Sunday, October 29, 2006

"Body" -> Investing $$$

I can't figure out why there are no decent investment books.

Oh, we might state that Benjamin Graham's "The Intelligent Investor" is one of the better ones, but I don't think that most people will slog through all 600+ pages.

So, with all the disclaimers attached that you shouldn't listen to me, and if you do, you may risk losing all your money, let's me "brainstorm" some ideas with you.

If you have no time, you can put your money in a bank. However, most banks do not pay a handsome return. Instead, you need to do enough investing to figure out how to get a bit more out of your money.

I will warn you right off the bat. I am attracted to dividend stocks. To quote Mr. Graham from the aforementioned book:

It is our belief that shareholders should demand of their managements either a normal payout of earnings--on the order, say of two-thirds--or else a clear-cut demonstration that the reinvested profits have produced a satisfactory increase in per-share earnings.... However, dividends are sometimes held down by relatively unprosperous companies for the declared purpose of expanding the business. We feel that such a policy is illogical on its face, and should require both a complete explanation and a convincing defense...

My first bit of advice, go spend .33 per day and subscribe to Investment Quality Trends for at least one year. To make a long story short, IQ Trends is basically one of the best ways to insure you survive "bad" markets, which are called bear markets. Once you get the hang of investing, you may want to get away from this, but by in large, IQ Trends will return around 10-12% per year.

Once you have a few nice stocks, then learn how to write "covered calls." If you combine covered calls and dividend stocks, there is no reason why you shouldn't be able to make another 2-3% on your money per year.

Let us spend just a minute on what a covered call is.

First, let's pick a stock off the last issue of Investment Quality Trends. They think that sooner or later McDonalds stock may go up. If you bough McD's stock today, they are paying a 2.4% dividend or exactly $1 per stock per year. This means that every year, for $100 worth of stock, they will send you $2.40. Many stocks don't pay you anything, they just expect you to buy the stock and sell it later on at a profit. Generally, over the long run, dividend stocks outperform non-dividend stocks if you count both the dividend and the appreciation of the stock.

This means that your stock portfolio can send you money every quarter (which is the normal payout for dividends) with you doing nothing! If you have a real good company, they will often keep upping the dividend. If you bought McDonalds stock in 2003, you could have bought it for just $12-13 dollars per share. Thus $100 dollars worth of stock would be paying you $8 today! (Plus the stock would have also gained $30 per share.)

However, in the short run, you have no idea if you have a winner or not. So, one way of getting more short term reward is offer to sell the stock to somebody in the future at a set price.

So here is the example:

On Friday, McDonalds Stock was $41.47 at the end of day. Let's say you bought 100 shares (which is the minimum size if you want to sell the right to buy the stock to somebody in the future). If you are starting out, this will be a lot of money. Roughly $4200 with an online broker. (Because they'll charge you roughly $13 to buy and store the stock for you.) However, you are pretty happy because you know that you are going to get a dividend from this stock. Since McD is paying $1 per share, you know that they'll be sending you $100. (Unless they drop their dividend, which has happened with bad companies!)

If you check the "option chain," you will find out that you can sell the right to somebody else to buy your McD stock to somebody in March of 2007 for $45 for .65 per share. If you are willing to do this, somebody will pay you $.65/share today, or $65 for the right to buy your 100 shares.

Let me say that again to make it less confusing:

1. You buy the stock today for $42 dollars
2. You offer to sell it to somebody in 5 months for $45
3. They give you $.65/share for this right.

So now let us go forward 5 months. The stock is at $47 dollars. Your broker will call you up and say, "well they want to buy the stock from your at $45." (This isn't exactly how it happens and they can exercise the option earlier, but it is close enough since most options are never exercised before the close date unless people can pick up a big dividend.) So you sell your stock to them at $45. Sell the stock at $45 isn't too bad, because in just 5 months, you made almost $4 per share. (A return of almost 9% in just 5 months.) So while you didn't get the maximum out of the stock, you ended up doing pretty well.

The other thing that may happen is that the stock is still at $41 per share. Nobody would want to buy the stock at this level, so they let their options "expire," and you get to keep both the stock and the .65 per share.

If you sell the options twice during the year (and there are many ways to do this), you are going to make another $1.30 per share (if you can get .65 the next time also). Now add this to the $1 that you'll make from the dividend, and you'll make $2.30 per share per year.

So rather than just making $100 per year, you've figure out how to make $230 per year off of your stock. This means that your stock, even though you haven't sold it, is bring you 5.5% return per year.

Now if you remember the stock with dividends was paying you around 2.2% per year. Here is the difference over ten years:

2.2% growth on $4200 = $5300 roughly -> Increased your money by $1100
5.5% growth on $4200 = $7200 roughly -> Increased your money by $3000

Now the only question is "why wouldn't I want to do this?"

There are two reasons:

1. If the stock is dropping like a rock (can be called catching a falling knife), then the options may keep you from getting out of the stock because you know that you need to sell the stock in 5 months. There are strategies to minimize this by "putting a collar" around your options, but this goes beyond the scope of this post. Therefore, I suggest that you start off small and learn a bit about options every day. There are ways to minimize this risk.

2. You might not be able to sell the stock at the top. Remember that if the stock would sky rocket to $100 per share, you would not be able to enjoy this because you are selling all your stock at $45.

The psychologists tell us that #1 is a bigger issue for most people. So, I will offer 3 strategies for handling this, and you may want to research them.

1. Portfolio diversification. You want to own a bunch of stocks. If McD craters, and this is all you own, then life is very miserable. However, if McD is only 5% of your stock, then all you could lose is 5%. As a general rule, you want to own at least 20 different stocks in different areas.

2. Buy reputable companies. Generally, if a company pays a dividend, it is pretty healthy. The very act of paying out money ever quarter makes them unable to hide a lot of problems. If the world wasn't sinful, you wouldn't want a company to pay dividends because it is a very poor way of distributing profits. However, as a fundamental check, it cannot be beat.

3. Put a collar around the option. Generally, I don't like this because it sucks up a lot of your profit. However, if you thought the stock was shaky, but you really wanted to hang onto it, this is the best way of dealing with a bad situation and getting some money out of the stock.

Now, I have heard some ignorant Christians say that the stock market is nothing more than gambling. This is clearly not true. In our modern culture, we are faced with a lot of things that the Bible speaks to, but cannot be directly translated. For instance, if you use paper money, you have strayed from a system that the Bible talks directly to. Since all of our money is money by fiat. This just means that our money is not tied to gold or silver, but is simply a piece of paper. In the times of the Bible, money was gold, silver, camels or grain.

So what principles apply to the stock market? If you read the principles on "fields" in the Bible, you will understand that the stock market is nothing more that the modern equivalent of a field.

You buy your field (stock), you plant your seed (your money), and you reap a reward (dividends and money).

And don't forget. Grain (money and dividends) are to be your tithes.

The Lord gets the first fruit.

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