The Basics

RISKY BUSINESS: Learning your risk tolerance

Do you like roller coasters, or do you prefer the merry-go-round? If you won a junket to Las Vegas, would you prefer watching a show to rolling the dice? Do you like rock climbing? Or would you rather just bask on a rock while everyone else is sweating it out on the side of the cliff? With investing, as with sports and entertainment, it’s important to know how much risk you can tolerate. Particularly when the market is making just about everyone queasy these days.

First of all, you should know that with investing, as with sports, the same old saying holds true: no pain, no gain. No risk, no reward. The market is always going to have its ups and downs, so if you have zero risk tolerance, you should rethink your plans to get into the market. (As long as you realize the biggest risk of all is outliving your savings and not keeping up with inflation.) You should also know, however, that the market has always recovered from what seemed at the time the worst of blows. Folks who got out of the market after the terrible tragedy of September 11th, 2001, locked in losses and failed to benefit from one of the best buying opportunities of the recent past.

The science of neuronomics has been giving us some interesting insights into the way our brains and emotions work when it comes to investing. We hate losing, for example, even more than we like winning! So if you take on more risk than you can deal with, you won’t sleep well at night, and you might do the kind of things people do when they panic. You might bail out of the market when it’s at a low, when your portfolio is down. And that means you’ll lock in your losses in stocks, bonds or mutual funds that probably would have recovered if you’d just had the patience (and fortitude) to give them time. If you have index funds, which follow various segments of the market, they would definitely recover, as the market comes back up. But not if you panicked and sold at the bottom.

Here’s a little quiz to test your risk tolerance:

1. If the market dropped fifteen percent tomorrow, you would:

a. Sell everything and put your money in cash.
b. Wait and see what happens before taking action.
c. Put more money in, taking advantage of the bargain prices.

2. If you were an animal, you would be:

a. Turtle, slow and steady.
b. Coyote, watching for opportunities.
c. Cheetah, letting it rip.

3. What do you think the future holds?

a. The outlook is scary, and I’m hunkering down for the worst.
b. I’m not sure, but I can cope.
c. I’m a cock-eyed optimist.

4. What is your primary goal in investing?

a. Protecting what I have.
b. Trying to beat inflation.
c. Trying to maximize my gains.

5. If you had to choose between investing in Microsoft, Apple and a CD with a three percent return, you’d choose:

a. the safe CD
b. Microsoft, the steady blue chip
c. Apple, the upstart with the cool stuff

Okay, for each a., give yourself one point. For each b., give yourself two points. For each c., give yourself three points.

If your score is between 5 and 6, your risk tolerance is low to nonexistent, and you should probably stick with Treasury bonds and CDs. If it’s between 7 and 11, you’re ready to take some moderate risks, and you’re ready for index funds. If it’s between 12 and 15, you’re considered an aggressive investor, and you’ll probably want to be investing in individual stocks.

June 29, 2008 • The Basics

Tricks of the Trade, Part II: All About Selling Stocks

We know that parting is such sweet sorrow, as Shakespeare said. But when it comes to stocks, it’s better to remove the rose-colored glasses and forget the romanticism. DON’T fall in love with your stocks.  Most savvy investors will tell you that knowing when to sell a stock is just as important as knowing when to buy it. Investing, like dating, can be emotionally charged, and you might be inclined to hang on too long. Or you might dump a good prospect too quickly.

If you’re working with a broker, financial advisor or money manager, you should be clear about what their guidelines or policies are with regard to selling. And if you’re managing your own investments, you should ask yourself that question as well. Because you might not actually have a clear policy, and that’s a liability.

Here at Woman with Portfolio, we try to minimize our trades in order to cut costs, taxes – and mistakes. One of the fastest ways to cut into your profits is to run up trading costs and capital gains taxes. But on the other hand, we sometimes need to sell. Obviously, in the best of all worlds, you buy low and sell high. The rule of thumb is “let your winners run and cut your losers.” But sometimes that’s not so simple. You also need to decide if the stock is a long-term buy-and-hold, which will let dividends accumulate and build your position in the stock, or whether it’s a short-term stock, which you’re buying, you hope, at the sweet spot, at a price that will increase to a trigger point where you’re ready to sell and take your profits.

So what are the tell-tale signs when it’s time to say good-by to a stock? For a boyfriend, there may be a strange shade of lipstick on the collar. For a girlfriend, an unusual spending spree on new lingerie. For a company, there are several warning signs that can tip you off to changes that may mean the price is headed south.

Be Aware of the Balance Sheet

If the company’s fundamentals (sales, debt, cash flow, etc.) begin to show signs of stress, it may mean something has changed that will negatively affect the stock’s price. In this case, don’t wait for the market to panic over a decline in revenue or another key fundamental. Be prepared to unload the stock while you still have a healthy profit.

Don’t forget the FUD Factor

Sometimes fear, uncertainty and doubt (FUD) affect the market, and your stocks along with it. If your stock is falling along with the market, that’s not enough reason to sell. If its performance is worse than that of the market, that’s a reason to consider selling.

Beware of Bad News or Hype

Bad news can send a stock price plummeting, sometimes permanently, but sometimes just temporarily. Try to decide if the bad news affecting your company is something that will pass, or whether it will have a lasting effect on a company ‘s bottom line. On the other hand, too much good news can sometimes be as bad as bad news. Watch out for hype. If a stock you own becomes a media darling and gets a lot of buzz, it may be time to look at taking a profit. These kinds of stock feeding frenzies attract herd-following investors who bid up prices only to have the market collapse when the hype dies. If you’re not careful, you can watch the price fall right past your profit line.

Selling the “Nut”

Some investors have a rule of taking partial profits when a stock reaches a certain price – say, doubling in price. You can sell a third of your holdings or at least enough to cover your initial investment, so that anything else the stock gains will be pure gravy. It’s also a way to make sure you have some profits locked in.

Using Stop Losses

Many investors set a floor on the stock’s price so that if it falls below a certain level, they sell. Some investors even have a set rule that if a stock falls a certain number of percentage points, that will trigger a sale. The limit can range from 5 to as much as 20%. You can keep adjusting that limit upward as the price of the stock goes up – that’s called a trailing stop. Be aware, however, that there are vulture traders out there who do nothing but try to scoop up stocks that have been set with automatic stop losses that fall within the stock’s trading range. The price may dip down to the limit for just an instant, but that’s enough for the vulture to swoop in and grab it. You can lose a good stock that way.

In order to set up your automatic sale at a certain limit, you fill out a sell order, filling in the “stop” price, meaning that when the stock falls to that price, it will trigger a sale. You then set a “limit” price, meaning the lowest price at which you are willing to sell. We have to warn you that the stop limit strategy can fail when a stock is falling so fast there is no one to buy the stock at your price limit. You can set a time limit for your sale as well, either daily, monthly or “unlimited,” which usually means three months.

You can also set an upper limit that triggers your sale. Let’s say that you’ve set a target price, following the target price set by a trusted analyst, or your own assessment of what the stock should be worth, and you’ve decided that you are willing to sell when the stock reaches that level. The rationale here is that you may be afraid that the stock will have a difficult time supporting a market price above a certain level and any hint of bad news will send the price into a nosedive. However, it’s important to “let your winners run,” so you should keep resetting your upper limit if it looks as though there is further room for growth.

June 23, 2008 • The Basics

Simple Solutions for Cash-Strapped Investors: What You Can Do with $100

One of the biggest barriers to investing is, well, money. Lots of women (and men, too) assume that you need a big pile of cash in order to start investing. The notion is that the stock market is a private club for rich people and pinstriped traders. But we’re out to show that the market can also be a way for the rest of us to get a goodly share of the wealth our system generates. And you can get started with just $100.

Okay, so you have a spare $100. And you’ll need to be able to put aside another $50 a month. If you can do that, you can start building a portfolio that will amaze you in a few years. It won’t happen overnight. The secret to successful investing is time.

You’re not going to be ready to buy individual stocks if you’re just getting started with a small stash of cash. But you can put yourself into some of the best mutual funds available.

So here’s what you can do. Check out a mutual fund family like T. Rowe Price (http://www.troweprice.com), which allows you get started in a fund with just $100, as long as you agree to an automatic investment plan in which you’ll continue to invest a minimum of $50 a month in the fund. The monthly amount is drawn from your bank account or an account you set up with T. Rowe Price. The company refers to these as “automatic asset builder” accounts. (You’ll need a minimum of $2,500 for a regular account, $1,000 for an IRA.)

There are some 90 funds to choose from, so you might want to look at a fund like their Capital Appreciation Fund (PRWCX), which is regularly ranked among the top funds. If this a retirement account, you can choose a targeted retirement fund, geared to the approximate year you expect to retire. If you set up an automatic investment plan, you’ll also be taking advantage of one of the best tricks of the trade in investing: it’s called dollar-cost average. By spreading your investments over a period of time, you take advantage of any dips, and you’re not investing a big chunk of funds when the price is high.

So why not shake out your piggy bank and see if you have $100? Or look under your mattress. Better sow some seeds for the future and let your financial garden start growing, the sooner the better. Check out our other Investment Gym workouts to see how you can keep developing your skills and building your portfolio.

May 19, 2008 • The Basics

The Secret to Safe and Easy Portfolios

We’re going to reveal one of the best-kept but most important secrets of investing. This is one that most brokers and fund managers would prefer that you not know.  It’s simple, it’s easy, it’s safe, and it’s cheap. It’s used by some of the richest people in the country.

Here it is: Index Funds.

The best way to diversify, minimize risks, and limit your expenses is to buy index funds or ETFs (exchange-traded funds) that allow you to equal the performance of the market. And that’s something that hardly any active mutual fund managers have been able to do over a long period of time. (By active, we mean funds that are not simply tracking an index.)

To learn what we mean by indexes, go to our previous workout called How Are We Doing, which explains the different benchmarks used to track the performance of the market, such as the S&P 500. You’ll be using these indexes to build your quick and easy portfolios.

The Lazy Woman’s Portfolio

This basic portfolio of three funds has been called by various names: the Margaritaville portfolio, the Coffee House portfolio, and the Couch Potato portfolio. These names indicating the small amount of time and concern expended in this investment. We prefer to call it the Lazy Woman’s Portfolio, which is no insult to those who prefer to take this shortcut to investing. It’s more likely that those who prefer this simplified approach are simply too busy to take more time with their investments. Or they might prefer to be having a massage. Whatever.

Most variations of this portfolio have three funds: a total market index fund, a total international index fund, and a total bond index fund or a treasury-bond index fund.

We’ve used funds from Vanguard, which is widely regarded as the powerhouse of index funds. It has a sterling track record, and its expenses are minimal.

You’ll need a minimum investment of $9,000 to create this portfolio. (Vanguard requires a minimum investment of $3000 in order to buy a fund.) If you don’t have $9,000, start with one fund and then add the others as the money becomes available.

33% Vanguard Total Market Index Fund (VTSMX): $3,000
33% Vanguard Total International Index Fund (VGTSX): $3000
33% Vanguard Total Bond Fund or Vanguard Inflation-Protected Securities (VIPSX): $3000

This ultra-basic portfolio gives you exposure to the total array of stocks in the U.S. market, as well as exposure to the other important world markets. You can choose either the index of relatively safer inflation-protected securities (the Treasure bonds called TIPS) or a more volatile index of the total bond market. During a bull market, you’ll be resenting those dull, boring bonds. But during a downturn, you’ll be glad you have them. 

The Slightly Less Lazy Woman’s Portfolio

For a slightly more diverse approach, based on portfolios followed by a number of institutional investors, including Ivy League universities, we have a six-fund portfolio that gives you exposure to the key indexes in the world and U.S. markets. It includes exposure to U.S. Treasury as well as corporate bonds.

15% Vanguard 500 Index (VFINX): $3,000
15% Vanguard Extended Market Index (VEXMX): $3,000
15% Vanguard Emerging Markets Index (VEIEX): $3,000)
15% Vanguard Complete World Market Index (VGTSX): $3,000
20% Vanguard Complete Bond Market Index (VBMFX): $4,000
15% Vanguard Inflation-Protected Securities (VIPSX): $3,000

This portfolio would cost you a minimum of $16,000. And if you’re a more aggressive investor, willing to take more of a risk for a higher return, you can get exposure to the volatile real estate market by adding $3,000 to the Vanguard REIT Index (VGSIX). We’d wait to buy the Inflation-Protected Securities (VIPSX) component of the portfolio because we think they’re in a bit of a bubble. For now, we recommend a substitute outside the Vanguard family. This is the Permanent Fund (PRPFX), which has a conservative mix of treasuries, gold, and Swiss francs. It’s a no-load fund (no front-end cost) with a minimum purchase of $1,000.

The Other Great Secret

Once you’ve established your basic portfolio of index funds, you can use the other great secret of investing to build on it: dollar-cost averaging. Vanguard and other mutual-fund companies will allow you to add monthly additions to your funds with as small an amount as $50. You can arrange for your monthly contribution to be automatically drawn from your bank account, so you won’t notice the pain. And the great advantage of buying in regular small amounts, through thick and thin, is that you’re buying when the price is down as well as up. You won’t be driven by emotion, and your portfolio will continue to grow. Those of you who have gardens know about the value of patience. It may take years for your planned garden to fill out and become lush and green. But it’s worth waiting for.

The Bargain-Basement Version of the Ultra Deluxe Lazy Woman’s Portfolio

We love to buy designer-quality clothes at bargain-basement prices, without having to fight the crowds at Century 21 (that’s the fabulous bargain-crazed store in lower Manhattan where we’ve purchased some world-class designer items at fire-sale prices). And so we also love the fact that we can put together a very inexpensive version of the index portfolios used by some of the country’s wealthiest families and institutions. And the way we do it is by using ETFs, the relatively new exchange-traded funds that track indexes, sectors, etc. You can buy an ETF for as little as the cost of a single share, though obviously, that would be a little silly, given your transaction fee. (We recommend a minimum of $500 per ETF to start with, though just get started with whatever you can afford.) You can purchase ETFs the same way you do stocks. We’ve looked at the model portfolios used by the leading money managers and financial advisors in the country and put together what we think is the best of the best and then tweaked it very slightly to make it even better.  We’ve included a closed-end fund for an exposure to gold and silver, but it’s purchased in the same way as an ETF. And we’ve just added an optional ETN (exchange-traded note that trades like a stock) that allows exposure to commodities. We think that because of growing demand from developing countries for basic commodities, from agriculture to metals, the demand for commodities is going to remain high indefinitely.

20% ishares Russell 1000 (IWB) or ishares S&P 500 (SPY) or ishares KLD Social Index (KLD)
15% Vanguard Extended Market ETF (VXF)
20% ishares MSCI EAFE, Diversified Foreign Stocks (EFA)
10% ishares Emerging Markets (EEM)
5% Vanguard REIT (VNQ)
10% iShares Lehman TIPS Bond (TIP)
15% ishares Corporate Bond (LQD) or iShares Lehman Aggregate Bond (AGG)
3% Lehman Short-Term Treasury Bonds (SHY)
2% Canadian Central Fund, gold and silver (CEF)

Please note that we have added KLD, a “green” alternative ETF to the major indexes tracking the Russell 1000 or the S&P 500. We find that the KLD Social Index performs as well as the S&P, and you get the added advantage of sleeping better at night. (See the workout on green investing for further information.)

For added zing, add the Elements Exchange-Traded Note based on the Rogers Commodity Index (RJI), established by the brilliant commodities guru Jim Rogers.

April 01, 2008 • The Basics

Tricks of the Trade, Part 1: How to Buy a Stock

It’s as easy as clicking on a mouse to buy a stock through your online brokerage. But there are a few simple strategies that you should know about that will increase your gains and lessen your losses.

When you’re interested in buying a stock, do your “due diligence,” which means your research. Use our “Values” system to evaluate the stock.

V=Valuation (crunch the numbers)
A=Analysts (check the “expert” opinions)
L=Leadership (is the CEO worth his or her salt)
U=Underside (what the company insiders think)
E=Edge (why is this company better than its competitors)
S=Sector (is the sector rising or falling)

Once you’ve decided to buy a stock, you’re going to determine your “entry” price – the price you pay per share for buying the stock. Using the Yahoo Finance page or your other favorite site for stock watching, click on the chart that will show you the range of prices for the stock both in the short term and the long term. Is it on the upswing or downswing? Find out if analysts have a “target” price for the stock, which is the price they expect it to reach within the year. If the stock has already reached the target price, you should probably pass.

If the stock is going straight downhill, you should probably wait or reconsider your choice. These stocks can be “falling knives,” with no discernible stopping point. If the stock is climbing or has recently begun to recover, you’re going to be looking for your entry point. Check the stock’s trading range – what is the daily high and low?

Here’s our most important advice. DO NOT buy a stock first thing in the morning with an open “market” order. You’ll pay the highest price that way. You’re going to want to use the category on your stock trading page called a “limit” order. Check the lowest price in the stock’s trading range and use that as your guide for a basic entry point. If you’re sure you want to buy the stock that day, click on the “day only” box. If you’re willing to wait longer for the stock to drop to your limit price, check the “good-until-canceled” box.

If your newly purchased stock has dividends, you’re going to want to make sure your dividends will be reinvested (unless you’re planning to use the dividends for income). If you can’t find that category on your brokerage portfolio page, give the brokerage a call and tell them you want all of your dividends reinvested.

March 21, 2008 • The Basics

Strategies for Older Investors: The Benefits of Income-Based Investing

At some point in our investing lives, as we begin to approach retirement, we’ll stop focusing so much on “capital appreciation”—on building the total net value of our portfolio. We’ll begin thinking more about the income stream we can expect to get from our portfolio. Most of us will want our portfolio to pay us “pension” checks – that is, dividends—throughout our retirement. For many people, the reason for investing is to get to this point – to use this income from our stocks and bonds to support retirement.

This shift in emphasis as we get older from building up the worth of our portfolios to extracting income from them means a shift in investing strategy and in the way we balance our portfolios. About five years before retirement, we’re going to want to start re-allocating, so that an increasing percentage of our portfolios is in income-producing assets. The best way to rebalance is to add to the asset class that you want to increase, rather than selling some of the asset class you want to de-emphasize. If you need to sell in order to rebalance, it’s best to sell within your IRA or other retirement fund.

You can still keep a Lazy Portfolio of index funds as your portfolio mainstay, but you’ll want to increase the percentage of bond index funds. Here’s the way the Lazy Woman’s Retirement-Ready Portfolio would look:

20% Vanguard Total Market Index Fund (VTSMX)
20% Vanguard Total International Index Fund (VGTSX) 

30% Vanguard Total Bond Fund (VBMFX)
30% Vanguard Inflation-Protected Securities (VIPSX)

You can keep getting the dividends from your funds reinvested until the time you need the income, and at that point, you’ll indicate to your broker, electronically or by phone, that you want to have the dividends either paid to you by check or added electronically to your cash account.

You may want to add a dividend-based index fund or ETF (exchange-traded fund) as part of the income-producing part of your portfolio. The Vanguard Dividend Growth Fund (VDIGX) has essentially the same return as the ETF equivalent, Vanguard Dividend Appreciation, with the stock ticker VIG. Along with Vanguard Dividend Appreciation (VIG), we’ve found that the First Trust Global Select Dividend ETF (FGD) has the best return of the many dividend-based ETFs out there.

March 02, 2008 • The Basics

How Are We Doing? The Basics of Market Tracking

When we talk about how the stock market is doing, whether it’s up or down, climbing or sliding, we’re usually referring to some key indicators, or indices, that have been devised to show stock performance. The best known is the Dow Jones Industrial Average (DJIA), first compiled by Charles Dow in 1896. When people talk about the Dow, this is what they’re referring to. This is the accepted benchmark of how well the nation’s big powerhouse company stocks perform each business day, and you can watch its fluctuations throughout the day.

THE DOW

Originally composed of 12 large industrial U.S. companies, the Dow has been expanded. The index now includes 30 top American companies chosen to reflect the country’s modern economy, covering a wide range of industries. The only original company in the first 12 that’s still around is multinational giant General Electric. Other major components of the current Dow include financial biggies like Citigroup, technology bellwether IBM, pharmaceutical giant Pfizer, and media and entertainment perennial Disney. This year, for example, Disney has actually outperformed most other components of the Dow, making Snow White and Seven Dwarves very happy.

THE S&P 500

Another key indicator of market performance is the S&P 500 Index, which includes the stocks of 500 large-cap corporations. The Index is maintained by Standard & Poor’s, a division of publishers McGraw-Hill. The companies in the S&P 500 trade on either the New York Stock Exchange or the Nasdaq. The index is considered to be a bellwether for the U.S. economy, and it’s often used to compare the performance of individual stocks or mutual funds. When someone refers to “beating the market,” they probably mean doing better than the performance of the S&P 500. It’s the most frequently used baseline for comparison. Many index funds and exchange-traded funds try to mirror the performance of the S&P 500 by holding the same stocks as the index.

THE NASDAQ

Another key indicator, or group of companies, is the Nasdaq, which stands for the National Association of Securities Dealers Automated Quotations. Its main index is the Nasdaq Composite. It’s the largest electronic stock trading market in the U.S., with more than 3,000 companies listed. (Electronic trading came about, by the way, after the 1987 crash, when many brokers didn’t answer their phones!) Many people associate the Nasdaq with the big tech-stock meltdown that began in the late 1990s because the exchange has so many tech stocks listed on it.

Other Indices

There are some other important indexes that are used to track certain kinds of stocks. Russell Investments runs a family of indexes used by many institutional investors to track how well fund managers are doing. And the indexes are also used as the basis of ETFs (exchange-traded funds) that try to mirror the performance of these indexes. These indexes include the Russell 1000, which represents a broader group of large-cap companies than the S&P. Probably best known is the Russell 2000, which includes small-cap companies. The Russell 3000 gives you the whole banana, the full array of small and large cap companies in the equity universe.

November 30, 2007 • The Basics

Dancing with Bears, Running with Bulls

Welcome to our first “workout” in Woman with Portfolio’s Investment Gym. We’re going for a quick hike outdoors to meet the symbolic animals that Wall Street types talk about when referring to the state of the stock market. You might want to put on some sturdy boots, as we might encounter some bull excrement on the way! 

Currently, as our economy seems perched on the edge of a slowdown, brought on by the subprime loan crisis, we find ourselves at the tail end of a bull market, possibly facing the beginning of a bear market. What does that mean for us and our investments? Should we head for the hills? Bury our loot in the back yard?
The stock market is as changeable as the weather, sometimes switching from sunny to stormy in a single day. But it also shifts in longer, more gradual trends, which can last for several months or even years. We call these trends bull markets and bear markets: bulls bellow and run; bears hunker down and hibernate. The market follows bull-and-bear, or boom-and-bust cycles, along with the state of the economy, going from “bullish” optimism and expansion to “bearish” pessimism and contraction, even recession.

As investors, it’s important to know where we stand in the market’s up-and-down cycle, whether we’re going to be running with the bulls or dancing with bears. Often the market is actually ahead of the economy, so that the bulls start heading for the barn and bears come out of their dens and start growling well before a recession begins.

We need to tweak our investing strategies, depending on where we are in the cycle. But it’s important not to overreact to these inevitable swings of the market. That’s when investors tend to make their biggest mistakes. Getting greedy in the good times or panicking in the bad times are guaranteed ways to lose money.

Hug the Bears and Watch out for the bulls---

Of course, everyone loves a bull market, when everything seems to be going well with the economy. Businesses are expanding, people are finding jobs and stock prices are rising. It seems a lot easier to pick winning stocks in a bull market, when everything seems to be going up. But this is also a time to be very cautious, because this is when stocks get overvalued. It’s important to avoid buying stocks at the very top of their price range. We have to be careful at the tail end of a bull market because we might get kicked! 

No one likes a bear market, when the economy is slowing, recession is looming, and stock prices are falling. Some investors even prefer to “play dead” in the face of a bear market, keeping their money in cash or money markets. The most famous bear market, of course, occurred during the Great Depression of the 1930s. But this is also a good time to go bargain hunting. This is when some of the great fortunes are made, when prices of even the best stocks tend to fall to affordable levels. Legendary investing guru Warren Buffett tends to increase his holdings during these down times.

It’s important to remember that over the last 100 years or so the U.S. stock market has increased an average 11% a year. So if you joined the bears, hiding out in their dens or keeping your money in a cave, you’d miss out on the opportunities to let your investments grow substantially over time.

Chickens and Pigs

Two other animals that hang around the market, but which do not fare well, are the chickens and the pigs. The chickens are investors who are too skittish to buy anything, no matter what the conditions. For these scared chicks, the sky is always falling, even on sunny days. The pigs are those who get too greedy, keeping up their buying even when it’s clear that stocks are overpriced and a storm is brewing. One of our friends told us a saying about investing from his uncle: “Don’t be a piggy, Ziggy.”

November 25, 2007 • The Basics