Posts tagged 'Investing'
Learning about investing can be painless and dare I say fun. While treated typically as a dry, jargon filled topic, investing can be more enjoyable and more rewarding than assembling a fabulous shoe collection. Don’t believe me?
Shoes can cost you a fortune: they’re expensive to buy and, inevitably, they go in and out of style. Some even hurt your feet. While it’s true that investments can sometimes hurt – occasionally even worse than a pair of shoes – they can also make you a fortune. Investments can last a lifetime and, simultaneously, increase in value. With that fortune, you can buy more shoes and, if you practice what this blog suggests, you might even be able to buy a dress and bag to go with them.
A great shoe collection takes patience, planning, and strategy. So does investing. A great shoe collection makes you happy. So does a big bank account. A great shoe collection makes you feel good about yourself. So do profitable investments. Rather than become the proverbial little old lady who lived in her shoe, wouldn’t you rather become the smashing woman who used her investments to live her dreams in a fabulous house or condo while wearing stilettos?
October 12th, 2009
When you buy a bond, the elements I mentioned in my last post create a language which might sound/read like this: This bond has a face value of 1,000 dollars, a coupon of 6 percent, and a maturity of 10 years. The total principal of the bonds to be issued is $10,000,000.
If you bought this bond when the company originally issued it, you would pay 1,000 dollars to the company, receive a total of 60 dollars (1,000 dollars times six percent) of interest per year for the next 10 years, by check, from the company. When the bond matures, after the ten years are over, the company will send you back your 1,000 dollars. So the total amount of money you stand to earn on this bond is 600 dollars (the interest the company paid you over 10 years.) Plus, you will get your original principal back as well.
Remember how I have written about opportunity costs ? (See May 5, 2009.) Understanding the difference in the risk/reward profile between treasuries, and bonds is an example of just how important this concept is. Let’s assume you have 1,000 dollars to invest. Which should you choose: A CD, a US treasury or a corporate bond? Since the amount of money you have available to invest is finite, you have to make your decision based upon your risk tolerance and the interest rate, and therefore the return you can expect to receive. The CD will pay the lowest interest rate, but is federally insured so you do not run any risk of losing your 1,000 dollars. The US treasury will pay more interest than the CD and is an obligation of the federal government, but it is not insured or guaranteed by anyone. So it is possible, although highly unlikely, that you could lose some of your principal if the US government decided it couldn’t pay all its debts.
The corporate bond will pay more interest than either the CD or the treasury, but is neither insured nor backed by the federal government. Instead, it is backed by an individual company, and depending upon the financial health of that company, the bond might not repaid in full when it matures. As we’ve discussed, you will get paid more interest for loaning to a borrower who is less likely to pay back the loan. The less likely the borrower is to pay you back, the riskier the loan and the higher the interest rate. So while choosing a safe low paying investment is fine, it also means you will miss out on the opportunity to earn more if you can learn to pick healthy borrowers who pay a higher interest rate.
For now, know that bonds, whether from the US government or a company, are a sensible and versatile alternative for the beginning investor. Like flats, they can make almost any outfit look good and ensure comfortable feet!
Fashionista Fact:
In the United States, women spend approximately two billion a year to make their feet more comfortable from surgery correcting problems generated by tight-fitting shoes and bunions. There is even a treatment to help make high heels more comfortable which combats pain by injecting collagen or DermaFiller into the fat pad in the ball of the foot.
Generally, the higher the heel, the higher the risk for future foot problems. Comfort offers a lower return, while the return from style is much higher. But remember there is an opportunity cost!
August 14th, 2009
Why do companies issue bonds? If they need money, why don’t they just go to a bank and borrow it? There are a few reasons, but the main reasons are that borrowing from a bank can be very restrictive and very expensive—more expensive than selling a bond to the general public. In other words, banks are usually more conservative when it comes to investing than people are. (Unfortunately, this is not always true—I wish they had been more conservative before making all those home loans that could never be repaid.)
So it costs a company more to borrow from a bank than it costs them to borrow from you. Plus, when a company borrows money from a bank, the bank often tells them what they can and can’t do with their money. The banks give the company lots of rules, which are called covenants. For example, a bank might tell a company that the money can only be spent on one thing, like operations and not on expansion. Or the bank might say that if the present head of the company leaves the company, all of the money is due back to the bank immediately. Or the bank might tell a company how much cash it must keep on hand at all times. Sometimes the bank requires the company pay back the loan too quickly for the purposes the company is raising money for, like building a new plant.
Companies can find these rules stifling. So, instead of going to a bank for a loan, a company will issue a bond through the bond market. (Think of a bond market as a huge shoe store—where you can buy all different kinds of shoes. In the bond market, you can buy all different kinds of bonds.)
Company bonds are typically issued in 1,000 or 5,000 dollar increments. These increments are called the face value. Face Value really refers to your principal—the amount of money you paid for the bond. The face value has to be paid back to you within a set time frame, called a maturity. The time period in which the face value must be paid can vary from as little as 30 days to as long as 30 years and anywhere in between—there are bonds with even longer maturity dates than 30 years, but they are rare. But typically a bond’s maturity is seven to ten to fifteen years in the future.
Generally in exchange for borrowing your money and issuing you a bond (which is the piece of paper or contract that describes the terms of the loan), a company will periodically pay you interest. Interest is the fee the company pays you for borrowing your money and is no different from the interest the bank pays you. When interest is paid from a bond rather than from a bank, it is called a coupon. To reiterate, a coupon payment is conceptually no different from the interest the bank pays you for leaving your money in a savings account. And, just like with a treasury, the longer the company borrows your money, the higher the interest rate because the longer you are agreeing to tie up your money.
So, when a bond is issued, the bond issuer (the company borrowing the money) determines how much money they need to borrow, the total value of each individual bond (principal), how long they need to borrow the money for (maturity), and the fee they are willing to pay to borrow the money (interest rate or coupon).
August 7th, 2009
Just as flats are a sensible and versatile shoe for women, corporate bonds can a sensible and versatile investment for the beginning investor. A corporate bond is a loan to a company for a set period of time. If you have been reading this blog then you already know all about them – they are pretty much the same as US Treasuries. The exact same explanations and logic apply except that corporate bonds (or “Corporates”) aren’t guaranteed by the US Government. Rather, they’re guaranteed by the particular corporation from whom the bond is purchased. Therefore, they are a bit riskier than treasuries but, as a result, pay a bit more in interest (a “higher return”). (Remember, the lower the risk, the lower the return; the higher the risk, the higher the return.)
When you buy a corporate bond, you agree to loan your money to a particular company, rather than the US government, in exchange for interest payments that the company will make to you. You can buy corporate bonds from a lot of different companies (lots of different types of companies sell bonds), for example Microsoft or AT&T. Buying a corporate bond is considered riskier (less safe) than buying a treasury or savings bond. Why? Because treasuries and savings bonds are backed by the US government while a corporate bond is backed only by the particular company from whom the bond is purchased. And, unlike to government, a company can’t print more money or raise taxes to pay its debts.
Just like with treasuries, the company that issues the bonds you buy will return your money (your initial investment) plus the interest you’ve earned (the company selling the bond sets the interest rate at the time they issue their bond) once the bond has run its course at a later set date (maturity).
Usually you receive your interest rate payments in the form of checks, sent out within a set time frame, often semi-annually. Then, when the loan matures, you receive the full amount of your original loan back. The original amount you loan the company is called the “Principal”.
Company bonds usually refer to loans that are longer than one year, but like the US government, corporations can also issue shorter term loans. These shorter term company loans are called “Commercial Paper”.
More corporate bonds tomorrow.
August 5th, 2009
In addition to treasury bills, treasury notes and treasury bonds, the US government also issues savings bonds. There are two kinds of savings bonds: “I” savings bonds and “EE/E” savings bonds.
I savings bonds can be purchased for as little as 25 dollars up to a maximum of 5,000 dollars. They pay an annual interest rate which is adjusted twice a year based on the consumer price index. The consumer price index is a measure the government uses to calculate inflation. As the index changes, your interest rate rises or falls during the time period of your bond. This is how the amount of money your money earns for you keeps up with the rate of inflation: when inflation is high, you earn more interest; when inflation is low, you earn less interest.
Note: Inflation is the reason keeping your money in a shoe box or under the bed is a bad idea. A dollar today will buy more than that same dollar tomorrow. If you put your money in a shoe box, and decide to spend it ten years later, the amount of money you put in will be worth less (you will be able to buy less with it) than you would have at the time you tucked it up in your closet.
Note #2: Fashionista Fact:
Manolo Blahnik’s first shoe collection appeared in 1972, when after presenting the legendary Vogue editor Diana Vreeland with some theater design sketches, she advised him to “go with the shoes”. Today, a pair of his fabulous shoes (known to Fashionista’s everywhere simply as Manolo’s) start at 500 dollars. In 1972, they would have cost 102 dollars—102 dollars in 1972 is the same as 500 dollars today. That’s inflation at work.
The interest paid is added to the value of the bond each month and is paid to you when you cash the bond I savings bonds must be held for one year but can be held as long as thirty years. There are some penalties if you hold them less than five years, but the maximum penalty is the forfeiture of three months interest.
EE/E savings bonds have many of the same characteristics as I savings bonds: they, too, can also be purchased for as little as 25 dollars up to a maximum of 5,000 dollars. They also must be held for one year but can be held for as long as thirty years. They have the same penalties as I bonds, forfeiting three months interest, if you hold them less than five years. However, unlike I savings bonds, EE/E savings bonds pay a fixed interest rate. Instead of calculating the interest rate based on the consumer price index as Series I bonds do, the interest rate is a combination of a fixed rate, which applies for the life of the bond, and a semiannual inflation rate which is calculated on an average six-month rate of interest on US government treasuries.
So the biggest difference between the two kinds of savings bonds is how the interest is calculated. And how the interest is calculated determines the interest rate you receive and, of course, reflects how hard your money is working for you.
You can buy savings bonds or treasuries, learn what interest each type of savings bond is paying, and otherwise get additional information at www.treasurydirect.gov. This website is managed by the Department of the Treasury. Reviewing this site is a good way to determine which of the two Series are best for you.
July 21st, 2009
The lowest risk investment class is those which are either federally insured or backed (meaning “guaranteed”) by the United States government.
Continue Reading July 14th, 2009
Let’s continue the last post. Why is an understanding of your personal risk tolerance important? Because if you decide to invest your money in anything more complicated than a CD, you’ll need to know how much risk you can stomach without getting queasy. Your risk tolerance helps determine what kind of investments you will be most comfortable with and where you should focus your attention.
Risk tolerance is different for everyone. You need to choose the risk level which feels comfortable to you. Most of the investments we will cover in this book are not federally insured. This means that if you lose any money, it’s gone. Obviously, some people tolerate this knowledge better than others. How do you know how much risk level you can stand? This quiz will help.
- Which Sex and The City Character do you most identify with: (a) Samantha, (b) Carrie, (c) Miranda, or (d) Charlotte?
- Which is your very favorite pair of shoes: (a) Stilettos, (b) Stacked heels, (c) Wedges, or (d) Flats?
- You are in Vegas! and you are down 500 dollars. How much money would you be willing to risk to break even? (a) Whatever it takes, (b) 1,000 dollars, (c) 500 dollars, or (d) nothing – you are done for the night!
- When do you stop to fill up the gas tank in your car: (a) not until I have to, (b) when the light comes on, (c) when the tank is one-quarter full, or (d) when the tank is half full?
If you answered mostly (a) you have a fairly high risk tolerance, (b) you have a moderate risk tolerance, (c) you have mild risk tolerance and, (d) you have very little tolerance for risk.
Note:
Any woman who regularly wears high heels understands the saying “no pain, no gain”. We all endure pain and discomfort in the name of fashion—and great looking legs—but we also know that those had to have them high heels could cause blisters, calluses, corns, bunions, lower back pain, and ankle sprains. Women everywhere know flats are inherently more comfortable. We balance—pun intended—how much we want the higher heels against the possibility of any pain or discomfort. Going after higher returns on our money requires the same balancing act. You must consider the risks of placing your money in less secure and more volatile investments against the security of federally insured but possibly lower returns. If you decide that your risk tolerance is low, that is perfectly okay. Flats are always “in” for a reason!
June 29th, 2009
I am thrilled to announce I will be on the radio discussing my new book. Please check my website (www.somanyshoes.net) for updated dates and times.
In the meantime, let’s discuss investing. Why should you think about investing your money? Why not just put it into a checking or savings account and let it sit there? Because investments offer a way for you to increase the money you invest by paying you a return.
One way to describe how fast your money is growing (or the increase in the value of your money), is through a concept called return on investment (ROI), a measurement of how efficiently your money is working for you. It is usually expressed as a percentage. It is an important concept to understand because ROI tells you how much your money will grow. Here is the formula for calculating your return on your investment: The gain from the investment minus the cost of the investment, divided by the cost of the investment
Note that while it is a math formula, it only uses subtraction and division. Let’s look at two examples.
Example one: you put 1,000 dollars into your savings account at the beginning of a year. The bank paid you interest on your money. Let’s assume you left the 1,000 dollars in there for the entire year and, at the end of the year, you check your savings account balance and see that you have 1,020 dollars. What was your return on investment? Your return on investment was 2%:
1,020 dollars minus 1,000 dollars equals twenty dollars.
Twenty dollars divided by 1,000 dollars equals 2%.
Example two: let’s assume you put 2,500 dollars into your savings account at the beginning of a year. You leave the 2,500 dollars in there for the entire year and, at the end of the year, you check your savings account balance and see that you now have 2,600 dollars. What was your return on investment? Your return on investment was 4%:
600 dollars minus 2,500 dollars equals 100 dollars.
One hundred dollars divided by 2,500 dollars equals 4%.
As you can see, in both cases you earned money, but the amount of money you earned was small. Your money earned money, but it could have earned more than it did. You work hard for your money and your money can work harder for you.
In a checking or savings account, your return on investment comes solely from the interest the bank pays you which are typically, fairly low amounts. However, in addition to checking and savings accounts, banks offer other kinds of accounts which pay higher interest.
One type of investment account that banks offer is called a certificate of deposit (CD for short). A CD is a special type of savings account and is a great place for a beginning investor to start investing their money. A CD differs from both a savings account and checking accounts because your money goes into a CD for a specific, fixed period of time (often three months, six months, or one to five years). During the period of time that you sign up for, you really don’t have access to your money. (In a regular checking or savings account, you can withdraw your money at any time you need to.) In a CD, if you pull your money out early, there’s a penalty fee. However, in return for leaving your money in the bank for so long, the bank pays you a higher interest rate than they pay on a checking or savings account. Once the period of time that you selected ends, you get back all of your money plus the interest your money earned for you. Then you can decide if you want to re-invest your money in another CD, selecting perhaps a different time period, or put it back into your checking or savings account.
Why is a CD a great place for a beginning investor to start? Because a CD pays a higher rate of interest than a checking or savings account and so you receive a higher rate of return (ROI) on your money. But because you can’t take your money out early without incurring penalties, you learn whether you have the tolerance to keep money tied up for some period of time. A CD is a way to check if you will miss having access to your money, without the risk of losing any of it. A CD is federally insured against losses, and allows you to begin to understand your personal risk tolerance.
More about personal risk tolerance and other kinds in investments in posts to follow.
June 24th, 2009
You thought you knew all about bonds – friendships, relationships, marriage, the hot one who actually did call the next day. So all this economic talk about rates and payments has you flummoxed.
In financial terms a bond is a loan to a company or to a government. When you buy a bond, you agree to loan your money to the company or government in exchange for interest payments they make to you and the return of your money at a later set date. You receive your interest rate payments in the form of checks, sent out within a set time frame. You receive the full amount of your original loan back when the loan matures. The interest rate you receive depends on how strong the company is. The stronger the company, the less risky the loan and therefore the less interest you receive. (Conversely, the weaker the company, the riskier the loan and the more interest you receive.)
Just as you have a credit score, so do companies and governments. Like you, the better their score, the lower interest rate they have to pay. Where are bonds traded? Just as there is a stock market, so is there a bond market. (See January 12 Stocks posting). However, unlike stocks, some bonds don’t have to be traded in the market. When bonds are not sold on the bond market the transaction is called Over the Counter (OTC).
Turns out, financial bonds are so much easier to comprehend than the real ones.
January 26th, 2009
There are as many different investing philosophies as there are fashions trends (According to Vogue.com Spring ’09 promises us: Nudes, metals, sky high stilettos, tribal, harem pants, and God forbid, jumpsuits.) The investing beginner should ignore this and choose with an eye towards the future, not just what is in style today. Day-to-day, stocks and stock markets, mutual and index funds will go up and down, sometimes a lot. If you did your homework before investing and kept current on your investments, you shouldn’t get overly excited either way.
There is a school of thought in investing that following crowd behavior – trends – creates opportunities. For example, if everyone believes denim jackets are back this season (Jcrew.com) and you spot the trend ahead of other people – you realize denim is going to be so this season before everyone else – you can profit by buying ahead of the crowd. You make money as denim prices increase.
However, there is also an investing school of thought who believes in eschewing trends: If denim is in, they ignore it and invest something else – such as leather. They believe that since everyone will be buying denim, and no one will be buying leather, denim will be over-priced and leather will be under-priced. When leather comes back into style, you profit because you bought leather when it was cheap and out of fashion.
Who is right? Both. However, unless you are a seasoned investor, remember, “Fashions fade, style is eternal.” Yves Saint Laurent
January 13th, 2009
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