The Tycoon Report

Banging the Cash Drum Thursday, May 29, 2008 | Jason Jovine

1.  Which types of investments are the best ones for you?

2.  Which style of investing/trading should you follow?

3.  Should you follow the advice of so-called “experts,” or should you do it yourself?

These are just some of the most important questions about your finances that you should ask yourself.  Do not answer these questions quickly; your answers should be thoughtful.


Money 101

Let’s start off today with a very short, simple lesson on the basics of money.  The way wealth is built is based on just a few things ...

1.  How much you make (your income).

2.  What your expenses are.

3.  How you invest your money.

(I am of course not factoring in any inheritance or gifts that you may receive; they are just icing on the cake.)


Moving Right Along ...

Unless you have been in a cave somewhere, you know that oil is at about $130 per barrel, inflation and food prices are out of control, and the economy is not in great shape.  Good jobs are disappearing in droves, and the gap between the rich and the poor continues to grow.

You have to be ever more creative to make money.  Traditional ways, such as just throwing your money in mutual funds, will not cut it anymore.  Unless you were born with a silver spoon in your mouth, you have to step up your financial game.

If you haven’t already, you should start moving your money out of mutual funds and into ETFs (Exchange Traded Funds).  In my opinion, they are tailor made for the “Average Joe” investor to get the benefits of a mutual fund without their crazy fees.

For a detailed listing of all of the fees, etc. that come with mutual funds, you can visit http://www.sec.gov/investor/pubs/inwsmf.htm#how.

In my opinion, the only downside (for some people) with respect to ETFs may be that you can buy and sell them as easily as you can.  The reason that I say that this may be a downside for some people is because, if you are impatient or have an addictive personality,etc., then you may know yourself well enough to stay away from investments that you can easily get in and out of.

In other words, if your personality is such that you are tempted to trade without a logical reason to do so, then perhaps the difficulties (such as fees) that come with a mutual fund will prevent you from trading needlessly.  An ETF, on the other hand, may (because of their ease) encourage certain types of people to trade.  If you do not have this type of issue, then you should certainly choose ETFs over mutual funds.

I like ETFs personally because they are less risky than individual stocks.  As you may know, you can never totally eliminate risk, but you can reduce it.  You can reduce risk by hedging, diversification, and insurance.  ETFs reduce risk through diversification, as you're not assuming the risk that your investment will go to zero based on the demise of one single company.

Let’s look at the growth of ETFs over the last several years:

 

As of September 28, 2007 (the date of the chart above), 560 ETFs in the US were managed by 17 ETF managers, with assets totaling approximately $554BN. 
 
Use ETFs to allocate the stock section of your portfolio correctly.  If you would like to trade them to give your portfolio that extra kick, just be careful!  Consider listening to Mr. Teeka Tiwari on this issue, as he has been in the laboratory for the last few months working on making the task of trading them much easier for people.


What strategies to incorporate now in the market to increase your return and decrease your risk:

The market and the economy have been ugly lately.  The best strategies for this type of market are:

1.  Selling Call Options - An investor who sells calls believes that the price of the underlying stock (or ETF) is going to remain stable or decline.
 
    Remember when selling calls that:

•  Your maximum gain is the premium received

•  Your maximum loss is potentially unlimited

•  Your break-even is the strike price plus the premium received

2.  Buying Put Options - An investor who believes that the price of a stock is going to fall would buy a put option on that stock (or ETF), etc.

    Remember when buying puts that:

•  Your maximum gain is the strike price minus the premium paid.

•  Your maximum loss is the premium paid.

•  Your break-even is the strike price minus the premium paid.

3.  Diversification - As mentioned above, if you are going to trade, then consider trading in ETFs over stocks right now, because the chance that every stock in the ETF will tank is less than the chance that one stock that you hold will go down in price ceteris paribus (Latin for all things being equal).

4.  Decrease your margin exposure - If you are borrowing money from your brokerage firm, etc. then do not keep a high level of margin.  So, say that you have a half a million dollar account (in cash and stock) with a brokerage firm.  Don’t borrow more than, say, $100,000-$125,000 on that $500,000 max.

•    Granted, interest rates are low, which means borrowing is less expensive, but risk is too high in my opinion to be too highly leveraged right now.  Some leverage is OK, but not too much.

I am outta here ...

P.S. As always, please send me your love/hate mail by commenting below.

Jason Jovine Contributing Editor The Tycoon Report