Secrets from the Millionaire Teacher, Andrew Hallam

“Review or door stopper,” read the subject line of the email.

Now that is a book review request I enjoy. Make me laugh, and you have my attention.

But this is not going to be a book review. This article will give you actionable tips from inside the book. Suffice it to say, Millionaire Teacher is a comprehensive personal finance book for beginning or intermediate investors. And I recommend that you read it!

Take Action

Read this article and come away with actions to implement to become a Millionaire. Some of these may not be completely new and that is because there are tried and true strategies to grow your resources.

First come the Quick Tips; next is the in depth information and motivation.

Nine Rules of Wealth Checklist

1. Spend like a Millionaire, if you want to become rich. That means don’t spend too much. In general, millionaires live conservatively, not extravagantly.

2. Start investing early to allow your funds to compound and grow over time.

3. Invest in low-cost index funds to maximize your future wealth.

4. Learn about stock market history, greed, and fear, so you don’t become a victim of buy high and sell low.

5. Learn to build a complete stock and bond portfolio using index funds. You will beat most professional investors.

6. Use index accounts, no matter where you live.

7. Don’t fall for an advisors ”hard sell”.

8. Watch out for “too good to be true” scams that promise outsized results.

9. If you want to dabble in individual stocks, do so only with a small portion of your portfolio.

In Depth Advice for Wealth Building

More detail pilfered from Hallam, a high school English teacher who built a million dollar investment portfolio on a teachers salary.

Spend Like you Want to Grow Rich

You’ve heard it before, the millionaires are not the folks riding around in Cadillacs and Porches but are those living in the modest home driving an older car. Hallam’s path to millionaire status was peppered with a cheapskate lifestyle for many years. This guy rode his bike 70 miles per day to work through rain and sleet. He lived on clams salvaged from the beach accompanied with low cost pasta and potatoes. Free rent was the byproduct of house sitting gigs for those Canadians wintering in the south.

That’s how he can afford to live well today; travel, live in a condo with a pool and squash courts, and drive a classic Mercedes.

What’s the takeaway for you? I certainly don’t want to get my food from the beach or ride a bike to work. Yet there are other ways to live conservatively with an eye towards the future. Substitute low cost alternatives for life’s necessities. You need a place to stay, you don’t need a luxury apartment. Take in a roommate or two. You need food, but you can cook at home instead of eating out. Have a peanut butter sandwich (I have one at least three days a week) for lunch once in awhile and pasta for dinner.

The lesson is this, delay gratification for a while and understand that the wealthy “Look to the Future.” Spend responsibly, think creatively, save profusely, and you can become wealthy on a teacher’s salary.

Conquer the Enemy in the Mirror; Watch out for Fear and Greed

I tend to worry a lot, so anything to do with “mental money” strategies catches my interest. Hallam explained that mutual funds tout 10% average annual gain. Great, that means that all the investors in the fund earned 10% annually as well? Not quite.

Investors tend to be influenced by the bifurcated emotions of fear and greed. When the price of a mutual fund falls, many investors get scared and pull their funds out. Then after the fund goes up for awhile they get back in.

What just happened is that those investors missed the largest portion of the funds’ gains. Hallam underscores the importance of the classic statement;

It’s not timing the market, but time in the market, that leads to long term financial growth.

The stock market goes up and down. In the short term, these movements are completely random. In the long term the trend is upward. Jumping in and out of the market leads to buying high and selling low. Not a great way to make money!

Hallam disclosed that he put money into the stock market after 9/11, when the fearful were pulling out. He reasoned that businesses weren’t worth less because there had been a terrorist attack. And of course, taking advantage of bargains when fear is in the air is a wonderful method of buying low.

Fight the tendency to follow the crowd and your profits will grow.

In sum, for those just starting out, there are engrossing stories and time tested wealth building strategies showcased in Millionaire Teacher. There’s even a section on how to make money buying and selling your vehicle. It’s a fascinating approach that anyone can try.

Remember, live sensibly, spend smart, and invest regularly. You may not get rich overnight, but you will set yourself on a path to a wealthy future.

Can’t Get Enough Wealth Building?

• 10 Rules for Building Wealth; CNN Money and Fortune
• How Young Adults Can Build Wealth; Young Adult Finances
• Side Businesses You Can Start Today; Wise Bread by Ashley Jacobs
• 12 Tips to Build Wealth for Early Retirement; Financial Mentor

Tried any of these strategies? What additional wealth building advice can you offer?

Jeff Rose at Good Financial Cents inspired me to write on the Roth IRA movement.

I’m one of those dinosaurs that started her first IRA in her 20’s at the beginning of the IRA movement. At that time, there was no such thing as a Roth IRA, so I went with a traditional IRA. On top of that anomaly, I was the only 25 year old at a retirement seminar in a room full of 60 year olds.

Although my passion for saving and investing has stood me well over time, I am deeply concerned about the financial future of those who haven’t yet started to save and invest. Read on for some motivation to get started investing in a Roth IRA today.

A True Retirement Story

At 8:00 AM I receive a call from an older neighbor, just wanting to talk. She started off by recounting the details of her husband’s firing from his job. My neighbor, June, believes he got fired because of his hot temper. Strike one, keep your temper in check at work.

The saga continues as she tells me about the new blinds she is buying for the home. I casually mentioned, that she might postpone this purchase since HER HUSBAND, THE MAIN SOURCE OF FAMILY INCOME JUST LOST HIS JOB. June replies, that expense was already planned so she will get the new blinds. Strike two, don’t add more financial stress after a job loss.

To top it off, June continues her financial mismanagement by sharing how she paid a consultant $100.00 to explain Medicare coverage to she and her hubby. Unable to keep my big mouth shut, I said that Medicare will explain their system FOR FREE. Strike three, don’t pay for information readily available for free.

The final blow came when she mentioned she has NO ROTH IRA, NO TRADITIONAL IRA, and not much saved up for retirement.

She stated “We don’t need retirement savings, we’ll have social security soon.” 

What is she thinking?

Why You Must Start a Roth IRA Today

I understand that retirement seems a long long way off for those in their 20’s and 30’s. Yet, the earlier you start saving, the less total money you need to save, and the more you will have at retirement time.

There is uncertainty in the future of social security. At best, benefits will be smaller and start later than they do now. Long term employment with a singular employer is practically nonexistent. So, if you fail to take responsibility for your future, you face a scary life in old age. As we all live longer, we need more assets to ensure that we don’t outlast our money.

I beg you to explore the data so you don’t end up old and poor.

Check out the facts:

Joleen’s Story

At age 25, Joleen began investing $200.00 per month in a Roth IRA and her employer added another $100.00 per month bringing the total up to $300.00 per month.

She invested the monthly retirement money* this way:

• 40% ($120.00) in Vanguard Total Stock Market Index Fund (VTSMX)
• 30% ($90.00)  in Vanguard International Stock Index Fund (VTIAX)
• 30% ($90.00) in Vanguard Total Bond Market Index Fund (VTBLX)

She started investing at age 25 and stopped at age 65, for a total of 40 years.

At age 65, Joleen’s contributions plus her employers’ grew to $787,444.00*.

Jamar’s Story

Jamar, Joleen’s brother wanted to spend his earnings and didn’t think about the future. No retirement investing for Jamar, he was having too much fun; Jamar figured social security would take care of him.

At age 40, Jamar had a change of heart. He woke up one morning and realized that he had nothing invested for his future; and he was scared. He decided to start investing and chose the same investments as Joleen, but decided to try to catch up. Jamar invested $400.00 per month, twice as much as Jill’s $200.00.

Jamar’s employer matched his $400.00 per month with an additional $100.00, just like Jill’s. This brought his total monthly investment to $500.00.

*Assume: Portfolio average annual return of 7%

At age 65, Jamar’s contribution plus the employers’ grew to $405,036.00, while Jill’s lesser contributions grew to almost twice that amount at $787,444.00.

INVEST IN A ROTH IRA

The Takeaway

My friend June is living in denial. When social security comes, it won’t match her husband’s former income. As her savings are small and she didn’t plan for the future she faces major lifestyle cuts as she ages.

The alternative to old age is death. If you expect to get old, own up to reality, and invest through work or a discount broker in a Roth IRA and start contributing today. Even if Social Security continues, don’t expect it to pay for a comfortable retirement. You can choose not to invest for the future, but be aware that social security is uncertain, and you will be poor in your old age without investing in an IRA.

Start now, you won’t miss the money and you’ll appreciate the financial security later.

You do need IRA, Social Security won’t be enough to support your retirement.

Have you started your retirement investing yet? If not, what are you waiting for?

Don’t forget to check out Part 2 and find out How to Profit from Low Interest Rates

In the university course I’m teaching, the  Investments text was published in 2010. The examples in the book use 12% as an expected return on stock investments and Treasury bill rates are projected at upwards of 5%. Compare those returns  with the recent 1.24% 5 year average return on the Vanguard Total Stock Market Index Fund (VTSMX) and the 3.55%  iShares Barclays 1-3 Year Treasury Bond Exchange Traded Fund (SHY) annualized 5 year yield.

Why are interest rates so low?

The students in my class complained about the unrealistic examples in the text book. They have no experience with actually receiving a few percent interest on their bank savings accounts and 5% CD rates.

What is Going on with Low Interest Rates?

In economic terms, the Federal Reserve Bank which decides monetary policy is trying to pull our economy out of a recession and jump start growth.  As part of this effort, the low interest rates are designed to promote spending by consumers and corporations. Firms fund growth through expansion and frequently take on debt to finance that growth. With low interest rates, corporate borrowing costs are rock bottom. This allows those corporations to expand at a cheaper cost than in a high interest rate environment.

Consumers make decisions whether to spend or save based on many factors. Included in that decision making are returns on saving. With low interest rates on savings, the government would like to see consumers spending in lieu of saving in order to help grow the economy. Actually, consumer spending is about 70% of Gross Domestic Product, the main metric to gauge the economic health of the country.

Savers and Retirees are Hurt by Low Interest Rates

The consequences for savers, especially retirees are difficult. Today, retirees are panicked as their CD income is nonexistent. My relatives with only cash investments have gone from high returns on their savings to retirement cash nibbled up by inflation. For the population past their earning years, hoping to supplement their social security income with interest from bank Certificates of Deposit, it is a dire financial time.

Ben Bernanke, the Chairman of the Federal Reserve Bank and one of the most powerful people in the U.S., pledged to keep interest rates low until 2014. That’s almost two more years. It is rare to have that type of clarity on the future of interest rates. In fact, I’ve never heard an official make such a public comment about upcoming monetary policy. Usually the Fed’s actions are hush hush and a complete surprise.

In the next article in this series, you’ll get some ideas about how to profit from the current interest rate environment. It is certain that it won’t last forever, yet instead of waiting for rates to rise and interest payments to grow, there are some tactics to boost your returns now.

In the Part 2, learn Three Ways to Profit in the Current Interest Rate Environment.

Related Reading for Those Who Can’t Get Enough

How Bonds are Valued and React to Interest Rate Changes at Moolanomy

Investing to Beat Inflation at Money is the Root

Low Savings Interest Rates; Good or Bad? Consumerism Commentary

Is the Fed Putting Your Retirement Savings at Risk? A guest article by Nerdwallet.com at One Money Design

How have the low interest rates affected your behavior?

• Recession
• Mortgage Meltdown 
• Sub Prime Lending Crisis
• European Debt Crisis
• 911
• Wars in the middle east
• Growth of China as a major world competitor

There are always outside forces that play on our economy and investment returns. These forces are called systematic or market risk. This risk is unavoidable and plagues all market participants. No matter how diverisifed your portfolio is, you cannot avoid systematic risk.

What is an investor to do?

In reviewing the stock market returns from 1928 to 2011 one could assume that rates went smoothly upward at 9.28% per year. Actually, that average hides a bumpy road. Returns on stocks over that time period ranged from annual double digit losses to annual double digit gains. Growth in investing is fraught with ups and downs. Not unlike life itself.

Is There a Pattern to Economic Growth and What Does it Mean for You?

Economic growth typically follows a path that looks a bit like a roller coaster, with gradual increases, leading to a high point of strong economic growth, followed by slowing GDP and usually a recession. This type of growth is certain, where the mystery comes in is the “when”. Cyclical growth is a given; but when the trend changes is unknown. 

 ECONOMIC GROWTH CYCLE

 This pattern means several things to investors. Investing is a long term endeavor. Don’t even think about investing any money you will need within the next 5 years in the stock markets. Stock market returns are way too volatile for short term investing. Knowledge of market behavior will help you stay the course during market fluctuations. Once you understand that the ups and downs in economic and investment returns are normal occurrences, you can learn not to be  surprised when the market tanks for a year or so. In fact expect that every few years, there will be a year with negative stock and/or bond returns.

Accept Ups and Downs in the Market as a Reality and Profit

As an investor here is a simple plan to stay the course.

1. Choose an asset allocation you can live with.

2. Select diversified low cost index funds from a range of asset classes for your investment portfolio.

3. Contribute regularly to your investment account during market ups and downs. In fact, contributing assets in a declining market yields the greatest rewards.

4. Look at how much money you can amass over a few decades of regular investing. Invest $4,000 per year from ages 25 to 65 in a diversified stock index fund with an average annual return of 7.5% and retire with close to $1,000,000.00. Regular investing over time yields great rewards. 

5. You must download my free eBook; 20 MINUTE GUIDE TO INVESTING to learn investing basics and receive a bonus subscription to the Wealth Tips Newsletter.

Following are some of my recent investing articles across the blogosphere;

• The Digerati Life, Buying Bond? The Effect of Interest Rates on Bond Value versus Yield
• Free Money Finance. Dividend Investing is Not the Perfect Solution for Yield
• Consumerism Commentary, I’m consulted about Buying a House with Cash

Women’s Money Week

I’m participating in Women’s Money Week next week. Women have historically been laggards when it comes to finances. This week is about encouraging women to speak up about money, take control of our finances, and reshape our financial future. Women’s Money Week will run from March 5th-11th, 2012 on WomensMoneyWeek.com — coinciding with International Women’s Day.

Following are a few of the participating blogs in Women’s Money Week (I’ll include a few more each day)

Moneylicious
Monroe on a Budget
Moola Saving Mom
Mortgage Free By 30
Mother Miser
Mrs. Nespy’s World
Ms. Money Savvy
Mummy Deals
Musing of an Abstract Aucklander
Musings of a Midlife Mom
My 1/2 Dozen Daily
My Broken Coin
My Dollar Plan
My Journey to Eliminate Debt
My Money and My Life
My Open Wallet
My Pretty Pennies
My Year Without Wasting Money
ND Chic’s Cents
Newlyweds on a Budget
Next Stage, The: Women and Retirement
No More Sheeple
No More Spending
Northern Cheapskate
Northern Living Allowance
Not a Coupon Queen
Not Made of Money
November Sunflower

Many of my readers have specific personal finance questions. The extra information in the WEALTH TIPS NEWSLETTER (sign up on right) seems to spur even more questions. I love sharing my financial experience with others, so here is this weeks question.

John wrote in and asked for advice for himself and his daughter;

HISTORICAL RETURNS

I would like your opinion and advice on how I should allocate my investments and my daughter’s investments among mutual funds. Both our accounts are with Fidelity. I am 56 and plan to retire at 60. I have $400,000 in IRAs (Traditional and Roth). My daughter is 24 and has $65,000 in an individual acct and $50,000 in both Roth and rollover IRA. There are so many funds to choose from and I feel overwhelmed. Any suggestions would be helpful.

Caveat; This article will touch on the topics to consider when choosing mutual funds. Please do not take this as personal advice for your individual situation. There are many considerations when planning an investment portfolio. For any specific investing information, please contact your own investment advisor or CPA. Fidelity has advisors on staff that can help with investment questions as well. Personal disclosure-I have an account at Fidelity.

Too Much Information is Not Always Better

There is scientific evidence that it is more difficult to make a decision when confronted with a large number of choices, than when given just a few choices. I think this is particularly true when it comes to investing in mutual funds. Did you know there are more individual mutual funds than individual stocks? How is someone able to decide among the over abundance of offerings?

Determine Your Risk Level First

Before considering how many and what type of funds to choose, you must figure out how much volatility or risk you can stomach. Those who cannot sleep when their investment portfolio goes up and down, should have less invested in stock investments and more in fixed or bond type investments. Additonally, the more time available before you need access to your funds, the more agressively you can invest.

Stocks and stock mutual funds are quite volatile and over the short term (which can be up to five years) can go up or down in value. Over periods of more than ten or twenty years, their normal trajectory is upward.

Never put any money in stock type investments which you will need within the next five years.

Bonds are less volatile, yet long term historical data suggests that they offer lower levels of return than stocks. Contrary to the past few years.

In general, if you are close to retirement and cautious about risk you should have a more conservative portfolio with a larger percentage of your funds in bond type investments than stock type investments.

John’s 24 year old daughter has a long working life ahead of her, time to make up any investment losses and should think about investing a bit more agressively.

Which Mutual Funds to Choose?

Actually, this is a much easier question than you would think. You only need a few index funds to have an optimal portfolio. Since John’s accounts are at Fidelity, I’ve included some Exchange Traded Funds (ETFs) which can be bought commission free at Fidelity. Most of these funds and ETF’s are generic index funds with low expense ratios.

Most low cost, broad based index funds of the same type are comparable. Vanguard has the largest selection of low fee index funds.

Pick an index fund from each category:

Total U.S. Stock Market Index Fund

• Vanguard Total Stock Market Index Fund (VTSMX)-Fidelity charges a fee to buy this mutual fund
• Russell 3000 Index Fund (IWV)- Exchange Traded Fund with no commissions from Fidelity

Broad-based International Index Fund

• Fidelity Spartan International Index Fund (FSIIX)

Diversifed Bond Index Fund

• Vanguard Total Bond Market Index Fund (VBMFX)-Fidelity charges a fee to buy this mutual fund.
• Barkleys Aggregate Bond Fund (AGG)-Exchange Traded Fund with no commissions from Fidelity

The percentages invested in each fund depend on your risk tolerance and preferred asset allocation. To learn more please sign up for my Wealth Tips Newsletter and get a free e-copy of 20 Minute Guide to Investing (top right of this site). There are sections on determining your risk tolerance and asset allocation.

The most important factors in investment wealth building are to pick an asset allocation and stay invested through thick and thin. The chart of historical returns illustrates that long term asset performance is generally positive. If history is any guide and if you believe the USA and world economies will continue to prosper, your investments will increase in value over time.

For more commentary on Index Funds:

Save Money with Index Funds at Invest it Wisely

Index ETF’s vs Index Mutual Funds; Which are Better? at My Personal Finance Journey

Money Help for Christians provides a Beginner’s Guide to Index Funds, Mutual Funds, and ETFs.

Are Actively Managed Funds a Fools Game Compared to Index Funds? at Squirrelers.

Consumerism Commentary offers a sophisticated debate; John Bogle and Jeremy Siegel Debate Index Funds.

What are your preferred investments?

SIMPLE ASSET ALLOCATION

MBA Series #1

“Don’t put all of your eggs in one basket.”

The beginning of the year is portfolio rebalancing time for investors. I write a lot about investing as I believe it is an achievable path to long term wealth. If you don’t know what asset allocation is or much about investing at all, then this article is for you.

Modern Portfolio Theory is the science that drives most of the writing about investing today. As I put the finishing touches on the university class I’m teaching this winter in Investments, I’m going to share some of the basics with you; FOR FREE!

Tried and True Investing

Diversification in investing means don’t put all of your money in one investment or one type of investment.

Why?

When that investment goes down, there goes the value of your invested assets-down.

Buy different types of investments, so that when one goes down in price, the others may go up, or at least remain stable.

Diversification smooths out the ups and downs of the value of your investments.

For example, it is rare for bonds and stocks both to go down at the same time. During the past decades bonds have outperformed stocks, an historically unusual occurrence. Over long periods of time stocks have outperformed bonds, but a combination of both asset classes reduces your portfolio volatility.

There are all types of asset classes such as, international stocks, country specific stocks, small cap stocks, commodities, real estate, corporate bonds, government bonds, international bonds and many more. All of these types of assets can be bought as individual holdings, or combined in mutual funds and exchange traded funds (ETF). But, you don’t need to worry about the wide variety of asset classes unless you are passionate about investment management. You can obtain a satisfactory amount of diversification with just  two ETFs or mutual funds.

Asset Allocation means selecting specific asset classes and choosing the percentage amount invested in each asset class. The chart above illustrates a simple asset allocation model.

Simple Portfolio Management

The research abounds that a basic asset allocation of a certain percent in stock investments and a certain percent in bond investments has led to long term wealth creation.

With annual rebalancing to make sure the percentages in each asset class remain in alignment with your stated preference, you can grow your assets with little time spent in managing them.

Index funds and ETFs are perfectly suited to a simple and effective portfolio management approach. The two asset portfolio shown in the chart above combines a world stock market index ETF with a total US bond fund. Depending upon your age and risk tolerance, place more or less in each asset class.

Rebalance your portfolio at the end of the year to get back to your originally selected asset allocation. In other words buy or sell from each holding to get back to the desired percentage amount invested in each fund. Paul B. Farrell of Market Watch has a wonderful series called the Lazy Portfolios with several asset allocations and performance metrics. For more ideas on this topic, it’s worth a read. The ten year annual returns of the 8 Lazy Portfolios ranged from 4.8% to 6.8% versus a ten year return of the S & P Index of 2.86%.

Consider this easy approach to investing to grow your wealth over time. This method is ideally suited for use with a workplace retirement fund.

For more on this topic, subscribe to my Wealth Tips Newsletter and receive a free ebook, 20 Minute Guide to Investing. (Sign up on the right)

Caveat; This article is for information purposes only and is not a recommendation to buy or sell any specific securities. For investment advice see your own personal advisor.

If You Can’t Get Enough Asset Allocation, Here’s More

Asset Allocation by Age at Couple Money

Doug Warshau wrote about Asset Allocation for People in their Twenties at Sweating the Big Stuff

The Absolute Importance of Asset Allocation at Money Help for Christians

My Personal Finance Journey shares his Asset Allocation

For those asset allocators out there, what is your asset allocation and why?

How Do You Analyze Invesment Performance?

In investing, you feel great when your statement shows a nice fat annual return like 12% or even 13%. Conversely, when you have a “bad” year with a negative return, you’re disappointed.

What is a benchmark? “A standard used for comparison. For example, the NASDAQ may be used as a benchmark against which a technology stock is compared.” Investorwords.com

What are the Correct Benchmarks to Use For My Investments?

What Does Index Mean? “A statistical measure of change in an economy or a securities market. … An index is an imaginary portfolio of securities representing a particular market or a portion of it. Each index has its own calculation methodology and is usually expressed in terms of a change from a base value. Thus, the percentage change is more important than the actual numeric value. Stock and bond market indexes are used to construct index mutual funds and exchange-traded funds (ETFs) whose portfolios mirror the components of the index.” Investopedia.com

How Did My Stock Fund Perform; year-to-date?

The Takeaway

Forget about absolute performance, if you seriously want to evaluate how your investments are performing. Find the benchmarks for your mutual funds, they are listed in the prospectus or on the web-site. Then look at how your investments did in comparison with their unmanaged index benchmarks. If you are besting the indexes over time, great. If not, consider switching your money into a low cost unmanaged index fund. You’ll be certain not to underperform the market!

I’ll let you in on a secret, many years ago, someone told my dad to buy gold. And he did. But after decades of no upward movement he sold. I know he is sorry now. The lesson is that in investing you have some hits and some misses.

ACTION PLAN:

Get a notebook and label it: “(your name) Personal Finance” and keep it by the computer. Use it to keep all of your personal finance goals, thoughts, activities, and plans.

• Choose a mutual fund or etf that you own or are thinking about buying. Go to the web-site of the holding.
• Look at it’s recent recent and long term performance.
• Compare the performance with it’s benchmark.
• If you fund is underperforming it’s benchmark, think about whether to keep it or switch into a related unmanaged index fund.
• Be sure to consider tax consequences.

(Remember, do not take this article as investment advice, but as educational information)

Top Investing Yakezie Blogs

• Buy Like Buffett
• OilandGasETFs
• Darwins Finance
• Financial Success for Young Adults
• Investor Junkie
• Money Mamba
• PTMoney
• The College Investor

Top Investing Websites

• Seeking Alpha
• Morningstar
• Investopedia
• Yahoo Finance
• CNN/Money

How are your investments performing?

image credit; ryanpyle.com

Why I’m Nervous About the Market

If you like what you’re reading, pick up my RSS feed and follow me on twitter so you get the word immediately.

This is a chart of some holdings in the professional portfolio I manage. I have some concerns about their valuations.

Investigating a few metrics implies conflicting valuation information. 

PE Ratio: As I wrote over at Buy Like Buffet in One Step Stock Analysis, the price earnings ratio (PE ratio) is a simple way to begin a stock stock (or Exchange Traded Fund) analysis. As a recap, lower PE ratios indicate undervalued and higher suggest an investment may be overvalued. The best use of this metric is to compare the raw ratio to its historical average.

52 week high and low prices: These prices show the annual price range of a holding. When the current price is hovering around the 52 week high, there’s cause for further investigation. It is more likely the price will drop rather than rise. 

MY CONCERNS

• The PE ratio’sof these ETF’s are either about average, or a bit low as compared their historical norms. This indicates at worst, fair value for the investments and at best, a bit undervalued.
• Since 1870 the historical PE ratio on USA stocks is about 15.
• Every price of these ETF’s is near their 52 week high. Although the prices could continue to rise, they have already increased over 100% in the case of VTI to 43.34% in VNQ. Compared with long term averages, these are substantial annual year increases.
•  In theory, stock prices should correspond with increases in revenues and earnings. In the short term, this rarely occurs. But, if the prices of these holdings moved in accord with their earnings, we should prepare for a substantial share price drop.
• In the short term, stock prices are extremely volatile.

 INCONSISTENCIES

Price earnings ratios are not seriously overvalued.

Rates of return are off the chart. In other words, the rates of return are enormous when compared to their historical averages.

Another consideration, as we are rebounding from several years of negative and low rates of return during the recession, these exceptionally great price advances are not unusual.

Large and small cap stocks average annual returns are 10.17% and 12.01% respectively. Last year, the Vanguard Total Stock Market index returned over 100%. If the statistical concept of “reversion to the mean” (simply put, returns adjust towards their average return over time) comes into play, we are in for some economic pain.

I’m not the only one unsure of the market valuations.

The Yale academic, Robert Shiller, and creator of the 10 year (trailing) Shiller PE is at odds with the market strategist, David Bianco. In the Wall Street Journal article, Is the Market Overvalued?, by E.S. Browning. Shiller believes the market is overvalued and Bianco disagrees.

MY RECOMMENDATION

Even if the market is overvalued, it may take some time to correct. No one predicts the future with certainty and consistency.

 If you are an investor, you need to accept the reality that financial assets go up and down in price.

Maintain an asset allocation you are comfortable with. If you are jumpy about market volatility, invest a smaller percent of your assets in stocks.

Do not invest any money in the stock market you need in the next 5 to 10 years.

& BARB RECOMMENDS LINK ROUND UP!

John responded to a recent article of mine in American Media Marketplace entitled Want to Get Rich From the Lottery? Start a Savings Plan Instead with this comment,

“(Saving) $50 a week for 52 weeks is $2,600, but it still wouldn’t meet the $3,000 minimum initial investment for the Vanguard Total Stock Market Index Fund.”

As a longtime cheerleader of Vanguad low cost Index funds, I WAS TROUBLED BY THAT COMMENT. I immediately called up Vanguard to confirm John’s comment. To my dismay, he is correct, not even with a commitment to automatic monthly contributions can you get around the $3,000 minimum initial investment. That’s way too high!

I frequently recommend getting started with investing, after taking care of these financial basics, by investing in a broad based mutual fund such as the Vanguard Total Stock Market Index Fund (VTSMX).

No more, although the advice still stands, the broad based United States Stock Index Mutual Fund has many clones. I stopped by Charles Schwab to check out their offering in this category.

The Schwab Total Stock Market Index Fund (SWTSX) is a better choice than the Vanguard Total Market Index Fund.

Schwab Total Stock Market Index Fund versus Vanguard Total Stock Market Index Fund

• Description: Seeks to track the total return of the Dow Jones U.S. Total Stock Market Index^SM, which includes all U.S. headquartered equity securities with readily available price data.
• Expense Ratio: Vanguard-0.19%; Schwab-0.09%
• Minimum Initial Investment: Vanguard-$3,000.00; Schwab-$100.00

Clearly, if you are just starting out, a fund with a small minimum required investment is an important consideration. Although a balanced portfolio should include a U.S.A. index fund, a broad based international fund, and some bond exposure, this article focuses solely on the U.S.A. index fund component.

Do not construe this article as a recommendation to buy or sell. Consult your own advisor for specific recommendations to fit your individual situation.

For a quick primer on investing download my FREE eBook 20 Minute Guide to Investing from the top right of this site.

Barb Recommends:

• Short and sweet at Yes I am Cheap; Answers to Common Personal Finance Questions.
•  At Yakezie, Sam, the Financial Samurai wrote Believe You Will Succeed, what could be considered a Guide to Life in this article, you must read it!
• Life and My Finances does a wonderful job explaining an important financial concept, gross income. He even throws in some ways to increase it!
• Soldier of Finance has a beautiful website with great advice, and a video too. Get informed and entertained; You Don’t Have That Much Debt, Really?
•  Free Personal Finance eBook, a great read by Carol in the Trenches
• One of the best articles on behavioral finance I’ve ever read at Money Crashers.
• Ever wonder about Buying a New vs. Used Car? Money Crashers offers some really good info.
• Ever consider getting a “debt free” college education. Read this guest article by Penny @  The Saved Quarter over at Get Rich Slowly.
• Should We Eliminate the US Postal Service? Ponder this question from Consumerism Commentary. I’ve thought about it myself.
• Want a good laugh? Head over to Millionaire Nurse Blog for some Money Saving Tips along with the humor.
• The College Investor asks, Why do Gas Prices Rise? I had to include this one as I’m a bit obsessed with inflation.

Barbara Friedberg Across the Blogosphere:

• Guest article; Eating Donuts Can Help You Stay on Budget at  Len Penzo dot Com.
• Guest article; Want to Get Rich from the Lottery? Start a Savings Plan Instead, at Making Money Blog at American Media Marketplace.
• Interviewed by Tim at  FAITH AND FINANCE.
• Totally Money Blog Carnival at Money Mamba
• Invest it Wisely
• Budgeting in the Fun Stuff
• Bucksome Boomer 

 If you like what you’re reading, sign up for my RSS feed and follow me on twitter so you get the word immediately.   

Chime in please; what other investment companies have LOW INITIAL MINIMUM INVESTMENT THRESHOLDS? 

image credit; the skateboarding maniac

INVESTING SOLUTIONS (part 3)

Welcome to Investing Solutions Week at Barbara Friedberg Personal Finance. This week there were three educational and enjoyable investing articles here. This is the final article in the series; please check out any you may have missed.

• Investing Solutions (Part 1); Why You Must Start Saving Now
• Investing Solutions (part 2); Six Investing Solutions Six Dangerous Investing Myths

I’m in the midst of teaching a Corporate Finance class for MBA students at a local university. Some of the concepts, although rather complicated, have important real world applicability. One of those uber-important concepts is, NET PRESENT VALUE (NPV). It is a method to put a dollar amount on future cash payments. It’s great if you win the lottery and want to determine whether to choose the lump sum payment or monthly option. Or what if you or your folks want to determine the present value of their monthly social security or annuity checks.

 When reading one of my favorite blogs, Consumerism Commentary, Flexo had to decide whether to take a lump some payment of his retirement account or monthly payments for the rest of his life. After reading the article, I went wild (not literally), but because I had to offer my 2 cents worth and do a net present value calculation for his predicament.

Here was Flexo’s situation:

He could receive a lump sum payment of $18,000 or $65.00 per month for the rest of his life.

Before I tell you which one he chose as well as the alternative most of his readers recommended, I’m going to introduce you to a systematic way to make this decision.

HOW TO CALCULATE AND UNDERSTAND NET PRESENT VALUE

You need to make an assumption before figuring out which alternative is better. The assumption is this; what percent return do you think you can get on your investment? I chose 7% because historically, a portfolio containing about 65% stocks and 35% bonds approximates a 7% return. Could I be wrong? Absolutely, I am making an educated guess.

To calculate how much a regular payment which continues indefinitely is worth today, all you need is this REALLLY SIMPLE perpetuity formula:

ANNUAL CASH FLOW/interest rate=PRESENT VALUE

If Flexo were to receive $65.oo per month, then he gets $65 x 12 or $780.00 per year.

Take the $780 and divide it by the 7%  interest rate: $780/7%=$11,142.86

THE NET PRESENT VALUE OF HIS $65.00 PER MONTH PAYMENT IS WORTH $11,142.86 today.

Since he was offered $18,000 or the $65.00 per month, he should definitely take the $18,000, because it is worth lots more than the NPV of the $65.00 per month or $11,142.86 NPV.

WHICH ALTERNATIVE DID FLEXO CHOOSE?

Flexo is a smart guy, as are his readers. And guess what, he took the $18,000 lump lum payment. And most of his readers also recommended that alternative.

Now all he has to do is invest that money in a few diversified index funds and watch it grow.

Help me get increase financial knowledge and tip this article. If you like what you’re reading, pick up my RSS feed and follow me on twitter so you get the word immediately. 

Don’t miss the first two Investing Solutions articles:

• Investing Solutions (Part 1); Why You Must Start Saving Now
• Investing Solutions (part 2); Six Investing Solutions Six Dangerous Investing Myths

Barbara Friedberg Personal Finance across the blogosphere:

My work was recently showcased at these sites. Why not stop by and check out the excellent articles?

• Carnival of Personal Finance; 7 Deadly Sins at Credit Cards dot com
• Little House in the Valley link round up; Energy Hogs Edition
• Carnival of Passive Investing at Free From Broke
• Investing Blog Roundup; No Emergency Fund at Oblivious Investor
• Black Coffee Link Roundup at Len Penzo cot com; Magic 8 Ball Edtition
• Carnival of Financial Planning at My Personal Finance Journey
• Investing Blog round up at Oblivious Investor

Which alternative would you have chosen, and why?

image credit:  Benjamin Theodore Payan