If all of your investment capital is kept in a single brokerage account there are likely better ways to make your money work harder for you. You may want to consider setting up a Roth IRA but let’s assume that you set up a traditional IRA that allows you to forego paying taxes on that money until you retire. Knowing that, we want to keep our realized gainers in or IRA and our unrealized gainers in our brokerage account. Here’s how to use it to keep more money out of the hands of Uncle Sam and in your account.

Realized Gainers

If you loaned a buddy $5 and told him that he had to pay you back $10, you would have a realized gain of $5 when he finally paid you. If the IRS found out, you would owe taxes on that $5. In the investing world, you can have realized gains by selling your investment for a profit or by earning dividends on your stocks and bonds.

You want your realized gainers in your IRA because you don’t have to pay taxes on those dividends or sales until you start drawing money from the account. This allows those realized gains to compound more rapidly because the IRS didn’t take any of the proceeds in the year that you earned them.

Not only will you keep your dividend paying stocks in your IRA, any fixed income investments like bonds and bond ETFs should have as their home, your IRA—most of the time. A rule of thumb among financial advisers is never to put a tax shelter inside of a tax shelter so your traditional IRA should not hold municipal bonds in most cases.

As Motley Fool says, IRAs and dividend stocks are like chocolate and peanut butter so as a general rule, keep any investment that is paying out a dividend in your IRA.

Unrealized Gainers

What if you loaned your buddy $5 under the same terms but he hasn’t paid you back yet? In the simplest sense, your $5 is an unrealized gain. The IRS can’t tax you on it because you haven’t pocketed the gains. You know that McDonalds stock that you bought that you plan to hold for 20 years? Put that in your brokerage account because as long as your gains are unrealized, you don’t have to pay taxes on the rise in value until you sell the stock for a profit. (Although you will have to pay taxes on the dividends that your McDonalds stock pays you)

I’m Not Warren Buffett

When Warren Buffett buys stock, he claims that his time frame is forever but what if you’re the type that picks stocks to hold for a much smaller time frame? If you pick the right high growth stocks, they will produce more income than the dividend payers. As Morningstar says, placing these stocks in your IRA may be a better bet.

Finally

Constructing a truly tax efficient portfolio is a difficult task for retail investors. Some financial advisers will show you how to position your holdings for maximum efficiency and only charge you a one time fee. The small fee for professional advice will easily pay you back many times over as your money compounds. There’s no reason you can’t get started on your own. If you remember the few general rules above, this will give you a good start.

Basic Rules to Make Your Portfolio More Tax Efficient from personal finance blog Bargaineering.com.

For most retail investors, they know of some of the more popular ETFs like the SPDR S&P 500 or the SPDR Gold Shares with the really cool vault full of Gold in an undisclosed location in the UK. What they don’t know about is the less flashy but equally important bond ETFs. Fixed income may not be exciting to watch but a large portion of the gains in a long term portfolio come from fixed income products or dividend paying stocks. Here’s how to add Bond ETFs to your portfolio.

What’s Wrong with Bonds

Why buy ETFs when you could just as easily buy bonds? Because buying bonds isn’t easy at all. First, bonds are often out of the price range of individual investors. Most bond brokers require a minimum purchase of $5,000 which may be out of the price range for most individual investors. Even if that’s within your capital level, it’s difficult to keep a diversified portfolio with that much money tied up in a single bond. Second, bonds are more difficult to buy and sell, and understanding the mechanics of bonds may be outside the scope of part time investors.

What’s a Bond ETF?

A bond ETF is a product that tracks the performance of a certain basket of bonds, a bond index, or other benchmark relating to bonds. The best reason to add these products to your portfolio is the advantage of giving you exposure to the bond world at any weighting you would like. If you only have a $5,000 portfolio but you want $1,000 of it in bonds, you can do that with bond ETFs.

You also get a level of diversification that you wouldn’t get purchasing individual bonds. Some Bond ETFs invest in hundreds of bonds so if one bond defaults it has little impact on the fund as a whole. No individual could achieve this kind of diversification and risk mitigation purchasing individual bonds.

Bond ETFs are also less volatile than individual stocks or stock based ETFs. Investors purchase bond ETFs to gain the dividend stream that comes as frequently as monthly on some ETFs but don’t expect a lot of capital appreciation.

How Do I Invest?

Although you don’t need an academic understanding of the mechanics of bonds, before investing in a bond ETF you should know how bonds work, how they’re priced, and the market conditions that affect their performance. Also understand bond ratings and how an investment grade bond differs from a junk bond. Click here to learn more.

Once you learn the basics, consider adding an investment grade bond ETF, an emerging markets or other foreign markets ETF, and a below investment grade or junk bond ETF. If you’re nervous about investing in below investment grade bonds remember that because these funds invest in so many bonds, the risk is largely mitigated.

With any ETF, you have to look at the fees. Some of the passively managed ETFs have very little fees where the more actively managed funds may have fees that are as much or more than some mutual funds. In general, keep the total fees below 1% although some actively managed funds may be worth a little more depending on performance.

Remember

All portfolios with the goal of long term growth should have some fixed income as part of their holdings. Bond ETFs are rapidly becoming the way to cash in on the yield that comes with fixed income investing without the hassle or diversification problems that accompany buying individual bonds.

Why Your Portfolio Needs Bond ETFs from personal finance blog Bargaineering.com.

Consider this – you can buy shares of blue chip companies with yields greater than 1-2%. You can start by looking at the dividend aristocrats but ultimately you can easily find safe companies who have stable cash flows capable of supporting dividend yields much greater than 1-2% (and you’re taxed at a much lower rate!).

In the end, both are financial tools that serve a specific purpose. Knowing which to use can be crucial in getting a little more out of your money.

Principal Risk

There’s no such as a free lunch. In return for those higher yields, you put your initial investment at risk. Here is where knowing your financial needs becomes crucial.

Are you looking at a 5 year CD because you need income? Or do you intend to buy a house in 5 years and you’re simply looking for a good home for your cash until then? If protecting your principal is goal one and interest is simply gravy, then CDs are the answer. Never let the hope of more money (greed!) distract you from the importance of protecting what you already have. If you’re looking to generate income and the principal is less important, at least in the short term, a dividend stock might make more sense.

If you can hold it for five years, or longer, chances are you can weather the ups and downs that come with a publicly traded company. As we’ve seen, a lot can happen in five years and it’s crucial to avoid knee-jerk reactions (which is possible if you’re not as worried about principal).

On the flip side, you also benefit from stock appreciation and dividend increases, which can be significant.

Transaction Costs

Buying a CD is very simple and it only costs your time. You’ll need to open an account, if necessary, and then deposit funds into the CD. When you get paid interest, you’ll add a few seconds to tax preparation to deal with the 1099-INT the bank will send you.

When you buy shares in a company, it’ll cost you both time and money. In addition to the account setup, if necessary, you’ll pay a commission when you buy the stock. You’ll also get a 1099 from the broker at the end of the year detailing the ordinary and qualified dividends. Alternatively, you can avoid some of these transaction costs by investing in a mutual fund like Vanguard Dividend Growth Fund (VDIGX), but you trade transaction costs for expense ratios.

Taxation

Here’s the big kicker – interest from a certificate of deposit is taxed as ordinary income. Dividends from a company, assuming they are qualified dividends, are taxed at long term capital gains. Ordinary income is taxed at your tax bracket whereas dividend income is taxed at a much lower rate.

Assuming you’re in the 25% tax bracket, a 1% APY CD is really a 0.75% APY CD, after taxes. A 5% dividend yield company is actually a 4.25% dividend yield company, after taxes. That’s a significant difference.

For the last few years, I’ve been building onto the inner wall of financial fortress and adding blue chip dividend companies. These aren’t the trendy hot tech companies like Pandora or Zynga, we’re talking nice boring companies like Diageo, Conoco Phillips, and Kimberly Clark. I like boring, especially if it pays slightly better than a CD.

Why Certificates of Deposit Suck & Dividends Rock from personal finance blog Bargaineering.com.

Facebook is more than the place you go to meet up with old friends; it’s a $25 billion company, twice as large as the much hyped IPO of 2011, Groupon. Wall Street investors are anxiously awaiting the emergence of Facebook in to the investing markets but when the hype gets even stronger, should you invest in the IPO?

What’s an IPO?

If you’re like most consumers, you’ve probably never heard of an IPO. An IPO or initial public offering is the first batch of company stock offered to public investors. A company may have issued shares to other investors but the IPO places shares in the public markets. The process of becoming a public company is complicated and expensive but here’s how it works. Larger companies pick one or more of the big investment banks to help with the process. These banks advise the company on what they can and can’t say publically during the IPO process as well as prepare all of the legal documents and help with the pricing of the IPO.

Then, a road show takes place. Company executives travel to big cities setting up meetings with large investors in the primary market. The primary market is made up of large institutional investors like investment banks, larger hedge funds, and mutual funds. If the road show goes well, the primary market will purchase all of the shares and offer them to some of their clients, which could be you. Very popular IPOs will leave very few shares left for retail investors to purchase. For companies like Facebook, it’s unlikely that you will be able to purchase shares at the IPO price before they trade publically.

Individuals like you and I, as well as the smaller institutional investors make up the secondary market. The secondary market is the market most investors understand as Wall Street. Some of the shares purchased in the primary market will enter the secondary market on the day of IPO where trading will begin.

Should I Buy?

Your broker may have purchased shares in the primary market making it possible for you to purchase shares at the IPO price but be careful. First, picking a stock with years of market data to examine is hard enough. An IPO has very little public information to examine. Second, IPOs only come to market when there is an appetite for stocks. The IPO date is timed to capture the highest price possible making it very likely that you’ll be forced to overpay.

Finally, a significant piece of the IPO market are stock flippers who will sell their shares within the first few days of the stock going public making the share price high on the first day but potentially much lower after that. In 2011, the average IPO was down 10.3%, according to Thestreet.com.

What’s Hot in 2012?

The hottest IPO of 2012 will be Facebook but others companies are set to go public this year. Electric car maker, Fisker Automotive, Groupon rival LivingSocial, cloud computing giant Dropbox, and real estate search site Trulia are a few of the others we may see in 2012.

Bottom Line

Think of an IPO like the newest piece of technology to hit the market. If you don’t mind paying a premium to be one of the first to own it, buying in to an IPO might be right for you. If you’re the type that would rather let other people pay the big money while you wait for all of the bugs to be worked out so you can buy at a lower price, stay away from IPOs. There will be plenty of time to purchase shares later

What’s an Initial Public Offering? from personal finance blog Bargaineering.com.

So how do you know if what you’re getting is a qualified dividend or an ordinary one?

What Makes a Dividend “Qualified”?

All dividends are considered “ordinary.” However, those that aren’t “qualified” are taxed as regular income. It’s in your best interest to ensure that your qualified dividends are recognized as such, and taxed accordingly.

According to the IRS, you ”must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.” This means that you need to look at the ex-dividend date, and then go back about two months. You must have held the stock for at least 60 days during the slightly more than four months previous to that. You can’t just purchase shares of a dividend paying stock a few days before the ex-dividend date, and then count the earnings as “qualified.”

When it comes to preferred stock, there are even more requirements from the IRS: “[Y]ou must have held the stock more than 90 days during the 181-day period that begins 90 days before the ex-dividend date if the dividends are due to periods totaling more than 366 days.”

Before you decide to consider dividend income as “qualified,” make sure that you double check how long you have held the stock, and ensure that you understand when the ex-dividend date is. This is all information that is made publicly available. You can also consult a knowledgeable tax professional to help you determine which of your dividends count as “qualified.”

Understand that if you use a DRIP to reinvest your dividends, you still have to pay taxes on what you were paid, even though you didn’t receive the cash directly. The exception is if the reinvested dividends are held in a tax-advantaged retirement account.

Dividend Income & Your Tax Return

When you earn money in dividends, it will be reported to you. If you are paid more than $10 in dividends from a source, you will be sent a 1099-DIV. Corporations, mutual fund companies and brokers send these out annually so that you can see what income you have from dividends.

You will find your total dividends received in Box 1a. In Box 1b, you will see the amount that qualifies for the capital gains tax — instead of being taxed as ordinary income. Finally, Box 3 offers non-dividend distributions, which are considered a non-taxable return of capital. When filling out your tax return, you will use those boxes to fill in the appropriate lines on your Form 1040.

If you have earned more than $1,500 in dividends during the year, you will need to complete a Schedule B, which will help you organize your dividend earnings from multiple sources.

(Photo: aidanmorgan)

What is a Qualified Dividend? from personal finance blog Bargaineering.com.

While your run of the mill coins aren’t going to bring you a great deal of riches, there are some collector’s items that are worth more than their face value. One example is pennies that were minted prior to 1983. These pennies are mostly copper — instead of being mostly zinc like pennies minted in more recent years. However, even those pennies can’t compare with some of the most interesting and rare coins in history.

Wikipedia has a list of the 10 most expensive coins sold. These coins have an interesting history, and one of them even sold quite recently:

1. 1794 Flowing Hair Dollar: The first dollar coin issued by the U.S. federal government was based on Spanish gold coins, which were widely circulated. States had their own mints, and other coins from different countries were also circulated. While the Flowing Hair Dollar didn’t completely replace other coinage, it did represent the first time the federal government became involved in creating money. The last buyer (a private sale) for this coin paid $7.85 million.
2. 1933 Saint-Gaudens Double Eagle: Unlike the Flowing Hair dollar, the Double Eagle was sold at auction and is the most expensive coin sold at auction, for $7.50 million. This is a $20 gold coin that never circulated officially. Many were actually melted down after the 1933 end to the gold standard in the U.S.
3. 1787 Brasher Doubloon EB on Breast: George Washington’s goldsmith neighbor cast this coin, modeled after Spanish doubloons. Even though not officially circulated by the U.S. government, the Brasher doubloon is thought to be the first gold coin in America that was denominated in dollars. This coin recently sold for $7.4 million.
4. 1804 Class I Silver Dollar: Interestingly, the coins bearing the 1804 date didn’t actually appear until 1834. The government began presenting them as gifts to foreign rulers. Some coins from Class I have been traced to the King of Siam, and legend has it that a Class I dollar was given to Anna Leonowens. In any case a Class I silver dollar sold for $4.14 million.
5. 1804 Class I Silver Dollar (Queller’s Collection): This specific silver dollar sold for nearly $3.74 million.
6. 1913 Liberty Head Nickel: One five of these rare, limited issue nickels are known to be in existence — none of them in perfect condition. These coins are so prized that there is speculation that a perfect coin could be worth nearly $20 million. The most expensive of these sold for about $3.74 million.
7. 1907 Double Eagle: This Saint-Gaudens $20 coin, in ultra-high relief, sold for $2.99 million.
8. 1787 Brasher Doubloon EB on Wing: Unlike the Brasher with the stamp on the chest, most of the surviving doubloons cast by the goldsmith have the stamp on the wing. This means that the this type of coin is rarer. However, that didn’t stop one of the coins from selling for $2.415 million.
9. 1804 Class III Silver Dollar: Most Class III 1804 silver dollars were actually made between 1858 and 1860. There are some design differences from the Class I versions. One of the Class III silver dollars sold for $2.3 million.
10. 1907 Rolled Edge Eagle: This particular gold coin design once sold for $2.185 million.

As you can see, the more unique the coin, the more it sells for. Additionally, there are coins that are valuable by virtue of casting mistakes and other quirks. Your “regular” coins aren’t likely to fetch a great deal, but with the right collection, you can still, with the right characteristics, find value.

(Photo: TahoeSunsets)

10 Rare Coins Worth Millions from personal finance blog Bargaineering.com.

The S&P announced a small change to their eligibility rules starting in 2012 (with this list) – only regular dividend payments will be considered for index eligibility purposes. Special dividends will not count and they will no longer count towards eligibility.

With ten additions and only one deletion, the current list has fifty-four companies on it.

2012 Additions

Last year, there were only three additions to the 2011 Dividend Aristocrats list, this year we can welcome XXX companies into the fold.

• AT&T (T)
• HCP Inc (HCP)
• Sysco Corp (SYY)
• Nucor Corp (NUE)
• Illinois Tool Works Inc (ITW)
• Genuine Parts Company (GPC)
• Medtronic Inc (MDT)
• Colgate-Palmolive Company (CL)
• T Rowe Price Group Inc (TROW)
• Franklin Resources Inc (BEN)

2012 Deletions

Only one company fell off, CenturyLink Inc (CTL), after it ended a thirty seven year run of dividend increases. Last year we saw the fall of Eli Lilly & Co and Integrys Energy Group after a 42 and 51 year streak, respectively, so it’s nice to see only one name grace this section of the article.

2012 Dividend Aristocrats

Here are your 2012 Dividend Aristocrats!

• 3M Co (MMM)
• AFLAC Inc (AFL)
• Abbott Laboratories (ABT)
• Air Products & Chemicals Inc (APD)
• Archer-Daniels-Midland Co (ADM)
• AT&T (T)
• Automatic Data Processing (ADP)
• Bard, C.R. Inc (BCR)
• Becton, Dickinson & Co (BDX)
• Bemis Co Inc (BMS)
• Brown-Forman Corp B (BF/B)
• Chubb Corp (CB)
• Cincinnati Financial Corp (CINF)
• Cintas Corp (CTAS)
• Clorox Co (CLX)
• Coca-Cola Co (KO)
• Colgate-Palmolive Company (CL)
• Consolidated Edison Inc (ED)
• Dover Corp (DOV)
• Ecolab Inc. (ECL)
• Emerson Electric Co (EMR)
• Exxon Mobil Corp (XOM)
• Family Dollar Stores Inc (FDO)
• Franklin Resources Inc (BEN)
• Genuine Parts Company (GPC)
• Grainger, W.W. Inc (GWW)
• HCP Inc (HCP)
• Hormel Food Corp. (HRL)
• Illinois Tool Works Inc (ITW)
• Integrys Energy Group Inc (TEG)
• Johnson & Johnson (JNJ)
• Kimberly-Clark (KMB)
• Leggett & Platt (LEG)
• Lilly, Eli & Co (LLY)
• Lowe’s Cos Inc (LOW)
• McCormick & Co. (MKC)
• McDonald’s Corp (MCD)
• McGraw-Hill Cos Inc (MHP)
• Medtronic Inc (MDT)
• Nucor Corp (NUE)
• PPG Industries Inc (PPG)
• PepsiCo Inc (PEP)
• Pitney Bowes Inc (PBI)
• Procter & Gamble (PG)
• Questar Corp (STR)
• Sherwin-Williams Co (SHW)
• Sigma-Aldrich Corp (SIAL)
• Stanley Works (SWK)
• Sysco Corp (SYY)
• T Rowe Price Group Inc (TROW)
• Target Corp (TGT)
• VF Corp (VFC)
• Wal-Mart Stores (WMT)
• Walgreen Co (WAG)

If you’re looking for a dividend stock, this is a nice list to start with. Just keep in mind that fortunes can change and that history is a poor predictor of the future.

2012 S&P Dividend Aristocrats from personal finance blog Bargaineering.com.

Numismatics, or the study and collection of currency, always seemed fun but I never got into it. In the past, I’d read about people collecting other coins for their melt value but the prospect of collecting per-1982 pennies because they’re currently worth two cents didn’t interest me. While I don’t really have much interest in searching through a pile of quarters, I do think that it’s fun reading about it.

Junk Silver

There’s a little corner of the investing world focused on investing in “junk silver.” Junk silver just refers to coins that have silver (usually 90%, also known as coin silver, because most of the suitable US coins have 90% silver) but are in circulated condition and thus have limited collective value above the value of the silver in the coins. They’re appealing because it often sells at the spot price of silver, the coins are still legal tender so the value has an established base, and it’s easy to break up the value. You would typically buy a bag of junk silver valued at $1,000 with 715 ounces of silver.

Which Coins are Valuable?

I found that the most useful site for finding about coin prices was coinflation.com and Wikipedia has a list of common US coins used for junk silver purposes. So I did a little research and collected some information on which “regular” coins might be worth a little extra. By regular, I just mean coins that you probably wouldn’t have known are valuable if someone didn’t tell you they were jam packed with silver.

• Half Dollars – Anything before 1964 is worth more than fifty cents. 1964 Kennedy is 90% silver, 10% copper as are 1948-1963 Franklins. I almost never see these out in the wild though, but worth mentioning.
• Quarter – Pre-1964 coins are the ones you want, with 90% silver and 10% copper. After 1965, coppers were made of 91.67% copper and 8.33% nickel which puts the metal value at under five cents. Before 1932, the quarter was a Standing Liberty Silver Quarter and it’s 6.25% grams of 90% silver and 10% copper. You’d know you had something special if you had a Standing Liberty quarter.
• Nickel – Composition hasn’t changed since World War 2 (75% copper, 25% nickel) and the metal value is a fraction less than the face.
• Penny – 1909-1982 pennies are 95% copper and 5% zinc, putting the metal value at a bit over 2 cents. After 1982, pennies are 97.5% zinc with a thin copper coating. 1982 pennies can be either and the only way to tell is to weigh them (copper pennies are 3.11 grams, zinc pennies are 2.5 grams).

Remember those wheat pennies? Those are always worth at least three cents but that’s based on collective/numismatic value and not metal value. I just wanted to throw that one in there. I think a pretty good rule of thumb is that if you have a coin before 1964, keep it because it’ll be worth more than face value.

Calculating Value

Calculating a coin’s value is very simple and you need just a few pieces of information:

• Value of the constituent metals
• Metal composition of the coin
• Total weight of the coin

Let’s take the quarter I found, the 1957 Washington Quarter. It’s weight is 6.25 ounces and it’s 90% silver, 10% copper. We have 0.625 ounces of copper and 5.625 of silver. You can either get the price of the metal in ounces or, if you go with the prevailing way it is quoted, make the conversion yourself. One thing to remember is that a troy ounce, which is used to weight precious metals, is more than a “regular” ounce, called an avoirdupois ounce, you are used to. Doing the proper conversions, we find the silver value to be about $4.8033 and the copper value to be less than half a cent. That puts the total value at around $4.81.

How about a quarter today? It’s 5.67 grams and 91.67% copper and 8.33% nickel. The copper in the quarter is worth almost 4 cents and the nickel is worth almost one. In total, it has a metal value of less than five cents.

Good luck and may you find a few valuable coins in your pocket!

(Photo: kevinl8888)

Finding Melt Value of Junk Silver Coins, or, How I Found $5 In A Field from personal finance blog Bargaineering.com.

Regularly Review Your Investment Strategy

For the buy and hold investor with a long-term strategy, there are few things worse than obsessively checking your portfolio every day or week. However, occasionally checking in to ensure that your investment strategy continues to meet your needs is a good idea. Here are some items to consider as you review your investment strategy

• Does your asset allocation still make sense? Your asset allocation will change according to your goals. As you reach certain milestones, such as sending a child to college or retiring, you might need to shift your asset allocation. Consider your timeframe, and what you expect to happen in the next few years.
• Overall, has your investment strategy been working for you? Consider how well your investment strategy has been working thus far. Have you been moving closer to your goals? Have circumstances changed that require some tweaking? Would a slightly different strategy better fulfill your financial requirements? Evaluate how well, overall, your investment strategy has been working.
• Has something changed fundamentally in your investments? Another consideration is what has changed about your investments. If there has been a fundamental change in your investments, such as a change in management, or a loss of market share, it might be time to change things up a little bit. You might actually have some losing investments that you can sell now to reduce your tax liability.

Before you switch things up in your portfolio, consider your situation, and re-evaluate your goals and needs as an investor. Measure your portfolio, long-term, against your approaching milestones, your current needs, and what you hope to accomplish with your investment portfolio.

If something isn’t working, or if your situation is progressing, it might be time to tweak things a little bit. It’s possible to shift your asset allocation, as well as switch things up, if you need to. Are you more interested in increasing your income right now? It might be time to move some of your assets into an income portfolio. Do you want a little more growth? Maybe it’s time to shift some of your assets out of bonds and into stocks. Consider your needs, and act accordingly.

You can also take your tax situation into account, and make some moves that just happen to improve your tax efficiency, while at the same time adjusting your plan to better reflect your changing priorities and situation. Your life isn’t going to stay still, and while you don’t want to make drastic changes without reason, it doesn’t make sense to continue what may not be working for you. Review your investment strategy, and make the changes necessary.

(Photo: thinkpanama)

End of the Year: Time to Rethink Your Investment Strategy from personal finance blog Bargaineering.com.

At first you might think that this is unfair, to spring an inactivity charge, but the requirements to avoid this are fairly low. If you have more than $2,500 in your accounts, you won’t be assessed the fee. If you don’t have that much, just make one trade. If you make just one trade, you won’t be assessed the fee. Paying $4.95 (or $9.90 round trip) is better than $50.

In my mind, if you have less than $2,500 and aren’t making any trades, your money is better off somewhere else (like a high yield savings account) anyway until you’ve accumulated more savings.

$50 TradeKing Inactivity Fee from personal finance blog Bargaineering.com.

Any time I read this I wonder why the investing community assumes that the relatively inexperienced investor has any idea what their risk tolerance or time horizon actually is. There are untold thousands of articles floating around with this phrase but very few telling you how to figure it out although it seems that it may be important to know.

In fact, it is important! Before you do anything you have to know both of these. You’ll find that what you believe your answer is to these two questions is rarely the real answer. Have you ever noticed that how you act and how you think don’t always line up?

Risk Tolerance

Your risk tolerance is simply the line where you go from cool, calm, and collected to anxious. Is there a point where maybe people don’t want to be around you because you’re so bent out of shape? For some, rattling their cage takes something pretty extraordinary while others become unglued when a traffic light takes too long to turn. Where on this spectrum do you fall? Remember, it’s not about what you think, it’s about how you act.

Second, how do you feel about money? Do you save every penny or do you fancy yourself a gambler? Most likely you’re somewhere in the middle but where would you put yourself? Gamblers have a higher risk tolerance than the more frugal minded people. Gamblers know that there will be big losses and big gains. Frugal people avoid losing or wasting money as much as possible.

Finally, your risk tolerance is directly related to your time horizon. The older you get the lower your risk tolerance should be regardless of your attitudes. If you’re 55, your risk tolerance should be exceedingly low because your time horizon is short. You may only be a few years away from retirement and don’t have time to make up for losses that come from taking big risks. If you’re 35, your risk tolerance should be quite high because if something bad happens, you have plenty of years to recover.

Want to figure out your investing risk tolerance? Go to Yahoo! Finance and start a virtual stock portfolio and observe how you react to changes in the markets. It’s fake money so it won’t be a perfect representation but if you’re like me when I was first starting out as an investor, you’ll be surprised by your reactions.

Time Horizon

Your time horizon is related to your goals. If you’re 28 years old and want to save for your child’s college fund, your time horizon is 18 to 20 years, or if you started the fund later, possibly much less. If you’re saving for a down payment on a home, your time horizon may only be a few years. Retirement savings could be 30 or more years.

This is what those articles mean when they say, “depending on your time horizon”. A high yielding corporate bond that pays 2% interest isn’t going to be helpful for somebody who wants large scale capital appreciation over the long term. It is, however, appropriate for somebody who wants to protect their money for an upcoming purchase but doesn’t want it sitting in a nearly zero interest savings account.

Your time horizon is your goal and you shouldn’t do anything until you know your goal. (If your goal is to get rich quickly, change it. That’s not how investing works)

Bottom Line

Don’t blame all of those writers. Many financial professionals have to say that in order to meet compliance regulations but now that you know, take some time and figure out your risk tolerance and your time horizon. Once you do, you’ll read those articles with a much different mindset.

Understanding Your Time Horizon & Risk Tolerance from personal finance blog Bargaineering.com.

Along with higher volume comes higher volatility and traders have learned that they can use these times to their advantage but beware. If you’re an inexperienced trader, and most retail investors are, the best advice may be to avoid these volatile times.

Why the Volatility?

The Wall Street Journal asked the same question and did a study to find out. If you’re an active trader, you may come home from work, do some stock market research and place buy or sell orders that will execute at the open of the market the next morning.

You aren’t alone. Not only are you and millions of other retail investors doing this but hedge funds and other institutional clients do it as well. Second, day traders as well as high frequency trading systems have to set their positions for the day at the beginning of the day.

So how about the afternoon? Those who are purely day traders don’t hold positions overnight so they buy in the morning and sell at the end of the day ending with 100% cash. Although high frequency trading systems work in a variety of ways, many function as day traders selling close to the market close.

Index based ETFs have to balance their actual holdings with the inflows or outflows from the day as well as the traders who prefer to buy and sell for the following day so they avoid the pattern day trading rules.

Can You Profit?

You can’t profit over the long term so using any strategies that involves market timing down to the hour is extremely ill advised but there are ways to use the beginning and end of the day to your advantage.

Use Limit Orders

Value investors are always looking to purchase on sale. Because of the high amount of volatility found at the beginning and end of the day, you might be able to purchase the stock at an unbelievable price. Use a limit order with the levels set at an unusually low price and see if the market gives you a gift. It works more often than you would think.

Trade the Earnings

If a company is reporting earnings after the close of the markets, purchase at the end of the day in the hopes that the company’s stock rises significantly after hours. The next morning, you can sell your shares. Companies sometimes move 10% or more but they can go down as easily as they can go up. Understand that it is nearly impossible to play earnings with an educated guess so play it as a gamble. Use a put option to limit your downside.

Still, the best way to build wealth is through a long term approach but setting aside a small part of your portfolio for discretionary trading is a common practice among money managers. Some professional traders will not trade in the first or last hour of the day because of the artificial price action. If they find it too difficult to navigate perhaps retail investors should as well.

How to Navigate the Volatile Hours of the Market from personal finance blog Bargaineering.com.

While I never thought about municipal bonds defaulting, I knew that it was a possibility. Certificates of deposit are backed by FDIC insurance. Treasury bonds are backed by the Federal government. If the Feds defaulted, I’d have bigger problems than losing what little I invested in those two vehicles. With municipal bonds, backed by states and counties, the default risk is very real.

Just last week, commissioners in Jefferson County in Alabama voted 4-1 to default on $3.14 billion in municipal bonds. The bonds were to fund a sewer renovation and commissions had approved a plan, back in September, that would avoid this that included $1.1 billion in concessions and a sewer rate increase of up to 8.2% over the first three years. Creditors wouldn’t agree to those concessions, the county legislature couldn’t pass a bill, and so now it appears the county will default.

While this particular default made headlines because of its size, the article goes on to discuss other defaults. Jefferson County is just the 11th this year and beat the previous record set by Orange County, California in 1994. In that default, there were $2.2 billion in debt outstanding.

Municipal Bonds Can Default from personal finance blog Bargaineering.com.

Despite these fears, the stock market is the easiest way for someone to invest their savings. When stock trades are only a few dollars and there’s a very liquid market, it simply can’t be beat. The question is whether you even want to play the game and I argue you should dip your toe in… and here’s how.

Contribute to 401(k)

No matter how scared you are, the one thing that most young people are comfortable with is investing through a 401(k). First, you get the tax benefits. Every dollar you contribute is tax deductible and you won’t pay taxes on it until you start taking disbursements in retirement. Depending on your tax bracket, that reduces how much it “costs” for you to invest and your initial investment is that much larger. Next, there’s the company match, if your company offers one. It’s like giving yourself a mini-raise.

Finally, and what I consider the biggest reason most people are comfortable, you can’t touch it for a long long time. This is money you’ve put away in a time capsule. It’s not part of your immediate financial plans and so you know that you can let time work for you. So when you see that the market has dropped, you aren’t as concerned because it’s not as immediate.

Be OK With Saving Later

We’ve all seen the charts – save now and the compounded returns will make you rich in a few decades. That’s true but the rate of return from the stock market isn’t a nice smooth upward trending line. It’s jagged with lots of ups and downs and while your investments will probably appreciate over several decades, it’ll do a lot of winning and losing in those intervening years. While you’re younger, chances are you will need that money more often and so it doesn’t make sense to start investing with money you might need to buy a house or a car. So despite the fantastic charts, it’s OK to wait a few years before getting more involved than through a 401(k).

Invest in Dividends

If you do eventually want to dip into stocks, I recommend checking out some dividend stocks. These are usually at older blue chip companies with low betas (a measurement of volatility compared to the overall market), so they don’t gyrate as much, and the dividend offers you some income and insurance against the gyrations of the market. I personally like starting with the Dividend Aristocrats, though I recommend reading about dividend investing in greater detail before you start picking stocks.

It’s important that you do whatever will let you sleep at night. For some, it’s avoiding the stock market entirely and knowing that their money is in a certificate of deposit that will not lose value. For others, it’s owning a few hundred dollars of a dividend company or maybe a hot new startup. Whatever it is, it’s important that you make a decision that you’re comfortable with. Your capital should be working for you, not keeping you up worrying about it.

(Photo: epicharmus)

How to Overcome Your Fears in Stock Market Investing from personal finance blog Bargaineering.com.

This can be dangerous to those with little experience. Here are a few habits to limit if you’re a part time investor and want to avoid losing your shirt.

Over Monitoring

You’ve probably seen pictures of traders surrounded with computer screens that are flashing wildly with green and red rectangles. These screens are filled with numbers, charts, graphs, and news reports all of which have value to those who are capitalizing on short term moves in the markets.

It’s vitally important to monitor your investment portfolio but watching an array of screens and reacting to all of the up and down movements of the market is a sure way to lose a lot of money. Short term traders have access to information that is often too expensive for retail traders and often have years of experience reading their array of computer screens. If you want to get the thrill that comes with trading like that, set up a virtual account and have fun. For most, long term perspectives with their money will yield more gains.

Chasing Fads

Once you hear about it, it’s probably old news and the easy money has already been made. Fad stocks tend to drop in value as fast as they rise and leave part time investors wondering what happened.

Watching too much Financial TV

Because of the increasing amount of people trying to make quick money in the markets, numerous networks are broadcasting daily programs that cater to the short term trading rules. Long term, income oriented investing isn’t thrilling enough for TV but that doesn’t mean that it shouldn’t be the cornerstone of your portfolio.

Not Enough Fixed Income

Portfolio managers know about diversification. Although they talk more about their shorter term activities, behind much of that trading money is a massive amount of fixed income investing. Are you doing that? Is a significant portion of your portfolio sitting in high yielding bonds? It should be. You can still keep a portion of your investment money allocated to trading but the chances of huge gains with that money are slim.

Day Trading

Short term trading and day trading aren’t the same. Short term traders keep positions for multiple days through multiple months. Day traders start and end their day with a zero balance. If statistics are true, most are losing money.

Assuming Truth

Just because somebody says that they’re making money in the stock market doesn’t mean that they’re being truthful. Retail investors who take part in a lot of short term trading don’t make a lot of money, according to statistics. Don’t fall in to the lie that fast gains without advanced knowledge and experience in the markets are possible.

If you want to gamble, go to a casino. Presumably, you’re investing in the markets because you’re trying to make money over a long term period. That is exceedingly difficult to do if all of your money is allocated to short term trading.

(Photo: petrick)

Six Dangerous Habits Learned from Short Term Traders from personal finance blog Bargaineering.com.