Invest your savings!

This post was prompted by a recent exchange with some friends – and judging by articles I’ve read, it’s a pretty common situation. Many folks are simply keeping their savings as cash in their bank accounts or paying off their student loans with it. Maybe the recession made them more cautious or maybe they just never thought about investing.

I feel folks are missing out here, so here are my thoughts:

  1. Don’t pay off your low-interest debt early. There’s no point in paying low interest debt early, especially if you have student loans in the <3% APR range – unless you plan to keep your cash under the mattress, which leads me to my second point;
  2. Don’t keep your cash under the mattress. I mean it both figuratively and literally. Let your money work for you.
  3. Figure out the risk level you’re comfortable with. That means both the “liquidity” that you want at hand, and risk tolerance (i.e. willingness to risk losing your money). You can then devise an investment strategy to manage for those constraints. For example, if your only concern is to have at least 50% of your savings on hand in case of need – you can still put ALL your cash into a stock and be 100% certain you’ll have cash if needed.
  4. Figure out how active / involved you want to be. Do you want to do your own research on companies to invest in, are you going to track your investments regularly, or just want to put your money into an account, and then check up on it a year later.
  5. Invest. Make a strategy that fits your needs, and let your money work for you.

Now, let me explain:

The richest people in this country make $$$ by borrowing money at a lower rate, and then investing it for higher returns – keeping the difference. A lot of people (especially from certain cultures) hate the idea of debt, and like to pay-off loans just to feel better – but the reality is that if you can manage your money, and put it to a good use, debt is no different than a wrench – it’s just a tool to get the job done.

Keeping money in a no interest bank account does nothing for you – in fact it just deflates. (It does help the bank do what I mentioned above – get free money from you, and lend it to others at a premium.) Considering the returns on bonds, CDs and such, I would highly recommend investing in stocks, especially if you’re in it for the long run. Commodities and such are an option too, but I would advise against that as your first step into investing. Low load Exchange Traded Funds (ETFs) are probably your best bet, unless you have a set of companies that you really believe in or just want to hand-pick your stocks. Either way, stocks (or equity based investment funds) are a better option than bonds in the long run – over any 10-year historical period, stocks have outperformed bonds. That is, if you buy at the market high, right before a crash – you’re still ahead 10-years later.

Stocks and ETFs are very liquid, so if you need the money out, you can close out any position(s) and have the funds in your checking account within a few days. So if liquidity is your only concern, this shouldn’t stop you from investing 100% of your savings in the market. I’m not necessarily recommending that, but it’s what I’ve been doing for a few years now. Last year’s 40% gains were surely a nice reward for that view. The main question however is whether you expect a forced sale event: e.g. what if you get laid off at the same time your investments take a (temporary) dive? If you buy high and sell low, you’re not winning. In my case, I just assume that between unemployment benefits and credit cards, I’d have some slack to manage through the thick of such a double-whammy.  As Warren Buffett said, the risks of being out of the market are higher than risks of being in it. =)

Speaking of buying high and selling low – you may hear folks say that right now is not a good time to move into the market because it’s had such a good run, and it’s due for a downward “correction”. Well, whoever can accurately predict that, will most certainly make tons of cash. For us mere mortals however, I would not worry about market timing (in fact, most commoners get it wrong).  You can start moving money into stocks in tranches – for example you could invest $50,000 by buying $5,000 of stocks per week for 10 weeks. You’ll buy some high, buy some low, and hopefully get the benefits of “dollar cost averaging”. The downside of not moving in at once is that you’re further delaying your investment, and missing out on earnings.

So now, the question is where to put your money? Certain stocks have done well for me lately: AMC, BAC (Bank of America), MSFT (Microsoft), QCOM (Qualcomm), AAPL (Apple) and even F (Ford). I am happy to make my picks… and enjoy (or suffer) the resulting volatility and performance. The implied statement there is that I know how to pick stocks that will outperform the market, which may or may not be true. (And by definition, half the people are bound to get below average earnings.) So, if you think you can pick well – go for it! Maybe it’s a tech firm you think has potential, or an old stalwart that’s weathered many storms… or a smart pick from a professional newsletter. You can go for growth stocks, dividend yielding ones, etc.

You could also invest in actively managed mutual funds – betting that the fund manager can beat the market. If you read “A random walk down Wall Street”, you’d be persuaded otherwise… but there are plenty of pros making the big bucks for their clients. Again, the key is in picking which one to put your money in. This is a bit like picking stocks to invest in, but you’re likely to reduce your volatility.

The more humble approach is to get into an ETF (say like an S&P 500 one) and just ride the market. You will be making the market returns (historically ~10%), minus a small fee. Chances are you’ll do better with an ETF than with options above, especially if you don’t want to micromanage your investment. You also have a certain level of security, if history is any indicator of future performance. Let me explain that by showing the S&P 500 best and worst five years:

Five Best One Year Performances (in %)

1954       +45.02%

1958       +38.06%

1995       +34.11%

1975       +31.55%

1997       +31.01%

Five Worst One Year Performances (in %)

2008       -38.49%

1974       -29.72%

2002       -23.37%

1973       -17.37%

1957       -14.31%

You can see two points above: shocks up are bigger than shocks down (on a yearly basis) and it would have to be the worst year ever for you to lose 40% of your cash. I am making this second point as people are often too conservative with their investments – even if you’re retired and living off your savings, you should still have a portion of your money in stocks.

Hope this helps!

Taxed vs. Withheld Income – What’s the Difference?

This is an area of common confusion, and not just among the “laymen” and employees at a company, but even among the HR professionals. I have heard many folks complain how their bonus is taxed at a higher rate, and it’s barely worth anything. I have seen numerous HR e-mails about supplemental payments, such as bonuses, vacation cash-outs and similar, being taxed at a higher (40%) rate. This is simply incorrect.

What many people are confusing is the withholding rate versus the tax rate, which are quite different. Withholding is just that – an amount withheld by the employer and paid to the government, until the tax bill is settled. The tax rate is the amount we actually pay, based on the full picture, including total income, deductions and other tax considerations.

While withholding aims to match the tax rate, it is simply an advance payment toward our year-end tax liability.  For employment income, it’s a rough calculation dependent on the projected yearly income and filing status (single or married, number of exemptions) as reported on the W-4 form.  This simplification is why virtually everyone either owes taxes or gets a refund at the end of the year.

For supplemental payments, which are currently withheld at the higher rate of 40%, many people think that they are actually paying a higher tax rate. The reality is that IRS doesn’t really know if you got $50,000 in salary and $20,000 in bonuses or $69,000 in salary and $1,000 in bonuses. All they see on the W-2 form is that you received a total of $70,000 from your employer. You will pay the same tax on it, whatever the distribution between the base pay and supplemental payments is. Therefore, the tax rate on supplemental payments is the same as on the rest of your employment income.

One thing to note is that as your income goes up, your tax rate will increase too (all else held equal) – so effectively a bonus or a pay rise does have somewhat diminishing returns. The exact impact of course depends on your specific tax situation.

How to Get Time Back!

I was reading an older issue of the Harvard Business Review and found this article titled “Stop Wasting Valuable Time”.

It had a great list of things we can do to be more efficient at work and make better use of the most limiting resource we have: time. I spend a lot of time in meetings, managing a fair amount of them, and I thought this was a good refresher on things to keep in mind:

  1. Deal with operations separately from strategy
  2. Focus on decisions, not on discussions
  3. Measure the real value of every item on the agenda
  4. Get issues off the agenda as quickly as possible
  5. Put real choices on the table
  6. Adopt common decision-making processes and standards
  7. Make decisions stick

This list addresses a common issue with meetings, where agenda setting is unfocused and undisciplined, often being a hodge-podge of items that different participants wanted to bring up. When we stop and think about it, I think we can all realize that meeting agendas need to be thought though, and prioritized accordingly. Some items simply don’t need the full team’s attention, while others may be urgent.

This leads me to the next point – urgency often seems to set the agenda, which may be good for an operations focused meeting, but this may come at a cost to planning and strategic decision making. If we are always focused on the hot potatoe, we may not leave enough meeting time to preventing the future issues from occuring. Allocating time among these is key.

Another issue I’ve noticed has to do with making sure everyone in the room agrees on what was agreed on. At times, this may be due to the team simply going off-course in the discussion, and never formally giving thumbs-up or down to a proposal, even though everybody agrees on what the decision oughta be. At other times, no decision was ever actually made. Or, as I’ve often seen, as the meeting time expires and people start getting up to leave, somebody we’ll make a statement “ok, so we have decided that.. “.

While it may not be always easy to manage a meeting room, it’s important to leave enough time on the agenda for the actual decision making, and ensure the final decisions are clear and documented. I believe that managing the meeting time effectively, can both reduce the time we spend in conference rooms, and improve a company’s information sharing and decision making processes.

Save Time: Avoid Left Turns!

Here’s my simple energy saving, traffic congestion and stress reducing piece of advice for the day: avoid left turns! Unless the road is empty, there is always a wait to make it – and in more congested areas it may even take several light cycles to get through.  It’s also a safety issue – you avoid crossing the oncoming traffic, and being tempted to run that “orange” light.

Of course, the opposite advice applies in England and other countries driving on the left side. =)

I wish the GPS devices would account for this left-turn time lag when calculating your directions. Most of them will allow you to pick the shortest or quickest route, but when calculating the latter, I doubt they put in a proper left turn penalty factor. Of course, they can’t just make up a delay to use (say 30 seconds) and would have to collect and analyze traffic data to be able to do so – but maybe it could be a custom setting? Another option could be to provide you with alternate routes? Google maps already does it, although I don’t think they’re specifically addressing the left turn issue.

Speaking of technology – a few years ago UPS implemented software that allows them to efficiently plan their routes, and big part of it includes not making left turns in commercial areas.

For the record, there are some neat apps that will plan and optimize routes for you (i.e. MapQuest Route Planner) – I wish they included a left turn time delay / penalty in their calculations.

PS: If you find an app that does this, please let me know!