General Investing Articles

Article / Updated 09-15-2022

Investing appears to be complicated and complex. But if you can take some relatively simple concepts to heart and adhere to them, you can greatly increase your success. Here are ten time-tested principles of investing success. Following these principles can pay you big dividends (and capital gains) for many years to come. Regularly save and invest 5 percent to 10 percent of your income: Do this as soon as you begin earning money on a regular basis. Preferably, invest through a retirement savings account to reduce your taxes and ensure your future financial independence. Understand and use your employee benefits: Often, the most valuable benefit you have through your employer is a retirement savings plan, such as a 401(k) plan that enables you to make contributions and save on your current income taxation. Thoroughly research before you invest: Be sure you understand what you're investing in. Don't purchase any financial product that you don't understand. Ask questions until you understand the risks and returns of the product. Shun investments with high commissions and expenses: The cost of the investments that you buy is an important variable you can control. All fees must be disclosed in a prospectus, which you should always review before making any investment. Invest the majority of your long-term money in ownership investments: With your long-term money, focus on investments that have appreciation potential, such as stocks, real estate, and your own business. When you invest in bonds or bank accounts, you earn a return that probably won't keep you ahead of inflation and taxes. Avoid making emotionally based financial decisions: Successful investors keep their composure when the going gets tough. You need the ability and wisdom to look beyond the current environment, understanding that it will change in the months and years ahead. Be especially careful about making important financial decisions after a major life change, such as marriage, the birth of a child, a divorce, job loss, or a death in your family. Make investing decisions based on your plans and needs: Your investment decisions should come out of your planning and your overall needs, goals, and desires. This requires looking at your overall financial situation first and then coming up with a comprehensive plan. Tap information sources with high quality standards: You need to pare down the sources you use to keep up with investing news and the financial markets. Give priority to those that aren't afraid to take a stand and recommend what's in your best interests. Trust yourself first: Look in the mirror. You'll see the best financial person that you can hire and trust. What may be missing is enough education and confidence to make more decisions. If you need help making a major decision, hire conflict-free advisors who charge a fee for their time. Work in partnership with advisors. Never turn over control. Invest in yourself and others: Don't get so wrapped up in making, saving, and investing money that you lose sight of what matters most to you. Invest in your education, your health, and your relationships with family members and friends.

Cheat Sheet / Updated 08-15-2022

Are you surprised that it's so hard to consistently earn money on the stock exchange? The explanation is as simple as it is sobering: It's because we are all human beings, with all the associated genetic dispositions that come with that fact. The neural structure of the human brain is the result of our evolutionary development. Your thought and behavior patterns, such as the deep-seated fight-or-flight response, continue to influence your decisions today on the financial markets. Your nature is not particularly well-suited to trading, but you can learn to do it. The human brain is capable of change and development. You can learn the mental prerequisites for brain-compatible trading. With the right mindset, you can recognize and avoid errors before they occur. The innovative discoveries of modern neurofinance research will lead the way to success factors for brain-compatible and, therefore, successful trading

Article / Updated 08-02-2022

Over the years, day traders have developed many different ways to manage their money. Some of these are rooted in superstition, but most are based on different statistical probability theories. The underlying idea is that you should never place all of your money in a single trade, but rather put in an amount that is appropriate given the level of volatility. Otherwise, you risk losing everything too soon. Calculating position size under many of these formulas is tricky stuff. That’s why brokerage firms and trading software packages often include money management calculators. Optimal F is only one method. There are other methods out there, and none is suitable to all markets all the time. Folks trading both options and stocks may want to use one system for option trades and another for stock trades. If that’s your situation, you have one big money management decision to make before you begin: how much money to allocate to each market. Optimal F The Optimal F system of money management was devised by Ralph Vince, and he’s written several books about this and other money management issues. The idea is that you determine the ideal fraction of your money to allocate per trade based on past performance. If your Optimal F is 18 percent, then each trade should be 18 percent of your account — no more, no less. The system is similar to the fixed fraction and fixed ratio methods, but with a few differences. The following figure shows the equation for finding the number of shares of stock, N, to trade according to the Optimal F method. F is a factor based on the basis of historical data, and the risk is the biggest percentage loss that you experienced in the past. Using these numbers and the current price, you can find the contracts or shares you need to buy. If your account has $25,000, your biggest loss was 40 percent, your F is determined to be 30 percent, and you’re looking at a stock trading at $25 per share, then you should buy 750 shares: The Optimal F number itself is a mean based on historical trade results. The risk number is also based on past returns, and that’s one problem with this method: it only kicks in after you have some trade data. A second problem is that you need to set up a spreadsheet to calculate it (so read Ralph Vince’s book if you want to try it out). Some traders only use Optimal F in certain market conditions, in part because the history changes each time a trade is made, and that history doesn’t always lead to usable numbers.

Article / Updated 08-02-2022

The Kelly Criterion is a method of management that helps you calculate how much money you might risk on a trade, given the level of volatility in the market. It emerged from statistical work done by John Kelly at Bell Laboratories in the 1950s. The goal was to figure out the best ways to manage signal-noise issues in long-distance telephone communications. Very quickly, the mathematicians who worked on it saw that there were applications to gambling, and in no time, the formula took off. Using the Kelly Criterion for trading is only one method. There are other methods out there, and none is suitable to all markets all the time. Folks trading both options and stocks may want to use one system for option trades and another for stock trades. To calculate the ideal percentage of your portfolio to put at risk, you need to know what percentage of your trades are expected to win as well as the return from a winning trade and the ratio performance of winning trades to losing trades. The shorthand that many traders use for the Kelly Criterion is edge divided by odds, and in practice, the formula looks like this: Kelly % = W – [(1 – W) / R] W is the percentage of winning trades, and R is the ratio of the average gain of the winning trades relative to the average loss of the losing trades. For example, assume you have a system that loses 40% of the time with a loss of 1% and that wins 60 % of the time with a gain of 1.5%. Plugging that into the Kelly formula, the right percentage to trade is .60 – [(1 – .60)/(.015/.01)], or 33.3 percent. As long as you limit your trades to no more than 33% of your capital, you should never run out of money. The problem, of course, is that if you have a long string of losses, you could find yourself with too little money to execute a trade. Many traders use a “half-Kelly” strategy, limiting each trade to half the amount indicated by the Kelly Criterion, as a way to keep the trading account from shrinking too quickly. They are especially likely to do this if the Kelly Criterion generates a number greater than about 20 percent, as in this example.

Article / Updated 07-19-2022

Among the mass market website tools and booklets focused on retirement planning, you should try T. Rowe Price’s Retirement Income Calculator. It walks you through the calculations needed to figure how much you should be saving to reach your retirement goal. The assumptions that you plug into this calculator are really important, so here’s a review of the key ones: Asset allocation: Enter your current allocation and then select an allocation for after you’re retired. For the retirement allocation, you can choose a fixed combination of 40 percent stock, 40 percent bond, and 20 percent money market fund. The calculator doesn’t include real estate as a possible asset. If you own real estate as an investment, you should treat those assets as a stock-like investment because they have similar long-term risk and return characteristics. (Calculate your equity in investment real estate, which is the difference between a property’s current market value and mortgage debt on that property.) Age of retirement: Plug in your preferred age of retirement, within reason, of course. There’s no point plugging in a dream number like “I’d like to retire by age 45, but I know the only way I can do that is to win the lottery!” Depending on how the analysis works out, you can always go back and plug in a different age. Sometimes folks are pleasantly surprised that their combined accumulated resources provide them with a decent enough standard of living that they can consider retiring sooner than they thought. Include Social Security?: T. Rowe’s calculator asks if you want to include expected Social Security benefits. We’d rather that they didn’t pose this question at all, because you definitely should include your Social Security benefits in the calculations. Don’t buy into the nonsense that the Social Security program will vaporize and you’ll get little to nothing from it. For the vast majority of people, Social Security benefits are an important component of their retirement income, so do include it. Based upon your current income, T. Rowe’s program will automatically plug in your estimated benefits. So long as your income hasn’t changed or won’t change dramatically, using the calculator’s estimated number should be fine. Alternatively, you can visit the Social Security website to get your latest estimate. Rowe’s analysis allows to you make adjustments such as your desired age of retirement, rate of savings, and to what age you’d like your savings to last. So, for example, if the analysis shows that you have much more than enough to retire by age 65, try plugging in, say, age 62, and voilà, the calculator quickly shows you how the numbers change.

Article / Updated 05-27-2022

Plenty of younger folks have debts to pay and lack an emergency reserve of money for unexpected expenses. High-cost debts, such as on a credit card, can be a major impediment to investing, in particular, and accomplishing your future personal and financial goals, in a broader sense. A high interest rate keeps the debt growing and can cause your debt to spiral out of control, which is why dealing with such consumer debt should be your first priority, just before establishing an emergency reserve. Pay off high-cost consumer debt Paying down debts isn’t nearly as exciting as investing, but it can make your investment decisions less difficult. Rather than spending your time investigating specific investments, paying off your debts with money you’ve saved may indeed be your best investment. Consumer debt includes borrowing on credit cards, auto loans, and the like, which are often costly ways to borrow. Banks and other lenders charge higher interest rates for consumer debt than for debt for investments, such as real estate and business, because consumer loans are the riskiest type of loans for a lender. Risk means the chance of the borrower’s defaulting and being unable to pay back all that he or she borrowed. Many folks have credit card debt that costs 18 percent or more per year in interest. Some credit cards levy interest rates well above 20 percent if you make a late payment or two. Reducing and eventually eliminating this debt with your savings is like putting your money in an investment with a guaranteed tax-free return equal to the rate that you pay on your debt. For example, if you have outstanding credit card debt at 18 percent interest, paying off that debt is the same as putting your money to work in an investment with a guaranteed 18 percent tax-free annual return. Because the interest on consumer debt isn’t tax-deductible, you would need to earn more than 18 percent by investing your money elsewhere to net 18 percent after paying taxes. Earning such high investing returns is highly unlikely, and to earn those returns, you’d be forced to take great risk. Consumer debt is hazardous to your long-term financial health (not to mention damaging to your credit score and future ability to borrow for a home or otherwise investments) because it encourages you to borrow against your future earnings. Tapping credit card debt may make sense if you’re financing a business. If you don’t have home equity, personal loans (through a credit card or auto loan) may actually be your lowest-cost source of small-business financing. Establish an emergency reserve You never know what life will bring, so having an accessible reserve of cash to meet unexpected expenses makes good financial sense. If you have generous parents or dear relatives, you can certainly consider using them as your emergency reserve. Just be sure you ask them in advance how they feel about that before you count on receiving funding from them. If you don’t have a financially flush family member, the onus is on you to establish a reserve. You should have at least three months’ worth of living expenses to as much as six months’ worth of living expenses as an emergency reserve. Invest this personal-safety-net money in a money market fund. You may also be able to borrow against your employer-based retirement account or against your home equity, should you find yourself in a bind, but these options are much less desirable. If you don’t have a financial safety net, you may be forced, under duress, to sell an investment (at a relatively low price) that you’ve worked hard for. And selling some investments, such as real estate, can take time and cost significant money (transaction costs, taxes, and so on). Riskier investments like stocks aren’t a suitable place to keep your emergency money invested. While stocks historically have returned about 9 percent per year, about one-third of the time, stocks decline in value in a given year, sometimes substantially. Stocks can drop and have dropped 20, 30, or 50 percent or more over relatively short periods of time. Suppose that such a decline coincides with an emergency, such as the loss of your job or a health problem that creates major medical bills. Your situation may force you to sell at a loss, perhaps a substantial one. Stocks are intended to be a longer-term investment, not an investment that you expect (or need) to sell in the near future.

Cheat Sheet / Updated 05-02-2022

Dark pools and high frequency trading (HFT) are contentious subjects in financial markets. Billions of dollars are traded through dark pools, and HFT algorithms with just small, incremental price differences make billions of dollars. And it all can happen in milliseconds. Most importantly, dark pools and HFT are part of the current market environment. Anyone who’s invested in the markets needs to know what they’re involved with and what they’re up against.

Cheat Sheet / Updated 04-06-2022

In high-level investing, investors and speculators track the major markets and critical global issues that affect stocks and other securities, both in the United States and other major markets. Check out the following sites, tools, and pointers to stay informed.

Cheat Sheet / Updated 03-17-2022

Money is the biggest component of the investing world, but time comes in a close second. When you combine the two, you have the potential to grow your money into a healthy nest egg. This Cheat Sheet offers some basic investing terminology and advice that will pay off with every dollar you invest.

Cheat Sheet / Updated 03-01-2022

Considering share investing? There are some fundamental aspects you need to be aware of before jumping in as a share investor in the UK. Avoid potential catastrophes and make the right investment choices by thinking ahead – take a look at the following points and tips.