How to Invest Going Forward

For those that have been following the portfolio I track in real-time on the left hand side of this blog (based on the last chapter in the e-book), it (along with the market) is basically flat year-to-date.

Although this might not seem like an accomplishment, go to any popular charts site (like Prophet.net's Javacharts) and compare DGP, TLT, and SPY year-to-date. You'll see that the portfolio of DGP and TLT equally invested has been down at most 6% throughout the year, whereas the market was down about 28% by 3/9/2009.

So, thus far the portfolio is holding up quite well, outperforming the market for the majority of the year with way less risk.

Also, now might be a good time to check out the first chapter of the e-book (available free on Lulu.com) for how to prepare for the possible entry for next month into stocks in case the S&P500 stays above its 10 month moving average.

New e-Book!

I have finally finished writing my e-book "Investing for the Long Term." The book is meant to empower the average investor and teach you how to beat the market with less risk by using simple math.

If you've been reading the posts on this blog, you would already know from a previous post that on average 80% of money managers underperform the stock market (on average they give you 2% less of a return). So, you can already beat 80% of these "professionals" by merely investing in an index fund like SPY which tracks the S&P 500. However, as we saw in 2008 such a buy and hold strategy can be devastating (40% loss in 2008!).

My e-book introduces you to one simple math concept: moving averages. In it I discuss how using such a simple concept beats the market both in return and risk (and would've eliminated the 40% loss of 2008) and also discuss several other strategies that improve on this. The main culmination of the book shows you how to make 24% a year with less risk than the market.

The first few pages of Chapter 1 are available free so that you can experience just how simple it is to outperform these money manages, financial advisers, and other "professionals." Hope you all enjoy it!

PF 101 - How one number can save you lots of cash: your FICO score

You've probably heard a lot about your FICO score through ads on TV. But what is a FICO score, what's yours, why should you care, and how does it impact your financial health?

FICO stands for "Fair Isaac Corporation," which is credited with creating the most reliable credit score model. This means that the company has analyzed data from millions of consumers and lumped their results into a number that ranges from 300 to 900, and indicates how much risk you respresent to anyone (bank, car dealership, school) considering lending you money. In a moment, I'll show you how this FICO score is roughly calculated, and some ways to improve your score. First though, let me tell you about the basic big picture idea.

FICO takes into account your overall credit use history. This means that every loan, credit card, mortgage, or other type of credit you have ever accessed is stored in your credit report. You can actually (and everyone should) obtain a free credit report once a year per Congress' recent legislation, and examine the report yourself. Aside from making sure that there's nothing on there that (1) doesn't belong to you, (2) is incorrect, and (3) is out of date, your credit report is the fundamental ingredient that drives your FICO score.

Your FICO score is composed of four basic types of areas. In order of greatest to least weight, they are:

1. Payment History (35% of FICO score): Making payments on time is crucial to lowering your debt, and is a good indicator of a sound borrower.

2. Debt amounts (30% of FICO score): Really, the most important thing here is the balance to credit limit ratio. Someone with only 1 card and a balance of $3,000 with a credit limit of $4,000 would be in better shape here than someone with 10 cards with a combined balance of $3,000 and a combined credit limit of $10,000. So, the idea is to keep this balance to credit limit ratio low, as it indicated responsible borrowing on your part. However, the easy way to abuse this is to get more credit by opening new accounts. FICO forsees this, and this is the main reason for the next item on the list.

3. Length of credit history (15% of FICO score): The most important thing here is the average length of time your accounts have been open. Someone who has 5 credit cards each 4 years old (average credit length of 4 years) does better in this category than someone who has 5 cards open, all five of them only a year old (average credit length of 1 year). The rationale is that opening cards too frequently (which drops this average) may signal a borrower in financial distress, which may mean he/she may be unable to pay their balance and hence comes off riskier.

4. The last two items are New credit (10%) and Credit Mix (10%): The new credit percentage is exactly what we discussed above: how frequently you've been opening credit, and how old the most recent account is. The Credit Mix is aapprently a bit harder to quantify. However, it appears that borrowers with both revolving credit (like credit cards) and installment loans (like car loans) are less risky borrowers than those who only have one type of credit.

Now that you understand what goes into your credit score, let's talk about why you'd like to raise that score. Since your score is used for just about every credit you try to access, the interest rates that come along with that credit are based on your FICO score. MyFICO.com has a great calculator which shows you how much you could save on typical credit accounts (mortgages, home equity lines, etc.) if you were to improve your credit score.

Depending on how much you improve your credit score, and on how much credit you are accessing, improving your FICO score can save you anywhere from tens to hundreds of thousands of dollars in interest over the life of the loan!

If this isn't incentive enough to become more disciplined about your finances and pay down your debt, then you should think about how many things you could accomplish with those savings.

Now, here are some practical tips for raising your FICO score:

1. Pay down your debt, with the most money going to the highest interest rate card first (see a previous post on paying down debt here).

2. Increase your debt to credit limit balance by applying for high credit limit offers (but no more than once every 6 months). WARNING: the idea here is not to end up with 17 credit cards, each with a limit of $200. The idea here is to capitalize on the good offers. For example, I recently (due to my higher FICO score from paying off debt) was offered a $15,000 card, which I accepted.

3. Always pay on time. Per the percentages above, payment history heavily influences your FICO score.

4. Try to stop acquiring consumer debt (go here to read more about the different types of debt). Since your FICO score does not take into account things like student debt, it is yet another way that we are all encouraged to acquire investment debt and shy away from consumer debt (i.e., we are encouraged to invest in ourselves through things like education more than we are encouraged to spend money on things that bring us immediate satisfaction, like a new TV).

Great! By following these simple ideas, you'll be well on your way to saving thousands on interest on every type of credit you access (credit cards, loans, mortgages, etc.)!

Save money on groceries with unit pricing 'till expiration

**This post will help you save anywhere from $80 to $100 per month on groceries and clothing**

Shopping for groceries can be stressful, fun, or dreadful. It all depends on your mindset, and on what you do while you're at the store. For me, my usual goal is to find everything I need, and then maybe get a few things I want. But more important than that distinction is how I select the items in those two categories: I buy depending on the combined unit price and price 'till expiration. Let me explain how you can use these to make smarter shopping decisions, and help you save some money (as well as avoid throwing away food someone else could've eaten).

Unit Pricing

Most items in a grocery store have a simple price on them. For example, you might see a 12 oz box of Cheerios selling for $3.50. However, the price of the item is insufficient to determine whether or not its a good value. To see this, let's say you see a 16 oz box selling for $4.00. Which is the better buy?

In comes the idea of unit pricing. Paying $3.50 for the 12 oz box is the same as paying about 29 cents for each ounce of Cheerios. On the other hand, paying $4.00 for the 16 oz box is the same as paying 25 cents for each ounce. In this situation, most people would say "why would I pay more for less (the 12 oz box), when I can get more for slightly more money?" Of course, most people don't stand in the cereal isle dividing numbers, but you do see this more commonly in the meat isle, where the prices are all clearly marked in terms of the same unit (usually pounds).

So, unit pricing is a method of comparing the price of two equivalent (or roughly equivalent quality) products based on how much they cost for the same unit (per ounce, per pound, per gallon, etc.). Whenever possible, most people use this to try and get the better deal on buying the things they need, and in general unit pricing is considered a more "sophisticated" way of shopping. However, here's the hidden danger in only using unit pricing.

Say you're the grocery store owner and you had a bad week in the milk department. You have many more gallon milks than you'd like, and they're all expiring soon (say within a week). In a desperate attempt to get them sold, you slash the price from the usual $5 to $3.75. The half gallon milks, on the other hand, have been selling well. You also just got a new shipment in with milks that don't expire for another two weeks. As a result, you decide to keep their price at $2.50.

Enter you, looking for some milk for the week. The usual unit pricing would tell you that you're paying $3.75 for the gallon, or $5 for two half gallons...the obvious choice there is the gallon milk.
However, the gallon expires in 7 days, and the half gallons expire in 14 days. So, one way to compare the two, taking that into account, is looking at the unit price 'till expiration.

To find the unit price 'till expiration, divide the unit price by how many days are left until the product goes bad. We get:

1. $3.75 per gallon / 7 days until it goes bad = about 53 cents per gallon, per day that the milk is still good,

2. $5 per gallon (2 half gallons) / 14 days until it goes bad = about 36 cents per gallon, per day that the milk is still good.

From this standpoint, its clear what's happening. If you're planning on drinking a full gallon of milk over the next 7 days, then the $3.75 gallon would be the best bet. BUT, if you for some reason get to the 7 days and still have milk left over, you'll have to throw it away. Depending on how much milk you throw away, you would have likely been better off sticking with the 2 half gallons for $5. In fact, if you end up with 1/4 of the gallon left after the 7 days, then you in fact paid $3.75 to drink 3/4 of a gallon, which is really $3.75/(3/4 gallon) = $5 per gallon...the same you would've paid had you gotten the 2 half gallons...and you the milk would've lasted you longer.

If you've ever thrown away food, then chances are you've suffered from this simple, yet costly mistake in the past. Now, stop to think not only about groceries, but what about eating out? Ever brought home some leftovers only to throw them out later? (which means that the actual price you paid for that food is higher that the price you paid at the restaurant, since you ended up only eating a fraction of it). To hammer down the point, the other category where this is heavily applicable is: clothing. Ever bought a cheap clothing item only to see it fall apart weeks or even days later? Chances are the more expensive brand would have lasted longer.

As you can see, unit price 'till expiration tries to quantify these things, and although I introduced it with food above, basically anything that can be assigned an "expiration" is fair game for this concept. With clothing, although it doesn't expire, it certainly becomes unusable after a certain amount of time due to wear and tear. It is also usually the case that the more expensive counterpart tends to last longer (if you buy a $10 pant that falls apart in 1 month, you could've bought a $40 pant that won't fall apart for a year...$10/1 = $10 per month vs $40/12 = $3.33 per month).

Lastly, on a much-harder-to-quantify level, cheaper things are usually cheaper for a reason. Unit pricing 'till expiration reveals the true price of these items, as it takes into account the quality, or expiration date of the item. However, this are things that are much harder to quantify, such as the effect of cheaper things on your overall health, for example.

In the milk example above, those of us who would've bought the $3.75 and ended up paying $5 since we only drank 3/4 of the gallon could have instead used those same $5 to by Organic milk instead (provided it expires later). Being Organic, it would have been a healthier choice, and possibly end up costing the same amount of money.

The same can be said about clothing as well. Its no secret that brand names are sometimes expensive just because of the brand, but its also true that you can more often find better quality clothing from these stores than from their cheaper counterparts. Case in point: we recently purchased some pants from Kohls which broke in a little over 2 weeks, but decided to buy those instead of ones at Banana Republic (from which we have several that are months/years old) due to their "cheaper price." In the end, we ended up needing to buy new pants again to replace those broken ones, and the total (had we bought the cheap kind again) would've come out to roughly the cost of the Banana pants.

In conclusion: be aware of not only the displayed price of an item, but also what factors are being displayed in the price. The two main ones I've tried to highlight here are: quality and durability (how long will the item last before you need to throw it away). Unit pricing 'till expiration can help you decide which one is then the truly better buy.

Balance Transfer APRs....beware!

Often times I get an offer in the mail from one of the credit cards that I currently have zero balance with offering me a special low APR for a set period of time (usually one year from the date I receive it). Credit card companies do this to try and lure you back into using their card once you've paid it off. Now, after having read the posts about the basics of debt, you should know that paying your higher interest cards off first is the best (mathematically speaking) thing to do. But, let's say one of those cards whose normal APR is 7% sends you and offer in the mail that offers you a 1.99% APR for one year if you transfer a balance from another account. Then, after the one year, the card reverts back to its normal 7% APR. Sounds like a great offer huh? Read on...

Here's the catch...if you read the fine print (usually not too fine actually), most of these offers charge a certain percentage of the balance amount being transferred, and add that amount to the total transfer amount.

So, to continue with the example, let's say the offer charges you a 5% fee (3% is the norm, but sometimes you get a 5% fee, and other times you get no fee...the best! while other times there is a maximum fee of anywhere from $90 to $150), then here's what would really happen to your balance on the card if you were to transfer a $2,000 to it:

a. You transfer the $2,000.

b. Your new balance is now $2,000 plus 5% of $2,000 = $2,000 + $100 = $2,100.

c. Assuming you don't make any payments, in one year you get charged 1.99% interest on that original amount and your new balance will be $2,141.79.

Ok, so let's see why this is a bad idea. To calculate how much interest you were charged, we divide the final balance by the initial balance, and subtract 1 from that: ($2,141.79/$2,000) - 1 = 1.070895 - 1 = 7.09%! This is more than the actual 7% interest APR on the card! What happened to being charged a "low" APR of 1.99?

You see, as soon as you transferred the balance, you were charged 5% of it as a fee, and then you were charged 1.99% on that new balance ($2,100), so one year later the interest that accrued did so on a balance which was already 5% more than what you transferred. This is also why the interest one year later is not just 5%+1.99% = 6.99%, but is instead 7.09%...that 5% fee (those extra $100) also accrued interest at the rate of 1.99%. Here's a play by play of how the interest actually accrued:

1. Upon transferring $2,000, you are charged 5% of that as a "fee," which is $100.

2. Then, one year later, your total balance is 1.99% of the new balance ($2,100), which is 1.99% of $2,000 (your initial transfer) plus 1.99% of $100 (5% of $2,000).

3. Since 1.99% of $2,000 is $39.80, and 1.99% of $100 is $1.99, the total interest charges are: $100 (fee) + $39.80 (from the "low" APR offer of 1.99% for one year) + $1.99 (1.99% of the $100 fee charged) = $141.79.

4. Your final balance at the end of one year is then $2,000 + $141.79 = $2,141.79, the same number we got in part c above.

Thus, the main thing to be aware of when figuring out if a balance transfer is a good idea is:

You need to determine the real APR that you're being charged to execute the balance transfer.

-------Mathematical Sidenote--------

Here's the easiest way to do it. Say that the new "low" APR they are giving you is x %, and that they are charging you a fee of f %. Then the actual interest charged over one year assuming you don't make any payments (the only fair way to compare apples to apples to the card's normal APR) is:

[{1+(x/100)}*{1+(f/100)} - 1]*100

For the example we used, the offer was 1.99% APR, with a fee of 5%. So x=1.99, f=5, and the above APR turns out to be (1.070895 -1)*100 = 0.070895*100 = 7.0895%.

Now, if your card is "generous" enough to cap the fee at $y (meaning they'll charge you the f % fee if it turns out to be less than $y, or $y if the fee turns out to be more), then the above APR needs to be modified. Assuming you are transferring a balance of $B dollars, the real APR would be:

[{1+(x/100)}*min{1+(f/100),1+(y/B)} - 1]*100

(here the min{.. , ..} means compute both things and then take the smallest of the two). To continue with the example above, suppose that the fee was capped at $50. Then, y=50, B=2,000, x=1.99, f=5, and the above APR is about 4.5% (its lower in this case since $50 is 2.5% of $2,000, so the cap effectively means that the fee they charge will not exceed 2.5% of the transferred amount).

On the other hand, if we wanted to transfer $900 instead of $2,000, we have:

min{1+(5/100),1+(50/900)}=min{1.050,1.055}=1.05,

so in this case the fee of $50 is 5.5% of the balance being transferred (so they charge you the lower fee rate of 5%), and the above ARR yields (1.0199*1.05 - 1)*100 = 7.0895%...the same interest rate in our original example. The lesson to learn here is that:

Even if the balance transfer fee is capped, your real APR may in fact end up being greater than the normal APR on the card. This is why I put generous in quotes above.

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How to avoid massive financial crises - Housing and beyond

I've yet to talk about housing, which is probably the single largest investment that most of us make. Usually, mortgage rates tend to be lower than credit card rates, as the Bankrate app I added shows, and in addition, taxes paid on your mortgage are usually deductible on your income tax return. Housing also tends to appreciate in value....most of the time. However, we are currently in the middle of one of the worst housing crises in this country's history.

There are those, however, that are still in the market for a home. The main question on their minds is: when will it end? When will housing prices bottom? The reason this is so important is that regardless of whether you're in the market for a home, or you currently own a home, the decline in the value of your home directly affects your retirement picture.

In the worst cases, some homeowners find themselves "upside down," whereby they owe more on their mortgage than the home is worth. Although it is somewhat too late now, let me discuss several things for you young ones out there that will come in very handy when thinking about your particular situations, and future planning.

First, let me review the concept of a hedge.

Let's say you are relatively sure that computer prices are going up. You were thinking of buying a new laptop that costs $700, but are not too sure that the price will drop in a few weeks. You decide to just buy the laptop now, but spend an extra $50 on a price guarantee, which gives you the ability to pocket the difference between the price of the laptop, if it falls, and your $700, for 3 months. If the laptop goes up in price, then the price guarantee doesn't do anything. Let's analyze some typical scenarios:

1. The price of the laptop sky rockets to $300. Then you saved yourself $250 since you paid $750 in total now, instead of $1000 later.

2. The price of the laptop plunges to $500. Then the price guarantee gives you back $200, but since you paid $50 for the guarantee, you really only got back $150...you paid $550 now, when you could've paid $500 later.

The price protection is an example of a hedge. For a certain price, it gives you the ability to lock in a maximum loss ($50) and have exposure to unlimited savings. Here's the important part:


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Believe it or not, you and I and everyone else, can hedge their basic economic interests very easily. --------------------------------------------------


The reason why I think this is one of the most important things you need to know is because we are now in an age where ETFs (exchange traded funds; learn more about them here) allow us to hedge our basic economic needs.

For example, if you kept up with the markets (I'll post more about this later), and somehow heeded the advice from everyone that the price of oil (and so gas) was going up in January of this year (2008), you could have, in your investment account, bought either: USO or DBE.

USO is the ETF that tracks the price of a barrel of oil in US dollars. DBE tracks the price of oil, but also of gasoline, and of heating oil. The important part? since gas has gone up, you have paid more for gasoline lately, but had you invested even a little money in either one of these (as little as $500), since they're up about 35% year to date, those $500 would turn into $675...enough to offset your increased gas costs.

It gets better. Had you heeded the warnings and advice of everyone in May of 2007 recognizing that the sub-prime mortgage mess would cause a housing crisis, you could have invested in SRS. SRS is the ETF that tracks the inverse of IYR, which represents the US housing sector. Here is a chart of IYR going back to 2006:



As you can see, the by the end of June 2007, the US housing sector was clearly in trouble. Now, here is a comparison chart of IYR and SRS starting June 1, 2007:



As you can see, whenever IYR (in red) moves down, SRS (in blue) moves up, and vice versa (actually SRS is twice the daily inverse of IYR, so it has more wild swings). So, since 6/1/2007 IYR, which represents the US housing sector, has declined about 25%...ouch. However, SRS, which track the double inverse, has gained 25%. Had you bought SRS, you could have hedged the decline in the value of your home.

The point of all of this is that with adequate research, its possible to hedge declines in the major financial assets that you currently own. You can hedge things like: gas prices, home values, food prices, electricity costs...and the list goes on.

To be more effective, you may want to hedge only partially. This means that, for example, if you are expecting your house to decline in value by 10% over the next year, and this represents a $30,000 loss in the value of your home, you could buy enough shares of SRS so that a 10% drop in the housing market (which would correspond to a roughly 20% increase in the price of SRS) would make you $10,000. This sort of partial hedge avoids one of the big pitfalls in hedging: you are never sure whether things are going up or down, so by partially hedging you are leaving room for the unknown (maybe your house goes up in price), but are still protecting yourself from the likely scenario.

One last point. Going back to the original discussion of "when will housing prices bottom out, and start going back up?" Just like everything else, people on Wall Street bet on this, and trade things called futures, which are roughly like stocks but not quite. The futures market gives one a clue as to what Wall Street is expecting future prices of certain sectors and commodities to be. What is it saying for housing? Here is the chart for the expected Median Price of housing in the US (from this seeking alpha article):



As you can see, Wall Street is expecting US housing prices to continue to decline until about November 2010. So, if you're in the market for a home, now may not be the best time to buy. If you live in one of the bigger cities in the US (LA, Miami, New York, etc.), you can go here to see the charts for your particular city. These last two links also contain links to the actual futures prices...so you can track Wall Street's bets for median housing prices in these big cities.

Bottom line: the more aware you are of the macroeconomic situation (and how the different parts of the economy interact), the more options you have to insulate yourself from financial crises. However, and here is my disclaimer: investing always carries along with it risk that you may lose money, even if your intent is to hedge the financial aspects of your life. The recommendations and analysis I provide are no exception, and are no substitute for personalized advice.

But, it sure is important to keep up with these things, and at least learn how the macro economy ultimately affects the prices you pay, and your ultimate retirement picture.

Blog Updates

I've made some updates to the Blog format I thought would enhance the functionality for everyone.
Here's a list of changes:

1. I have enlarge the column widths to fit some HTML code.
2. I've added a Bankrate.com interest rates daily update
3. I've added a Google Document detailing the real-time performance of an equal weight portfolio. This particular one is just a fancier version of the basic asset allocation I talked about in a previous post. Feel free to use the scroll bars to get real-time info on the ETFs used, how the portfolio is divided up, and what asset class each ETF covers.

As I post more changes I'll just briefly describe them here.