Showing posts with label Beginner's Investing. Show all posts
Money Market vs. Certificate of Deposit Which Is Better - Money Markets or CDs - For Your Portfolio?
Certificates of deposit and money market funds are popular choices for investors in the United States because each offers a unique set of advantages, terms, yields, pricing, conditions, and restrictions. Depending on circumstances, resources, and your own investment portfolio preferences, either, or both, can work for you when you are looking for a place to earn a relatively secure stream of interest income, but don't want to dive into tax-free municipal bonds orcorporate bonds.
In the Left Corner: Certificates of Deposit
Certificates of deposit (or CDs for short) are debt instruments issued by banks and other financial institutions to investors. In exchange for lending the institution money for a predetermined length of time, the investor is paid a set rate of interest. Maturities on certificates of deposit can range from a few weeks to several years, with the interest rate earned by the investor increasing in proportion to the time his capital is tied up in the investment under most yield rate environments.
Pros: The investor can calculate his expected earnings at the outset of the investment. Certificates of deposited are FDIC insured for up to $250,000 and offer an easy solution for the elderly who desire only to maintain their capital for the remainder of their life.
Cons: If the investor opts for a longer maturity and, thus, higher rate of interest, he will lose access to his funds and forego alternative uses of his capital.
In the Right Corner: Money Market Funds
Money markets, on the other hand, are very different. First, it is important to understand the difference between and FDIC insured money market account at a bank and a non-FDIC insured money market mutual fund offered through a brokerage firm. They are not the same thing.
A money market account at your bank offers many of the benefits a certificate of deposit does, only it has the added feature of check writing, in most cases. If you have a larger balance, you might be able to get a slightly higher yield depending on the rates being paid at the time, and you won't have to wait for certain maturity dates to get your hands on your principal. On the flip side, withdrawals are often limited to a set contractual amount (e.g., no more than 4 withdrawals a year).
Money market mutual funds, in contrast, are pooled mutual funds focused on acquiring portfolios of government t-bills, savings bonds, certificates of deposit, and other safe and conservative financial instruments. The portfolio manager strives to keep the fund at exactly $1.00 per share so it appears to work like cash, even though it's not. In times of severe stress or manager error, a money market mutual fund can theoretically "break the buck", though it has been a very rare event, historically.
Pros: Depositing money in a money market is as easy as depositing cash into a savings or checking account. Cash is immediately available for alternative investments if you change your mind and want to put your capital to work elsewhere, in stocks, buying real estate, or even spending it.
Cons: Some financial institutions place a limit on the number of checks that can be drawn against the account in any given month. The rate of interest is directly proportional to the investor's level of deposited assets, not to maturity as is the case with certificates of deposit. Hence, money markets are disproportionately beneficial to wealthier investors.
The Verdict
Although both can be useful, for those who need access to their capital and / or have much higher cash balances, money markets are often the superior choice. For those who want to time maturities to certain events or benefit from a willingness to lock away savings for a long period of time, certificates of deposit are often the better portfolio selection.Tag :
Beginner's Investing,
The Rule of 72 A Quick and Easy Way to Calculate Compound Interest
In You’re Spending Your Millions $1 at a Time, you learned that compound interest has the power to turn seemingly small amounts into large fortunes if given enough time and the right rate of return. This article discusses the so-called Rule of 72. This rule allows the investor to quickly and efficiently answer two questions:
How long will it take me to double my money if I earn X%?
What return must I earn if I wish to double my money in X years?
Using the Rule of 72 When the Rate of Return Is Known
An investor that knows he can earn 12% on his money may ask the question, “How long will it take to double my money at this rate of return?”.
Using our handy Rule of 72, this is a snap to calculate! Simply divide the magic number (72) by the investor’s rate of return (12). The answer (6) is the number of years it would take to double the investment.
Using the Rule of 72 When the Number of Years Is Unknown
The Rule of 72 can also be used in reverse. An investor who wanted to double his money in a certain number of years could use the rule to discover the rate of return he would have to earn to achieve his goal.
Imagine, for a moment, a businessman who wanted to double his money in four years. To estimate a rough rate of return required to achieve such a feat, he'd divide 72 by 4. The result (18%) is the after-tax compound annual rate of return he would have to earn to meet his goal on time.
Practical Examples of the Rule of 72 in Action
Q: John Q. Investor needs to double his money in seven years to reach his financial goals. What rate of return must he earn to do this successfully?
A: John would take 72 divided by 7. The answer, 10.2857%, is the amount he will need to earn on an after-tax basis to successfully reach his goal.
Q: Susan Q. Investor is earning a 9% after-tax return on her investments. How long will it take her to double her money?
A: To calculate the number of years necessary to double her money using the Rule of 72, Susan would divide 72 by 9. The answer, 8, is the number of years it will take for her investment to double after taxes.
Tag :
Beginner's Investing,
How Much Of Your Household Income Comes from Investments?
The composition of family income, which is the dry powder that makes funding an investment portfolio possible, differs significant from the middle class to the upper class. In 2010, the most recent year data was available from the nation's central bank, it showed some interesting characteristics.
A family in the 50th-74.9th percentile distribution of household income generated money as follows:
- 76.3% wages
- 0.4% interest or dividends
- 4.8% Business, farm, self-employment income
- 0.1% capital gains
- 15.9% Social Security or retirement plans
- 2.5% transfers of societal benefits
Meanwhile, a family in the 90th-100th percentile distribution of household income generated its money as follows:
- 55.8%% wages
- 8.7% interest or dividends
- 23.9% Business, farm, self-employment income
- 2.3% capital gains
- 7.8% Social Security or retirement plans
- 1.5% transfers of societal benefits
That means the richer families - those making a median income of $238,000 per year - are generating vastly higher proportions of annual household income from combination of dividends,interest income, capital gains, and small business profits. The rich are much less likely to sell their time for a paycheck and, instead, own equity in a firm of some sort.
Tag :
Beginner's Investing,
Education Remains the Best Financial Investment a Person Can Make
Still plowing through economic data as part of my day-to-day work at the office, I am now examining the household income of various demographic groups. Median household income in 2010 (the latest data available) based on educational attainment was as follows:
- No high school diploma = $23,000 per annum
- High school diploma = $36,600 per annum
- Some college = $42,900 per annum
- College degree= $73,800 per annum
That amount is where half of the people in your category make more than you and half make less. Over a lifetime, the cumulative dividend from a college degree is in the millions of dollars. Value investing works in this area, too, because the key is not to overpay for the degree by taking on too much student loan debt or picking a discipline that doesn't monetize well unless you can afford such a luxury.
Tag :
Beginner's Investing,
52% of American Families Report Saving Money Each Year
When it comes to investing, there are three ways you can make money from owning a share of common stock.
The initial dividend yield you collect
The growth in intrinsic value per share, which will fund dividend increases and capital gains
The change in valuation applied to the firm's earnings (i.e., how much every $1 in profit is valued)
When it comes to owning a bond, there are also three ways you might be able to make money.
The interest income you receive on the money you loaned the bond issuer.
The capital gains generated by buying a bond prior to a drop in interest rates or following an increase in the credit quality of the bond itself.
Special operations from unique circumstances, like conversion privileges being attached to a bond allowing you to swap it for common stock under certain scenarios.
When making a new commitment with your hard-earned money, it's often best to identify, clearly and specifically, how you think you are going to make your profit. This one disciplined practice can help you avoid major bubbles as others get washed away by over enthusiasm, paying too much for their holdings.
Tag :
Beginner's Investing,
The 3 Ways You Can Make Money Investing In a Stock There Are Only Three Possibile Sources of Profit for You as an Outside Investor
Renoir once said, "Nothing is as disconcerting as simplicity." He was correct. Investors demonstrate this every day by behaving irrationally when it comes to managing their portfolios. They try to be clever or outsmart their neighbor when what they should be doing is focusing on buying high quality assets, structuring their acquisitions in a tax-efficient manner, and growing richer with each passing year.
Let's take a moment to look at investing in stocks to illustrate how simple the process is. The future value of stock must equal the sum of three components:
The initial dividend yield on cost
The growth in intrinsic value per share (for most firms, this amounts to the growth in earnings per share on a fully diluted basis)
The change in the valuation applied to the firm's earnings or other assets, often measured by the price-to-earnings ratio
That is it. Those are the only three ways that someone who invests in stock can benefit economically. He can collect cash dividends, he can share in the proportional growth of the underlying earnings per share, and he can receive more or less for every $1.00 in profit a company generates based upon the overall level of panic (fear) or optimism (greed) in economy, which in turn drives the valuation multiple.
For some companies, such as AT&T, the first component (dividend yield) is substantial. For others, such as Microsoft for the first 20 years, it isn't because all of the return comes from the second component (growth in intrinsic value per fully diluted share) as the software giant grew to tens of billions of dollars in profit annually. At all times, the third component, the valuation multiple, is fluctuating but has averaged at 14.5x earnings for the past 200 or so years in the United States. That is, the market has historically been willing to pay $14.50 for every $1.00 in net profit a firm generates.
Using These Three Guidelines to Project Future Returns on Your Stock Market Investments
Imagine you want to invest in a lemonade stand that has only one (1) share of stock outstanding. The lemonade stand owner offers to sell you this share of stock. Your initial dividend is 4%. The business grows at 10% annually. You hold the share for 25 years and expand the company before selling it.
The historical price to earnings ratio for the stock market is 14.10. Today, the S&P 500 is valued at a p/e of 14.07.
At today's prices, I think there is considerable evidence that an investor buying and holding a low-cost index fund such as the S&P 500 for the next 25+ years and reinvesting all dividends has a good probability of earning the historical real (inflation-adjusted) rate of return on capital of 7% compounded annually. In terms of purchasing power, that would turn every $10,000 invested into $54,274 before taxes, which might not be owed if you held your securities through a tax-advantaged account such as a Roth 401(k) or Roth IRA.
Over the next 50 years, the same $10,000 investment could grow into $294,570 in real, inflation-adjusted terms. That is a 30 year old man or woman parking money until he or she is Warren Buffett's age.
Stated another way, if you are a 30 year old investor and you put $100,000 in an S&P 500 index fund through a tax-advantaged account, you have a very good shot at having purchasing power equal to $3,000,000 by the time you are Warren Buffett's age without ever saving another penny.
This Is the Rational Approach You Should Use to Investing Your Money
Looking at your stock investments rationally is the only intelligent way to manage your wealth. Whenever you are considering acquiring ownership in a business - which is what you are doing when you buy a share of stock in a company - you should take out a piece of paper or index card and write down all three components, along with your projections for them.
For example, if you are thinking about buying shares of stock in Company ABC, you should say something along the lines of, "My initial dividend yield on cost is 3.5%, I project future growth in earnings per share of 7% per annum, and I think the valuation multiple of 25x earnings that the stock currently enjoys will remain in place."
Seeing it on paper, if you were experienced, you'd realize that there is a flaw. A 25x multiple for a stock growing at 7% per annum in today's world is too rich*. The stock is overvalued. Either the growth rate needs to be higher, or the valuation multiple needs to contract. By facing your assumptions head-on, and justifying them at the outset, you can better guard against unwarranted optimism that so often results in stock market losses for the new investor.
Tag :
Beginner's Investing,