This is a common barrier that discourages new entrants to investing and the stock market. Basically, it states that for every dollar gained in the stock market, another dollar has to be lost by another participant. In the strictest sense, I can guarantee to you this is not the case, at least not in the long run! If this were true, then the stock market would not have produced real returns over the last 100 years! Since the S&P 500 consists of the vast majority of all investable US equities, the average long-term US stock investor would receive a return comparable to the long-term return of the S&P 500 by definition (at least for the US equities portion of his asset allocation.)
Over the short run, the market may seem to be a zero sum game since it's most likely not trending or moving in any decisive direction (up or down) most of the time. Many books on short-term trading may consider the stock market a zero-sum game and they're pretty much right - the average investor doesn't gain or lose much (assuming they held through the entire period and didn't panic sell on the dips.) There's also this notion that you must "take money" away from other (usually less sophisticated) investors in order to build your wealth in the stock market. These people then believe that in order for them to make money at investing, someone else has to lose money which makes them feel investing is a dog-eat-dog world.
Beating the market, on the other hand, is a Zero-Sum game. If you think about it, half of all the dollars invested in the stock market will underperform the average and half will outperform. If the return was, say, 20% last year and you returned 40%, then there exists 1 or more investors who must have performed below the average for this logical balance to exist. However, since the stock market has outperformed inflation over the long run, the average performing investor, assuming he/she stayed invested, would still have benefited. (Even a somewhat below average performance would still have created wealth for many long-term investors!)
Investing isn't a race or some endeavor to steal money from other investors. It's how the free market rewards you for bearing risk and lending your excess capital to companies that need it more. Sure, some companies might end up being duds but if you diversify properly and hold on to a long-term attitude in your investing, your efforts will likely pay off in the end. In future posts, we'll explore the right attitude to have when investing.
Tuesday, May 6, 2014
Friday, May 2, 2014
Troubleshooting Credit Card Hacking: Occasional late fees are inevitable
But don't take this the wrong way and assume that late payments are OK, especially on a regular basis!
If you've got 10 different credit cards with 10 different due dates, even if you check you balance twice a month, you're still bound to run into occasional problems with late fees or overdrafts. The Margin for Error is simply too high with this activity. In fact, the average credit card user probably gets charged more fees and interest than what is made back in rewards, otherwise this practice of extending credit card rewards would not be a sustainable business practice!
In my use of credit cards since 1999, I've probably averaged about 1 mishap a year, usually a late payment or an overdraft. But earning rewards and rarely carrying a balance has definitely paid off in providing me a net monetary gain in this endeavor. Let's use an example here: suppose Joe Schmo charges $1500 a month and pays off the balance entirely, except that he makes a late payment every 6 months. The average amount he's charged, including the late fee, overdraft, and/or interest is $40 each time. He averages 2% in credit card rewards each time (some of his cards only offer 1%, others offer bonus rewards on selected categories). So he gains $30 in rewards each month on average. His net gain from his use of credit cards each year is: 12*30 - 2*40 = $280.
If you occasionally carry a balance, make late payments, or incur overdraft fees, do take note and try to stop it from happening in the future but don't beat yourself up and lose sleep over those. It's not likely gonna have a noticeable effect on your credit score and the rewards you earn will likely cancel out the fees. If it becomes a regular occurrence (say multiple times a month or several months in a row), then it's probably best to take a time out from collecting rewards. Pay off all your balances and stick with 1 card (or use cash entirely) at least until you're confident you can pull finances back in order again.
If you've got 10 different credit cards with 10 different due dates, even if you check you balance twice a month, you're still bound to run into occasional problems with late fees or overdrafts. The Margin for Error is simply too high with this activity. In fact, the average credit card user probably gets charged more fees and interest than what is made back in rewards, otherwise this practice of extending credit card rewards would not be a sustainable business practice!
In my use of credit cards since 1999, I've probably averaged about 1 mishap a year, usually a late payment or an overdraft. But earning rewards and rarely carrying a balance has definitely paid off in providing me a net monetary gain in this endeavor. Let's use an example here: suppose Joe Schmo charges $1500 a month and pays off the balance entirely, except that he makes a late payment every 6 months. The average amount he's charged, including the late fee, overdraft, and/or interest is $40 each time. He averages 2% in credit card rewards each time (some of his cards only offer 1%, others offer bonus rewards on selected categories). So he gains $30 in rewards each month on average. His net gain from his use of credit cards each year is: 12*30 - 2*40 = $280.
If you occasionally carry a balance, make late payments, or incur overdraft fees, do take note and try to stop it from happening in the future but don't beat yourself up and lose sleep over those. It's not likely gonna have a noticeable effect on your credit score and the rewards you earn will likely cancel out the fees. If it becomes a regular occurrence (say multiple times a month or several months in a row), then it's probably best to take a time out from collecting rewards. Pay off all your balances and stick with 1 card (or use cash entirely) at least until you're confident you can pull finances back in order again.
Tuesday, April 29, 2014
Margin for Error: Be prepared when things DON'T go your way!
Many of us have experienced something along these lines: we take up a project and plan out all the details. We'll do task A first, then B, then C, etc. all the way to task Z. Somewhere in the middle of our execution, say task T, we screw up and the project is a complete failure despite all the effort we put in from tasks A to S. Sometimes, we may fail at task T but we can still finish the project satisfactorily. I think of this phenomenon as Margin for Error.
It's hard to define Margin for Error precisely but it's pretty easy to give a sense in plain English. Picture any project or task you're doing that involves multiple steps or decision points. If at any step you perform poorly and there's a good chance the project or task will fail, then there's a high margin for error. Think of 5 pounds of a special bread: if the amount of any of your minor ingredients like salt, sugar, cinnamon, etc. are off by 1/16 of a teaspoon and the bread will not taste right, then there's a high Margin for Error.
In other words, any one mistake will derail all the effort you've put into a task implies a low margin for error.
Driving is an example of a task that doesn't have a high margin for error despite the possibility that a single bad move can end up killing you. Assuming you've received the proper training to drive a car, you'd need to make a pretty drastic or utterly careless move to get yourself killed in most cases. On the other hand, performing brain surgery has a high margin for error since it'll involve hundreds of steps and any slightly imperfect move in any of those steps may cause the surgery to fail. Fortunately, most brain surgeons will receive years if not decades of training for this delicate procedure.
Day trading stocks is another activity with a high margin for error. You're likely to risk a lot of capital making many trades each day. Most traders know well enough to cut their losses on a bad trade but with so many trades happening, decision fatigue may set in on your 106,478th trade. It only takes forgetting 1 stop loss to incur a huge loss despite all the effort you put towards your last 106,477 trades. This is a major reason why I stick with passive investing over active trading.
If you're unfamiliar with the financial markets, let's use an example with gambling. Suppose you go to a casino and you play a game where you can bet double or nothing. If you start by betting $1 and wager your entire winnings from one game to the next, you'll have $1 million after about 20 games. Suppose you've devised a system that has a 90% chance of winning, what's the probability that you'll win 20 consecutive games? About only 12%. If your winning probability goes down to 80%, each game, you only have a 1% chance of winning 20 games in a row. And I've never heard of anyone who consistently wins anywhere close to 80% of the time in a casino!
It's still important to work hard and plan ahead to minimize the possibility of failure in any important project or task you pursue. But you're likely setting yourself up for disappointment if you do not have a realistic sense of the margin for failure accompanying the task. (Chris Guillebeau used the metaphor of dominoes falling to describe this same concept which inspired my post.)
It's hard to define Margin for Error precisely but it's pretty easy to give a sense in plain English. Picture any project or task you're doing that involves multiple steps or decision points. If at any step you perform poorly and there's a good chance the project or task will fail, then there's a high margin for error. Think of 5 pounds of a special bread: if the amount of any of your minor ingredients like salt, sugar, cinnamon, etc. are off by 1/16 of a teaspoon and the bread will not taste right, then there's a high Margin for Error.
In other words, any one mistake will derail all the effort you've put into a task implies a low margin for error.
Driving is an example of a task that doesn't have a high margin for error despite the possibility that a single bad move can end up killing you. Assuming you've received the proper training to drive a car, you'd need to make a pretty drastic or utterly careless move to get yourself killed in most cases. On the other hand, performing brain surgery has a high margin for error since it'll involve hundreds of steps and any slightly imperfect move in any of those steps may cause the surgery to fail. Fortunately, most brain surgeons will receive years if not decades of training for this delicate procedure.
Day trading stocks is another activity with a high margin for error. You're likely to risk a lot of capital making many trades each day. Most traders know well enough to cut their losses on a bad trade but with so many trades happening, decision fatigue may set in on your 106,478th trade. It only takes forgetting 1 stop loss to incur a huge loss despite all the effort you put towards your last 106,477 trades. This is a major reason why I stick with passive investing over active trading.
If you're unfamiliar with the financial markets, let's use an example with gambling. Suppose you go to a casino and you play a game where you can bet double or nothing. If you start by betting $1 and wager your entire winnings from one game to the next, you'll have $1 million after about 20 games. Suppose you've devised a system that has a 90% chance of winning, what's the probability that you'll win 20 consecutive games? About only 12%. If your winning probability goes down to 80%, each game, you only have a 1% chance of winning 20 games in a row. And I've never heard of anyone who consistently wins anywhere close to 80% of the time in a casino!
It's still important to work hard and plan ahead to minimize the possibility of failure in any important project or task you pursue. But you're likely setting yourself up for disappointment if you do not have a realistic sense of the margin for failure accompanying the task. (Chris Guillebeau used the metaphor of dominoes falling to describe this same concept which inspired my post.)
Friday, April 25, 2014
How to Pay Rent with your Credit Card (and earn LOTS of points in doing so.)
(Note: these tactics can be applied to any major recurring payments in your life such as mortgages, insurance payments, car payments, child support, etc.)
Background
In addition to the credit card you want to earn points on, you'll need a Bluebird Account. This is basically a checking account that can be loaded using credit cards although the process has become more convoluted recently as Vanilla Reload cards can no longer be purchased using gift cards. Then you can write a check from your Bluebird Account (make sure you follow their instructions for registering the check, writing the authorization code, etc!)
Note that when you open an account with Bluebird, you can order 100 free checks from them, at least until mid 2014. If you run out or if the offer expires, you can buy 100 for something like $26.95 (can't remember the exact amount.) Bluebird will also give you their Bluebird AMEX card which can be used to transfer funds to the Bluebird (as well as spend them.)
How to Earn Points by Loading your Bluebird Account
First, you'll need to locate a few stores in your area:
1) A drugstore (i.e. CVS, Riteaid, etc) or a grocery store that sells gift cards.
2) A Walmart with a Moneycenter (I think most do as of 2014.)
Go to the drugstore or grocery store and search for VISA or Mastercard gift cards, preferably ones that can be loaded with up to $500. (According to Million Mile Secrets, you may want to avoid AMEX gift cards even if they can be purchased with credit.) There's usually a $4 - $7 charge for buying the card regardless of how much you load so I'll usually go with the maximum amount. Check the back and make sure there's a mention of a PIN or a process for setting up the pin. If you're unsure, Google the card on your smartphone and see what the process for setting up the PIN is like. Most of the time, the card will offer one of the 2 following options for the PIN:
1) You need to call them to manually set it up.
2) (Preferred) You set it to whatever you want upon your first purchase with the card.
Then go buy the card at the register. If the cashier won't allow it to be loaded using your credit card, then try buying another gift card or go to a different store.
Here's an example of a card you can purchase:
Once you've purchased your gift card (and activated it if needed), head over to your local Walmart and hit up the Money Center! Go to one of the kiosks and select the Bluebird option. It'll ask you to swipe your Bluebird debit card. After that, it'll ask you to input the amount you'd like to transfer to your Bluebird. Enter the amount loaded on your gift card. After a few prompts, you'll be asked if you're loading with a Credit or Debit card. Enter Debit, swipe the card, and enter your PIN (if you didn't need to set one up, just enter 1234 or any 4 digits.)
If everything goes right, you'll now have effectively loaded your Bluebird account with money from your credit card (which is earning rewards.) Now you can pay your bills that don't take credit (like rent) and still earn points!
Background
In addition to the credit card you want to earn points on, you'll need a Bluebird Account. This is basically a checking account that can be loaded using credit cards although the process has become more convoluted recently as Vanilla Reload cards can no longer be purchased using gift cards. Then you can write a check from your Bluebird Account (make sure you follow their instructions for registering the check, writing the authorization code, etc!)
Note that when you open an account with Bluebird, you can order 100 free checks from them, at least until mid 2014. If you run out or if the offer expires, you can buy 100 for something like $26.95 (can't remember the exact amount.) Bluebird will also give you their Bluebird AMEX card which can be used to transfer funds to the Bluebird (as well as spend them.)
How to Earn Points by Loading your Bluebird Account
First, you'll need to locate a few stores in your area:
1) A drugstore (i.e. CVS, Riteaid, etc) or a grocery store that sells gift cards.
2) A Walmart with a Moneycenter (I think most do as of 2014.)
Go to the drugstore or grocery store and search for VISA or Mastercard gift cards, preferably ones that can be loaded with up to $500. (According to Million Mile Secrets, you may want to avoid AMEX gift cards even if they can be purchased with credit.) There's usually a $4 - $7 charge for buying the card regardless of how much you load so I'll usually go with the maximum amount. Check the back and make sure there's a mention of a PIN or a process for setting up the pin. If you're unsure, Google the card on your smartphone and see what the process for setting up the PIN is like. Most of the time, the card will offer one of the 2 following options for the PIN:
1) You need to call them to manually set it up.
2) (Preferred) You set it to whatever you want upon your first purchase with the card.
Then go buy the card at the register. If the cashier won't allow it to be loaded using your credit card, then try buying another gift card or go to a different store.
Here's an example of a card you can purchase:
Once you've purchased your gift card (and activated it if needed), head over to your local Walmart and hit up the Money Center! Go to one of the kiosks and select the Bluebird option. It'll ask you to swipe your Bluebird debit card. After that, it'll ask you to input the amount you'd like to transfer to your Bluebird. Enter the amount loaded on your gift card. After a few prompts, you'll be asked if you're loading with a Credit or Debit card. Enter Debit, swipe the card, and enter your PIN (if you didn't need to set one up, just enter 1234 or any 4 digits.)
If everything goes right, you'll now have effectively loaded your Bluebird account with money from your credit card (which is earning rewards.) Now you can pay your bills that don't take credit (like rent) and still earn points!
Tuesday, April 22, 2014
The 80/20 of credit card rewards: sign-in offers
You ask your favorite airline (or any airline for the practical purposes) how many points you'll need to accrue to receive a free ticket. They may tell you something along the lines of 40,000 miles for a domestic ticket and 60,000 miles for an international flight (all round-trip.) You realize that you might earn an average of 4,000 miles per flight that you book normally and receive 1 mile per $1 you spend with their reward credit card. Needless to say, you'd need to spend a TON of money and/or take numerous flight before you receive your well-deserved reward ticket.
There has to be a better way, right?
If you have reasonably good credit (700+) and don't mind the paperwork in opening and tracking some new credit card accounts, you're in luck! There are a plethora of credit cards out there that will award you around 20,000 to 50,000 points or miles if you spent $500 to $5000 in the first 3 months! This is usually referred to as a sign-in offer or minimum-spend offer.
Pop quiz! If you sign up for a card that awards 1 point per $1 spent AND has a sign-in offer of 50,000 points for spending $5000 in the first 3 months, what's the effective number of points you received per dollar spent if you spend exactly $5000 in the first 3 months?
A. 1 point per dollar
B. 10 points per dollar
C. 11 points per dollar
If you picked C, bingo! By spending $5000 in the first 3 months, you receive the sign-in bonus of 50,000 points AND another 5000 points from the standard rate of 1 point per dollar. So that brings your total to 55,000 points. 55000 points / $5000 = 11 points per dollar which is 11 times the standard rate!
Sometimes, the sign-in bonus isn't enough for 1 round-trip ticket What to do now?
You will want to go for multiple sign-in offers by signing up for multiple credit cards. Also, get some cards from Chase that offer Ultimate Reward points. These points can be transferred to multiple airlines such as:
There has to be a better way, right?
If you have reasonably good credit (700+) and don't mind the paperwork in opening and tracking some new credit card accounts, you're in luck! There are a plethora of credit cards out there that will award you around 20,000 to 50,000 points or miles if you spent $500 to $5000 in the first 3 months! This is usually referred to as a sign-in offer or minimum-spend offer.
Pop quiz! If you sign up for a card that awards 1 point per $1 spent AND has a sign-in offer of 50,000 points for spending $5000 in the first 3 months, what's the effective number of points you received per dollar spent if you spend exactly $5000 in the first 3 months?
A. 1 point per dollar
B. 10 points per dollar
C. 11 points per dollar
If you picked C, bingo! By spending $5000 in the first 3 months, you receive the sign-in bonus of 50,000 points AND another 5000 points from the standard rate of 1 point per dollar. So that brings your total to 55,000 points. 55000 points / $5000 = 11 points per dollar which is 11 times the standard rate!
Sometimes, the sign-in bonus isn't enough for 1 round-trip ticket What to do now?
You will want to go for multiple sign-in offers by signing up for multiple credit cards. Also, get some cards from Chase that offer Ultimate Reward points. These points can be transferred to multiple airlines such as:
- United Airlines
- Southwest
- British Airways
- Korean Airways.
For example, there's a way to amass 184,000 United Airlines miles (as of April 2014). You'll need the following 4 cards:
Card 1: Chase Sapphire Preferred: 40,000 Ultimate Reward Points for spending $3000 in the first 3 months.
Card 2: Chase Ink Bold Business: 50,000 Ultimate Reward Points for spending $5000 in the first 3 months.
Card 3: Chase Ink Plus Business: Another 50,000 Ultimate Reward for spending $5000 in the first 3 months.
Card 4: United Airlines Explorer: 30,000 United Miles for spending $1000 in the first 3 months. (Alternatively, if you stop by a Chase branch, you can also get another version that awards 50,000 United Miles for spending $2000 in the first 3 months.)
Note the Ultimate Rewards above can be transferred to United Airlines. So if you meet the above minimum spending requirements, you can potentially amass 170,000 + 14000 = 184,000 United miles, enough for 2 international round trip tickets for two!
Ending Remarks
Hopefully, I've given you an overview of the low-hanging fruit in earning points for travel or simply to get more rewards on your dollar. In later posts, I'll explore how to deal with common roadblocks in the process such as prolonging your points (so they don't expire), what to do if you're denied (and how to minimize the chances), what your options are if you don't have a business and want a business card, etc.
Friday, April 18, 2014
So you want to start investing? Look before you leap to picking stocks!
I see posts like these on investing forums like these all the time:
"I'm a [20-something] just getting started at investing. Here are the stocks I'd like to buy."
or "I'm a [20-something] starting investing. What stocks should I buy?"
The reply is usually something along the lines of "the stocks you've picked clearly show you know nothing. You have no business investing right now." Then that individual tragically gives up when they could have made a head start at getting slow but steady returns using index funds and let compound interest do its work over the decades. Like I mentioned earlier, it doesn't take much to be an average investor, but if you pick stocks incorrectly, you CAN end up losing a ton of money.
Good news, if you don't know how to pick stocks, you can still invest (and probably should)! You need to use diversified index funds! Start with something simple and stable like Rick Ferri's 2-fund portfolio or the Permanent Portfolio on the Boggleheads Lazy Portfolio page.
A monkey can probably pick stocks better than you
When I was in business school, my professors would openly proclaim that a monkey can probably pick stocks better than we can. Not just novices but monkeys seemed to even beat many seasoned stock pickers as well! (Now I know a few stock pickers in the industry who have a great track record at picking stocks but I can attest that most probably don't beat the S&P500 in the long run.)
I'll go into more detail on this later but studies show that you only need about 10-20 stocks to achieve most of the benefits of diversification. So let's say I have 100 readers here pick 20 random stocks and invest 5% in each. Then I have another 100 learn the basics of stock picking and pick 20 stocks of their choice and even decide on their own weighting scheme (doesn't have to be 5% each.) 5 years later, it is likely that the 1st group will have outperformed the 2nd group as a whole!
Does this mean you should randomly pick 10-20 stocks and be done with it? The idea of randomly picking stocks and investing your hard earned money in them is a bit disconcerting. I'd personally stick with Index Funds despite how research shows that random picking and equal-weighting stocks even beats indices like the S&P500. (For a detailed mathematical explanation, you can check out this article.)
So what should I do?
If you're getting started investing, go with indexing rather than stock picking despite what your friends or the media tells you. You can get a 2nd opinion from a Financial Advisor if you'd like confirmation that indexing is a wiser choice. If you're brave and you've read my disclaimer, you can randomly pick 10-20 stocks and equal weight them (for the equities portion of your asset allocation.) And only play with money you can afford to lose in either case!
"I'm a [20-something] just getting started at investing. Here are the stocks I'd like to buy."
or "I'm a [20-something] starting investing. What stocks should I buy?"
The reply is usually something along the lines of "the stocks you've picked clearly show you know nothing. You have no business investing right now." Then that individual tragically gives up when they could have made a head start at getting slow but steady returns using index funds and let compound interest do its work over the decades. Like I mentioned earlier, it doesn't take much to be an average investor, but if you pick stocks incorrectly, you CAN end up losing a ton of money.
Good news, if you don't know how to pick stocks, you can still invest (and probably should)! You need to use diversified index funds! Start with something simple and stable like Rick Ferri's 2-fund portfolio or the Permanent Portfolio on the Boggleheads Lazy Portfolio page.
A monkey can probably pick stocks better than you
When I was in business school, my professors would openly proclaim that a monkey can probably pick stocks better than we can. Not just novices but monkeys seemed to even beat many seasoned stock pickers as well! (Now I know a few stock pickers in the industry who have a great track record at picking stocks but I can attest that most probably don't beat the S&P500 in the long run.)
I'll go into more detail on this later but studies show that you only need about 10-20 stocks to achieve most of the benefits of diversification. So let's say I have 100 readers here pick 20 random stocks and invest 5% in each. Then I have another 100 learn the basics of stock picking and pick 20 stocks of their choice and even decide on their own weighting scheme (doesn't have to be 5% each.) 5 years later, it is likely that the 1st group will have outperformed the 2nd group as a whole!
Does this mean you should randomly pick 10-20 stocks and be done with it? The idea of randomly picking stocks and investing your hard earned money in them is a bit disconcerting. I'd personally stick with Index Funds despite how research shows that random picking and equal-weighting stocks even beats indices like the S&P500. (For a detailed mathematical explanation, you can check out this article.)
So what should I do?
If you're getting started investing, go with indexing rather than stock picking despite what your friends or the media tells you. You can get a 2nd opinion from a Financial Advisor if you'd like confirmation that indexing is a wiser choice. If you're brave and you've read my disclaimer, you can randomly pick 10-20 stocks and equal weight them (for the equities portion of your asset allocation.) And only play with money you can afford to lose in either case!
Tuesday, April 15, 2014
Active vs. Passive Investing
When you invest, do you prefer to check on your portfolio and make buy/sell decisions on a regular basis? That's Active Investing. Or do you prefer to buy and hold a few index funds? That's Passive Investing.
The average Active Investor does not beat the average Passive Investor.
It may be difficult to prove this exhaustively but consider the S&P 500 index which contains the vast majority of the market cap of all publicly traded US stocks. If the S&P500 returned X% last year, it is likely the average stock investor returned something around X% last year as well. In fact, because roughly 80-90% of the participants in the financial markets are institutions, it is likely that the average mutual and hedge fund also returned around X% last year as well.
Active investing involves more frequent trading than passive investing (which is essentially buy-and-hold.) When the average active investor receives the same return as the average passive investor BEFORE he/she pays trading commissions, the average active investor ends up making LESS than the average passive investor AFTER fees!
You can be an average investor with very little work!
Funny thing about investing, as opposed to many other disciplines, is that you can be nearly average with very little experience. The same cannot be said of medicine, sports, law, engineering, pretty much every respectable profession. Simply buy an S&P500 index fund like the SPDR S&P500 Fund, SPY, or a total stock market index fund like Vanguard's VTI and you're on your way to being an "average" investor. You don't need to know a thing about investing or finance, just a few thousand dollars to open a brokerage account and you can be average!
But wait, before you make the leap.
Being average means you accept the average returns of the market (which are around 7-10% per year over the LONG term) but you also accept the average losses and risks. In 2008, the S&P500 lost 38% which means the average investor lost a similar percentage of his investments. How much risk you want to accept depends on a thorough analysis of your present and projected (future) financial situation. You will also likely need to consider an asset allocation that includes not just stock but also bonds and maybe commodities and real estate.
Investing isn't as simple as blindly buying a few popular index funds but it isn't as complex as picking the right stocks and trading in and out of the market every few days or weeks. In future posts, I'll go over the principles in investing sensibly.
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