Friday, May 21, 2010

What If There Were a Sale (and Nobody Bought)

Do you remember looking back at the market low in March, 2009 and thinking, "I wish I had bought then"?  Here's another chance.
When I was in the business of investing other people's money, I often thought it ironic that I picked the only business where nobody wanted to buy when there was a sale.  Investor sentiment is a powerful thing, and, like the little girl with the little curl right in the middle of her forehead, when it's bad, it's horrid.  Fear paralyzes, and when the paralysis wears off, then the fear turns to greed - "I'd better buy soon or I'll miss the rest of the upturn."
It's not often that two corrections occur when memory is fresh.  But here it is.
Let's talk a little about why you may want to summon the courage to invest the money you won't be needing for the next five years.
I.  Safe isn't safe
If you thought you were very smart by keeping your money in cash over the last ten years, if history repeats itself, you will find the last decade an anomaly.  Generally, Certificates of Deposit, insured Money Market Accounts and the like are very good places to keep money that you need in the near future, and the very worst place to keep money you need for the long term.  Why?
  • Inflation, the slow increase in prices over time; and
  • Taxes.
Let's look at an example.  Right now, you can find money market accounts paying about 1% interest.  Inflation over the last twelve months is running just under 1% (.95%).  So, the increase in the cost of goods and services that you buy reduces your return to 1% - .95% = .05%.  Then, you also have to pay taxes on your interest income.
Federal and state tax rates for most people run about 20%.  20% of 1% is .20.  Subtract .20 from the .05% you had left after inflation, and you are left with negative .15%.  After inflation and taxes, your real return is negative.
For money you need in the near term, that's fine.  You can't risk the volatility of the stock or bond market with  short term money.  But, as you know, women live longer than men.  And most women don't like the idea of "old and poor."  So, we have to invest our money where it will earn more than inflation.
For that, you have two choices.  Real estate (investments, not your home) and stock and bonds.
Real estate requires a very large initial investment, so most women choose to invest in the capital markets.
II.  The two primary considerations
When you buy stocks and bonds, there are only two things you need to decide.  First, you need to know what to buy.  Second, you need to decide at what price to buy it.
The discussion of how to evaluate stock purchases is a primary focus in Financial Planning courses I taught at UCLA, and it required years of study.  But here are a few useful shortcuts.
If you are a value investor, you can buy Berkshire Hathaway Class B shares managed by Warren Buffett.  These shares trade at about $72 per share right now, down from $83.57 last March.
If you'd rather invest in the Standard and Poor 500 Index, including 500 US companies, you can buy it for about $1085 per share right now, down from about $1220 last April.
For risk purposes, many women
  1. Subtract their age from 100
  2. Invest that percentage of their long term money in stocks
  3. Invest the rest in investment grade short term bonds.
So, there you are.  Stocks are on sale.  The sale's not as good as it was in March, 2008, but you have another chance.
Mary Buffett notes that women are good shoppers.
For the sake of our long term well-being, I hope she's right.

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