Category Archives: Investing



The Fed Doesn’t Move on the Interest Rate – What Does this Mean for You?

will-interest-rates-rise

It’s been a little over a week since the Federal Reserve (or the Fed) announced it would not raise the interest rate as so many in the investment world were anticipating.  As a result, markets are down.  In fact, since the market closed on September 17th (the day of the Fed’s announcement), the S&P 500 is down 3%.

What is this “Interest Rate” you speak of?

Why it’s The Federal Funds Rate of course!  This is the rate charged by banks when they lend “overnight” money to other banks.  Banks are very particular about how much cash they keep on hand, so they borrow from other banks to keep their numbers tidy.  This rate typically affects what interest rates banks set on savings accounts and loans.  So, an increase in the Federal Funds Rate, would likely mean an increase in all interest rates.

Why raise it?

So, why is the Fed considering raising the interest rate.  This rate is currently set at 0.25% and hasn’t budged since it was lowered to that level on December 16, 2008.  Does 2008 ring a bell?  That’s when the last big stock market crash happened and we found ourselves smack in the middle of the Great Recession.  People and businesses don’t like to borrow money when the economy is in the tank.  So, to encourage borrowing, which tends to accelerate economic growth (at least in the short-term), the Fed dialed down the rate.  The idea was to get the economy back on track as quickly as possible.  But, the Fed is playing with fire.  If they keep the interest rate too low for too long, a back-draft of inflation can ignite causing prices to climb and consumers to stop spending, suffocating the economy.

So what does this non-move mean for you?

Well, for the typical investor, this shouldn’t mean too much. Yes, markets fell after the announcement, but that was a short-term reaction.  Don’t sell!  Just hold on and don’t panic.  The key to long-term investing is not reacting to the news of the day.  It’s probably only a matter of time before the Fed does crank up the rate.  But, no one can say for sure what time that will happen.  So for now, just keep your hands in your pockets.

What happens when rates do finally go up?

When rates go up (and they will), savers will rejoice and borrowers will lament.  Rates on savings accounts and some investment accounts will likely go up.  Rates on mortgages, car loans, student loans, and credit cards will also likely go up.  If you currently have a loan or two outstanding and the interest rate is fixed, you’ll be fine.  But if you have an adjustable rate, watch out!  Likewise, if you have lot’s of money in a long-term fixed-rate CD, you’ll probably kick yourself because your rate won’t budge.  But, if you own a liquid savings or money-market account, you might start seeing your rates inch back up above 1%.  Wouldn’t that be amazing!

Are you at all concerned about rising interest rates?



Got the Stock Market Queasies? Sidle up to Dollar Cost Averaging

Is the stock market roller coaster ride giving you a bad case of the queasies?  After Monday’s close, the S&P 500 was down 11% from its all-time high.  But, as the last week progressed, the S&P shot back up, closing on Friday 5% higher than Monday’s low.  No one is really sure what to expect next week with questions still looming about the declining economy in China, weakening oil prices, turmoil in the Middle East, and the dark silhouette of a Federal Reserve interest rate hike on the horizon.

If this wild ride is making you sick, consider taking a buddy with you.  I remember when I was a kid going on all the big kid roller coasters at Six Flags Magic Mountain for the first time.  The drops seemed gigantic, the turns looked terrifying, and the loops just looked impossible.  But, it never seemed too scary with a friend by your side to face the unknown.

In the wild word of investing DCA can be that brave friend.  Dollar Cost Averaging, or DCA, has been around for a while.  He’s reliable, never gets sick, and no matter how steep the drop gets, he always stays calm, cool, and collected.  DCA is an investment strategy where you invest a fixed amount of money at regular intervals over a long period of time.  So, let’s say you invest $100 every month.  A year goes by and everything seems fine and dandy until suddenly, in one month, the stock market drops 10%.  The next month you’re $100 will buy you 10% more stocks.  Let’s say the following month the market quickly rebounds, shooting up 5%.  This time, your $100 will buy 5% less.  In essence, DCA forces you to invest exactly how you should – buying more when the market is down and buying less when the market is up.  You might have heard the old saying, “Buy low, sell high.”  I prefer, “Buy more low, buy less high.”

You may already be friends with DCA and not even know it.  Does your employer take money out of your paycheck every two weeks and invest it in a 401k or other type of investment account?  Do you have an automatic investment plan setup at you brokerage firm that deducts a fixed amount from your checking account every month?  If so, congratulations!  You’ve been chumming it up with DCA this whole time!

DCA is the strong, silent type – often forgotten about, but always there for you.  He just sidles up next to you without saying a word.  Just standing there, quietly protecting you from the stock market ups and downs.  No one would ever mistake DCA for the life of the party. He’s never going to try to convince you to sell your investments before the market gets any lower or to hurry up and buy so you’ll be rich the next day when the market rebounds.  He’s never going to pitch that secret, “sure thing” stock that no one has ever heard of. He’ll never reward you with overnight riches, but he also won’t leave you poor and penniless.



Warren Buffett – A Fifty Year Success Story

BHTP LogoNow in case you’re new to the blog, I’m a pretty big fan boy of Warren Buffett and his investment strategies.  Who is this guy?  He’s the third richest person in the world building most of his wealth over the last fifty years as the Chairman & CEO of Berkshire Hathaway.  In this year’s annual report to share holders, Buffett and the Vice Chairman, Charlie Munger, took some time to look back at the history of a company that today, in Buffett’s own words, is a “sprawling conglomerate, constantly trying to sprawl further.”  Incidentally, A conglomerate is a company that owns multiple smaller companies.  Berkshire’s  more famous holdings include GEICO, Dairy Queen, Fruit of the Loom, and See’s Candies.  Here are some of the highlights…

“You can’t get rich trading a hundred-dollar bill for eight tens…”

Buffett is very candid about early mistakes Berkshire made including a couple of failed forays into the New England textile industry.  The worst mistake made by Berkshire seems to be it’s purchase of Dexter Shoes in 1993.  For the privilege of owning a company whose value tanked soon after being purchased, Berkshire gave up $443 million worth of stock that is now valued at $5.7 billion.  Ouch!  That seems just a little worse than trading a Benjamin for eighty bucks.

“Since I know of no way to reliably predict market movements, I recommend that you purchase Berkshire shares only if you expect to hold them for at least five years. Those who seek short-term profits should look elsewhere.”

Berkshire is a company built to stand the test of time.  Not only has it lasted, and grown significantly over the last fifty years, Buffett expects the company to continue grow by acquiring or investing in quality companies.  If you’re the type of investor that only sells when Halley’s Comet comes to town, Berkshire is the place to be.

“Berkshire shares should not be purchased with borrowed money. There have been three times since 1965 when our stock has fallen about 50% from its high point.”

Buffett has no doubt Berkshire will see this kind of 50% drop again.  When this happens, it’s the investor who speculates on leverage that will lose out.  If you’re considering hitching your wagon to the Berkshire star, be sure you’re investing with cash.

“it is entirely predictable that people will occasionally panic, but not at all predictable when this will happen.”

I simply stated way of saying markets will crash, but no one knows when.  The best you can do, is invest for the long-term and ride out the panic-driven dips that occur in the short-term.  It’s foolish to think you can time the market – buying and selling based on where you think the market is going.  It’s for this reason that Berkshire keeps plenty of cash socked away.

“Cash … is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent.”

It’s the same concept as you and I keeping an emergency fund around.  Too many companies (and individuals) fall into the trap of placing little value on cash holdings.  Why hold on to cash, when you can make far more money in the short-term investing those dollars?  Because bad things happen.  And, when that emergency hits, and it will, you’ll be glad you have cash to help you stay afloat.



Bonds. What the Heck are They?

EE Savings Bond
By United States Treasury, Bureau of Public Debt [Public domain], via Wikimedia Commons
You may hear recommendations here and there about using bonds to diversify your portfolio.  But, what are these “bonds” of which people speak so highly?  A bond is a loan in which you, the purchaser of the bond, act as the bank.  The government entity or company that issues the bond takes your money and agrees to pay you back in a certain period of time with interest.  If you’ve ever voted in a local election, you may have seen a school bond on the ballot to build new buildings or a city bond to fund some sort of grand construction project.  You’re voting on whether or not to allow your school district or city to issue bonds to investors.

Safety Means Small Return

Generally, bonds are considered to be a safer investment than stocks, but don’t offer as big of a return.  In fact, bond prices tend to move in the opposite direction of equities.  So, when the stock market crashes as it did in 2008, bond prices tend to go up. When the stock market is up like it is now, bonds prices tend to go down.  Bonds help smooth out the bumps in your portfolio.

Price Factors

The price of a bond is generally affected by three factors:

  1. Interest rates. As interest rates fall, bond prices tend to rise.
  2. Inflation: As inflation falls, bond prices also tend to rise.
  3. Credit ratings: The higher the credit rating of the bond issuer, the higher the price of the bond.
Junk

You may have heard of junk bonds in the news.  These are bonds that are issued by an entity with a low credit rating and so are much cheaper than your average bond.  These bonds are very risky, but are appealing to some because of their potential for a huge return.  Before you run out and buy, keep in my mind the odds are very much against junk rated bonds going up in value.

Diversification Tool

The general rule a lot of investment advisors use when recommending an investment strategy is to invest your age in bonds and the rest in stocks.  So, if you’re 35, you would invest 35% of your portfolio in bonds and 65% in stocks.  Once you reach 70 years old, you’re bond percentage will have ratcheted up to 70%.  The idea behind this being, as you get older, you’re less able cope with the ups and downs of the stock market.

Do You’re Homework

Bonds aren’t for everyone, including me.  But, before you decide if they’re right for you, it’s a good idea to know what you’re getting into.  I encourage you to do some more research.  Talk to a few different financial advisors.  If you then decide in favor of bonds, I would recommend one of two strategies:

  1. Stick with an indexed bond fund – something that follows an average of bond prices.  This eliminates much of the risk of picking the right bond.
  2. Short-term U.S. Treasury bonds.  These bonds are very low-risk and are the preferred bond of Warren Buffet.  But, he doesn’t use them as a way to make money.  Instead, he uses them as a way to store his cash.


I’m Not a Big Bond Guy, But I Might be When I Grow Up

Now, when I say “bond guy,” I don’t mean the mysterious love interest of Daniel Craig in one of the latest 007 movies.  I’m talking about the investment flavor and I’m not a big fan.

The advise handed out by your typical investment advisor, might be to diversify your investment portfolio in some mix of stocks and bonds.  The more conservative, old-school investors such as Benjamin Graham, might suggest a 50/50 split.  The trendy tip now a days is to invest your age in bonds and the rest in stocks.  So, if you’re 35, you would invest 35% of your portfolio in bonds and 65% in stocks.  Once you reach 70 years old, you’re bond percentage will have ratcheted up to 70%.  The idea behind this being, as you get older, you’re less able cope with the ups and downs of the stock market.

This article by Financial Samurai, makes the case for a little more aggressive diversification strategy: all stocks until you’re 35 years old, then start gradually mixing in some more bonds until you’re 75 years old.  Then you just cruise along with the rest of your life at the comfy-cozy 50/50 mix.

My strategy is a little more cut and dry – no bonds.  Why?  Well, I’m a really long-term investor, meaning, I buy investments with the intent of holding on to them for twenty plus years.  In the long run, the biggest risk is not market volatility, but loss of purchasing power and bonds have an average return that is half as much as stocks.  I don’t care if the market dips 50% like it did in the last crash of 2008.  The only reason to worry about a crash is if you’re looking to sell your investments and I’m not.  In fact, when the market crashes, everything is on sale and I’m pushing my shopping cart up and down the stock market aisles looking for deals.

Now, when I say “no bonds”, I don’t mean one hundred percent stocks.  You see, Mrs. Pennypacker and I currently own a home on which we pay a mortgage.  Even though we have a really low interest rate (under 3%), we pay extra on our mortgage every month.  This has two big purposes:

 

1. As we get closer to paying off the house completely, we lower our risk.  It becomes less likely that we will lose our home to foreclosure.

 

2. By paying extra on the mortgage, we in effect earn 3% on that extra we pay.  Not much, but it’s better than a savings account and it’s better than a 30 year U.S. Treasury bond.

 

While the stock market is booming, we’re diversifying our portfolio by “investing” in our mortgage.  Once I’m older and wiser and the house is paid off, I may look at putting a small share (no where near 50%) of our portfolio in short-term bonds (This is actually the Warren Buffet strategy – “…Put 10 percent of the cash in short-term government bonds and 90 percent in a very low-cost S&P 500 index fund…”).  But, more than likely, I’ll just stick with cash.  It’s more flexible and liquid than bonds, making it easy to buy more stocks if a sale comes my way.



Square Six – The Final Square

Last time we talked about squares, it was all about gearing up for your retirement.  Now that you’re done with that, it’s time for the fun part – build up your net worth and buying stuff.

Here are six things you can start doing as part of square six:

1. Save for your next car.    

Remember that car payment you were sending off to the bank every month?  Well, now is your chance to be your own bank and make that car payment to yourself.  In five years or so, you ought to have enough money saved up to buy the used car of your dreams.

2. Save up for a house. 

Are you renting?  Start saving up a down payment for a house.  Somewhere between 10 and 20% is pretty healthy.  The more you can put down, the less you’ll owe to the bank.  If you’re feeling really aggressive, save up and pay cash for the whole thing.

3. Pay off your house.   

Are you on a 30 year mortgage?  Do you have an interest rate higher than 4%?  (I know this sounds like the beginning of a bad a late-night infomercial)  If you answered yes to either of these questions, you might consider refinancing to a 15 year mortgage and/or a lower interest rate.  Then, start sending some extra money to the bank every month and get that mortgage paid off fast.  When that mortgage is done, your risk of foreclosure drops to zero and you’ll have more money to spend on the other things in this list.

4. Start buying additional index funds on top of what you’re already buying for retirement.    

This is probably the single best way to keep your net worth growing.  Open up a brokerage account and buy index mutual funds or ETFs.  Do this and you’ll be well on your way to financial independence.

5. Save up and buy rental property.  

This one is a little more challenging, but if you like the idea of owning real estate, rental property is a great investment.  Just make sure you save up the money and pay cash for your properties.  Otherwise, the risk of mortgaging these rentals can make you regret your investment.

6. Buy some fun stuff. 

You can also start saving for some fun stuff.  Is there somewhere you’ve always wanted to travel?  Maybe there’s a home renovation project you’ve had your eye on.  Perhaps there’s a charity you care deeply about.  Basically the world is wide open.  You can buy or do just about anything you set your mind to, as long as you save up for it first.

You shouldn’t pick just one of these things to throw your money at.  Divide your money up.  Do some fun stuff, but also do some wealth building.  Mrs. Pennypacker and I are currently working on numbers 1, 3, 4, and 6.  Once our house is paid off, we plan to add number five into the mix.