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!

Chevy Volt Review – That was fun!

This past weekend I got to test-drive a Chevy Volt, and I have to say that I was pleasantly surprised. While I still have some concerns about the price, and whether the upfront capital expense is worth the gas savings down the line, I would actually enjoy owning one.

First, let’s address the battery range. If you’re fortunate enough where you can charge both at work and at home, you can probably go for a year on a single tank of gas. After a full charge, the dashboard claimed that I could go 30 to 35 miles, but I easily got 40+. Sure, this depends on your driving, and I was fairly gentle on the gas and the break paddle – keeping the green ball happy! (See the picture of the dashboard). I’ve also found a fair number of public charging stations, with quite a few offering free juice! Thanks Santa Monica!

Side note about charging: while some charging stations are free to use, others do require a payment. One of them was $2/hour, or $1.50/hour with membership. This really made no sense to me. It takes about 4 hours for a full charge, so even at the reduced rate this would be $6 for a “full tank” or about 40 miles in electric only mode. Considering that gas is $4.50/gallon, and that the Volt will easily get over 40 mpg in hybrid mode, it makes no economic sense to pay for charging more than a $1/hour. In fact, charging at home is about a $1 for a full charge, depending on your electricity rates, which is a nice saving.

The car is quite comfortable, even for a taller guy. While it’s sure no Escalade, four adults can comfortably fit in. The trunk space is decent, although a bit shallow. It’s one of those funny things where some folks may complain “What if I need to move something giant… like say my brand new 60” TV?” Well, no, you won’t be able to fit it in, but you also won’t need to do that very often. In fact, most people rarely need more space than a Fiat 500, yet we’ll buy an 18-wheeler “just in case”. But I digress. (The book Predictably Irrational by Dan Ariely explains this tendency to overvalue optionality very well.) My point is that there is enough space for four adults and the usual amount of junk in the trunk.

The technology part of it is done well. The interfaces are generally easy to use and intuitive. Some of the displays can be a bit distracting when driving, but I’m guessing that’s just the new car effect that would wear off after a week or so. The part that may require some getting used to is the regenerative breaking, and figuring out when it happens. For example, letting go of the accelerator can result in it. Generally, I would say not to worry about it, and just focus on the road first and on that green display ball second. If the ball is green and centered, you’re efficient. If you hit the gas or break hard, you’re not.

Overall, the car was a fun commuting experience. I put 122 miles on it while using just 0.1 gallons of gas and 3 free charges. That makes for a fuel cost of $0.003 per mile, which can’t be beat.

Chevy Volt Dashboard

Save on Auto Insurance: Pay in Full!

I have noticed that many folks I know pay their auto insurance on a monthly basis. This seems as a convenient option, allowing for budgeting and spreading out your cost accross the year. They can also auto-deduct the amount from your account, so there are no bills to think about, checks to send or stamps to buy – as long as you have the available balance in your account, you’re good to go.

The question though is, does this make financial sense? While the terms may change from insurer to insurer, my auto policy is as follows: I can pay in full upfront, or get billed monthly for my premium plus a 16% APR interest charge. It’s this last piece that changes things – it’s a ridiculously high interest rate for anyone with a decent credit.  If you have the cash to pay for this upfront, do it. It’s unlikely that you can get a better after-tax return on you rmoney somewhere else.

If you don’t have the money to pay in full upfront, pay what you can as early as possible. You can consider getting a balance transfer, and pay much less in interest. For example, if your insurance premium is $1800, you can end up paying about $145 in interest.  A recent balance transfer offer I got was 0% APR for almost a year with a 4% balance transfer fee, resulting in an effective finance charge of $72. This is a quick way to save about $70 – by simply paying off your insurance bill with a balance transfer check, and then making the monthly payments to your credit card.

My advice is simple: pay off your highest interest debt first. Monthly insurance bills carrying a finance charge are no different than credit card bills, even though you’re technically paying as you go.

Saving on Auto Insurance

Every time I hear one of those Insurance ads claiming “people who switch to [..] on average save $x” I chuckle a little bit. Of course that people that do switch insurers save money – that’s why most people switch in first place! The statistic they provide is useless to most people, as you have no idea what your actual saving, if any, would be. What they’re telling you is that of all those people that get a quote from them, some (maybe a majority, maybe a small minority) will switch insurers, and on average save x amount of money. The only valuable piece of information that a consumer is getting here is that shopping around, be it for insurance or any other service or product, is usually a good idea, and you may find a cheaper provider.

I just find it funny how numbers are used in advertising to suggest things. The message that they are trying to imply is that if YOU switch to THEIR company, YOU will save money. Now, they can’t say this outright, as there will be some percentage of folks who won’t save by switching. What would be useful is if they provided a statistic, saying “20% of folks who call us switch, and save $400 on average”. Now I know that my expected “ROI” for calling them to get a quote, and spending 10-15 minutes with their agent is 20% x $400 = $80 / year. Assuming I don’t earn more than $320 / hour, this is now a valuable use of my time (for simplicity, I’m ignoring future years’ savings). However, if only 5% of people save the quoted amount, and I expect to spend 30 minutes for the quote, my expected ROI is only $20 / year – so $40 / hour of my time, ignoring future years’ savings. Not bad, especially if you assume future year savings, but not nearly as attractive as the first scenario.

Now, while the premium paid is likely the top concern to most folks when choosing an insurance company, I am almost concerned switching to a lower cost provider. While there is no guarantee that a higher cost company will provide me with a better service or value, I am curious to know how they can afford to charge me less. Where is it that they’re saving money on? They could have better actuaries, or at least be able to better assess your “risk level”. That said, they could also be undervaluing your risk level, and giving you a break by mistake. (This works for the individual consumer, as long as it’s not a widespread problem which would cause the insurer to default.) What I’m concerned with thought is that you just may be getting a worse value – and get short changed when an accident happens. How will the insurer treat you when you need them is just as important as what you pay upfront!