Personal Finance 
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Four Money Mistakes You Might Not Realize You’re Making

Blind SpotsOne of the biggest challenges in almost anything you do is knowing where your blind spots are. In simpler terms, you don’t know what you don’t know. :)

So today, I’ll point out four money mistakes you might be making that you don’t even realize you’re making! Hopefully, you’re making none of them. If you are making one of these, don’t beat yourself over it. Now you know you’re making it and you can take steps to fix it.

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 Investing 
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Even Day Traders Recommend Index Funds

That’s right! A guy who actively buys and sells stocks is suggesting you should stick with Plain Jane index funds.

Why?

Because it’s too difficult for 99% (a completely unscientific statistic) of the general public to outperform the market over an extended period of time.

Every week, at least one person will ask me for a hot stock tip. Almost every single time, I tell them to buy a basic Vanguard S&P 500 index fund. If they keep up the pressure and want something more aggressive, I tell them to buy the Vanguard Small-Cap Index Fund which passively invests in smaller, higher growth, but higher risk companies.

Now, before the pro-index fund, Boglehead crowd showers me with kudos and the pro-trader crowd throws flaming bags of dog crap on my porch, allow me a few moments to debunk the Get Rich Quick by Becoming an Active Trader myth.
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 Investing 
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Index Funds Are Only Part of Your Investment Plan

There isn’t a single reason why you shouldn’t like index funds. They’re cheap, they offer market rates of return without fail, and they are simple to buy. They beat actively managed mutual funds a majority of the time and they are often advocated as the best investment the average Joe can put their money in. So why not put all your money into an S&P 500 Index fund like the Fidelity Spartan 500 Index or the Vanguard 500 Index, call it a day and enjoy more time with the family? Because that would be a huge mistake.

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 Devil's Advocate 
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Don’t Invest In What You Know

Devils Advocate Logo
This is a Devil's Advocate post.

One of Peter Lynch’s most famed principles of investing is “Invest in what you know.”

I humbly disagree.

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 Investing 
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Pick Investments Strategies That Fit Your Lifestyle

Blurry Stock TickerThe key to a successful investment plan is to pick one that fits your personal style. If you’re always busy and simply can’t find the time to pay attention to your investments, you need to pick a style that matches your life. There’s no sense adjusting your life to your investments, it should be the other way around. It’s difficult to pigeonhole anyone into one particular bucket but find the various suggestions in each grouping to see how best to use them to match your life.

The Novice

Everyone starts as a novice, there’s absolutely no shame in being a beginner when it comes to the stock market. In fact, it’s probably better that you’re a beginner. It was the experts that got us into the whole sub-prime mortgage mess. Until they closed their doors, the halls of Bear Stearns was full of experts. That being said, if you’re a novice when it comes to the stock market, put your money into a high yield savings account and start playing with a “play portfolio” at one of the finance sites. While you’re learning, your savings will still earn a nice interest rate.

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 Investing 
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Introduction to Lazy Portfolios

Ever heard of the Margarita portfolio? How about the Couch Potato portfolio? Or the No-Brainer portfolio? No?

They’re all Lazy Portfolios.

A Lazy Portfolio is one that you can just set it and forget it and relies on low cost index funds or ETFs. There’s nothing particularly special about any Lazy Portfolio, besides their use of low cost index funds, and one isn’t necessarily better than another in all economic scenarios. As with any investing strategy, there are pros and cons. The pros, that it’s simple and you make few decisions, results in cons in that you may become complacent and ignorant of your investment decisions. It’s better to keep it simple and well understood than to make it complex and obfuscated. I’d rather make a choice that turned out wrong than make a decision I didn’t understand.

How They Perform

Paul Farrell of MarketWatch tracks eight Lazy Portfolios each year and in 2008, they have extended their winning streak of beating the S&P 500 for the sixth year (on a three-year and five-year basis). In other words, having a one of the eight Lazy Portfolios over the last six years has gotten you a better return than the stock market itself. (This year, three of the portolio’s got beat because they had a lot of REIT funds, but they are still besting the S&P over the last few years).

Here are the funds with the best names: (some of which weren’t featured in Paul Farrell’s wrapup)

Couch Potato Portfolio

This portfolio is the brainchild of Dallas Morning News columnist Scott Burns and is as simple as they come. All you need is 50% in the Vanguard 500 Index Fund (VFINX) and 50% in the Vanguard Total Bond Fund Index Fund (VBMFX). That’s it. You can go a little more aggressive with the variant Sophisticated Couch Potato Portfolio of 75% in the Vanguard 500 Index Fund and 25% in the Vanguard Total Bond Fund Index Fund.

Margaritaville Portfolio

This portfolio is also another one of Scott Burns’s creations and is the second simplest portfolio with equal parts of three funds: Vanguard Inflation-Protected Securities (VIPSX), Vanguard Total International Stock Index (VGTSX), and Vanguard Total Stock Market Index (VTI).

No-Brainer Portfolio

Created by Dr. William Bernstein, a neurologist known for his work in modern portfolio theory and his book The Four Pillars of Investing, the No-Brainer Portfolio consists of four funds of equal weight: Vanguard 500 Index (VFINX), Vanguard Small Cap (NAESX) or (VTMSX), Vanguard Total International (VGTSX) or (VTMGX), and Vanguard Total Bond (VBMFX) or (VBISX). There is also a No-Brainer Coward’s Portfolio that includes 9 funds.

Coffeehouse Portfolio

This little gem was created by money manager Bill Schultheis, author of The Coffeehouse Investor: How to Build Wealth, Ignore Wall Street, and Get On With Your Life, created the Coffeehouse Portfolio that consists of seven funds:

  • 40% in Vanguard Total Bond Index (VBMFX)
  • 10% in Vanguard 500 Index (VFINX)
  • 10% in Vanguard Value Index (VIVAX)
  • 10% in Vanguard International Stock Index (VGTSX)
  • 10% in Vanguard REIT Index (VGSIX)
  • 10% in Vanguard Small-Cap Value Index (VISVX)
  • 10% in Vanguard Small-Cap Index (NAESX)

Those are the cooler sounding ones but there are many many others out there!


 Investing, Personal Finance 
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Money: Only 7 Investments You’ll Need

Money Magazine recently released the only 7 investments you’ll ever need and, surprise surprise, my favorite firm, Vanguard, was listed first choice for five of the seven. Their founder, John Bogle, was a major proponent of index funds and it shows in their offering, as almost all of Money’s choices were low-expense ratio index funds.

Need another reason to have a mutual fund account at Vanguard? (No, Vanguard doesn’t sponsor this site!)

Blue-chip US-stock fund: Fidelity Spartan 500 Index (FSMKX) because it replicates the S&P 500 with an expense ratio of 0.10% (coincidentally, Vanguard’s version, the Vanguard 500 Index Fund Investor Shares (VFINX) is 50% more expensive with a ratio of 0.15%).

Blue-chip foreign-stock fund: Vanguard Total International Stock Index (VGTSX) because of its solid performance, beating 90% of its peers, and because it’s an index fund with an expense ratio of 0.27%. Another Vanguard fund, the Vanguard FTSE All World Ex-U.S. ETF (VEU), was listed as an alternative.

Small-company fund: T. Rowe Price New Horizons (PRNHX) is an actively managed fund, one of the few actively managed funds they selected, and is “one of the most efficient of the actively managed crowd.” Considering it is actively managed, an expense ratio of 0.8% is pretty good, about half the average.

Value fund: Oh look, another Vanguard fund – the Vanguard Value Index (VIVAX) and its 0.2% expense ratio and a record that trumps 78% of its peers. Value funds go after investments that appear overlooked or beaten down and try earn a little off those cigar butts and dividends, rather than looking for growth potential.

High-quality bond fund: Vanguard Total Bond Market Index (VBMFX) snags this category with a 0.2% expense ratio. Bonds are good to be the rock in your portfolio to give you some grounding as your other investments shoot up and crash down. :)

Inflation-protected bond fund: This last category was won by Vanguard’s Inflation-Protected Securities Fund (VIPSX) and it’s 0.2% expense ratio (Vanguard’s index funds are ridiculously efficient). “Among TIPS funds, Vanguard Inflation-Protected Securities has several things going for it, including lower costs and better management than you would get if you assembled your own TIPS portfolio. While the fund returned 6.6% over the past five years, you shouldn’t expect it to make a pile of dough. Its job is to protect the money you already have.”


 Investing 
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What I Learned From My First Investment

Stock Market and DiceI made my first investing decision ever when I was 11 and I learned quite a bit, in retrospect, from that little experience. I participated in a classroom stock picking competition that was not unlike the stock competitions you see online practically everywhere nowadays. The contest ran for about a month, the stock choices were limited to those listed on the major markets (anything not OTC or pink sheet), and you started with a mind boggling (at the time) $10,000 of play money. I think the classroom competition was part of a bigger competition (or at least mirrored it), but our team never made it out of our classroom.

I don’t remember where we placed at the end of the month but it certainly wasn’t first but it certainly wasn’t last. We chose to put the entirety of our investment into Caterpillar at the advice of one of our team members. He recommended that we purchase shares of Caterpillar because they’d be instrumental in the rebuilding of Iraq (yes, this would be the first time we went in back in the early nineties with another President Bush), something he invariably heard from his parents since we were 11 and I doubt many of us had much insight into those types of matters. Anyway, we plowed our entire $10,000 seed money into Caterpillar and watched as our investment hovered around $10,000 for the entire month. It might have gone up by a few dollars, it might have gone down by a few dollars, but it didn’t really do all that much in the month long competition.

In the short term, the stock market is basically gambling. In a time span of a month, you’re essentially gambling when it comes to selecting an investment. The team that won the month-long competition was one that invested in a microcap company that spiked at the right time for them and perhaps they understood this idea better than we did. While our team didn’t necessarily research Caterpillar extensively, our choice of a large cap, blue chip company sunk us before we executed the trade. If you’re interested in reading a famous book detailing this well known idea, I recommend A Random Walk Down Wall Street by Burton G. Malkiel.

Don’t watch your stocks every day. In conjunction with the idea that you should be long in the stock market, you shouldn’t watch the market every single day. Since a stock, depending on its volatility, is likely to jump and drop at essentially random, if you watch the performance of your stock every single day then you’re likely to read into those moves when there’s nothing to read. This may cause you to make a decision based on random events and not on the fundamentals, what should’ve caused you to purchase the stock in the first place.

The stock market is boring. At the time, I thought the stock market was ridiculously boring. The speed of information was much slower back in 1991. If you wanted a “free” stock quote, it came in the newspaper the next day. Financial news? Newspaper, maybe even the television in your local news. There may have been cable financial television shows but I wasn’t aware of any. Nowadays you have free instant stock quotes, financial news 24/7, and a connection to the global markets in a way that never existed to the common investor back in 1991. As awesome as it is, the stock market is still as boring (to me) as it was back in 1991. While I’ve learned a lot and I’m very much interested in broader market information, the stock market, and individuals stocks in particular, simply doesn’t excite me and it’s something I can’t find myself devoting a ton of time to. This is probably why a majority of my investments are in index funds.

I must warn you, I didn’t realize any of these “lessons” back when I was 11 (except maybe about the market being boring), it wasn’t until I looked back later (and consumed a few Motley Fool books) that I realized, latently, what I had learned. I probably picked up a few other things back then such as how to read financial news and basic vocabulary (what is a dividend? what is a split?) but I think those ideas above were the most important.


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