Your Take 
6
comments

Your Take: What Are You Clueless About?

Email  Print Print  

Risk!I’m clueless about a lot of things but the number one thing on my mind lately has been risk in investing. I don’t mean stock market investing or real estate investing, I meant the concept of investing and risk (specifically, determining and being paid for taking risk).

Most people associate investing with the stock market because that’s the easiest way to invest. The stock market is the perfect investment system in that your assets are pretty liquid and the barriers to entry are low. It’s absolutely free to open a brokerage account and trades are dirt cheap (cheapest is $0 a trade at Zecco, but that has gotten mixed reviews; second cheapest reputable brokerage is TradeKing). You can buy and sell stocks pretty easily as there is never a scramble to find interested parties, though the price you get may not be to your liking. You hope for good equity appreciation (increase in stock price) and perhaps take some cash flow along the way (dividends). The rate of return on the S&P has been around 10% for the last 80+ years.

Now take the second thing people associate with investing – real estate. In real estate, the assets aren’t as liquid (especially now!) and the barriers to entry are much higher. At best you have to come up with a downpayment and transaction costs (Realtor fees, lender fees) are high, fewer people get involved in real estate investing. (Over the next two weeks I’ll have four guest posts going over real estate written by Trisha Allen, a seasoned real estate investor, so if this is up your alley keep your ear to the grindstone) With real estate, again you hope for good equity appreciation (increase in home value) and perhaps some cash flow (rent) along the way. The rate of return on this has generally been about inflation (surprisingly) according to some experts (they could be wrong).

There are other means of investing (such as owning your own Rita’s Italian Ice!) but the gist is to put your hard earned money to work for you. However, how do you analyze risk?

Every risk analysis class I’ve taken, be in undergrad or for the MBA, has always explained the same thing. You take the severity of a bad event times the probability and that’s your risk. They never talk about how to guesstimate the severity or the probability, just that you multiply and some magic number comes out. Also, they never talk about how much of a payoff you should get for shouldering how much risk. Real estate seems riskier to me than the stock market (higher barriers, more money involved, more headache), yet the stock market has greater returns. One expects riskier investments to yield greater returns.

Anyway, that’s what I’m clueless about, how about you?

(Photo by Patrick Haney)

{ 6 comments, please add your thoughts now! }

Related Posts


RSS Subscribe Like this article? Get all the latest articles sent to your email for free every day. Enter your email address and click "Subscribe." Your email will only be used for this daily subscription and you can unsubscribe anytime.

6 Responses to “Your Take: What Are You Clueless About?”

  1. Chris says:

    Rita’s, good man!

    That’s an interesting thing to point out as it is particularly relevant both as an investment option and something I am not too knowledgeable about. Rita’s is great, and owning a franchise would be an interesting investment opportunity (though I do wonder/worry about the seasonality of it).

    But franchises are a blackhole to me, especially since I am not looking for a new or 2nd career. I would want to invest in a franchise where I can either be a silent partner, or a mostly hands-off one. However, it seems exceedingly difficult (impossible?) to find someone to run it for me if I can’t/won’t.

    So to your final point, am I better off just sticking with stocks? Instead of buying a real estate investment property (such as a condo or two to rent), should I just buy a REIT that is now much cheaper than 3 years ago?

  2. Mrs traineeinvestor would give you a long list of things that I am clueless about, but when it comes to finances the more advanced maths used to calculate a variety of financial measures is something I never bothered to take the time to learn. When it comes to comparing the potential risks and rewards of different investments (or portfolios of investments), this is a weakness that I am sure has cost me money.

  3. Posco says:

    I’m clueless about life insurance. Not the need for it. But how to determine how much and how to distinguish between policies.

  4. Lo. Price says:

    Interesting take on Risk/Reward with the US stock market vs. real estate. I’m sure much smarter people than I can give you comprehensive answers to the risk/reward question, but one thing to think about is “efficiency.” Though plenty would debate this, I think many people agree that the stock market is generally efficient, which means that it correctly prices stocks given the current information. This can be seen in the near-instantaneous changes in a stock price once a big piece of news about the company is announced. Real estate, however, is not as efficient a market for a variety of reasons. First, real estate is not sold in centralized exchanges (like the NYSE or NASDAQ), which means that markets are localized, making local knowledge and expertise key to succeeding in the industry. It also means that real estate is not being constantly bought and sold, making it tougher to price. Also, barriers to entry are higher, as you discussed. Though home ownership is fairly widespread, real estate investing is not as ubiquitous as stock investing. My point is that since real estate markets tend to be less efficient than stock markets, greater opportunity exists to exploit inefficiencies by talented investors; however, given the widespread homeownership by average people more interested in living in a place than investing in it, real estate as a whole has tended to provide less than stellar (I’ve heard about 6% on average) returns.

  5. Khyron says:

    Posco:

    That’s an easy one, IMO.

    1. Life insurance should really be called death insurance. However, since people are generally afraid of death…

    Basically, the minimum amount of insurance you want would be enough to provide for your dependents and/or spouse in case of your death. If you have neither, then the minimum should be fine; just enough to bury you. Maybe you factor in some more coverage to handle paying off certain debts if you so choose. I am single and have no kids, so I have the least amount of insurance my employer provides.

    In the case of dependents, you basically want to be able to replace your income and maybe (possibly? probably?) reduce the family living expenses too. So, enough insurance to pay off your mortgage (if you have one) + enough that can be invested at a conservative rate of return to throw off an equivalent amount of income for your dependents. I really don’t feel like trying to do calculations since I’m supposed to be sleeping right now, but that should be a good starting point.

    Maybe then you consider funding the kids education accounts, or some other use that would normally be addressed by your income if you were living. That’s really your call. I am adamant that you DO NOT insure your kids, since they likely don’t generate income. The burial costs should, ideally, be fundable from an emergency account. I guess you could get the minimum amount of insurance, and if you use the same company for all of your policies, then you might be able to get some discounts. However, life insurance should be used to replace income or otherwise allow the family to continue with lessened financial stress (especially if the hosuehold income drops to a single income). If you are married and your spouse doesn’t work, then you probably need to increase the numbers a bit to take that into account (since its a single income household already).

    I can already hear grumbling from some troll about how you don’t love your kids if you don’t get insurance on them, and that’s total B.S. This is a financial decision, not an emotional one. If your kid is a child actor who you manage and they make $5M annually, then they need significant life insurance. If the kid is just an average kid that you love, then you need none or the smallest amount that will allow you to bury the kid without undue financial hardship. Don’t confuse the emotional loss with the financial loss. The money will never replace the kid if they die, anyway, so what sense does it make to spend it for a larger payout in case of the kid’s death? THAT sounds sicker to me. Use the money you save on insurance to fund the college savings account, or your retirement, or a vacation. Insurance should be reserved for catastrophic FINANCIAL losses. The emotional losses are not of consequence in that equation.

    2. Insurance is not an investment, unless you’re so rich that you have no business asking this question anyway. Literally, there are way better ways to invest your money than whole or universal (so-called “cash value”) insurance. Term insurance is pure insurance sans investment feature and is generally cheaper. Get enough to cover your working cover life (30 years of work = 30 year term), or you could be more or less aggressive based on certain factors (e.g. good health overall, maybe you get a bit less insurance; bad health, maybe a bit more, etc.) I think you can typically do 10 and 20 year term policies, although it has been a while since I researched this.

    Basically, any insurance should be insuring a catastrophic loss. Losing an income is usually such a loss. Homeowner’s insurance, health insurance, and basically any other insurance are conceptually based on answering the same question in various forms – what’s the largest loss you could sustain w/o throwing your finances into hell? If you have an emergency fund of sufficient size, then maybe you can drop comprehensive insurance and just pay for a new (or good condition used) car, or at least fund a significant downpayment. If you lost your laptop, could you afford to buy a similar model at retail? If not, you need insurance on it. (I use State Farm, and they call it a personal articles policy.) If you can replace it without undue financial hardship, then having less or no insurance makes more sense.

    Get it?

    NOTE: Here’s my disclaimer. I was once a licensed life insurance agent in MD, in my early 20s, when I joined Primerica Financial Services. Say what you want about the company’s sales practices and MLMs, it was very eye opening. My license expired ages ago. Most of this is coming from my personal experience with insurance, and a small amount based on my long past life.

  6. Khyron says:

    Hey Posco!

    Jonathan just wrote about this recently. Don’t know if you saw it, but if not, see http://tinyurl.com/43rrbc for his story. Definitely a more thorough take on my basic points.


Please Leave a Reply
Bargaineering Comment Policy


Previous Article: «
Next Article: »
Advertising Disclosure: Bargaineering may be compensated in exchange for featured placement of certain sponsored products and services, or your clicking on links posted on this website.
About | Contact Me | Privacy Policy/Your California Privacy Rights | Terms of Use | Press
Copyright © 2014 by www.Bargaineering.com. All rights reserved.