Index Funds...The Investor's Training Wheels

The average man doesn’t wish to be told that it is a bull or a bear market. What he desires is to be told specifically which particular stock to buy or sell. He wants to get something for nothing. He does not wish to work. He doesn’t even wish to have to think. -Jesse Livermore

On my birthday during one my wonder years (where I did not have to worry about things like bills, stocks, recession, etc), my father bought me a bike. After the initial excitement of realizing that I got a bike had passed, I realized that I was going to have to learn how to ride the thing. I was a bit timid of the thought of having to get on the bike, maintain balance and pedal all at the same time. After all, I could fall off the bike, get hit by a car in the street or many other bad things.

However, my friend Zack would come by my house on his bike. His house was a mile away from mine and while it took me about 15 minutes to walk to his house, he could get to my house in 5 minutes. Well, now it was my turn, now that I have my bike, I was capable of getting to his house within 5 minutes or less, I just had to learn how to ride it.

So when I tried to ride my new bike for the first time, I hopped on and tried to pedal. Unfortunately I did not understand the concept of balancing on the bike and got approximately 1 foot forward before having to put my feet down to prevent me from falling. After a week after these failed attempts, my father came out and showed me a couple of tricks. He taught me how to coast down a heel to learn how to maintain my balance. Once I learned how to maintain my balance, I learned how to pedal and eventually was able to put the two together and ride my bike.

At the end of the whole learning process my dad told me, "Man, maybe I should have gotten you some training wheels, that would have made this a lot easier and you would have been riding in no time." What, training wheels? Are you serious!? Are you telling me that I could have gotten back at least a few days of failures if I just had training wheels!?

Well, it seems like history repeats itself, because I made the same mistake on my initial entry into the stock market. The simple rule to succeeding in the stock market is to "Buy low, Sell High". Sounded simple enough to do so back in October 2007, Washington Mutual was on its way down and I thought that they looked like a good buy. They were down to $20 from their high of $47 and I just knew when they rebounded, I was going to be able to recover all of my money as well as make a hefty profit.

Well, if you have not followed Washington Mutual's fate, currently they are bankrupt meaning that their stock is worth $0 and no longer exists. Fortunately, I was able to recover some of my money before losing it all, however, the fact of the matter is whether I lost $1000 or $10, I still lost which is the exact opposite of my motivation for investing in the stock market.

Once I realized that my individual stock picking skills were not up to par, I realized that I need to get some "training wheels" so that I do not let history repeat itself. While researching one day, I came across Index Funds.

Index Fund: A type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor's 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover.

(Index Fund Definition taken from Investopedia)

*For a list of other common stock indexes, view the Wikipedia page*

An Index Fund is the novice's best investment tool as it offers the following benefits:

1. Allows you to easily diversify your portfolio without having to choose individual funds
   
• Diversification: A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio. (Cited from Investopedia)
  
2. Low Management Costs
• Since Index funds are managed by computer models that try to purchase the exact funds listed by an index rather than relying on stock analysts, the fee to manage index funds are typically lower than those of other mutual funds.
  
3. Low Turnover
   
• Turnover: The number of shares traded for a period as a percentage of the total shares in a portfolio or of an exchange. (Cited from Investopedia)
• Lower turnover allows you to pay less transactional costs as well as reduce the capital gains tax that you will incur for trading funds held less than a year.
4. No commissions to pay when bought directly from some mutual fund companies.
• Unlike many online stock brokers, when you buy more shares of an index fund directly from the mutual fund company, you do not have a to pay a commission for each purchase. In addition to that, you typically do not have to pay a commission to redeem the fund at a later date.
5. Easier to do Automatic Investing for dollar cost averaging
   
• Dollar Cost Averaging: The technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. (Cited from Investopeida)
  

Although there are many advantages to investing in Index Funds, there are some disadvantages as well.

1. Index funds are designed to perform at the index rate of return
• If you are trying to get a higher return than the rate that is given by the market, you will typically not achieve it by having an index fund.
  
2. As with all investments, there is a risk that the overall index can go down meaning you would get a negative rate of return. (i.e. our current market situation)
3. Investing through a brokerage typically requires a hefty minimum if you are investing in a general account.(i.e. Vanguard requires $3000 for a minimum investment into their funds for a general investment account)
   

Index funds give you the chance to invest in the stock market without a lot of experience or knowledge. I highly recommend that you if you wish to start investing in the market, that you do so using an index fund especially with the market at historic lows. For those who are interested in getting their feet wet with index funds, you can do some research at Vanguard for the different funds they offer.

Do you have any recommendations for Index Funds or any other beginner investments, please share them in the comments below.

Stay Disciplined!

Are foreclosures a good investment?

Every Cloud Has A Silver Lining ( be hopeful because difficult times always lead to better days ... ) - Unknown (quoted from GoEnglish)

Everyone knows about the huge sub-prime mortgage debacle that is unfolding in our country right now. According to the New York Times, (link to article), six million people are expected to default on their mortgages this year. In addition to that, houses are rapidly decreasing in value all over the United States due to lack of demand. Although this is really bad news, for some, it presents a huge opportunity.

This opportunity is to diversify your current investment portfolio. I have been looking into expanding my investment portfolio into the real estate arena because stocks are still highly volatile and the prices in the real estate market have fallen drastically. Plus, having a guaranteed way to make passive residual income is very appealing. However, before diving in head first, I wanted to take the steps to educate myself on the topic to see if it is a viable way to invest.

Earlier this week, I attended a Foreclosure Investment Property Seminar at the Georgia Tech Alumni Association given by Mary Beth Lake who is a Realtor with the Harry Norman Realtors company. She provided us a very informative and interesting presentation that covered the pros and the cons of investing in Foreclosure properties. I felt that this presentation is great information to share with anyone who was thinking about investing in Foreclosures or Real Estate in general. Below is a summary of the presentation she provided as well as some of my added notes:

Investment Real Estate (Foreclosures)

Investment Real Estate: Real estate that generates income or is otherwise intended for investment purposes rather than as a primary residence. (Citation)

Foreclosures

Foreclosures are typically "distressed" properties that a bank repossesses in means to recover the cost of the loan that a homeowner has defaulted on. Foreclosure usually progresses in the following stages:

1. Pre-Foreclosure
• If the homeowner misses one mortgage payment, the foreclosure process can begin.
  
• Sometimes during the pre-foreclosure stage, the bank will work with the homeowner and agree on a "Short Sale" in which the bank agrees to take a lower price on the home than what is actually owed.
2. Foreclosure by the Bank
• The bank goes through the process of evicting the tenant out of the home and repossessing the home to put it up for sale.
• The bank can advertise the home on the courthouse steps to have the property bidded on.
  
• Some states are non-judicial meaning that the bank does not have to take the home owner to court to evict them.
  
3. Sold/Auctioned as a Foreclosure
• The bank can sell the home on the courthouse steps.
• If the home does not sell, the bank can choose to list the who with an Real Estate Owned (REO) Agent who can either choose to sell the property through a public auction or by using the traditional means such as the Multiple Listing Service (MLS).
  

Caution: Pre-foreclosures and Short Sales can take a lot of time and require a lot of patience. Short sales are very risky and foreclosure homes are usually sold without any disclosures. This is important to know because states like Georgia are "Buyer Beware" which means the buyer would not be able to hand back the property if they decide they do not want it anymore after signing the contract.

Due Diligence

Prior to investing in the foreclosure market, much due diligence needs to be done to determine whether or not the home is a good investment. To assist in the planning of this one must realize the four financial benefits of owning investment real estate and how to calculate them. The four benefits are the following:

1. Income
2. Principal Reduction
3. Income Tax Savings
4. Appreciation

Income: Revenue generated by the Real Estate property (rent).

Principal Reduction: Reducing the amount borrowed or the amount still owed on a loan.

Income Tax Savings: Deductions that you can claim on your income from owning Investment Real Estate. For more details, click the "Financial World" link. (Financial World )

Appreciation: An increase in the value of an asset over time. (Investopedia)

To assist with the analysis of the investment property, the presenter (Mary Beth) provided us with an excel spreadsheet she acquired from Tom Lundstedt who gives seminars about investing in Real Estate. (Thanks Mary Beth and Tom!) This file is accessible to our members through the "files section" on the Pamplona Finance Google Groups Page.

For those who review the pre-filled excel spreadsheet, the scenario to accompany that file is listed below:

Scenario:

• You are investigating a property in east Point that is listed for $139,000. You think that you can negotiate the seller down to at least $130,000.
• You plan to put 20% down and pay all the closing costs.
• You would like to close in early December 2008 so that you can make any necessary repairs over your holiday break and hopefully have it leased by January 1st 2009. You plan to lease it for a year.

Some other useful tips during due diligence is to do the following:

• Use the tool to analyze multiple homes in the area.
• Fill out a Schedule E for Real Estate Investments to claim on your taxes.
• Can request a Schedule E if purchasing this home from a Real Estate Investor.

For more information about the Schedule E, consult about.com article here.

Gathering the Money to Invest

With the economy being in the state that it is, many investors are not able to reach deep into their bank accounts to put the money up to obtain an investment property. Most first time investors will have to take some type of loan from a bank and pay the money back over an extended amount of time. This part of the presentation was given by George Connolly who is a mortgage broker with SunTrust Mortgage. Below are the initial requirements needed to finance a Real Estate Investment if borrowing the money from a bank:

1. 20% of the sale price down payment.
2. 3% closing cost of the loan.
3. Six month property emergency fund to cover mortgage and monthly expenses when the house is not generating income.
4. $5,000 - $10,000 in liquid reserve for repairs, emergencies.
5. Monthly expenses
• Accounting Fees
• Attorney Fees
• Landscape Maintenance
• Utilities
• Taxes
• Insurance
  

The Exit Strategy

With all businesses, it is important to know what you are going to do once you figure that the property is no longer a good investment or you are ready to cash in. In the optimum situation, the house will appreciate over time and you will build equity in the home. Equity is the difference between the current market value of the property and the amount the owner still owes on the mortgage. (Investopedia) There are three ways to move the equity:

1. Sell the current property and buy another.
• Will have to pay Capital Gains Taxes. (Captial Gains Tax Calculator)
  
2. Refinance the current property and use the money to buy another property.
3. 1031 Exchange.
• 1031 Exchange - A tax deferred exchange that is for like-kind investement with property with a specified strict time period. (IRS)

More Useful Information

• Always purchase Owner's Title Insurance.
• Financiing can make the difference between a property performing well or going down the drain.
• Don't confuse Inflation with Appreciation.
• Places to purchase a great deal
• Excellent School Districts
• Developed/Developing areas
• Places you would not mind living yourself
• Get a team of proven professionals to assist you with investment decisions. Team should include the following:
• Accountant
• Attorney
• Loan Officer
• Property Management Company
• Realtor
• 1031 Exchange Qualified Intermediary

One thing that the presenter shared with us is that Foreclosed homes are a lot of work and may not be as lucrative of an investment as many people think it is. To help with your decision, I have included a video that I took while surveying a home that I found on www.ushomeauction.com.

In summary, if you are willing to put in the effort, time and money needed, a foreclosure can be a good investment. However, I think that it may be worth the time and effort to spend a little extra money on a non-foreclosed home as it may require less work to make it habitable for re-sell or a tenant. From my research, I have learned that it if you want to invest in Real Estate, do not just limit yourself to searching for foreclosed homes.

Do you think that Foreclosures are still a good investment? Please leave your comments below.

Stay Disciplined!

By the way...we do workshops too!

So to step away from one of my regular posts, I just wanted to bring to your attention another great resource that you can use on your journey to personal finance freedom. We, in the Pamplona Finance Group, typically hold a monthly - quarterly workshop about a personal finance topic that we receive input on from our members. The workshops are free of charge (for now) and all we ask is that you come out ready to participate and learn.

The video above is a trailer from the latest workshop done in September. (Please forgive my video editing skills) The workshop was very interesting and informative. The presentation was delivered by our very own Marc Wilson who is passionate about taking the proper steps to secure his financial future.

If you would like more information about our workshops, please join our subscription list by adding your email to the section labeled "Google Groups" on the right side of the page. We send out the information about our workshops to members who are subscribed to our list.

We really encourage you to come out to learn as well as share any information that you want. In addition to that, this is a good way to network as well as meet some potential accountability partners who can help you achieve your financial goals.

Stay Disciplined!

Surviving the Recession...Getting Back to the Basics

To use fear as the friend it is, we must retrain and reprogram ourselves...We must persistently and convincingly tell ourselves that the fear is here--with its gift of energy and heightened awareness--so we can do our best and learn the most in the new situation. -Peter McWilliams, Life 101

Earlier this week I took a trip to New York for my job. Now, I am by no means a fan of airplanes, but I understand that they are relatively safe and each time I have flown, I made it safely to my destination. So in my mind, it was going to be business as usual as I settled comfortably in my coach seat, although there was a slight drizzle coming down and the sky was painted gray with clouds at Hartsfield Airport.

The most fearful part of flying for me is taking off as I have heard that many say that the highest risk of something going wrong is during that part and landing. As we aligned ourselves straight on the take off runway, I hear the engines roar and we are off. As I feel the plane separate from the ground, I notice that everything seems to be going normal. Just as I get ready to breathe a sigh of relief, the plane takes a sudden drop. My stomach goes to my chest and we hear the captain of the plane say "Please remain in your seats with your seatbelts fastened as we are going to be in rough air".

Shortly after the intercom turns off, the plane takes another dip and I look around to see other people with fear obviously on their faces. I begin to think to myself that this is the end and say a short prayer as I may be getting ready to meet my Maker. However, the captain continues to push the engines full throttle and after we experience a few more dips, we finally level off at 41,000 feet where the air is a little smoother. Needless to say, although we experienced a few more bumps in the air, we arrived to our final destination safely and in one piece.

Later that day, I realized that the airplane ride was a strong analogy to what our economy is going through right now. We are currently at the point where most Americans are looking at each other with fear on our faces thinking some variation of "this is the end". However, just as the captain did what it took to navigate through the turbulence in the air, our government will do the same. Although we may go through a few more bumps while trying to get to our final destination, ultimately we will arrive safely.

If you do not know that a recession is going on right now, then this is your wake up call. All the times of spending more than we make, eating out, burning gas, etc are coming to an end. Below are some of the basic principles that I am using to survive this recession.

1. Budget.
• One of my friends always budgets and sets aside a specific amount of cash that he can spend at his discretion (eating out, partying, etc). He does this because it really resonates with him as he sees cash leave his fund as well as allows him to think twice before spending the money. Once that money is gone, he knows that he has to wait until his next paycheck before he can do any further discretionary spending.
  
2. Save at least 10% per paycheck.
• One of the most important assets to have during tough times is a fund that is highly liquid (Emergency Fund). This comes in handy to carry you in between pay periods as well as cover any unexpected expenses that can occur while money is tight.
• Devoting 10% of each paycheck to a high-yield savings fund will add up quickly. Recommended bank where I keep my Emergency Fund: HSBC
  
3. Plan out trips.
• Having a car is quickly becoming a larger and larger expense because of the cost of gas. Planning out the trip and knowing exactly where you are going prior will allow you to consolidate trips and conserve gas rather than having to make multiple trips in one day.
4. Cook.
• On average, I spend about $7/meal when I eat out at a (decent) fast food restaurant. When I eat at a sit-down establishment, that goes upward to $13 - $15 (tip included).
• My average meal at my house costs about $15 to make, however, it typically lasts for 3 days. I typically eat leftovers twice a day for those three days which roughly equals 6 meals total. Doing the math, you see that my average cooked meal costs $2.50. Big big savings!
  
• Below are some useful websites with quick and easy recipies.
  
• Kraft
  
• All Recipies
  
5. Work Overtime (if your job allows it).
• Overtime is great because it typically pays 1.5 times your hourly rate as well as it typically does not require any extra work outside of your regular job.
• Overtime gives extra unbudgeted income that can be used to weather the recession period.
6. Turn a hobby into Entreprenuership.
• One of my biggest hobbies is computers. I have turned my hobby into a small entreprenuership where I help out people with any computer problems they may have. This is a double win because I get money for doing something I would do for free as well as people save money by using my services rather than some big company that charges an arm and a leg for the same service.
  
• Some other entreprenuer ideas...fashion consultant, tutor, dance instructor, bartender, party planner...get CREATIVE.
  
7. Find creative (cheap) sources of entertainment.
• Game nights have become a regular routine amongst my friends. Rather than going out to spend money, we typically organize a game night or crank up some Rock Band and have a blast..
  
• Another interesting idea to do is have a potluck dinner where each of your friends cook an item and create a buffet of food. Just make sure your friends can cook.
  

No one said this was going to be easy, however, it is very doable. The key is to not give up and become very resourceful to make it through these turbulent times. So fasten your seatbelts and hold on because the ride is going to be bumpy, but if we stay the course, we will make it through it. What are some of your tips to make it through this recession period? Please share them in the comments below.

The Credit Default Swap...A Contributing Factor to Today's Economy

There is not really one clear reason as to why the economy is in the situation that it is in today. There are many contributing factors that have been at the center of the government's investigation consisting of subprime mortgages, high consumer default rates as well as unemployment. However, one of the known, but not talked about, contributors to the current state of our economy is an investment product called a Credit Default Swap.

Below is a short explanation of the credit default swap as shown from wikipedia:

A credit default swap (CDS) is a credit derivative contract between two counterparties, whereby the "buyer" or "fixed rate payer" pays periodic payments to the "seller" or "floating rate payer" in exchange for the right to a payoff if there is a default^[1] or "credit event" in respect of a third party or "reference entity". (Source)

To put this in more plain terms, take the following example:

Most of us (the buyer) who have cars have car insurance in the case that something happens to our car and we need to have our car replaced. We pay a periodic "premium" to an insurance company (the seller) in return to have the insurance company to provide the replacement cost of our car in the event that something happens to it. In most cases, if something happens to our car, we have to provide evidence to the insurance company by showing them the car. After the insurance company sees the car, they will more than likely provide you the money according to the previous agreement. Sounds reasonable right...

Well, let's take a look at Credit Default Swaps. The way it was designed to work is to allow investors to buy insurance on fixed income that they bought from a company (such as a company bond) so in the case that the company went bankrupt, they could recover some of the cost they invested in the bonds. Well, due to many factors, this started to be abused by investors and instead of actually buying the insurance to protect against losses for bonds possessed by the investor, they began buying the insurance with intent of receiving a big payout if the company went bankrupt.

Since there is technically no regulation in this market, investors did not need to show proof that they owned $10 million dollars worth of bonds to take out $10 million dollars of protection against this bond. In addition to that, the companies providing the protection (insurance companies and others) would gladly accept the insurance premium paid by the investor to insure companies (such as Lehman Brothers and Washington Mutual) that seemed financially sound and did not look to have a big risk of defaulting over the past years.

In most cases, those same insurance companies did not set aside the needed capital to cover the coverage promised in the case of a default by those companies (although they signed contracts legally obligating them to pay the specified coverage). So in turn, when major corporations, who have been opened for multiple decades (such as Lehman Brothers and Bear Stearns), began to fail, those insurance companies were unable to pay contributing to the bankruptcy problem being experienced by our financial institutes.

The insurance companies never should have accepted premiums from investors that could not prove if they owned the fixed income securities. In addition to that, they should have operated as their purpose and set aside the money necessary to cover the insurance claims in case of a default.

The financial lesson learned is that unethical business practices (AKA greed) never pays off and is eventually destined to fail. A lesson that we all can learn from this is that there are not too many highly-probable ways to get rich quickly. It all comes down to how much risk you are willing to take as well as the level of loss that you are able to deal with. Below are some of the lessons that I have learned recently about greed and personal finance in regards to my situation:

1. Day-Trading in the Stock Market
2. Investing in Penny Stocks
3. Investing without doing Due Diligence on companies

By no means am I trying to discount these methods of investing as many will argue that these exact methods have worked for them. I am purely providing my experience with these methods in hope to save someone the financial grief that I have experienced before. By all means, if you have the magic formula that works for you 99.99% of the time, please feel free to share it with us.

P.S. - I learned about the Credit Default Swap product from attending a highly informative ToigoTalk about the subject. Click on the link to learn more about this and other financial topics.

For another interesting article about Credit Default Swaps, check out the following link:

http://www.dailywealth.com/archive/2008/oct/2008_oct_04.asp

More Information about Recessions

Well, I think that the country is in a bit of a recession now. No worries though, during my usual exploring on the Internet, I found an interesting chart that contains information about past recessions the country has experienced. The link below provides a bit of an explanation as to why the recession may have occurred as well as give the duration of it.

This may help to calm all of your fears about our current economy. Check it out!

Brief History of Recessions [Harvard Business School via Consumerist]