This is a five part series written by Trent of Stock Market Beat and each part will be published this week. In Part 1 we showed how to calculate the present value of a cash flow that is expected to be received in the future: divide it by (1 + r)n. In Part 3 we concluded by saying the value of a stock is the present value of all the dividends the shareholder will receive, plus the present value of whatever it will be worth when the investor decides to sell it. Simple, eh?

Sure. Until you consider that an investor may hold the stock for many years (we used 35 years as an example in Part 2) and both the dividend and the stock price will grow at an uncertain rate in the future. For our investor, that means first forecasting each dividend for the next 35 years, as well as figuring out what the stock price will be in 35 years, then calculating their present values as follows:
D1/(1+r) + D2/(1+r)2 + D3/(1+r)3… + D35/(1+r)35 + (Ending Stock Price)/(1+r)35. At this point, you are probably thinking “never mind. I’ll take my chances with the lower return on bonds.”

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This a guest post by Raj Dash, a personal finance blogger who writes at World Wealth View.

One mindset that is crucial to increasing your wealth is to stop thinking linearly and thinking in “compound” terms. Previously, I’ve discussed how it’s easy to believe that saving $50 or $100/month is not much and thus not worth doing. But that is thinking linearly. Let’s look at saving $50/m over 10 years, using a variety of investment vehicles. Fifty dollars becomes a lot more than you’d think. No amount is too small to save, and fifty dollars is a lot easier to save than a hundred, if you’re struggling. Or undisciplined.

Here’s the general plan: stop thinking linearly and save at the highest rates you can find, without paying ridiculous service fees or penalties. Pretty simple plan, right?

Sure, 10 years X 12 months a year X $50 per month is only $6,000. That’s still $6,000 you wouldn’t otherwise have saved but if you leverage your savings by using online savings accounts, money market accounts or funds, CDs, index mutual funds, and maybe later on, stocks or DRiPs (Dividend Reinvestment Plans), you’ll have more than $6,000 saved in the same time period. Or you could eat that $6,000 in extra donuts and coffee every day for the next ten years. You choose.

Online Savings Accounts
Let’s start with an OSA (Online Savings Account), where we’ll put the savings for the first three years. See the spreadsheet I’ve set up for you. With all the competition right now in the OSA market, interest rates keep changing. Which one you choose depends on whether you think you’ll be taking money out, or even adding extra contributions in. Some OSAs have a minimum balance requirement, and a long list of service fees if you don’t maintain that minimum.

To make it simple, let’s say that the interest rate on your OSA is 4%, compounded daily, no minimum. That means the %APY (Annual Percentage Yield) is (1 + (0.04/365)) ^ 365 - 1 = 4.08%. In other words, $50 left for a full year will be worth $52.04. Still doesn’t sound like much, but stay with me.

After 3 years, with 4% compound interest, saving $50 each month turns into approximately $1915. Nearly two grand saved, simply for cutting back on some discretionary expenses. What if you were able to add an extra $25/m in the second year and an extra $50/m in the third year? You’d have about $2845. Sounding a bit better? Almost an extra $1000 in the same amount of time, just for being a bit more spending-conscious (and thus savings-conscious).

Now that you have some significant savings - but not enough to retire on - you should consider longer-term deposits at higher interest rates.

CDs, Money Market Accounts or Money Market Funds
These are three types of investment vehicles that people sometimes confuse. Money Market Accounts (MMAs) provide a high interest rate on your balance. Money Market Funds (MMFs) are mutual funds, which are not protected by the FDIC. They tend to keep the same unit value, with fluctuating interest rates.

MMFs will often pay out higher than MMAs, but could be risky. (Although that tends to be rare with MMFs.) The interest from an MMF can usually be rolled into purchasing more units. Some MMFs require a term deposit. Here’s an article that compares money market accounts and money market funds in more depth.

Another term deposit is the CD, or Certificate of Deposit. (In some countries, these are called GICs, or Guaranteed Investment Certificates, but amount to the same thing.) CD term durations are often 90-day or 1-year multiples, and interest rate increases with duration. But because of the term commitment, not everyone likes them. It all depends on your personal needs. If you think you won’t need to spend the money soon, go for the CD. If you can afford a bit of risk, try the MMF. Alternately, you may want to split your investment amongst several choices, to reduce risk yet remain mostly liquid.

Again, if you’ve learned enough discipline after several years to invest long-term, pick a CD. For the purpose of an example, let’s pick a CD that pays at least 4.50% for a 3-year term. Remember that you have either $1915 or $2845, depending on how much you saved each month in years 2 and 3. Plus you’ll be depositing at least $50/m.

Check the spreadsheet, and you’ll see that after the second three years, you’ll either have about $4,120 or $9,020. The $410 savings is if you are depositing only $50/m. The $9,020 is if, each year, you’re increasing your monthly contribution by $25. Thus, in the sixth year, you would be saving $175 each month.

If you’ve got the hang/ habit of saving by year six, you might want to consider buying some stocks or index mutual funds, to increase your yearly return.

Index Mutual Funds and Stocks
Neither mutual funds nor stocks are insurable. So if the value of your investment goes down, the loss is gone, unless you can recoup it in the future with some luck. While you can write off your losses against your income, it’s still disheartening.

Stocks are potentially very risky, and share prices require careful watching. Index funds are less risky, but only if you apply DCA, or Dollar Cost Averaging. This is the act of buying the same dollar value each month of an index fund, thus evening out the unit-price spikes of some months.

Say that when you start, the index fund you purchased was at $21 per unit. Divide the amount of money you are investing (in this case either $4,120 or $9,020). That’ll give you the number of units you’ll own. Then, if you are investing $50/m, you’ll get $50 worth of units at whatever price they’re at in a given month. (Funds allow fractional unit ownership.) So when the price drops, you might still be investing only $50, but you’ll be getting more units. Then when the market rises, the index fund’s unit price rises, so you are getting less units for that $50/m, but your overall index fund value will rise.

It’s hard to say what percentage return an index fund will give you using DCA. In the past, it’s been as high as 11-12% over a long term of 5 or more years, especially for an index fund tied to the Dow Jones Index. Whatever the case, applying DCA on an index fund is likely - but not guaranteed - to give you a better return than a money market account, money market fund, or CD.

Simply for the sake of an example, let’s say 7%. Very conservative. You might do better. I’m making this up, because I have no idea what a fund’s unit price will be each month for the four years remaining in our example. You’ll put your savings from the end of year 6 into an index fund, and contribute at least $50/m.

Thus, with your money in an index fund for years 7-10 (4 years), you’ll end up with about either $8,225 or $24,850, depending on how much per month you are saving. So that paltry $50 a month could be worth over $8,000 in 10 years. Saving a little bit extra in later years might generate nearly $25,000.

Now do you think $50 a month is not worth saving?

Fandango is giving away tickets to an An Inconvenient Truth if you use the promotion code AnInconvenientTruth3, there is a $1.00 service charge for Fandango’s service. If it’s playing at a local AMC, you can also try on a pair of jeans at American Eagle and get a free ticket that way too. If you’re curious what it’s about, visit the Inconvenient Truth homepage (at least I think that’s the homepage).

Update: Some people were not charged a service fee, I’d try this out myself except I’m in Lake Tahoe now and I’m not going to a movie.

This is a guest post by Figure Eight, who apparently looks younger than she is (lucky!), and she blogs over at Figure Eight (blog has since been removed).

I’m someone who looks quite a bit younger than I am. Not long ago, I was pulled over by a traffic cop after I misread a sign and made an ill-advised left turn.

He took my license and registration back to his car, and when he came back to my car, he was laughing. “You must get carded all the time,” he said. He went on to tell me that he was in the business of sizing people up, and he was rarely wrong. “But I looked at you,” he said, “and I thought: 22, maybe 24 tops.”

He let me off with a warning–partly, I think, out of surprise.

I guess I can’t help the fact that I look young. I think it has something to do with the long hair, minimal make-up, and casual clothes. I would say it’s my genes, except for the fact that my younger sister—who is eight years younger—has been taken as older than me since she was 13.

Not long ago, I went to Home Depot for a kitchen redesign. I paid $60 for someone to come out and measure my kitchen, then sat down with a designer to decide what we would do. Before long, I got the sense that his heart wasn’t really in it. After every small decision we made, he would say: “Well, let’s find out what that costs.” And he would calculate the cost and then look at me, as if he expected me to panic or flee. I made three separate trips to Home Depot before we finalized the design, and he was supposed to send it out for a labor quote, but that never happened. The designer left the store, and things fell between the cracks, and after a few misbegotten attempts to resurrect the process and order something, I called the manager and got my money back. I’m now repeating the process (with slightly more success) with Lowe’s.

I’m finding out that the kitchen design center at all the major home improvement stores are massively understaffed. And yet I can’t help but wonder if the kitchen designer looked at me and thought I was too young to be a serious customer. If so, it was his (expensive) mistake. But it was also a waste of my time. Still, short of marching in and announcing, “I may look young, but I’m quite flush and I’m planning to pay cash for this kitchen renovation” I’m not sure how to go about correcting the impression. Thoughts?

Figure Eight is a New England-based writer and editor who’s been reading financial blogs almost as long as they’ve existed. She was recently inspired to start her own blog, which covers financial subjects, but from the perspective of finding out how to cultivate an enjoyment of what you already have.

This is a five part series written by Trent of Stock Market Beat and each part will be published this week. In Part 1 we demonstrated how to calculate the future value of a dollar today, or the present value of a dollar in the future. In Part 2 we explained why investors in stocks want more dollars in the future than investors in bonds. Now we get to the nitty gritty: where do the dollars come from when you buy a stock?

The most common thing people look at is the company’s earnings, which can be divided by the number of shares outstanding to get Earnings per Share (EPS). Very often people refer to Price to Earnings (P/E) multiples when looking at stock values. The long-term average P/E multiple for the stock market (and also the present multiple) is about 16x. That means that a stock with $1.00 of EPS is trading, on average, for $16.00.

You can also turn the P/E multiple upside-down to get E/P, which is also called the earnings yield. Using the same example, a P/E of 16x equates to an earnings yield of 1/16, which equals .0625 or 6.25%. The Federal Reserve did a study one time that showed that the earnings yield on stocks has historically been followed the yield on 10-year government bonds. Gabe Harris created a chart of the relationship:

At the very least, it offers a basis for comparison. You can look at the 6.25% yield on stocks and compare it to the 5% yield on a CD to decide whether the extra return is worth the extra risk of owning a stock.

But didn’t we say that on average stocks have paid 4% to 6% more than risk-free assets? How can that be if the earnings yield on stocks is the same as the yield on bonds? The reason is that, in addition to any current payments, stocks also tend to grow in value over time. So the total return on the stock is the current yield plus any growth in the value of the stock over time. In essence, the Fed Model shows that it is that growth that compensates for the additional risk of stocks.
This brings us to the fact that earnings might not be the best measure of cash flow. If you buy a stock and the company earns $1.00 per share, they don’t give you $1.00. Usually they keep some or all of their earnings to invest in their growth.

Even if you ask for it, they won’t give it to you. Even though by owning a share you are part-owner of the company and “entitled” to your fair share of the earnings. Although they can be useful when comparing the value of companies, or the ability of companies to grow and return money to shareholders, they might not be appropriate to determine the money a shareholder can expect to receive.
From the shareholder’s perspective, the two sources of cash flow from a stock are the growth in value and any dividends the company pays. Dividends are similar to the interest payments on a bond. They are usually paid out on a quarterly basis and quoted as an annualized yield.

For example, Verizon pays out a dividend of $0.405 per share per quarter, or $1.62 per year. At the recent share price of $32.24 this equates to a 5.0% yield, similar to that available in government bonds.

So now we can get to the heart of what a stock is worth to an investor. It is the present value of all the dividends the shareholder will receive, plus the present value of whatever it will be worth when the investor decides to sell it.

William Trent, CFA has been a securities analyst since 1996. Since March
2006 he has been the editor of
StockMarketBeat.com;.
Prior to that he was Senior Equity Analyst for New Amsterdam Partners LLC,
which manages $6 billion for pension funds, endowments and other
institutions. His experience covers all market-cap sizes and is primarily
within the TMT (Telecom, Media and Technology) and Transportation sectors.

This is a guest post by frugal and was originally published at 1stMillionAt33.

The annual 401k contribution limit is $15K in 2006 now. Every year I always contribute to the max allowed by the law. My company allows the worker to contribute up to 60% of the salary. 60% of my salary at about $100K is $60K, far exceeding over the $15K annual limit. At the first thought, one would think that 60% is probably for the people whose salary is around $25K, but choose to crazily contribute 60% of the income into 401k account. Obviously, I don’t know of anyone who can live on a $25K - $15K = $10K pre-tax income. But after a little contemplation, I foud out this trick of earning extra 1.45% return without any risk in my 401k account.

Here is how I do it. I simply contribute at the maximum possible rate of 60% at the beginning of every year. My investment choice is usually cash/bond at Fidelity which is yielding about 3.8% APR. Now if you look at the following comparison table, using 26 bi-weekly contributions:

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Yeah, you read that right, Penny Nickel of Money and Values put together the thirty-second Festival of Frugality in Limerick Form. It’s absolutely amazing and it must have taken a lot of time, if you have any time do please visit and marvel at the hard work Penny’s put in.

No, this isn’t going to be a post about Cher and fish-net stockings, it’ll be a metapost about what I would’ve done differently if I had to start my blog all over again. I’d have to say I’ve been pretty lucky and I haven’t made as many mistakes as I could’ve but most of my mistakes have been with respect to interaction with other bloggers - reading their sites, communicating with them, etc…

1. Name of my blog: Blueprint for Financial Prosperity is just too long of a name for a blog, I wish I spent a little more than ten minutes thinking up a name. While I do basically layout a blueprint, my blueprint towards prosperity… certainly a name with fewer than 129304823094823 letters would’ve been better.

2. Contact other bloggers sooner: JLP was the first personal finance blogger I ever sent an email to and that was quite possibly a month after I started blogging. A month! If I started over, I would’ve emailed every single blogger I knew just to say hello and ask them anything to open up a dialogue. Back then there weren’t things like MBN Forums where bloggers in the personal finance/investing/money niche could connect and share tips and ideas but if there were I’d be the most prolific member out there… in blogging it’s all about communicating with your peers and learning as much as you can.

3. Subscribed to blogs via RSS sooner: The first time I discovered RSS, I used some application installed on my PC instead of ubiquotous web based app like Bloglines - wow what a mistake. Plus, I didn’t even use RSS often in the beginning to keep up with what was going on in the world, what people were talking about, what was hot at the time. What a mistake… now I periodically read close to two hundred feeds. Granted, I don’t hit up each feed every single day but I do peek in at least once a week. There is so much stuff out there that visiting each site is impossible.

I’m sure there are many others that I can think of but none as big as the three I’ve just listed. I think the most valuable thing about blogging is it lets you connect with people you otherwise wouldn’t have.

This is a five part series written by Trent of Stock Market Beat and each part will be published this week. This is part two of the series, in part one we explained that a dollar today is worth more than a dollar in the future, and showed how to calculate exactly how much more. Now we will show you how you can apply the same principle to stocks to determine how much they are worth today.

The trick is to determine how much money you are going to get in the future. With a CD you know how much you are going to get, and can be pretty sure you get it. With a bond issued by a large company, you know how much you are going to get, but it is possible the company will go bankrupt and you won’t get it – so they have to pay you more to make up for that risk.

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This is a guest post by Jason of Pragmatic Finance.

Let me just say that I only have experience with Capital One’s credit cards and not any of their other services. But my experience with their cards has made me weary of ever looking into using them for any other financial services. Last month I received a letter in the mail telling me they doubled the limit on my platinum card with them and I would be receiving an upgrade to their no hassle rewards card. Sounds great? Well, it would be if my original limit wasn’t only 300. And it has been that way for over two years since I opened it. I have called in the past to get it raised but have been told they don’t do customer credit limit increases.

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