Michael

That is speculating for short term gains and I don't recommend that path unless a person can devote full time to the market, fully understands the market, and has nerves of steel.

I agree that a person won't get much advice from a financial planner/investment advisor. If her financial planner works for a brokerage, she should drop him. Generally those financial planners charge an annual fee, charge triple to make the trade, steer customers to high commission annuities and/or front load mutual funds, steer the customers to the brokerages mutual funds, recommend that the customer excessively trade his/her equities to increase his commissions, and make it difficult to terminate their services.

If someone needs a financial planner, they should use a pay by the hour financial planner and then make his/her trades through a discount broker if he/she agrees with the advice. A pay by the hour financial planner has no incentive to steer you to specific equities except to hopefully make the customer money and therefore happy so that he/she will return for further advice and/or recommend him to your friends.

Some people need a financial planner for reassurance that they are doing the right thing. However if a person doesn't understand the basics of the stock market, he/she would be investing their money with advice from someone how doesn't have a great deal to lose (other than your business). Therefore if you don't understand the basics of the stock market, I would not recommend that you invest in the market.

However, financial planners generally read from a script depending on your risk tolerance. If your risk tolerance is low, they will recommend DOW or value stocks, if moderate they will recommend solid S&P500 stocks with moderate growth, and if it is high they will recommend high growth speculative stocks. There is nothing that they perform that you can't do yourself with a little bit of effort as long as you are a long term investor.

Trading stocks regularly is much more complicated and is very difficult to time the market or stock price to sell it at the top and purchase at the bottom. No one really knows how to do that but many try and very few perform better than the long term investor.

fatbrit

Precisely!

And buying stocks on the basis of news of a buy-out is speculation for short-term gains

Michael

Tutorial number 2: Fundamentals, Trends, Day Trading, and Gut feelings.

There are four main types of investors. There are investors that look at fundamentals (p/e, dividends, earning estimates, income statements, balance sheets, and anything else that deals with fundamentals). On a previous post I described how to access those. Investors that follow fundamentals are common in the market. Warren Buffet follows fundamentals when deciding which companies to invest in.

Another major player in the market are investors that follow trends. These investors are known as technicians. The only reason that trends can work in the market is that there are so many technicians in the market using the same principles that each is driving up or down the market using technicals.

You may hear on CNBC where analysts talk about 50, 100, or 200 day moving averages and support levels. They also talk about oscillators and many other strange terms. This concept is much too complicated to explain in detail but I will give you an overview of what is happening.

The most basic technical is the moving average. Msn money has the ability to show moving averages but it doesn't seem to work. Therefore we will use yahoo finance to demonstrate moving averages. In the following link, I am displaying the 3 month chart for AT&T with a 50 day moving average being displayed in red.

http://finance.yahoo.com/echarts?s=T...urce=undefined

As you can see from the chart, the AT&T stock price has dropped slightly since the beginning of the year and the moving average is downward. The technician monitors moving averages on a daily basis and uses the moving average to determine when to buy or sell. AT&T is not a good example since it has declined slightly over the past three months but it is likely that the technician has sold his holdings in AT&T and may be shorting the stock forcing it downward. But if the AT&T stock rises over a period of time, technicians will jump in purchasing the stock forcing the price higher.

A better example of a stock that a technician would likely attack is Dow Chemical (DD). You can see that the stock has risen over the past three months and the moving average is upwards.

http://finance.yahoo.com/echarts?s=d...urce=undefined

One of the problems with being a technician is that the investor must perform trades very often causing the investor to get a large amount of short term capital gains or losses which are taxed at the same rate as earned income. Also investors that swing trade often do not do as well as investors that buy and hold.

However there are resistance levels. When a stock or a market has been rising for a period of time and then has a pullback, the resistance level is when the market or stock reaches the moving average. That is when the technician purchases that stock forcing the stock upwards. So the market basically follows mob rule.

However no matter how many technicians are forcing the market up or down, events (earnings reports, economic reports, world problems, oil prices, etc,) can cause the market to not follow the rules of the technicians. That is because greed or fear is a stronger instinct than anything technicals can overcome.

The third type of investor is the day trader. He uses sophisticated software to track stock movements over very short periods of time, will buy when the software indicates it is a good time, and sells when it indicates when to sell. Usually that is during the same day but can be over several days. For his effort, he may make or lose money during the day and normally only has to be correct 51% of the time to make money. To be his day job, he would likely have to be correct 60% or more of the time with an investment of at least $100,000. There are a significant number of day traders who lose large amounts of money.

The forth type of investor bases his/her purchases on gut feeling. They may like a product or a service and purchase stocks in the company that provides that product or service. They may also base their purchases on tips or rumors. Sometimes they get lucky for a while but usually over the long run they do very poorly.

dunroving

I'm with others who have suggested mutual funds and ETFs rather than an individual company, unless you literally are looking at this as a gamble.

I'd also suggest simply investing in a tracker fund, not an actively-managed fund. A very small number of actively managed funds beat the regular share index in the long-term, mainly because of silly annual fees.

When stocks and shares, or specialty actively managed funds tank ("China Special Situations Fund", "Japan Tech Fund"), they can REALLY tank, and it can be years (if ever) before they even return to par. I invested in a supposedly gold plated tech fund in 2000, and it's still only at 35% of what I paid for it. I invested in Lucent (down to zilch), Amerindo mutual fund (defrauded by the CEO, down to zilch), invested in Marconi (down to zilch, company essentially went bust), invested in Krispy Kreme, went down to 10% original value in about 18 months. Cisco - down by 20% in 6 years, Microsoft the same.

The only company I invested in that is making me any money is Morrison's supermarkets (invested £500). After 11 years they have doubled, and I have probably received £100 in dividends.

The average person should not consider stocks and shares as a sound investment, IMO.

Michael

I agree that ETFs are a good way to go for many investors. The yearly management fee for DIA is only 0.18% per year and and SPY is only 0.10%.

That is a lot better than mutual funds which average 1% or more per year. On a $100,000 investment over 10 years, the management fees would likely cost over $10,000 compared to $1,000-$2,000 for low fee ETFs.

There are also some mutual funds that also track indexes with reasonable management fees but if they are not close ended funds, you can possibly get hit for taxes during a bear market if the fund manager has to sell stocks that had gains due to redemptions. Therefore I prefer ETFs which are almost impossible to get hit with taxes until you sell the ETF.

So since I don't like paying management fees and and if I want a conservative investment (I'm over 65 so I want conservative investments), I can investigate and choose 6 or 8 stocks from the DOW and if I am ok on my picks, I could do better than the index. I just make sure that I do a lot of investigating and make sure I am diversified. I have yet to purchase tech stocks from the DOW due to the problems you mentioned and also the possibility of chip shortages from Japan due to the earthquake. The only tech stocks that I am considering from the DOW is HP and Intel but I think I'll wait.

Michael

Toyota and Honda has announced that it will idle some US plants due to parts shortages.

GM has announced plant shutdowns in Louisiana, Spain, and Germany and layoffs at other plants due to parts shortages from Japan.

Even if a company assembles their cars from mainly local parts, a company can't keep building cars and trucks if they can't get a part that is exclusively manufactured by a company that is having problems meeting schedules.

The parts shortages in the auto industry has started.

robin1234

We're in for a rough ride. We need another war! No hang on....

JULIEROSE

I own a lot of stock, and also trade stock options, along with forex currency all from my home computer, as a part time job, (as I have young children). Everything has a risk - it takes time, management, experience to trade yourself. Personally, I prefer to control my trading and portfolio. There is a ton of analysts out there giving free info on what they are buying and selling. If you really want to get into it and make money look at options - make sure you have stop loss orders in place and manage the risk. Investools http://www.investools.com/ is a great place to learn, start educating yourself about trading.

Michael

Penny Stocks, Stock Options, Margins, and Hedge Funds

Penny Stocks:

Many newbies in the stock market look to penny stocks to make money. After all they are cheap and swings can be very large but there is a dark side to penny stocks.

Penny stocks are stocks that are less than $1 per share, traded on the Over The Counter (OTC) exchange, and consists mainly of stocks that were delisted from the major exchanges due to poor earnings, bankrupted companies, or startup companies that couldn't acquire venture capital funding and could not meet the requirements to be listed on one of the major exchanges.

Unlike normal stocks which are usually positive sum games (most investors are winners even if they sell their shares too early) which typically rises over the long run, penny stocks are usually negative sum games (the majority of investors lose money) since most of the stocks are racing towards the bottom and will eventually become insolvent.

Penny stocks only exist because newbies with little or no knowledge believe that they can make a large amount of money with little cash but waiting in the shadows are professionals that manipulate the market and take advantage of the newbies.

Volume is very thin on the OTC so placing a "market order" can be disastrous. The newbie may think that he can purchase shares for the same price as the last trade so he may place a market order only to find out that he paid double that price of the last trade.

Newbies may not understand that when a company is bankrupt, it has little or no value but still purchase the stock thinking that if the company again becomes public, the stock will be worth something. As an example when GM went bankrupt, the stock was delisted from the NYSE and relisted on the OTC as MTLQQ (last Q indicates bankrupt). However from that day in June 2009 until now, the stock price has been on a gradual decline from about a $1 per share to the current $0.04 per share.

http://moneycentral.msn.com/investor...ocookie=1&SZ=0

Finally there are professionals that work the OTC looking for suckers. He may purchase a significant number of shares and then monitor the market for all outstanding bids and asks and then places both a bid and ask (all or none order each from a different account) that will guarantee that the trade will be made between his two accounts. He pays nothing other than the commissions for that trade but forces the stock price upwards. If he does that several times during the day, he may be able to force the price upwards by 20% or more. When he finally finds someone that is willing to pay that price (because there appears to be momentum), he then dumps as many shares as possible above his original purchase price. There are a lot of other tricks that professionals use to manipulate stock prices on the OTC.

Stock Options - Puts and Calls:

Stock options are used to place a side bet on an equity that the share price will either rise or fall over a period of time. The advantage of a stock option is that amount of cash required is small as compared to purchasing the stock out right.

Purchasing a call is when you believe that the stock price will rise and purchasing a put is when you believe that the stock price will fall. Normally most brokerages will not allow a customer purchase puts and calls unless they have experience in the stock market and have a certain amount in their account.

Options are sold as contracts (1 contract equals 100 shares) so if the option price is $1, you will pay $100 plus commission for a contract. Some use options to hedge stocks that they own and this is referred to as a covered call or covered put. If you don't own the shares, this is referred to as a naked call or a naked put.

The following is a link to the April 15th calls and puts for AT&T.

http://finance.yahoo.com/q/op?s=T+Options

The strike price is the price that the stock must reach at the expiration date before the initial seller of the put or call will need to pay any money to the owner of the option. The last price is the price that you need to pay to purchase each share in that option (the last price may not be the price you would pay since volume is low and the last trade could have been made before the stock moved in any direction or there are no sellers at that price).

Examples:

AT&T current price is $28.54

You believe that the AT&T share price will rise so you purchase the call option with the $29.00 strike price for $0.14 (total price $14 per contract). If the stock price rises above $29.00 per share by April 15th, you are eligible to receive some money back. If it rises to $29.14 you will be eligible to receive all your money back. If if rises to $30.00, you will receive $100 per contract at expiration.

You believe that the AT&T share price will fall so you purchase the put option with the $28.00 strike price for $0.36 (total price $36 per contract). If the stock price falls below $28.36, you are eligible to get some money back. If it falls to $27.36 you are eligible to get $1 per share back ($100 per contract).

You must normally notify the brokerage to exercise the option since it will cost money (the commission) to exercise the option and that could possibly be more than the amount that you get back.

At anytime prior to the expiration, you can sell a put or call if you can find a buyer that is willing to pay the desired price. If you own a call and the stock price rises, normally the market price of your call will increase in value. However the closer it gets to expiration date will tend to reduce the market value of the call. If you own a put and the stock price drops, normally the market price of your put will increase in value.

You are also allowed to initiate a new put or call by selling a call or put that you do not own. However you will be responsible for paying the owner of that put or call when it expires. The following link lists the Jan 15th 2012 call and put options for AT&T.

http://finance.yahoo.com/q/op?s=T&m=2012-01

Example:

AT&T current price is $28.54

You sell a call contract with a strike price of $29.00 for $1.18 per share and will receive $118 for the contract. If the price does not reach $29.00 on the expiration date, you made $118. If the strike price reaches $30.18, you will need to pay the purchaser $118 so you will break even. If the price exceeds $30.18, you will lose money.

Before you are allowed to initiate a new put or call, the brokerage normally requires you to have experience in trading options and normally requires a large amount of assets in your account.

Options trading is also a negative sum game since you have to pay commissions. Without commissions it would be a neutral sum game (50% winners and 50% losers).

Margins:

When you open a brokerage account, you can request the brokerage to make the account a margin account. A margin account allows you to borrow money at the margin interest rate to purchase shares:

Example:

You deposit $10,000
Your Stock Buying Power (BP) is $20,000
Your Options Buying Power is $10,000

You only pay the margin interest rate when you purchase stocks that exceed your deposit and then only pay interest on the amount above your deposit.

Therefore you will be able to purchase $20,000 worth of stocks or $10,000 worth of options. Once you purchase $20,000 worth of stocks, your buying power does not necessarily go to $0 but may still be $5,000. However, by the time you have purchased about $30,000 worth of stocks, your buying power will likely be near $0.

You must be careful if you reduce your buying power to near $0 since you are getting close to having a margin call if the price of your stocks drop (typically you get a margin call if you are borrowing more than 70% of the current market value of your shares). If a margin call is made, you will need to deposit more money in your account or sell some of your shares. If that is not done in a certain period of time, the brokerage will sell some of your shares.

Hedge Funds:

You have probably heard of hedge funds. Hedge funds are only available for the rich (typically the minimum investment is $250,000 or more and the customer is required to have a very large income). Also hedge funds are typically restricted to 100 investors and the investors can only redeem their investment once a year during the redemption period.

Hedge funds normally do not hedge but actively trade futures, options, or equities using leverage. Typically a hedge fund charges 2% of the amount invested annually plus 20% of the gains (withheld monthly). Because hedge funds are very actively traded, the investors normally gets a tax bill at the end of the year on any gains made during the year and it is taxed at the same rate as earned income.

Due to the high management charges and high tax rate (typically 35% for the investors in the fund), the hedge fund manager typically needs to make more than twice the percentage gain of the market to keep investors happy.

Example:

Market gains 8% including dividends
Hedge fund gains 16% after trading commissions and borrowing costs but before management fees and taxes.
(2% management fee) 16% - 2% - 14%
(20% management take on gain) 14% * 0.80 = 11.2%
(Tax at 35%) 11.2% * 0.65 = 7.28%

In this case, investors would likely not be very happy since the hedge fund returned only 7.28% after taxes and the market returned 8%. Although the above example does not include taxes for the average investor, those taxes are normally 15% or less and will be delayed (except for dividends) for long term investors.

Prior to the credit crisis, hedge funds were the way to go for rich investors but during the crisis many hedge fund investors got burned very badly not being able to withdraw their funds as the market crashed.

During last year hedge funds did very poorly averaging less than half the return to investors before taxes than the market. The reason is that is due to lack of bank financing to highly leverage their purchases and lack of investor appetite for risk.

Poppy girl

Thank you to everyone that has contributed to this fascinating thread I had no idea it would be so interesting....special Thanks to Micheal for all his information and time spent on replying to us all

The Horticulturalist

Yes, I liked that last bit about the hedge funds, I had of course heard of them but had no idea what they were.

Michael, Can I ask what it was that Bernard Madhoff was running? I mean, I know it was a ponzi scheme, but was it under the guise of a hedge fund or were people just lured in by a get rich quick scheme? I go the impression reading some stories of investors who lost out that they were not very rich.

Ok and one more question I had not given investing any thought until I moved here (been here nearly 3 years) and get the impression that the average Brit is much less likely to either know about or participate in investments (apart from linked to a mortgage or pension) than the average American, do you think that's true and is there a difference in the way you can invest here and back in the UK?

Michael

Bernie Madoff was an independant investment manager (financial planner that manages peoples money at his descretion). Many assumed that since his operation was located on the floor above his brokerage firm, they would be protected from fraud by the SIPC insurance ($500,000 for securities but can be more) that all brokerage firms are required to carry. They also assumed that any cash in their account would be protected by the FDIC or SIPC (amount of insurance varies) depending on the type of account.

People must learn to not trust independent investment managers and to start to question anyone that promises or consistently returns significantly higher returns than would normally be expected after management expenses. If an investment manager is living a life that you could never dream of, he is likely running a ponzi scheme or taking extremely high risks with your money.

Usually most ponzi schemes are detected before the total investment exceeds $1 billion.

Since the internet came into many people homes in the mid 1990s, trading commissions in the US have dropped dramatically as brokerages offered services through internet making it very inexpensive and easy for the average American to trade stocks. Since many Americans already managed mutual funds through 401k and IRA accounts, it was easy for them to understand trading concepts. Europeans have been slower to offer those services and prices and if people do not understand the basics of trading, they are less likely to become involved.

Also the US market is the worlds largest cohesive market. In Europe every country has its own exchange with different rules, Many times it is difficult in Europe to trade on an exchange that is not located in their country. Taxes and fees also vary between exchanges. Besides US stocks, the US market also lists stocks of large foreign companies from around the world. The stocks are packaged as American Depository Receipts (ADRs) and are traded on the US exchange.

During a later topic, I will be covering how to open an account at a discount brokerage, how to trade, fees, and some useful tools that can be provided by the brokerage.

The Horticulturalist

I recently watched a UK show hosted by Sir Gerry Robinson called "You can't take it with you" where he talked to families and individuals who had not yet made a will and took advice from a top wills lawyer in London. One family had a disabled adult daughter who lived with them with some degree of independence but would need help for the rest of her life. From memory they had about GBP 400,000 to leave her and were worried that it would not last her lifetime.
I thought it interesting that no-one discussed investing the money as a long term option. Should either one of us pop our clogs then we would plan to invest the life insurance pay out with the hope that we could live of the investment profits rather than deplete the lump sum.

Michael

Life insurance should be inexpensive term life insurance. A whole life insurance policy pays a very low return even lower than an annuity.

If you have extra cash instead of paying for whole life insurance, it would probably be better investing in the stock market for the long term. If you are young, 100% stocks would likely be fine but as you get older, a portion of you investments should probably be in fixed income investments (will be discussed in a later topic). Over the last 80 years, the US stock market has returned about 8% compounded annually plus dividends. No one can say that will continue (just check out the Japanese market for the last 20 years or the NASDAQ exchange since the tech bubble burst 10 years ago) or there won't be major setbacks over periods of time (just look at the last 10 years or from 1965-1975 when the US market was flat).

I would suggest that both of you cash out your whole life insurance policies, purchase term life insurance policies, and invest any cash returned in the market. Also purchase more equities on a regular basis for any money that would have been used to pay for your whole life policy. This way you are income averaging which limits potential losses due to market pullbacks.

Watch Suze Orman on CNBC on the weekends (usually on in the evenings) for some very sound financial advice. She hates whole life insurance policies and annuities and her advice is conservative and sound for the average person. Should also has specials on PBS.

Dave Ramsey on Fox Business Network also gives decent sound advice for the average investor but sometimes he can be slightly incorrect especially for the elderly investor.

Michael

Management Fees

When you purchase a mutual fund or ETF, there are management fees. Generally those fees are not shown in your statements and are deducted under the covers without your knowledge.

The fees can be deducted from dividends paid, the selling of stock in the funds, or other methods.

When purchasing an ETF that pays dividends, the estimated dividend for that ETF already has the fees deducted. This is the preferred method for indexes since many times the ETF is priced the same as the index, 1/10th the price of the index, or 100th the price of the index. As an example DIA sells for 1/100th the DJIA (DOW) index (may vary slightly due to impending dividends or supply and demand) and the SPY ETF is 1/10th the S&P500 index. This makes it easy for purchasers and sellers to determine the fair market value of the ETF.

When purchasing an ETF that doesn't pay interest or dividends, assets are sold to pay the management fees. Usually this is reflected in the Net Asset Value (NAV) or in other words the current price you pay for a share. As an example, the the gold ETF initially came on the market with 0.10 ounces of gold was held for each share. Currently there is 0.097521 ounces of gold held per share as the gold was sold to pay the management fees. Some investors don't realize that is happening and will purchase the ETF not realizing that the ratio is no longer 10 to 1.

http://www.spdrgoldshares.com/sites/us/value/