Wednesday, February 25, 2015

Discipline Is More Important Than Motivation

I remember the first time I saw a Tesla up close. It was at the Tesla showroom in the Scottsdale Fashion Square mall. I remember sitting in the driver's seat and seeing that big, shiny display that controls everything in the car with just a touch. I knew I had to have one. This was a car for tech geeks. This was a car for electrical engineers. This was a car for me.

In the weeks that followed, I thought constantly about how I could afford one and what I needed to do in order to get the money to buy one. It was during those weeks that I came up with the basis for this blog - use passive income to pay for the car.

That was over a year ago. I still love the Tesla and can't wait to have one, but time and increased familiarity have diminished my motivation somewhat. I still want one something fierce, but I don't have that same excitement that I did when I first sat in the drivers seat of the showroom model. (I'm sure an actual test drive would cure that, though.)

So when your motivation starts to fade, what keeps you moving toward your goal?

Discipline. is what enables you to achieve long term goals. When your time horizon is so far out, it's discipline
that helps you keep moving forward when motivation flags. Your progress towards your goal should be something that is done automatically, without any thought on your part.

When I get paid, the first thing I do is distribute money to my various goal accounts according to my budget. Some money goes into the Tesla fund, some goes into the appliance replacement fund, some goes into the emergency savings fund, some goes into the retirement fund. Only after all those funds have been paid, do I look at what's left as spendable money.

Discipline turns this into second nature. It's done without even thinking about it. Then one day, I'll wake up and look at the balance in those accounts and realize I've reached my goals.

Wednesday, February 18, 2015

Ditch Your Savings Account the past, when people wanted to save money, they put their cash in a savings account at a bank. I remember when I was growing up in the 1970s and 1980s, I had a passbook savings account at a local savings and loan that paid 5.25% interest. Today, however, the Federal Reserve has been keeping interest rates incredibly low in order to stimulate the economy. A consequence of that policy is that the interest rates banks pay on savings accounts have plummeted to almost zero.

I bank at a credit union, which typically pays higher interest rates to its customers than a bank does. A savings account at my credit union currently pays 0.05% interest. The highest rate they offer is 0.2% and to get that, you need to open a money market account and have $250,000 in it. Yes, in order to earn a measly little two-tenths of a percent, you need to have one quarter of a million dollars on deposit. Think about that for a minute. That works out to just $500 per year in interest. On a quarter of a million dollars. That sucks!

Online banks are slightly better. I have a savings account at Capital One 360, formerly ING Direct, that pays 0.75% interest. That's significantly better than my credit union, but still somewhat sucky in general.

But Savings Accounts Are Safe!

Yes, savings accounts are insured by the government and are one of the safest places to park your cash. That safety comes with a steep price, however.

According to the latest available figures at the time I am writing this, inflation is at 1.7%. (Inflation measures the rise in the cost of goods and services over time.) If inflation is at 1.7% and your savings account is paying you 0.2%, you are actually losing money at the rate of 1.5% per year. That $100 you have in your savings account today will only buy $98.50 worth of stuff next year.

So What Can You Do?

There are a couple of alternatives you can look at and which one is right for you depends on what the money in your savings account is for. Or to put it another way, what you do with that money depends on how soon you need it. To put it a third way, it depends on your time horizon.

If you absolutely must have the safety that a savings account offers or you will be needing your money in the short term (0 - 9 months), a traditional savings account is probably the best bet for you, but at the very least get one at an on-line bank, such as Capital One 360. Not only will you get a higher interest rate, but you will likely also have lower, if no, fees. You lose the ability to go into a local branch office and withdraw money, but who does that anymore? With ATMs and internet transfers, there is really very little need to visit a physical branch. You still will lose out to inflation in the long run, but at least that loss will be less than it will at a traditional bank.

If your savings account is more for a long term goal or an emergency fund, invest in the stock market. If you won't need your money for over a year or you plan not to touch it unless an emergency happens - such as a job loss or a major appliance or car breakdown, then I suggest opening a brokerage account and investing that money in a very low cost index fund. I like Vanguard's Total Market Index Fund or Dividend Appreciation Index Fund. These mutual funds have an expense ratio of 0.2% or less and their five year returns are 14% or higher. (See this series of posts on why expense ratios are important factors to consider when choosing a mutual fund.) You can purchase shares of these funds through a brokerage, which will probably charge you a commission (although some brokerages do not), or you can buy them directly from Vanguard. Buying directly from Vanguard however, will require a minimum purchase of $3,000.

Going this route does mean your money is less liquid. Still, if an emergency came up and you needed access to that cash quickly, you could sell your shares and get the cash within a week. If you need it sooner, an option would be to put your expenses on a credit card until your funds become available (and then pay the card off, so you won't get hit with interest charges).

Another option is to open an account with Betterment. When you open an account with them, you can specify the purpose for your account - such as an emergency fund, retirement, etc., give them your age and income and they will recommend an investment strategy for you. They will diversify your investments for you, but you can always adjust the risk level and investments yourself if you want to have more control. You can set up automatic deposits and purchases and put your savings on autopilot. Fees range from 0.35% to 0.15%, based on how you much have in your account. There is no minimum balance required to open an account and you can transfer funds electronically to and from your checking account.

A fourth option is to invest in individual stocks that pay dividends. This is riskier than any of the other options and is not for everyone. The lack of diversification means you are exposed to the risks of the price volatility of one or two stocks. However, if you have been following a company for years and have a good understanding of the business and they have a strong history of increasing dividends, this might be the way to go. Personally, my Tesla funds are invested in Realty Income until I accumulate enough to lend out as a hard money loan.

You'll notice I'm recommending investing in funds and stocks that pay dividends.Why not just funds or stocks in general? If you buy a stock that does not pay a dividend, you are at the mercy of the market when it comes to your return. The stock price will fluctuate outside of your control. But if you have a stock that pays dividends, you will get a fixed amount of money each quarter or each month for every share of stock you own. That's income you get regardless of whatever the market decides the stock is worth on any particular day. The dividend will help protect you from price fluctuations. Let's look at an example.

Say you bought 100 shares of XYZ company at $100 per share. They pay $5 per share per year in dividends, paid monthly. That works out to $0.41667 cents per share per month. Suppose, after 15 months, the stock price has dropped down to 95 dollars per share. Your hundred shares that you paid $10,000 for is now worth only $9,500. But in those 15 months, you have been paid $625.00 in dividends, so your investment, including the dividends you got paid, is really worth $10,125. Even though the price per share has dropped since you purchased the stock, you have still made money. This is what I mean when I say dividends can help protect you from price fluctuations.

In Summary

In the current low interest rate environment, keeping your money in a savings account is a losing proposition. Your earnings in a savings account will not keep up with the pace of inflation and the actual buying power of your money will decrease over time. Any of the four options I've listed will give you a greater return on your money than you'd get parking it in a savings account at a bank or credit union. In the current environment, the only way to beat inflation is to invest in the stock market and the safest way to do that is to invest in a diversified portfolio, either through a service like Betterment or a low cost mutual fund. 

Note: The links to Capital One 360 are referral links and I will receive some money if you use them and open an account. You will also get free money for doing so - $25 to $50, depending on the type of account you open. Other than that, I receive no payment from Capital One 360 and they played no part in the creation of this post.

Wednesday, February 11, 2015

Want To Make Money In The Stock Market? Think Long Term.

Several years ago, I heard about an organization that wanted to help people start thinking long term - like really long term. The organization, The Long Now, was (and still is) doing this by building a clock that will run for 10,000 years. It ticks once per year and a cuckoo comes out once every 1,000 years. Making a physical clock that will last that long obviously has some huge challenges and to overcome them, engineers and designers are forced to think about how things can change over that long timespan. Once completed, the clock will be open to the public, hopefully instilling in them the same long-term thinking.
The power mechanism for the clock

Humans are notorious bad at thinking long term. We only live a century or less. Americans, I would argue, are even more fixated on the short term than Europeans. After all, our country is less than 250 years old. People have been living in Europe, however, for much longer than that. Many Europeans are reminded every day of the distant past when they see the remnants of those old civilizations around them today - the Colosseum of Rome, the Acropolis of Greece, the pyramids of Egypt (which, I know, isn't in Europe, but still makes my point).

In financial circles, long term thinking is virtually non-existent. Humans are typically loss-adverse - we would rather avoid losses than achieve gains.We monitor stock prices daily. If a stock we own drops, we feel the pain and many times will sell. As a result, we end up buying high and selling low, instead of the other way around. Studies have shown again and again that this is to our detriment. This study shows just how stupid that behavior is. It looked at the return of an S&P 500 index fund versus the performance of the average investor. The most amazing thing to emerge from this study is this fact:

Not a single investor in today's market practicing legitimate buy and hold in a low-cost index fund has ever lost money. Not one.

That is amazing. Let me repeat it.

Not a single investor in today's market practicing legitimate buy and hold in a low-cost index fund has ever lost money. Not one.

If you are a true buy and hold investor, you would have made money even if you bought at the worst times possible: at the top of the dotcom bubble in 2000, at the top of the market right before the 2007 crash, the day before 9/11. Even if you bought stock right before all those big crashes, as long as you held on and didn't sell, you'd still be ahead today.

Market declines are normal. Since 1928, the S&P 500 has dropped by 20% or more 20 times. Yet, if you look at the long term picture, during that same time frame, the overall index increased 140-fold.

As an investor, I would LOVE to see my wealth increase 140-fold! But to get that, I would have had to have had the fortitude to stand seeing my investment drop in value by 20% or more almost two dozen times. Few investors today have that sort of moxie.

It's hard to blame them. Our news programs, politics, and society in general, revolve around crisis, outrage, and fear. (Fox is an entire network built on manufactured outrage and fear.) News programs jump to a new crisis as soon as the current one ends (or when people stop tuning in to hear stories about it). If the market drops 100 points, it's headlines on every news program and news website out there. Stories report on the billions of dollars that have been wiped out by the drop and you can't help but feel like you have lost huge sums of money as well. If you want to make money in the market, you need to be able to tune out all that crap. You have to take a long term view and realize drops happen. Recessions happen. You don't have to enjoy them, but you have to realize they are a part of life and the market will recover.

The Long Now Foundation also runs a site for long term bets called, appropriately enough, Warren Buffett has a $1 million dollar bet on there with a hedge fund manger with the proceeds going to charity. Buffett has made the following bet: “Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.”

Clearly, Buffett is thinking long term and knows that trying to time the market is a losing game. I think every individual investor could benefit by adopting his outlook.

Wednesday, February 4, 2015

Goal Update: End Of January 2015

At the end of each month, I post an update of my goals, including a brief discussion of any notable events that might have occurred during the month. The latest month's figures can always be found under the Featured menu in the menu bar at the top of the blog.

Last updated: End of January, 2015
Current value: $13,275
Change from last month: +2,470
Percent of Goal:  12.21%

Note that the funds in this account are invested in stock, so there will be fluctuations in value that are outside my control. I never withdraw money from this account, so any dips are purely due to stock price changes.

Events Of Note Last Month: January saw the largest ever monthly payment from my online courses. (The January payment was for November enrollments.) As I mentioned in my November update, Udemy ran a Black Friday sale where they dropped the price of courses to a low of $10. This is much lower than their standard discounts instructors agree to when they publish their courses and, because of that, they had to get permission from the course authors to include their courses in the sale. I was hesitant to participate. My most expensive course goes for $99 and I get anywhere from 25% to 75% of that, depending on how the student signs up. So initially, I just saw the sale as a huge loss of income. But I decided to take a chance and participate in the sale.

I'm so glad I did! Udemy obviously spends more effort promoting their site than I do, and I am able to reap the benefits of that. By including my course in their Black Friday event, the number of students enrolled in my courses skyrocketed. At one point, I was getting notifications of new student sign ups 6 or 7 times a day. Even with the lower price, my total income from that sale led to me setting an all-time monthly income record: $581.75. That is exactly triple my previous monthly high amount.

Apparently, the sale was successful for Udemy as well. Soon after it ended, they offered instructors the opportunity to take part in similar sales on a regular basis. I signed up, of course. They ran a $10 sale again for the first two weeks of the new year and, once more, I saw in increase in enrollments.

I gained some additional income this month via another quarterly bonus from my employer. We missed getting the maximum amount, but got the next lower tier - resulting in about $178 to me after deductions and taxes.

I received $56 from an AT&T class action lawsuit settlement I have no recollection of applying for.

I also received $4 in royalties for my ebook.

With this month's contributions (and O stock still near a 52 week 5 year high), I've crossed the 10% saved threshold and unlocked an achievement!

I'm getting a bit nervous. Realty Income has been on a tear lately and it's approaching an all-time high. The highest it has ever been was $55.09 on May 17, 2013. As I write this, it's at $54.35 and both yesterday and today, it broke the $55.09 mark during intraday trading. The stock typically trades in the $40-$45 range, so I'm looking at a potential paper loss of $2,300 if it drops $10. That would suck. On the other hand, I do realize that you can't time the market.(I've got a post coming next week about this very topic. A drop to $44 would be about a 20% drop - exactly the amount of decline used as a data point in next week's post.)

So I'm fighting the urge to sell and lock in my profits. If I do sell, I'll lose out on my monthly dividend, which is about $50 right now. And I'll have to pay some capital gains tax on the profits when I sell. I'm pretty sure I can resist the sell urge - at least until the stock price reaches $60. If it does that, it would represent another gain of about $1,100 and I think I'll give in and sell at that point.