The Investment Risk-Return Correlation

Q: Pam asks, “After my portfolio value dropped by 40%, I panicked and pulled out of the stock market. I have $150,000 sitting in my savings account, earning squat. I know I should put it back to work, but with the state of our economy, I don’t know what to do with it. Any thoughts?”

A: If you’re terrified of the volatile economic climate today and would be an insomniac if you were invested in the market, perhaps it’s best to keep it parked until you are emotionally and behaviorally ready to stomach the ride and stick to a strategy. Preserve your capital while you take some time to reassess your goals and risk tolerance, determine an appropriate (perhaps more conservative) asset allocation, and explore various investment strategies to find a good fit for your goals and personality.

First, let’s address the risk-return correlation. In subsequent posts, I’ll tackle the other pieces.

Generally speaking, the goal of an investor is to be compensated for the amount of risk they take. Better yet, the investor seeks out the best risk-adjusted return — I’ll discuss this piece later.

If you are willing to accept high volatility (investment risk) for a high potential return, consider investing in a diversified portfolio of:

  • aggressive growth funds
  • small cap stocks and funds
  • micro-cap stocks and funds
  • foreign company stocks
  • international funds
  • sector funds
  • precious metal funds
  • emerging market funds

If you are willing to accept moderate volatility (investment risk) for a moderate potential return, consider investing in a diversified portfolio of:

  • large cap stocks and funds
  • S&P 500 and Wilshire 5000 index funds
  • convertible bonds
  • high-yield (junk) bond funds

If you are willing to accept low volatility (investment risk) for a low potential return, consider investing in a diversified portfolio of:

  • high quality short and intermediate term municipal and corporate bonds and bond funds
  • US savings bonds
  • Treasury bills and notes
  • fixed annuities
  • money market mutual funds

If you are willing to accept very low volatility (investment risk) for a very low potential return, consider investing in a diversified portfolio of:

  • CD’s (Certificates of Deposit)
  • money market deposit accounts
  • interest-earning checking accounts
  • savings accounts

Pay Mortgage Early? Financial Freedom Definition? How To Land A Job? It’s Q and A Time!

Wow. Thanks for all the curious/concerned emails lately asking, Where are you? All okay? It feels awesome to be missed :>) I’m fine; just took a blogging break. Actually, I’ve been writing a quite a bit lately, just not here… forums, media inquiry replies and interviews, a book proposal and outline, coaching followups, storybooks with my kiddo… Frankly, my backside couldn’t bear another minute sitting in front of the keyboard! It hasn’t been all writing though — I’ve been having tons of fun too: several house guests, Chinese New Year parties, homeschooling with my voracious little learner, raising and training ten baby parakeets (my hubby calls it our 4-H-in-the-condo project). But I have missed my blogging friends! So without further ado, I will pull some interesting questions from my inbox and respond to them here. Identifying details have been changed or removed. Feel free to add your suggestions in the comments as I’m sure these folks would appreciate alternate viewpoints.

Q: Carolyn asks, “For the past two years I have enjoyed your emails. My savings has grown from an average $1,500 to $35,000. I have committed to saving a set amount but also some unexpected money has come my way which I have saved all of it. I think changing your mindset along with action and education has contributed to my money growth. My next step is to pay my mortgage off early. Any suggestions?”

A: Awesome progress, Carolyn. Congratulations! While I don’t know all of the pertinent details about your financial situation, I feel compelled to share this: In my opinion, paying a mortgage off early is one of the very last steps most should take in their financial life. Why? Because there are many other money matters that take a higher priority. As a general rule of thumb, here’s the order of financial steps I typically recommend:

First: Pay off “toxic debt”: start with credit cards and loans that charge the highest interest rates (because you’ll save money), and those with account balances that hover closest to maximum credit limits (because it’ll improve your credit score). Raise quick cash immediately by selling stuff you no longer need, want or use.

Second: After you’ve paid off all debt balances with interest rates over 8-10%, start saving at least 15% of every dollar earned to build an emergency fund equal to 6-12 months of take-home income.

Third: Once your emergency fund is complete, start investing AT LEAST 10% of your monthly gross income in a diversified portfolio of no-load mutual funds, ETF’s, stocks, bonds. Start with your tax-advantaged retirement account(s).

Fourth: Get cracking on any remaining lower-interest rate (below 8-10%) debt balances.

Finally: Paying off the mortgage would be the last financial task on my list, especially if the mortgage rate is reasonable. Better yet, if I had a home with a mortgage and I was seriously in debt, I’d sell my home to pay off my debt with the equity. Besides, renting is often cheaper than buying!

Q: These days, simply being a (one) millionaire is not enough to be financially free, depending on ones age. Unless universal healthcare is achieved and unless I learn to cut back on expenditures, I think I would need 2.5 million to be financially free. At least. I don’t see that happening unless 1) we inherit a bunch of money or 2) my husband works another 15 years (minimum) AND the stock market behaves. He has a good job, we have a nice, recently remodeled home plus a small vacation cabin, and we have an emergency cash stash. I don’t want to have to buy a new car for a few years because we pay cash for cars and I don’t want to see the emergency fund take a nosedive. Good thing I love my 10 yr. old minivan! Anyway, how much do you think it takes to be financially free? ~K

A: You’re concerned about how many digits sit in front of your six $0’s and how the stock market behaves. Your husband is employed, you have two homes, a car and an emergency fund in place. In many people’s eyes, you already have financial freedom!

There is no one-fits-all magic financial freedom number. To some $50,000 sounds like a dream come true and to others 50 million wouldn’t be enough. To lots of people I’ve come across, simply breaking free from their paycheck to paycheck existence, or the shackles of debt repayment, or sleeping well at night because they have an emergency fund and a contingency plan in place is enough to make them feel financially free. Personal finance is called personal because it is so, well, personal.

Traditionally, many define financial freedom as having enough passive income that you no longer need to work; your passive income covers your living expenses. Funny thing with this definition is that there are so many variables contained within: What do you consider passive? Is it investing in CD’s, stocks, or a business? How about getting paid for “work” that you love so much that you would do it even if you didn’t get paid? What are your living expenses? Can they be reduced substantially? Can some be eliminated entirely? What if you sold your home(s), invested the equity, and moved to Mexico or Thailand or somewhere else where living expenses are dramatically less than in the US? Again, so much of this is personally defined.

My husband and I consider ourselves financially free because our family hasn’t set an alarm clock in years. Whether it be work, parenting or play, we wake with the sun, eager to spend each new day doing whatever we choose. This definition affords us the flexibility we value, therefore, regardless of the exact numbers on our net worth statement, we have “enough”.

Q: CarA writes, “I love your entire story! You’ve made some great moves throughout your life. I’m curious, how hard (or was it all hard) to talk your husband into selling your home? Did he just have complete faith in you? Or was it a joint effort? Just curious because you said so many around you were skeptical of selling your home to rent.”

A: Ha! It was INCREDIBLY difficult for my husband to jump on board with my plan. I’d crunch the numbers, craft reams of brilliant spreadsheets and grinning from ear to ear, I’d enthusiastically share my financial freedom plan. He’d remark (skeptically), “If it’s really that easy, why isn’t EVERYONE doing it, Jen?” I think the biggest obstacle for him was getting over what everyone else would think about our choice to rent. We sold when the market was hot and everyone thought real estate was THE best place to invest. Remember the days when the mantra was “real estate prices may flatten but they never go down”? Our friends and family questioned my logic. Fortunately I’m not easily deterred and my husband trusts me. But it took a lot of effort on my part to show him the numbers in such a way that he got it, too. And he had to get over his concern about what others thought about it. I gave him the time and space to deal with those issues and I reminded him that renting didn’t need to be a permanent choice.

Today he recommends renting to all his friends. I think he loves looking so smart for getting out before the market crashed :>)

Q: I follow your blog and love all the insight you share with us. Lately, there has been a lot of talk about inflation and hyperinflation heading our way in 2010. Can you offer us some insight, tips to prepare for this? Angeli

A: I wrote about this topic in June 2009 here: Hyperinflation or Prolonged Deflation? Coping and Investing Strategies For Either Scenario. The market is being so manipulated that it’s anyone’s guess what will happen, but I still think that inflation is a ways off; deflation is our first concern. Also, check my Resources page for links to web sites that focus on the economy. I follow many of these debates and only one thing is clear to me — no one really knows how to get us out of this mess. My primary goal at this point is my personal capital preservation.

Q: This spring, I will be a new college graduate. Like thousands of others, I’ll be facing a brutal job market. Any tips? Lisa

A: Get your foot in the door, Lisa. Work to get noticed rather than to get paid. Ideally you do this while pursuing your degree — if not, start now:

  • Shadow those who are doing what you want to do so that you see first hand what is involved in your chosen field.
  • Hook up with a mentor who can show you the ropes and introduce you to others who can hook you up with a job.
  • Get noticed by those in your field: volunteer
  • Negotiate an unpaid apprenticeship: offer your services in exchange for hands-on learning experiences. This is how I learned how to train dogs, teach classes, and became a professional dog training instructor and business owner.
  • Get creative: find a problem, see it as an opportunity, and present the solution. Create your own job or business!
  • Take the time to brainstorm, journal, and bounce ideas off of supportive “can-do” people.
  • Take an honest look at your lifestyle and eliminate or cut back on anything that is superfluous. Create some financial breathing room.

Readers, I welcome your viewpoints and advice in the comments. Please send me your questions, too, and I’ll respond to more. Thanks!


Is The Recession Over? My Gut-Check Impressions on the Future of Our Economy.

I’ve been receiving emails lately from people asking questions like:

“Is the stock market experiencing a true recovery or is this just a bear market rally?”
“Do you think we’ll see a V, W, U or L shaped recovery?”
“Should we expect deflation or inflation?”
“When will my house be worth as much as I paid for it?”
“How should I invest my money? Stocks, bonds, cash, real estate, gold, or foreign currencies?”
“Is the recession really over?”

Some are saying that I’m prescient (have knowledge of events before they take place). As much as I wish this were true, it isn’t, I promise. I got out of real estate and stocks before many others simply because I stopped listening to mainstream and acknowledged the writing that was already plastered on the proverbial wall.

Like many of you, I hear and read convincing forecasts made by a variety of so called experts who support opposing arguments and recommendations. And each time, I try like hell to take a step back and take a gut check. What seems to make the most sense to me? Is there evidence to support it and if so, who or what is the source? What emotion am I feeling and what does this emotion “want” me to think? What is the worst thing that can happen if a particular forecast comes true? How can I reduce the risks associated with various outcomes? And last but not least, what decisions will allow me to sleep well at night?

I’m hesitant to share my recession outcome opinions with others for a few reasons: 1) I don’t want anyone to make decisions based on my guesses, 2) Discussion of possible outcomes often turns to politics — and political discussion tends to get overheated, 3) Some might take perverse joy from pointing to this post in the future, with a wagging finger, telling me how wrong my guesses ended up.

But I’ve decided that I’m as entitled to guesstimate forecasts as anyone else, so here it goes, for nothing more than entertainment value and for exposing my potential bias. Normally I provide hyperlinks to information, statistics and educated opinions that support my writing, but not today. If you want to read the news or hear what the “experts” are saying about this stuff, use Google, turn on the boob tube, crank the radio or grab any newspaper. There is no shortage of opinions thrown about. Please come to your own conclusions.

Here are my gut-check guesstimates on the future of the economy:

I think the stock market will climb a bit more, then retest the March lows. Minus some funky blips, I think we’re in for a long “L” shaped recovery; or really, one that looks more like a long bathtub:

(March ’09)    /\_____________/    (several years later)

Note: The bottom of my tub diagram should have an overall slow gradual curve to it plus a few wicked and jagged up-down points but I don’t know how to illustrate this with my keyboard. My bathtub edges should look taller, too. If it wasn’t so close to my bedtime, I’d draw you a picture instead…

I think we’ll continue to experience deflationary pressure. I think the Fed will continue to “stimulate” the economy but will face an upward battle trying to make it stick. If and when deflation is curbed, measures will be needed to tighten the money supply to prevent hyperinflation. I think these measures will be taken. From what I understand, it is easier to curb inflation than it is to stop a deflationary spiral.

I think housing prices have further to fall in most areas. Besides the probability of an overcorrection, Baby Boomers are beginning to hit retirement age and because much of their net worth in real estate and stocks has been wiped out, they will be downsizing en masse. McMansions will languish on the market or they’ll be repurposed into multi-family or extended-family units. Commercial property will be hit with a sledgehammer.

I think I will continue to stash most of my cash because with deflation, cash is king. When I do buy ETFs (only the ones that are experiencing upward momentum), I will keep tight stop losses in place. I will take a look at the currency market (certainly not my area of expertise) to see whether or not it’s a good fit for me. Overall, during this extremely volatile market, my main focus is capital preservation. This keeps me sleeping as snug as a bug in a rug.

In this economy, I think one of the best places to invest is in one’s own skills and education. I think vocational schools will see an increase in enrollment while universities see a marked decrease.

Entrepreneurs most likely to succeed will be the ones who bootstrap, sell low-priced necessity items, entertainment or services and keep overhead extremely low. Most of them will operate from in-home offices.

Because I think prices will continue to fall, I will continue to put off large purchases.

And finally, as painful as the process is likely to be, I think the Great Recession will ultimately be the Great Shake Up our society and planet needs to get on the financially and ecologically sustainable track. (Wow, that’s a mouthful.)

Okay, now it’s your turn. What do YOU see in your magic crystal ball? Please share your opinions and guesstimates in the comments. Have fun and play nice.

Relevant Post: Hyperinflation or Prolonged Deflation? Coping and Investing Strategies For Either Scenario

Mailbox: Outsourcing Edition

“When the economy tanked, I was forced to come out of retirement and work as a taxi driver.”

Photo: Visit Puppies Are Prozac for a dose of adorable, funny animal photos to chase the grumpies away.

Readers’ Questions Answered:

“You mentioned being better at the business side of things, but what did you do to help your husband make more money in the same, or less, time? ~Gregg

My husband is a third-generation construction tradesman. During his twenties, my husband worked as an employee for hourly wages, earning $20,000 to $35,000 annually. Meanwhile, his boss made several times as much revenue off of my husband’s efforts.

At age 30, my husband quit his job, affixed a rooftop rack onto an old Econoline van and became his own boss. After a year or two, his annual net income climbed to $60,000 before leveling off. He was on the right track, but for the hours he worked, he wasn’t earning what he could.

I had spent my twenties bootstrapping a couple of small businesses. I loved the creative process, the networking, the number crunching. After selling my businesses, I reviewed his business operations and found inefficiencies. My husband is an excellent tradesman with fantastic people skills; however, the math and minutiae of business management wasn’t his strong suit. Thankfully that’s where I shine so we joined forces and doubled the plumbing business’ annual net income to $120,000 the following year.

My husband is awesome with mechanical problem-solving and people; I have a talent for brainstorming ideas, analytical problem-solving, and implementing a sound plan. My husband and I both have different strengths that we bring to the table and together, we make a great team.

Statistically, the majority of millionaires are self-employed business owners. But it’s difficult for one entrepreneur to wear all the hats. Stick to what you’re best at doing and get help with the rest.

I’ve been outsourcing various tasks since I was 14 years old. My two siblings and I hated spending our weekends off from school cleaning the house, so the three of us pitched in equal shares from the money we earned from babysitting / paper-routes / dog-walking to hire a weekly housecleaner. Since we were better at our after-school jobs than we were at cleaning house, it made sense for us to do so.

I still use a housecleaner; I have a bookkeeper who comes to our home weekly to pay our bills, balance our checking accounts, file papers and send correspondence; and I just hired a personal assistant to help me tackle other tasks I’m not good at or don’t enjoy doing myself. When we’re really pressed for time (like after we returned home from China with our new daughter), we hire someone to stock our freezer with ready-to-cook meals. We hire subcontractors to do the work we aren’t good at — or don’t want to do — for our various businesses, too.

Outsourcing allows my husband and I to wear the hat that fits us best. As a result, we make more money AND have more free time to enjoy it!

You can read more of my tips (and others’) on outsourcing in a recent interview by US News and World Report.

“What are your favorite personal finance books?” ~Kelly

Here are my top 3 all-time favorite books:

  1. Your Money or Your Life: 9 Steps to Transforming Your Relationship with Money and Achieving Financial Independence: Revised and Updated for the 21st Century
  2. Wishcraft: How to Get What You Really Want
  3. The Millionaire Next Door: The Surprising Secrets Of Americas Wealthy

Click on the following categorized lists to view more books I like:

Books That Changed My Life (Highly Recommended)
Building Wealth
Millionaire Mindset
Personal Finance Software
Raising Money-Savvy Kids
Self-Employment, Small Business
Simple Living, Saving Money, Frugality

These titles are offered at Amazon but many of the titles can be found at your local library, too. Shop at from my store link and I’ll use my referral fees to help small businesses operated by working, impoverished women through

Online articles that captured my attention this week:

What If You Don’t Plan to Retire? Save Anyhow! @ Get Rich Slowly

Why It Could Take Years to Recover @ The Motley Fool

New HGTV show gives homeowners the cold truth @SFGate

(photo by ff137)

Can’t Sell Your Home In Today’s Market? Here Are Some Suggestions.

A reader asks, “Our family needs to move to another state soon because of my husband’s job transfer. But homes for sale in our area are sitting on the market for a long time. We have enough in savings to cover a couple months of mortgage payments after our move, but after that, our unsold home will put us in a financial pickle. Do you have any suggestions?”

My Suggestions:

Drop the asking price. If this means you’ll be upside down with your mortgage, ask your mortgage company to consider a short sale.

Hire a home staging service. These expert home image consultants can dress up your home to appeal to buyers better.

Exchange free housing for private property caretaker services. This way, you’ll have someone around to keep an eye on your home, maintain the lawn, and keep it tidy for Realtor showings.  Advertise your exchange in the Caretaker Gazette or in your local classifieds.

Alternatively, rather than selling, consider turning your furnished home into:

  • business travelers / short-term corporate housing* Hotels get expensive and are often less comfortable for long-term business travelers. Contact local corporate housing departments to discuss their needs.
  • family vacation rental* This could be a viable option for you, depending upon your home’s location. Charge by the night or by the week. Peruse Vacation Rentals By Owner to research this potential market. You’ll probably need to hire a management and/or housekeeping service, so charge accordingly.
  • special needs housing* For example, lease to members of a substance abuse recovery program on a per-bed “all bills paid” basis. Give one tenant a discount for acting as “house manager”.
  • university student housing* If your home is located near a university, lease it on a per bedroom, per semester basis. Once again, provide one tenant a discount for acting as manager to maintain your home.

*Before selecting one of these options, make sure you check with your local zoning department and homeowner’s association first.

When calculating cash flow, don’t forget to consider the following expenses: mortgage payments, insurance, taxes, maintenance, repairs, management fees, utilities, a vacancy allowance, and lost opportunity costs.

Readers, please share your suggestions in the comments below.

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Readers’ Questions Answered

Are you still renting? Will you ever buy a home again?

Yes, we’re still renting. We’ve been renting since we sold our last home in May 2003 in anticipation of the housing market crash. As home prices plummet in today’s market, we’re watching the price-to-rent ratios. When this number drops once again to long-term historical norms, we’ll consider buying. I have been keeping my eye out for real estate bargains. Cash is king in this market, and we have plenty of cash sitting on the sidelines. I’m watching the fundamentals and ratios that indicate housing affordability. I expect housing prices to continue falling for at least the next year or two. (A common consensus appears to expect an additional 15-20% national average price drop.) Therefore, I’d need to find a seller anxious to unload at a steep discount to convince me to buy today.

Eventually, we’d like to build our own home again. We’ve been collecting photos and ideas for our “dream home”: we’re envisioning a not-so-big (1500 sq. ft.) house filled with interesting architectural details, lots of natural light, cheerful colors, renewable resource products, off-the-grid energy, and perhaps enough room for a pony and a few chickens in the backyard.

In the meantime, we’re looking to downsize into a mere 230 feet… on wheels! When our current lease expires this summer, we’d like to travel the country for awhile in an RV. (Anyone selling a used 28′-29′ Airstream with rear bedroom and mid-bath?)

How is your portfolio currently invested?

Since my investment style is to follow momentum trends, I’ve been moving out of stock mutual funds and into cash since early 2008.  86% of our investment portfolio is parked in FDIC-insured banks; the balance is invested in a variety of Upgrader funds. When the markets show upward momentum again, I’ll move my cash incrementally into the new market leaders as they emerge.