work. It can almost be considered a pay raise, and you never even miss the money because it's taken out before you get the paycheck. Things to consider: Don't put all your money in the company stock. If things go poorly, you could have no savings(think Enron). Do put your money in a broad market index fund. This will give you the best returns over time while minimizing risk.

Option B: Go to Vanguard.com and setup an Roth IRA with a target retirement fund. This is also a good option if you have already met your companies matching contribution. When you are setting it up choose the reinvest dividends option, and then setup automatic monthly withdrawals from your checking account. You can even choose the "maximize IRA contributions" option to ensure you make the most of it. If you're like me, the target retirement date is about  the year 2045. The hardest part is getting your foot in the door. You need $3000 dollars to buy into the fund. After that you can contribute as little as $100 dollars a month with no fees for contributing more money. Even sharebuilder.com charges $4 a transaction, which is a 4% hit on a $100 investment.

Q: Why Vanguard?
A: They have a quality product and the lowest fees in the mutual fund industry. There are many other good mutual fund companies out there, but Vanguard delivers all around. The key to building wealth is minimizing fees that you pay for other people to handle your money. Over 40 years of steady investing, everything else averages out.

Q:Why a Target Retirement fund?
A: Because you don't have to worry about where your money is invested as you get older. It is automatically readjusted so that as you get closer to retirement, more money is moved out of risky investments like stocks, and into guaranteed investments like bonds. It's the only fund you every need.

Q: Why a Roth IRA?
A: Everybody should have an IRA account, even if you have a company retirement plan. Anybody who earns income can open one. In fact, you can have multiple IRA's. The only limit is how much money you are allowed to put in each year. This year's limit is $5000 for individuals(that's combined total for all IRA's). You can put any kind of investment you want in an IRA. A Roth IRA is nice because while you pay taxes on the money you contribute now, you don't pay on earnings or withdrawals after you retire.

These are the simplest options. There are many other interesting ways to invest, but these require the least amount of trouble if you are someone who wants a good retirement, but doesn't want to work for it. In a later post I'll look at a way to get the absolute minimum in fees on a retirement account(it's a little more work, so I didn't include it here)