Starting With Stocks
November 29th, 2006We talked yesterday that if aggressive growth is what you are looking for, stocks are the best option. A quick comparison of portfolio returns would make it clear why.
Take a look at the Money 65 list of best actively managed funds. Go to the column that says “5 year return”, and look at the returns that different types of funds have returned.
Why 5 year? It’s possible that one year had a stock market boom, or a particular sector like oil or technology had a spectacular up or down. Over a number of years, these individual variations will get averaged out, and a comparison makes more sense.
The average range for stock funds is between 3.7% to 25.7%, excluding the foreign funds; if you don’t consider large cap / blue chip funds, you’d find the range even better - 8.2% to 25.7%.
Contrast that with the bond funds - the range is between 4.3% to 10.9%.
To understand why, you’ll have to remember that bond funds have a return rate, that usually tracks with the market rate. On the other hand, stocks can vary due to a number of other factors; individual performance, market sentiment or rumors, or even just general market fluctuation like bonds. Couple this with the fact that most businesses need to generate returns higher than the cost of borrowings, and the chances of getting a better return increase. A third factor is that growth oriented stocks typically reinvest earnings into growth, rather than distributing it by way of yearly returns; you get the benefit of compounding.
Choosing Bonds Over Stocks
November 28th, 2006When do you invest in bonds? What makes it a better alternative for you as compared to stocks or other options like savings and CD’s?
Typically, bonds make the most sense when
- You need a periodic income from your investments
- You’re looking at protecting your capital rather than growth
- You need specific factors like tax-free income
On account of these, bonds make much more sense for a late-stage investor; someone who has a substantial networth, expects to retire from active earning soon and needs to substitute another income stream, and has provided for most requirements and hence doesn’t look for aggressive growth.
For a young investor with a small capital, stocks make much more sense; typically, these grow much faster. Especially if you’re investing your IRA funds which are tax-protected, it makes sense to aim for fast growth to meet anticipated future requirements.
More About Bonds
November 27th, 2006Several factors need to be considered, while evaluating a bond for investment.
Interest rate / yield
A bond could have a fixed interest rate, a floating rate pegged to market rates, or even a balloon payment upon maturity (also called a zero coupon bond). Keep in mind that your actual yield may vary significantly from the nominal rate, depending on your purchase price.
Maturity period
Most bonds have a specified maturity date, upon which the bond is called in and redeemed for cash. There are some “perpetual bonds” which are never redeemed. Bonds could be short, medium, or long term bonds. The maturity date can make a difference to your overall yield.
Credit ratings
Credit ratings for bonds generally indicate how safe or risky the bond is considered; however, use this with caution. For example, Enron continued to be rated “investment grade” almost upto the end.
Other factors
Other factors that you need to consider are redemption bonuses, call or put options, bond insurance and tax status.
Fundamental Bond Investment Strategies.
November 24th, 2006If you’re planning to invest in bonds, you need to define a strategy. Bonds come in different flavors ; high and low risk, high and low yield, floating rate or fixed rate; treasuries, municipal and corporate bonds, not to mention “junk bonds”. Any of these could find a place in your portfolio, depending on what you’re looking for. High returns? Regular income? Appreciation? Safety? Or a combination of all the above?
There are two fundamental aspects to bond investment strategy that you should consider.
Diversification
Simple - don’t put all your eggs in one basket. Or even focus on just one type of egg. Investment in multiple different types of bonds can significantly reduce your risk of capital or income loss.
Laddering
Bonds typically have a maturity date; when the principal gets redeemed. This can play a significant role in determining price fluctuations - if the maturity is a long time away, prices fluctuate more than compared to a short-duration / maturity bond. As the maturity date nears, the chances of changes in what you’ll get are much lower, resulting in more stable prices.
Buying bonds with staggered maturities is called laddering - you reduce the sensitivity to interest risk, provide for periodic reinvestment or cash out to meet any possible requirements, and can moderate or tweak your investment profile at periodic intervals.
Investing In A Bond Fund?
November 23rd, 2006Many rookie investors assume that Bond Funds are a convenient alternative option to investing in bonds directly. After all, the fund invests in Bonds; and they are able to diversify better, as well as get expert advice. In addition, they would have investment experience, which ought to make the returns better?
Bond funds can be quite different from bonds themselves because they are not really fixed-income investments. Even when a mutual fund’s invests only in bonds, the fund itself has neither a fixed yield nor a contractual obligation to give investors back their principal at some later maturity date. In addition, the risk-return profile keeps changing as the fund trades bonds.
While bond funds do get fixed returns from the investments, a significant part of the returns are likely to be from trading bonds. As bond prices fluctuate with changes in interest rates, there can be substantial gains or losses.
There could be convenience in investing through a bond fund, especially if the fund itself focuses on specific types of bonds; tax free municipal bonds, or triple A corporate bonds. This is because the entry investment is a lot lower; if you had to build a diversified portfolio of these bonds, you would need to have at least $100,000 to invest. A good quality bond fund from Vanguard or other fund managers would require a starting investment of $5,000.
Keep in mind though, that the risk - return profile is quite different for a fund. These are more akin to equity funds than to bonds themselves.
Investing In Bonds?
November 22nd, 2006If interest rates are high, should you be looking at investing in bonds? Especially fixed rate bonds; traditionally, high interest rates mean that bond prices are low, helping you lock into a high return.
Floating rate bonds like the 10 year treasury are a different option; the rates on these change as the economic outlook and market rates change; these usually have a lower interest rate than market, since these are considered to have no risk at all.
T-bond rates have had a small decline over the last 6 months - with a positive outlook for the near future, it might mean that the current high rates won’t stay as high.
If you believe that interest rates have peaked, it’s worthwhile investigating high return fixed rate bonds. Consult your financial advisor before making any investments.
CD’s or Money Market Funds?
November 21st, 2006Most investors debate between CD’s and Money Market Funds, as alternatives for short to medium term saving and investment. While there are other possibilities including investing on the stock market, there are times when you would choose to keep your funds in fixed return investments. For example, while planning a major purchase or investment such as a house, or higher education for children.
As remarked in Sunday’s post on CD rates, the current increase in returns make CD’s a highly desirable alternative. However, the funds are locked up for the period of the CD; if you need the money in between, there can be significant charges and penalties incurred in releasing the money.
Money market funds offer rates which are lower than CD’s; but provide flexibility by way of checking facilities, to let you draw out money when you need it. The price you pay for convenience is the lower interest rates.
To decide between these two, you need to assess - are you going to need the money at short notice, or can you keep it invested for a predetermined period. If you have alternative resources to tap if required, CD’s are a better choice.
CD Rates on the Way Up
November 19th, 2006As banks are looking for more ways the attract customers, CD rates have risen over the past year and appear to be continuing this thrend in the immediate future. Many banks have been offering rates around 5% or more for terms of 36 months or longer. But, there are even some banks that are offering rates around 5.5% or better for terms as short as 3 months. You can compare CD rates at the Bankaholic blog.
In a recent post there, it was announced that AmTrust Direct is offering a 6 month CD at 5.51%. This is one of the highest CD rate available today. You can even open up a CD with them for as little as $1000.
There are many other great rate offers out there as banks compete for business. If you are looking at purchasing a CD from Chase, you may want to compare the Chase CD rate you have been offered to other banks in the market. With rates approaching and eclipsing the 6% mark, it pays to shop around.
Choosing A Fixer Upper
November 17th, 2006The most important word in property investing is Location - and it’s even more important when you’re considering a fixer upper. Don’t look at buying something just because it’s cheap; poor location could cost you heavily in the long run. Make sure that the property is in a generally desirable location, with potential to appreciate. Read the rest of this entry »
Fixer Uppers
November 16th, 2006Another strategy used by real estate investors, is to buy run-down property, fix it up, and then resell it at a handsome profit. In some cases, the approach varies - the idea is to buy a property significantly below value, and live in it after renovation; thereby getting a home that’s much better than what you could otherwise afford. Read the rest of this entry »