Don’t buy junk

crap

On average, women outperform men in stock market investments.  The reason for this is quite simple: women tend to buy and hold whereas men trade stocks more often.  The average investor (probably 90% or more of small investors) sell when the market is down and buy when the market is up.  I remember in 2008 as most of my colleagues freaked out and bailed out of the market.  Most women held their stocks through the market sell-off and continued to dollar cost average through 401(k) investments and had positive returns by 2010.  Many of the men who tried to “market time” the market sold at the bottom and then returned to buy at the top.

I count myself among the “guilty” when it came to second guessing the market – and eventually missing great market gains and suffering stock market drops after buying too high.  I’ve sought knowledge, read and studied and only in the last few years have I begun to enjoy strong market gains, whether the market advances or declines.

In this article we will cover the first of the big mistakes that investors make.  If you avoid these pitfalls, you will GREATLY improve the returns on your investments.

1.  Don’t buy junk.  This sounds obvious, but the vast majority of stock investors own “junk” investments.  I’m not talking about junk bonds, those can have a place in a well diversified investment portfolio, I’m talking about bad investments.  Before you know what a “bad” investment is, you need to know first what a good investment is.

To understand what a good stock investment is, you need to stop thinking about investments as buying stocks.  Instead, you need to focus on buying businesses.  Imagine for a moment that you just won the lottery for $8 million dollars.  After taxes you take home $5 million.  You decide that you want to buy some businesses in town.  Let’s say that the “average” business in your town sells for a million dollars.  Let’s say that you decide to buy 1 bar, 1 retail store, 1 restaurant, 1 auto repair garage, and an apartment building.

We will start with the restaurant: you have a choice of a “popular” bar that has a flamboyant owner who is often in the news.  He regularly drives around in his convertible and has several girlfriends.  This guy is well known in town and very popular.  His bar is “the place to be” on Friday nights and often has a line formed up outside on weekend evenings.  Everyone wants to get into this bar on the weekends, it is popular and there is a lot of “buzz” about this place.  Most investors would love to be a part of this business; it is exciting, it is sexy.

And so, you begin to look at the books of this business.  You see that it has a strong cash flow on the weekends but during the week, it draws significantly less in revenue.  You see that the rent on the building is VERY high, the wages paid to the staff are quite expensive and the liability insurance for this “popular” watering hole eat up most of the profits.  Despite the “colorful” lifestyle of the owner, you see that he barely turns a profit.  Moreover, because of several fights at the bar in past weekends, some lawsuits are pending.  This business “looks good” from the outside, but in reality, it does not return much money to the owner.

Take a look at many stocks that are “popular.”  Many pay low dividends, have weak earnings and are priced very high.  I am regularly astounded that stocks with no earnings and high P/E (price to earnings ratios) sell at such high premiums.  And why?  Because  idiots like “Kramer” on CNBC and silly online companies like Motley Fool recommend them.  As I talk to more and more small investors I find that most people are buying stocks based on what’s in trend, what’s en vogue and what is “popular” on CNBC.  Over time, these investments return very little to the owner.

We look at another bar.  The local Irish pub.  It has a steady and loyal customer base, it is “busy” 7 days a week, has low overhead and expenses and returns a cash flow to the owner.  The current owner (who is now retiring) draws $8,000 per month in owners’ equity (salary) and leaves several thousand in the bar for improvements and to grow equity.  You realize that if you draw $8,000 per month, each year you will “take out” $96,000 per year.  In about 11 years you will return your initial $1,000,000 investment.  Starting in year 12, you have a “free bar” and the income that comes in is all profit.  Imagine now that the intrinsic value of the bar has grown in these last 12 years so that now you can sell it for $1.5 million.  Now, not only have you taken all of your money back, but you’ve made a 50% return on your basic capital.  Meanwhile, the “popular” bar had its business slow and after a year or two, it went out of business.

I ask people, “Why did you buy that stock.”  What I hear astounds me.  They ALWAYS have a “story.”  Something someone told them, something their broker told them, something they saw on CNBC or read in Fortune Magazine.  I ask them about the stock’s earnings or its dividend and they have a blank stare on their face.  These people – and I might be talking about you – aren’t investing, they’re gambling.

When you buy a stock you should look for a company with strong earnings, little competition, a strong return of capital (strong dividend) and good future business prospects.  I’ve had this conversation at work a dozen times and every time, I’m asked the question, “Well then, what stocks fit this description?”  And when I answer, I see eyes roll over, sighs of sarcasm and chuckles as though I don’t know what I’m talking about.  To most investors, these investments are “boring” and they don’t have the patience for them.  But good stocks are considered by most to be boring.

Let’s take a look at some “good stocks.”  These are stocks that pay ever increasing dividends, have little competition and increase owner equity through the practice of paying a strong dividend and share buy-backs:

Walmart

Coca Cola

McDonalds

Microsoft

Hershey’s

Sysco

Procter & Gamble

I’m sure you get the idea – fat companies with thick profit margins.  If you buy the stock of one of these companies and reinvest the dividends into more shares, you’ll average about 15% return.  And considering that much of the gains will be long-term capital gains, you’ll never pay tax on the growth of the price of the shares until you sell.  Warren Buffet bought 5 or 6% of Coke back in the 80’s and has reinvested his dividends ever since.  His dividends now pay back the entire cost of his investment EVERY SIX MONTHS!  Think about that for a minute, lets say he invested $10 million, he’s getting back $20 million every year just in dividends!  That initial Coke purchase paid for itself and now pays dividends year after year while the base value of the stock continues to grow.

And yet, I hear of other “investors” buying this or that stock because of some crazy idea they heard on TV.  Example, one of my clients bought Remington (the firearms manufacturer) because Obama’s plans for more gun controls = increased sales.  Maybe.  But does Remington have the fat profit margins and increasing dividends each year like McDonalds has?  No.  Not even close.  When I suggested that he sell his Remington and buy Coke or Walmart or McDonalds, he looked at me as if I had a bullet hole in my forehead.  Again and again, I share the “logic” of buying good companies and people nod in agreement and then tell me how they’re buying Ford or GM because, once upon a time, it traded for 3x what it trades for today.  How silly.  You want a company that pays you to own it, not the company that is popular or has a good story.

The BULK of your portfolio should be boring Blue Chip stocks that are fat with profits, insurance companies, oil & energy transport and some real estate investments that pay you regular rents.  The way to win in the market is slow and steady gains without taking massive losses.  If you can earn 12% year in and year out, you’ll beat all of your co-workers who are chasing Apple to $600 a share.

More on this idea later – but if you own a bunch of junk – stocks that don’t earn (and pay) rich profits, you should consider shifting the bulk of your portfolio to some boring stocks that pay you and pay you year after year.

Good luck.  Good investing!

The use of copyrighted material in this website is protected by the Fair Use Clause of the U.S. Copyright Act of 1976, which allows for the sharing of copyrighted materials for the purposes of commentary, criticism and education.  All shared material will be attributed to its owner and a link provided when available.  All other comment on this site may be reproduced with the author’s consent.  Please source any references or quotes of this website to: http://www.my1stmillion.net

7 percent

7 percent

I recently read an article explaining the benefits of long-term compound interest.  In the article, a situation similar to the one that I used in my post Compound Interest was used, but in the example in the article, an interest rate of 7% was quoted.  As I often do, I read some of the comments at the bottom of the screen and I saw over and over again that people were “complaining” that it was impossible to earn 7% interest today.  I am sure that most of these people only know of two places to invest their money, one is under their mattress at home and the other is at an FDIC insured bank.  After taxes and inflation, both offer negative rates of return.

I thought to myself, “It isn’t so hard to earn 7%” interest.  And so, here are a few places where I’ve invested in the last year and the interest rates that I have experienced:

Symbol / Name / Interest Rate / Description

TWO / Two Harbors Investment Corp. / currently pays 18.10% dividend / This is an Interest Rate REIT (Real Estate Investment Trust) that borrows short term money (low interest rate) and then buys long-term treasury backed securities.  As long as Bernacke keeps rates low, this stock will continue to pay fat dividends.

LendingClub.com / The Lending Club / I am currently earning about 16% return on my investment / Allows investors to lend directly to borrowers – most loans are used to consolidate credit cards.

NLY / Annaly Capital Management / currently yields 12.2% / same as TWO.

ETP / Energy Transfer Partners / 7.8% dividend yield / Natural Gas and Oil pipeline company – this company charges big oil to move their product and collects a steady and dependable income.

(no symbol) / Selling uncovered puts and covered calls / I have earned an annualized yield of 19% writing options contracts on stocks, gold, silver and the Australian Dollar / More about this strategy later – but it is one of the safest and highest yielding investments I know of.

EXC / Excelon Corporation / 7.2% dividend yield / United States electricity utility, is a large nuclear power producer.

DPM / Midstream Partners / 6.6% dividend yield / Same as ETP.

TGP / Teekay LNG Parnters / 6.7% dividend yield / Owner-operators of large ships that transport liquified natural gas.  With cheap natural gas prices, the demand to move it around the world is booming; TGP has good prospects for future work & stock appreciation.  I also write covered calls on this stock boosting my yield into the 10%+ range.

These are just some ideas for you to check out.  Remember to always do your own homework; I don’t know your financial situation and you shouldn’t take my recommendation as your only source of income.  I do not guarantee any return nor do I take any risk for your investments, it is up to you to do your own due diligence.  Having said that, there is always risk and return and the two (sometimes) correspond, sometimes they do not.  Most think of an FDIC insured bank as a “safe bet,” but considering a 4% inflation rate, taxes and the .25% interest the bank pays, you’re losing about 4% each year in purchasing power.  Doesn’t sound like much?  Consider that if you put $100,000 in the bank today, in ten years, that $100k will be worth $60,000.  4% isn’t much this year, but over time it will eat up your investments.

Also consider some of the “safe” Blue Chip Stocks like Walmart, Coca Cola, McDonalds and Microsoft.  If you reinvest your dividends into additional shares of stock, most of these stocks have returned upwards of 10% each year in combined dividends and capital gains.

If you want to be a millionaire, you can’t look at life through a set of FDIC insured glasses – you have to look outside the “normal” arena for investments that will provide a  return that will propel you to the next level.

Good luck and good investing!

The use of copyrighted material in this website is protected by the Fair Use Clause of the U.S. Copyright Act of 1976, which allows for the sharing of copyrighted materials for the purposes of commentary, criticism and education.  All shared material will be attributed to its owner and a link provided when available.  All other comment on this site may be reproduced with the author’s consent.  Please source any references or quotes of this website to: http://www.my1stmillion.net

Lending Club

Once in a while I come across an idea that is so brilliant that I lament that I wasn’t the one who had thought it up.  When I first heard about “peer to peer lending,” I was a bit intrigued and I did some research.  It seems that the two largest companies are the Lending Club and Prosper.  After looking at both, I found the Lending Club’s website to be easier to use and their “deal” seemed better.  I studied, read their literature and decided to give peer to peer lending a try.  After some months enrolled in the program, I have found that the results match the advertisements and I bring the idea to you here so that you might be able to benefit from it.  I wish I had found it 5 years ago, I might have retired earlier!

First, let me explain peer to peer lending.

The typical Lending Club borrower is someone with credit card debt who is looking for lower payments.  Some credit cards charge 25% and if you have ten or twenty thousand dollars at very high rates, the payments can be crippling.  Even if you can make the payments, it is often difficult to pay down the balances.  Trying to obtain a second source loan, maybe from your local bank, will likely incur equally high interest rates.

The Lending Club offers loans to qualified borrowers and sets an appropriate interest rate and the borrower applies for a Lending Club loan just like they would for any credit card, revolving charge line or car loan.  The Lending Club credit department verifies basic information like credit scores, employment verification and (sometimes) income levels.  If the loan is “approved” by the Lending Club credit department, the loan is placed for funding on the company’s website.  The website lists loans, not unlike you find products on eBay, and investors (you and I) can purchase these loans.

The Lending Club collects a fee, typically about 1% of the loan and payments to do the credit check and verifications and to process the payments.  Having done personal and business loans, I know how much work it can be.  They definitely earn their fee and I am happy to pay it!

The biggest problem with investing in loans is that you must often need a LOT of capital.  AND, you have a HUGE risk if the loan defaults.  If some person is paying 25% on a $20,000 loan, you could loan them $20,000 at 16% and give them a chance to pay their bill down much quicker and save a lot of money in finance charges.  But, what if they default?  You just lost $20,000.  For a large corporation like Visa or Master Card, this is not a problem as they have hundreds of thousands of loans.  If their default rate is 10% and they are collecting (on average), 20% in interest, they still clear 10% in finance charges.

And here is the brilliance of the Lending Club.  You don’t have to buy the whole $20,000 loan, you can buy a fractional share!  The minimum investment in any loan is only $25.  With an investment as small as $2500, you can purchase 100 loans.  If you average 14% notes that have a expected default rate of 4%, you will (all things considered) average about 9-10% return on your money.

Quick disclaimer:  I made my purchase with the Lending Club based on my financials.  I am merely explaining how the company works.  I cannot say if this type of investment is appropriate for you.  Be sure to check with your accountant and/or financial planner and ALWAYS: don’t invest more than you can risk.  Also, Lending Club loans are 3 to 5 years.  Do not invest money that you will need in less than 3-5 years.  This kind of investment is appropriate only for long term investment capital (in my opinion, your IRA or Roth IRA account is a good place to start).

The Lending Club reports that they only “approve” about 10% of the loan applications that they receive.  I have attempted to “purchase” loans that were in funding that later failed one or more of the credit verifications (the applicant exaggerated their income or they failed to send in key documents as required to process their loan).  It was actually a good feeling when, sometimes, half of the loans that I attempted to purchase were disqualified during underwriting: my money was returned to my account to use to select another loan.

“Dipping my toe in the water,” I decided to fund a Lending Club account with $5,000 from one of my IRA accounts.  I opened my account in September and the results have been as advertised.  In the top photo, I have made a screen capture of the main page of my account.  In it, you can see the annualized rate of return on my portfolio of loans (not including default rate), how much interest I’ve received (in a little over two months), the value of my account (up to $5,150.53 from $5,000 ), the amount of capital that is applied to loans that are being approved, how much accrued interest I have made (but not yet paid), a listing of my loans and if they are current or late, and a summary of the payments I have received to date.

I am sure I will receive some feedback that lending money to unsecured borrowers is dangerous.  Really?  Visa and Master Card do it every day and make millions.  The way to limit risk is diversification: spread your money out and if any one, two, three or four loans go bad, you make up the difference on your loans that pay on time.  Think about how much your bank savings account pays you now.  .25%?  .50%?  Maybe if you are lucky, .80%  In about 2 1/2 months with Lending Club, I have returned 3% on my money.  OVER TIME, the additional 10%, 12% or 16% you earn on an account like this will most likely exceed your loss rates through defaults.

Loans are packaged in A, B, C, D, E, F and G categories.  The A paper has the less risk and typically pays about 6%.  The Lending Club provides some statistics and I have copied that page below.  In the bottom left you can see the expected returns for each of the credit grades, the expected default rate and the overall expected yield.  I have primarily purchased B-F paper.  Looking at the return after default, I think that the A and G provide the lowest yield to risk ratio.  Really, the biggest risk to a portfolio of Lending Club loans is another recession like we had in 2008.  I figure, that in a situation like ’08, someone with good credit (A paper) is just as likely to get laid off as someone with mediocre credit (D or E paper).  If I can earn a greater yield before the next economic hard times, why not make my money work for me while the economy is doing alright?

After I successfully invested my $5,000, I began receiving payments a little after 30 days.  My monthly payments are approximately $150.  Of that, $100 is a return of capital (the borrow is paying down the principle of the loan) and $50 in interest.  With the $150 I receive in payments each month, I am able to buy bits of 6 more loans at $25 each.  In the screen capture below, I segregated my loans into the initial investment and then the monthly accrued interest that is used to purchase additional notes.  The monthly payment amount for the initial purchase increases each month as I receive payments on the loans purchased with interest.  In this way, my money compounds and continues to work for me.  I plan to add an additional $5,000 at the end of the year and perhaps make a larger investment next Spring.

The amount of money you receive in interest can have an ENORMOUS difference on your net worth over time. If you do not already know the “Rule of 72,” you should understand how it works. Take the number 72 and divide by the interest rate and you will know how long until your money will double.If you are getting a 1% return in a savings account, your money will double in 72 years. Most get less, perhaps .5% – so, your money will double every 140 years. Subtract taxes and inflation and you are actually losing money. THE ONLY WAY TO GROW YOUR MONEY is to beat inflation after taxes are taken out.If you pay 30% in taxes, you must earn a MINIMUM of about 6.5% return to beat inflation.If you earn 7%, your money will double every 10 years. At 10%, your money will double every 7 years.Most people make the mistake thinking that 10% is only 3% more than 7%. Over time, this can be a costly mistake.

Lets say you invest $10,000 at 7% and $10,000 at 10% for periods of 20 years.

The 7% money is going to to double twice:
$10,000 initial
$20,000 year 10
$40,000 year 20

The 10% money is going to do much better:
$10,000 initial
$20,000 year 7
$40,000 year 14
$80,000 year 21

In almost the same amount of time, gaining only 3% more in interest DOUBLES the amount of money you earn. At 15%, your money will double every 5 years and the results are staggering.

$10,000 intial
$20,000 year 5
$40,000 year 10
$80,000 year 15
$160,000 year 20

And you wonder why Visa and Master Card make so much money? My point is this: don’t be afraid of investing in (what you may consider) “risky” investments that pay more than your local FDIC bank. Earning .25% return on your money with an inflation rate of 4% means that after taxes, you are losing 4% a year.

Not bad, you think? After 10 years, you’ve lost 40% of your purchasing power. The possibility of a 20%, 30% or even 40% default rate on consumer credit lending doesn’t sound so bad when compared to a guaranteed loss of 40% in a bank savings account? If every 5 or 10 years, you have a small or even moderate loss lending money in an account like this, the years you earned 15% will more than make up for it. You don’t think that Visa and Master Card put their money in FDIC insured banks do you? They are making millions on credit card loans.

What the Lending Club does, it allows you to undercut some of Visa’s business, give the borrower a good break on their interest rate and make a healthy profit for yourself. If a borrower with $10,000 in credit cards at 22% is still a “good risk” for Visa, they should be a GREAT risk for you at 16%!!!

Below is a “typical” loan sheet of a loan that I purchased. You can see the amount borrowed, the loan % rate, the length of the loan, how many payments I’ve received so far, the next scheduled payment and the payment history at the bottom. A great thing about the Lending Club is that the payments are auto-deducted from the borrower’s account. No worry about the customers forgetting to mail their payment, if the money is in the account, it automatically drafts to Lending Club. I will see that the payments due today are “in process” and about 5 days later, my account will be credited with the interest and principle.

Here is a screen capture from the long list of notes that I have purchased.  Here you can see the loan number, which “portfolio” I have saved it to, how much I invested, the note credit rating, the interest of the note, the term length of the note (36 months or 60 months), how much is outstanding in principle, the monthly payment I receive for the note, the day of the next scheduled payment and the note status.

And this last page is a typical loan listing from the borrower.  This page explains how much is to be borrowed, the amount of payment, the borrower’s income and employment information, why they want the note and all sorts of other information.  I like to see a borrower who has been on the job some time and who has a low credit line utilization.  With this borrower, they have spent about 57% of their credit card maximum.  I don’t like anything about 60%  I think that a borrower who is at 95% of their credit line might be using their credit cards for “living expenses.”  This gives me feelings of default and I avoid this.  You can set your parameters and screen for all sorts of debt, income and employment factors as well as the overall credit worthiness of the borrower (A, B, C paper etc).

I am quite impressed with the professional look and navigation of the Lending Club website.

If you have some long term capital that is inflating away in an FDIC bank, you may consider investing some of your capital towards your goal of someday becoming a millionaire.

Good luck!

The use of copyrighted material in this website is protected by the Fair Use Clause of the U.S. Copyright Act of 1976, which allows for the sharing of copyrighted materials for the purposes of commentary, criticism and education.  All shared material will be attributed to its owner and a link provided when available.  All other comment on this site may be reproduced with the author’s consent.  Please source any references or quotes of this website to: http://www.my1stmillion.net