Millionaire Mommy Next Door » Mailbag

The Investment Risk-Return Correlation

Millionaire Mommy Next Door — Thu, 19 Aug 2010 01:40:18 +0000

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!

Millionaire Mommy Next Door — Fri, 12 Mar 2010 20:32:37 +0000

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!

~Jen

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

Millionaire Mommy Next Door — Thu, 13 Aug 2009 04:34:18 +0000

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