Tag Archives: Investing

What is a stock index?

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A stock index is a list of stocks that are created to represent a certain segment of the market.

A stock index is not an investment, although there are investments that are designed to mimic stock indexes.  More on that in a future post.   For a definition of a stock, see my prior post where I answered the question “What is a stock?”

Stock index – segmenting the market

Let’s take the United States stock market as an example, it can be segmented many different ways; Large Company stocks, Mid-Sized Company stocks, Small Company stocks, Large Company Value stocks, Small Company Growth stocks, the list could go on and on.  There is even a St. Louis Stock Index called the Bloomberg St. Louis Index.  One or more indexes (or lists of stocks) can be created for each of these segments.

What the purpose of a stock index

The purpose of a stock index is to give you a quick measurement of the performance of that segment of the market that day and over time.

Large Company Stock index

Even within one segment of the market, there can be more than one index created to represent that segment of the market.  Take the United States Large Company stock market for example, three common indexes that represent the US Large Company stock market are:

  • Dow Jones Industrial Average: “The Dow”, 30 companies on the list, does not represent all industries
  • S&P is 500: 500 of the largest companies in the US; covers 75% of the US equities
  • Russell 1000: approximately 1000 of the largest companies in the US; covers 92% of the US equities

Dow Jones, S&P and Russell are all companies that compile the list of stocks that comprise each respective index.

With lists that range from 30 stocks to 1000 stocks to represent the Large Company stock market it is easy to see why the indexes do not move in lock step.

The Dow or S&P 500

According to The Dow Jones Indexes website, the Dow was one of the first market indicators, which is probably why it is quoted every day, it is tradition.  However, 30 stocks is not a very good representation of the overall Large Company stock market, especially considering it is not representing all industries.  That is why you also hear the S&P 500 index quoted as well.  There are some days in which one of these indexes ends the day down, and the other ends the day up, even though they both represent the Large Company stock market.  They can not measure the segment in exactly the same way since they are looking at two different lists of stocks.

Should we pay off our mortgage?

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“We have a lot of cash in our savings account.  Should we pay off our mortgage or invest the money for retirement?”

When you give financial advice “by the hour” you get asked questions like these.  And the answer is… it depends.

It depends on;

* your attitude about owing money

* how much of a nest egg you have accumulated for your retirement because you will need cash to pay bills after you stop working and therefore stop getting paychecks

* what other financial goals you have and if you are on track to achieve them

* what interest rate you will pay on the mortgage and the assumed rate on the investments, and other assorted mathematical inputs

“Should we pay off our mortgage?” is a question that is more than a math calculation.  After the math is figured, take it a step further and think about how you will feel during retirement with and without a mortgage payment.

No mortgage in retirement

I have never heard anyone say they regret paying off their mortgage.  And there are ways to tap into a portion of the home equity if needed.  However, many retired folks have shared with me that they wished they had been wiser in their approach to mortgage debt so they didn’t have a mortgage while retired.  I have sometimes noticed during an initial meeting when I meet with a couple who have a mortgage, they seem more concerned about market fluctuation than other couples who do not have a mortgage.

Mortgage in retirement

There are a few couples that I can remember meeting with that have a mortgage in retirement and they were comfortable with it.  They outlined the math in a logical way and how it made sense for them.   They liked that it left them with more available cash in retirement.  I agreed with them, that it seemed to work for them.

When to pay it off? 

If your last mortgage payment is due after the day you would like to retire, jump on one of the many financial calculator websites and figure out the extra payment you would need to send each month in order to time your last mortgage payment with your retirement date.  You might be surprised to find how little additional money needs to be sent in order to pay the loan off by your retirement date.  How great would that feel?  Be sure to call your mortgage servicer to be certain that you do not have a pre-payment penalty, pretty unlikely, but just in case.  Make sure that you can still afford to make enough of a contribution to retirement accounts so that you can retire on time!  And that you are able to save for any other financial goals that are important to you.

What not to do

What I think is unfortunate, is to see a young couple that has heard that it is good to pay off your mortgage sending every available dollar to the mortgage company – with no emergency fund!  And they have not been saving in the company retirement plan, no savings for vacations or other goals.  A balance is needed.  Get the emergency fund created first!  Then create a prioritized list of goals and send money to each based on your priority.

The mortgage problem

The mortgage problem of having a large mortgage when retirement time rolls around isn’t usually created with the starter home, it usually happens when people move up into a series of bigger and bigger homes or take out cash to remodel.   That is when it is especially important to check to see if you can afford to pay the mortgage off by your target retirement date.

What To-Do?

Write down the approximate date that you would like to retire.

Write down the date that your mortgage payment will be done.

If the mortgage will be done after you retire, satisfy your curiosity and find out how much extra you would need to send in to pay your mortgage off in time for retirement.

You could call your mortgage company and ask them.  Or you could use an online mortgage payment calculator and the amount of principal left on your loan, how many months or years until retirement, the interest rate on your loan and find out for yourself.  Just remember that the monthly payment it quotes you is just the principal and interest, if you have your taxes and insurance escrowed you would add that on top of the principal and interest.

Invest just a few minutes, and you could be on track to having your mortgage paid off in retirement.

St Louis stock index

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Did you know that there is an index designed to measure the St. Louis economy?  You may have heard of the S&P 500 index which is a list of the largest 500 companies in the United States, and that watching the performance of this group of 500 companies will give you an idea of the direction of the overall large company market in the United States.  There is a similar list of companies that attempts to represent the St. Louis economy; the Bloomberg St. Louis Index.

Bloomberg St. Louis Index Members 

As of this date, there are 47 companies on the Bloomberg St. Louis Index.  You will notice that while most of the companies are headquartered here, not all of them are headquartered in St. Louis, but they must have a large presence here.  They also must have a minimum market capitalization of $15 million.  Market capitalization means the number of outstanding shares times the share price.

Who is Bloomberg?

When I first started in the investment business, more than 20 years ago, Bloomberg was a company that provided news and research to investment professionals through a “Bloomberg Machine”.  They were very expensive and only a few people in the firm had them.  In the places where I worked, it was usually the bond traders, because the Bloomberg Machine was also the way to find out the bond prices and one way for bond traders to communicate with other firms.  But the bond traders could also use the Bloomberg Machines to pull up news and the most amazing charts for me.  Please remember, this was before internet and e-mail.  My firms always gave me a computer with a subscription to another news and charting service called Reuters, but the Bloomberg Machines really had the good stuff back then.  But now, because of the internet, Bloomberg is so much more.  Everyone can get news and research from Bloomberg, which is the way it should be!  And, Bloomberg still has Bloomberg Machines for the bond traders and they still charge investment firms for premium research.

What does the St. Louis Index tell us?

Looking at the St. Louis index can tell you if the St. Louis market is moving in the same or different direction as the rest of the US markets.   The St. Louis Index has small and large companies on the list so it would make sense to look at the performance vs. a small cap index such as Russell 2000 and a large cap index such as S&P 500.  It would also give you a sense of the cycles of the publically traded St. Louis companies by tracking the performance over time.  With as diverse of an economy as St. Louis has, I would not draw too many conclusions about the overall St. Louis economy based on these 47 publicly traded companies.  Remember as you drive around town, that many of the businesses that you see are privately held and not part of an index like this.  However, it is another interesting perspective to add to your research.

Peter Cottontail Makes A Lousy Financial Advisor!

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Oh, I know he’s beloved by millions. And I can’t wait to bite off those chocolate bunny ears he will bring me on Sunday. But let’s face it; you wouldn’t want to get your financial advice from someone who puts all his eggs in one basket! You have probably heard that old adage, but do you know what it means?

Portfolio Diversification

Have you ever been in rush hour traffic and the lane you are in is practically stopped but the other lanes around you are moving faster. So you decide to switch lanes, but as soon as you change lanes, your new lane slows down and the lane you were in finally speeds up. That’s the problem with only being able to make one choice at a time, you have to pick the right one or you lose. With investments it is even trickier because there are so many different areas in which to invest. Luckily, with investments, you do not have to choose just one. You can diversify, and put a little bit of money in each area so that you are sure to be invested in the best performing area but you do not have all of your money invested in the worst performing area either.

Asset Classes

So what are these areas of investing that we are talking about? A portfolio should be diversified, or spread out, among stocks, bonds, and cash. Whether you should invest in an asset class or how much depends on your particular situation.

Depending on your situation, your stock portion can be divided up among the following asset classes:
* Large Company, United States stocks
* Mid-Sized Company, United States stocks
* Small Sized Company, United States stocks
* Developed International stocks
* Emerging Markets stocks

Depending on your situation, your bond portion can be divided up among the following asset classes:
* Short Term Bonds
* Intermediate Term Bonds
* Long Term Bonds

Portfolio Rebalancing

You have probably seen the investment pie charts, either in your work retirement plan materials or if you have an investment account, in the materials they provided you. Have you ever wondered “Why is it that everyone keeps telling me to use these darn pie charts?” Each different color of the pie chart represents a different asset class and that illustrates the diversification of the portfolio. So once you pick your asset classes and populate them with investments you are done right? Not so fast!

Annual Portfolio Rebalancing: The most important part!

The marketing materials give you the pie charts; they just don’t tell you how to use them. And that is a shame because, when used properly, in a disciplined fashion, they can take a lot of the stress out of market downturns. Here’s how.

Picture your pie chart, let’s say that your pie chart tells you that you should have 35% in Large Company United States stocks and that area of the market has had a terrific year and you have watched that portion grow from 35% to 38% to 40% to 45% in a year’s time! “Wow”, you say, “I have finally found an investment that makes money!” So human nature tells us, “Add more money to it”. But not so fast. Haven’t we all heard that to make money we are supposed to “Sell High and Buy Low”? Well, fortunately for us, the pie chart is going to help us do that. More on that in a minute.

Picture your pie chart again, let’s say that your pie chart tells you that you should have 15% in Small Company United States stocks and the market has not been kind to small companies this year. You watched your Small Company slice of pie shrink from 15% to 12% to 10%. Your first instinct might be to sell this investment because it didn’t do as well as the others. But that is not what you should do, instead, you should “Buy Low”. Without a plan, human nature makes us do the wrong thing at the wrong time.

Now that does not mean you buy a poor quality investment, speaking to the topic of diversification again when you buy a single stock it can go out of business, when you buy an investment that represents an entire asset class, such as an S&P 500 index fund, it is highly unlikely that all 500 companies will disappear at once.

Annual rebalancing is simply the discipline to evaluate the portfolio once a year to look for changes in the quality of any of the investments and then to check to see if your asset allocation (slices of pie) have gotten out of alignment over the year. If they are more than a few percent off, make some changes. Please keep in mind there may be tax consequences, unless you can make the adjustments in retirement accounts.

What Annual Rebalancing will do for you:

1) Help you sell high (the best performing asset classes) so you can take your money off the table.

2) Help you sell high so you can protect yourself if when “the bubble bursts”.  Have you ever noticed that it is often the investments that have gained the most, that end up falling the most when the market corrects?

3) Help you buy low (the underperforming asset classes), when prices are low.

4) Helps you prepare for when the underperformer rebounds.
2008 worst performing asset class was MSCI Emerging Markets -53.18%
2009 best performing asset class was MSCI Emerging Markets +79.02%

5) Removes emotion! Emotion has you selling when you should buy and buying when you should sell. But having a diversified portfolio and using a pie chart with an annual rebalancing plan will get you through every type of market cycle.

What are stocks and why should you invest in them?

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What is a stock?
The ownership of a publicly traded corporation is separated into shares of common stock, which is a type of investment. When you invest in common stock (buy shares) you become a partial owner (shareholder) of a corporation and you take on some of the risks and rewards of being an owner of a company. Equity is another word for stock.

Why buy stock?
To make money.  Although, you can lose the money you invest, that is the potential reward vs. risk of stock investing. There are two opportunities to make money on stocks 1) capital gains and 2) dividends.

Capital Gains and Capital Losses
The dollar value per share of stock will fluctuate up and down depending on the perceived value of the share of stock. Stock is sold in an environment where there are buyers and sellers and it is their perception of the value of the stock that drives the price up and down. The buyers and sellers are observing many variables, some of which are directly tied to the stock itself, some of which are related to the stock’s competitors, some variables pertain to the U.S. economy as a whole, and some variables pertain to markets overseas. There are so many factors that go into the daily fluctuation of the price of the stock; it isn’t just the underlying value of the corporation itself that determines the share price of a stock.

If you buy a stock for $10 per share and sell it for $15 per share you have a capital gain of $5 per share.  Congratulations, you have made money on your investment! Don’t get too excited though, Uncle Sam wants his cut.  You will have to claim the income on your tax return. If you have held the investment for less than a year (short term capital gains); it will be taxed at your income tax rate. But it isn’t all bad news; for investments that were held longer than a year (long term capital gains); the 2012 capital gains tax rates are lower than income tax rates; 15% for those in the 25% income tax bracket or higher and 0% for those in the 15% income tax bracket or lower.

If however, you buy a stock for $10 and you sell it for $8, then you have a capital loss of $2, you have lost money on your investment. Uncle Sam lets you write losses against gains, and then write off $3,000 of capital losses against income as a capital loss deduction and then carryover any remaining loss to be used in future years.

See the www.irs.gov website for details.

Dividends
One of the rewards of being a shareholder includes participating in the earnings of the company, if they are paid out, in the form of dividends. Keep in mind that sometimes companies keep their earnings to invest back into the company with the goal of improving the company.

Shareholders also have the opportunity to vote on the election of board of director members and mergers and acquisitions.