Money Under 30 » Stan

Four Common Investing Mistakes

Stan — Wed, 17 Feb 2010 14:24:56 +0000

Savvy investors know that a single mistake can wipe out months—even years—of solid returns. And beginning investors often make their share of the same four common blunders. In fact, tactics for identifying and avoiding these investing missteps are among the most important things a new investor can learn. Here they are:

Swinging for the Fences

The Mistake: Making big bets on small iffy stocks.

Why We Do It: We know that it’s wise to invest in companies with strong fundamentals. Unfortunately, we also recognize that there is less upside investing in companies with already-proven track records. They’re profitable. They’re safe. They’re boring.

Young growing companies, on the other hand, promise higher returns. We hear about investors who got in early with Microsoft or Wal-Mart and made a fortune. Trouble is, such successes are rare and “swinging for the fences” is not the best way to build a financial future.

Loading up on risky all-or-nothing stocks is a sure route to investment disaster. Small growth stocks typically just putz along, unless they go belly up (which they often do). Example: Between 1997 and 2002, Nasdaq delisted eight percent of its listed firms each year. That’s approximately 2,200 firms whose shareholders most likely suffered big losses before the stocks were knocked out from the exchange.

How to Avoid It: Strive for consistent growth backed by fundamentals instead of throwing darts at smaller companies hoping that one of them is the next overnight success.

Investing With Your Heart

The Mistake: Investing in a company solely based upon your connection to the company or its products.

Why We Do It: It’s an easy trap to fall into. We can develop emotional attachments to companies and their stocks just like anything else. (For example, we work for the company, our parents spent their entire careers there, or we’re avid users of their products). So we invest in the company on faith rather than fundamentals. Our emotional connections blind us to more important indicators of whether or not the company is a good investment.

How to Avoid It: When we invest, what matters are the quantity and price at which we buy, the quantity and price at which we sell, and any dividends we receive. Period. It’s great that you love Panasonic because you love their new 50” flat-screen HDTV, and their quality product may lead you to research their company as an investment. That’s fine; but don’t let your connection to your TV lead you to invest before doing your homework. Great products and innovative technologies matter when assessing companies, but sound valuations matter more.

Following Trends

The Mistake: Investing with the herd.

Why We Do It: We humans are social creatures. We want to fit in, and we all assume that when masses of people act in a certain way, it must be the right way to do things. It’s hard (and scary) to be different. When there is a massive sell-off on Wall Street, fear combines with our desire to go with the pack and we are likely to sell too when, in fact, prices are going down and we might want to do the exact opposite.

Investing is a psychological balancing act of fear and greed. Too much of either will spell catastrophe. Success comes with taking a calculated risk when the chips are down, and knowing when to get out before the storm hits. Stocks are at their cheapest when everyone else is avoiding them.

Morningstar conducted a study every year for the past several years, which show the performance of unpopular funds. After evaluating which fund categories had the highest money inflows and which categories experienced the biggest money outflows, the asset classes that everyone hated outperformed those that everyone loved in all but one rolling three-year period over the past dozen years.

How to Avoid It: Timing the market is nearly impossible, so don’t try to pinpoint the bottom and top. But do go against the grain once in a while and seek out bargains in overlooked areas of the market instead of buying into the latest “hot” sector.

Ignoring Valuations

The Mistake: Investing in a company without understanding why the stock price is what it is.

Why We Do It: Making great investments requires a lot of research and a solid understanding of how companies and their stock prices are valued. Instead of buying only companies that are undervalued in the market, we often make investments based upon hype. Trouble is, that hype usually means that the company’s stock price is inflated…just the opposite of what we want.

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How to Avoid It: Making an investment requires a lot of research. Do it. A great investment should not only have great fundamentals of the company you’re investing in, but the price at which it’s trading should be reasonable. It’s possible that a great company has already been over-hyped, leading to a high price tag.

Also, when you buy stock in a company, you become a part owner of that company. The only reason you should buy a stock is that you think the business is worth more than what the market is accounting for. Also, don’t rely solely on earnings. Companies can make accounting-based earnings-per-share say whatever they want them to. Instead, look into a company’s cash flows. You can spot trouble by watching the trend of operating cash flow relative to earnings. Operating cash flows declining relative to earnings may be a red flag worth looking into.

The Bottom Line

Don’t let a single costly mistake ruin your portfolio’s annual performance. Avoid these common blunders and you’ll be light years ahead of the average investor.

About the Author: Stan is a recent college graduate living in New York City, where he works for a trading firm. Before graduating from college, he was already running an investment fund for family and friends. He writes a weekly column providing economic and investing commentary and maintains his own blog, The Zen Financier.

Economic Bubbles: What They Are, Why They Happen, and Why You Should Care

Stan — Wed, 10 Feb 2010 15:24:17 +0000

You don’t need a Ph.D. in economics to know that economic bubbles—and their ensuing POPS!—can take us all for a wild ride.

Bubbles occur anytime asset prices appreciate unrealistically; and they happen more often than we think. In the United States alone we have seen two in the past twenty years: The dot-com bubble in the late nineties and the mid-2000s real estate craze that has resulted in today’s downtrodden economy.

Bubbles happen everywhere. Japan, for example, experienced a huge surge in real estate and stock prices in the late 1980’s. Apartment prices doubled or even tripled in value in only a few years. By 1990, the value of Japan’s real estate had grown to five times the value of the entire U.S.; The Imperial Palace alone was valued as much as the entire state of California.

At the end of the boom, however, Japan’s balloon economy became distressed and fell hard, entering into a decade-long deflationary slump. This so-called lost decade is a painful reminder of what can result from such a bubble. In fact, Japan is still struggling to revive its economy today, in part due to the recent global financial crisis.

Why Do Bubbles Occur?

There is no single, widely-accepted theory to explain why certain assets sometimes grow rapidly and unsustainably.

One theory is that as an economy gains momentum, companies report higher earnings and pay individuals higher salaries. Instead of putting aside money in savings, individuals spend more than they should, purchasing a home that’s beyond their means thinking that as prices appreciate, they will be able to pay it off easily. They may also be more inclined to make risky stock market plays. This causes a contagious domino effect that eventually leads to a bubble.

An alternative theory is that as an expanding economy pumps more money into the financial system (liquidity), borrowing money becomes cheaper. With interest rates down, investors are more likely to leverage their capital by borrowing money from banks and investing in other assets such as real estate. When investors are putting too much money into a limited number of assets, prices rise. Multiply this effect by the number of individuals and large institutions that participate, and you get a classic bubble.

In my opinion, these and other theories are neither right nor wrong; many factors combine to create the “perfect storm” that leads to a bubble.

Should We Prevent Bubbles?

The more appropriate question might be: Can we prevent bubbles?

Although increased regulation can partially depress bubbles, economists have a difficult time accurately identifying bubbles and an even harder time implementing policies that won’t negatively affect other areas of the economy.

Most commonly, the Federal Reserve attempts to stifle bubbles by creating monetary policy aimed at controlling rising asset prices. The Fed increases the federal funds rate when there are inflation concerns and lowers the rate to spur economic growth. And when banks raise interest rates, borrowers have a harder time getting loans to fund investments or small businesses.

But even as the Fed raise interest rates up to 6.75% back in 2006, the U.S. real estate bubble continued to expand until its crash in 2008.

Looking back, bubbles seem obvious. Unfortunately, however, bubbles are difficult to detect as they occur because they typically begin with modest and innocent optimism.

That makes bubbles inherently difficult to stop a bubble from forming. Besides, who wants to be the guy taking away the punch bowl as the party just gets started?

Can Bubbles Benefit the Economy?

Bubbles scar the economy, and the healing process is long and painful. Just look at Japan.

But if you’ve ever enjoyed getting an incredible job offer, earning a plump salary, or making a lucrative investment during a bubble, you might be wondering: “Well, bubbles can’t be all bad”.

One benefit of bubbles are extensive standard-of-living increases for large segments of the population. Bubbles are capitalism’s way of rapidly metamorphosing an economy.

Without the Internet bubble we might have missed companies like AOL, which connected virtually every American household to the Web. Although 1999’s inflated salaries and stock prices are ancient history, the Internet remains and has transformed the way we share information and do business.

Looking back even further, electricity was commercially available in America as early as the 1880s, but utility companies faced certain barriers that delayed the implementation of electricity until the 1920s. The bubble of sorts preceding of the Great Depression contributed to electricity’s spread into rural areas and consequently, electrical household appliances that drastically improved Americans’ way of life.

Not all bubbles are transformational, but those that are enhance our quality of life and pave the way for future innovation. So as we endure the present downturn and look back on the culprit bubble as a cancer, we can remember that this cycle may actually be making our lives better and our economy stronger for the long run.

What do you think? Can bubbles be avoided? Do you see them as good in any way? What do you see as their negative or positive impacts?

When to Sell a Stock

Stan — Thu, 04 Feb 2010 20:36:56 +0000

To make a successful investment, you must know when to buy and when you should sell. The reality is that there are only a handful of companies worth holding onto for long periods of time—and there are very few investors who are perceptive enough to buy only those companies.

There will always be good times to sell stocks we own, and knowing when to sell is just as important as knowing when to buy. Yet we often find ourselves selling our winners too early and holding onto our losers too long.

Here are some questions to ask yourself to help decide when it’s time to sell your stocks.

Did you make a mistake?

Don’t hold onto a stock you bought for a reason that’s no longer valid. You may have bought stock thinking that management could turn the company around only to later learn that the task was harder than you predicted. Or maybe you hoped that the company would expand into other niches but you overlooked strong competitors in those areas.

Whatever your initial reason for investing, if you learn that it’s no longer the case, cut your losses, sell your stock, and re-evaluate your investing strategy.

Have the fundamentals changed?

Sell your stock if the company has stopped growing, its core business has slipped, or other fundamentals have changed. After several years of accelerated growth, the company you bought has started to show signs of slowing down. There is growing competition in the industry and your company is having a harder time finding profitable new investment opportunities. Could this be the time to reassess the company’s future prospects? If they’re significantly worse than they used to be, it may be time to sell.

Is the stock overvalued?

No matter how great the prospects of a company, the price of the stock still has to be right for a great investment. Popular, thriving companies frequently trade well above their intrinsic value. Trouble is, with such high expectations, the stock may not have much more room to run.

Estimate the stock’s intrinsic value and ask yourself a.) How much more you think the market is willing to pay you than your estimate and b.) How likely it is that your estimated value could go up over time?

You don’t have to sell great companies just because their stock is pricey, but you should be careful when expectations become too high.

Do you need to rebalance your portfolio?

Periodically reassess your portfolio and make changes when needed. Paying attention to your portfolio and periodically making calculated adjustments is critical. For example, if you’ve been slowly buying more and more technology stocks, a regular review of your asset allocation could reveal that your portfolio is too heavily weighted in that area.

Although this may be great if technology stocks are doing well, putting all your eggs in one basket will come back to haunt you later. No matter how profitable a company is, if an investment is a significant portion of your portfolio, it’s time to consider selling some.

Is there something better you can do with your money?

Always look for ways to compound your money at the fastest rate relative to your risk tolerance. There is no shame in selling investments—even those that are undervalued or those where you’ve lost money—to free up cash for another investment that might yield you a higher return.

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For example, if you see that a company’s stock is trading at a large discount from what you think it’s actually worth, you may want to think about selling some stock that you believe has the smallest chance for more growth to free up some cash.

Summary

Before making any investment, research the company’s business inside and out. When you decide to buy stock, consider your exit point as well so that you aren’t stuck holding onto stocks that have small growth prospects. Good luck!

What do you think? When do you sell stock? Share your strategies in a comment.

Waging War on Wall Street?

Stan — Fri, 29 Jan 2010 13:46:24 +0000

Just over a week ago, the Obama Administration waged war on Wall Street.

President Obama has proposed financial reform that would limit the size and activities of the largest U.S. banks by separating proprietary trading, hedge funds, and private equity operations from banking (taking deposits and making loans). Theoretically, these reforms would simultaneously reduce the size of these banks and curb risk-taking.

Assuming that the new proposal passes the Senate, how effective will Obama’s proposal be? Will it ensure financial stability and long-term economic growth for the U.S.? Not necessarily. Here’s why.

Bad Timing

Although I do agree that regulations designed to mitigate risk at “megabanks” can contribute to a stable economy and is the right long-term policy, Obama’s timing introducing these reforms could not have been worse.

In a political move to deflect attention away from the Democrats’ huge loss in Massachusetts jeopardizing the healthcare reform, Obama decided to announce his plans for financial reform only a few hours after Goldman Sachs reported better-than-expected earnings attributable, in part, to restricted pay.

The jubilant news that the financial sector, a crucial element to the growth of a nation’s economy, has finally shown evidence of stabilizing was crushed by Obama’s new proposal.

The proposal even called Federal Reserve Chairman Ben Bernanke’s confirmation to a second term into question. (He was confirmed this week by a 70-30 vote, although 11 democrats voted against the confirmation.)

All of a sudden, the prospect of a stable economy recovery seems to have dissipated, and replaced with panic and uncertainty.

Banks are Crucial for Recovery

An economic recovery will require a stable financial system so banks can lend to small businesses, advise firms on raising capital, and spur on the growth of businesses (so that business can hire workers again). With that in mind, a fragile economic recovery is not the best idea to stage a battle with the big players on Wall Street.

By creating greater uncertainty on the profitability and structure of large banks, Obama has, for now, sabotaged any impending recovery. If Obama’s proposal passes, his reforms will hit lucrative divisions of every major U.S. bank…and hard.

Goldman Sachs’ proprietary trading division, for example, which accounts for about 10 percent of the firms’ total revenues, would suffer; JP Morgan Chase’s successful Highbridge Capital hedge fund would be separated from its parent company; Morgan Stanley’s hedge fund and proprietary trading units would be affected; and so on.

When regulations eat away at banks’ profits from these divisions, the banks will have less to lend. That means the economy may continue to drag its feet, slowing the process for a full recovery. So if Obama wants to create more jobs through small businesses, he needs to stabilize the banking system first.

Same Old Lesson

In 1933, the U.S. passed the Glass-Steagall Act in the wake of the 1929 stock market crash. The act separated commercial banks from investment banks, which restricted commercial banks taking on speculative bets with depositors’ money. But Congress repealed the Glass-Steagall Act in 1999 because there was debate over how restricting financial innovation could hurt the industry. Many argued that if banks could diversify their operations, this could lead to a more stable sector.

Now, Obama’s financial reform proposal, though not necessarily the same as the Glass-Steagall Act, certainly echoes it. Will the same debate about limiting market innovation surface again?

Progress is the Result of Careful Risk-Taking

Innovations that improve our standard of living always come with a risk of failure. The Internet boom of the 1990’s revolutionized how we communicate, obtain information, and shape businesses. However, it ended in the early 2000’s with thousands of small online businesses failing, ultimately leading to a recession.

The Internet has been one of the most influential innovations in recent years. It took several thousands of small online businesses to fail to end up with today’s Internet powerhouses such as Amazon, eBay, and Google.

Likewise, financial innovation that improves efficiency of the free markets can only be developed through risk-taking. Unfortunately, the current financial crisis accelerated with the securitization of mortgages during the time of the seemingly never-ending real estate bubble. The good news is that we can learn from our mistakes, making progress towards greater transparency and efficiency.

Summary

So is Obama’s new proposal the cure for stabilizing large banks? Although to American’s angry with Wall Street’s past missteps the regulations may sound great, we can’t believe that we’re out of the woods just yet. There are more questions now than before, which means that we may face an even longer recovery period.

What do you think? Do you agree that tighter regulation on Wall Street is a bad idea or think that the Obama administration is doing the right thing? Should the same banks that take our deposits and give us mortgages be allowed to continue running riksy proprietary trading divisions and hedge funds? Share your thoughts in a comment.

The Future of ETFs

Stan — Sat, 23 Jan 2010 14:30:35 +0000

This past week, the Boca Raton Resort & Club hosted the Third Annual Inside ETFs Conference, the world’s largest exchange traded fund (ETF) event with over 750 participants. CNBC even broadcasted live from the event with interviews from ETF issuers, marketers, fund managers and others involved in the ETF business.

With over 800 ETFs in the U.S. and total ETF assets recently surpassing the $1 trillion mark [WSJ sub. req'd.], the ETF industry is certainly growing fast. But where are ETFs going? Let’s take a look.

Active vs. Passive

Actively-managed ETFs began to pop up in 2007 but have recently gained momentum due to their advantages over traditional mutual funds. Both actively-manged ETFs and mutual funds offer a low cost of entry and the convenience of having professional managers handle your money. However, ETFs typically have lower expense ratios, better tax advantages, greater trading flexibility and more transparency of underlying holdings than mutual funds.

One feature of ETFs is that their holdings are disclosed on a daily basis, creating greater transparency for individual investors.

Initially, this may seem counter-intuitive, as individuals could easily use the disclosed holdings to construct their own portfolios without paying a fee. To avoid this issue, ETF funds disclose their holdings daily after the markets close, to eliminate “front runners”.

Another concern is the lagging performance for actively managed funds overall. Historically, active managers haven’t been too successful when comparing their track record against passive funds.

Nevertheless, actively managed ETFs seem ready to explode. As of now, there are 15 funds but that could rise to more than 40 soon with the number of issuers willing to take a chance.

Specialization of ETFs within Asset Classes

Another theme to look for is the expansion of ETFs that are specialized within an asset class. There has been an increasing number of Commodity, Fixed Income, and Currency ETFs coming into the market with a focus on expanding within specific asset classes.

For example, United States Natural Gas Fund (UNG) is an ETF that tracks the front month of a natural gas futures contract. Two months ago, United States 12 Month Natural Gas Fund (UNL) was introduced to reflect the average prices of 12 consecutive months’ futures contracts equally weighted, instead of just the front month.

This trend can also be seen in Fixed Income, where investors now have the option of investing in all different types of ETFs including a 1-3 Month T-Bill ETF (BIL) or a 20+ Year Treasury Bond (TLT) depending on their investment strategies.

This specialization and expansion of ETFs within asset classes should provide sophisticated investors with plenty of tools to construct their portfolios.

Value & Region Based ETFs

You can now even invest in ETFs based on your faith. On December 21, 2009, the first Christian ETF (FOC) hit the market. This fund tracks a Christian index, which excludes companies involved in gambling, anti-personnel landmines, tobacco, alcohol, pornography, abortion, and/or stem cells.

For those who are strongly religious, these ETFs are a perfect solution to diversify across a broad range of stocks without worrying about investing in companies that are out of line with their faith’s beliefs.

Similarly, Geary Advisors LLC has recently launched two state-based ETFs: Oklahoma ETF (OOK) and a Texas ETF (TXF). These ETFs track indices that seek to measure the performance of publicly traded companies that are headquartered in Oklahoma and Texas, respectively.

These ETFs give individuals living in Texas and Oklahoma the opportunity to invest in their own state. Furthermore, Geary Advisors is now working on different types of state-based ETFs, including a mid-cap Texas ETF as well as a small-cap Texas ETF.

Summary

The ETF business has grown exponentially in recent years. Has it expanded too fast too soon? Despite its success, ETFs may have reached a saturation point with investors; there are many funds that aren’t able to gain traction due to lack of interest. These funds die slowly, shriveling up from lack of assets.

With the continuous inflow of new, exotic ETF funds, check the daily volume of the funds are before investing in them so you aren’t stuck with anything you can’t get out of.

The Inverse Relationship Between Gold and the Dollar

Stan — Mon, 11 Jan 2010 12:30:57 +0000

Gold has been one of the hottest topics in the investing world in recent months, and with good reason. In 2009, investors received a 25 percent return on gold—the biggest absolute annual gain in three decades. Arguably, gold’s nine-year streak of positive returns is even more impressive.

If you’re considering whether to invest in gold, it’s important to understand the close relationship between the value of gold and the value of the dollar.

A Brief History of Gold and the Dollar

To understand how and why gold has had such a historical run-up, a little history lesson on the relationship between gold and the dollar is helpful.

The relationship between the dollar and gold is tied to the concept of tangible assets vs. financial assets. To put it simply, gold has real value, while the dollar is a representation of real value.

In 1944, the Bretton Woods Agreement launched the first system of convertible currencies and fixed exchange rates, requiring participating countries to maintain the value of their currency within a narrow margin against the U.S. dollar, which was fixed at a rate of $35 per gold ounce.

However, in the 1950s and 1960s, the increasing supply of U.S. dollars along with capital outflows aimed at Europe’s postwar recovery put downward pressure on the dollar.

Eventually, a series of dollar devaluations in the early 1970s ended the Bretton Woods system, allowing the dollar to be freely traded and freely sold, beginning the long drawn-out period of the falling dollar.

An Inverse Relationship

Perhaps one of the most well-known relationships in currency markets is the inverse relationship between the U.S. dollar and the value of gold. This relation occurs because gold is typically used as a hedge against inflation through its intrinsic metal value. As the dollar’s exchange value decreases, it takes more dollars to buy gold, increasing the value of gold.

While the dollar’s value is at risk of fluctuation through shifts in monetary policy, gold’s value is largely determined by supply and demand, without interference from shifts in monetary and corporate policies.

Between January 1999 and May 2008, the correlation between the two has been a staggering (-0.84), indicating a very close negative correlation.

As with any close relationship between two assets, the gold-dollar inverse relationship has not been without periods of temporary decoupling. The most significant exception to this rule occurred between April and December 2005 when the correlation between gold and the dollar was as high as 0.66. During this period, the U.S. raised interest rates while China revalued its currency, giving them an opportunity to snatch up gold and other commodities.

Monetary Policy Effects on Gold

The dollar’s value is largely determined by monetary policy enacted by the Federal Reserve Bank. Over the last few decades, the Fed has used the federal funds rate as a tool to control inflation and stimulate the economy and in doing so, has also impacted the price of gold.

In plain English, when the central bank lowers the federal funds rate, banks can lend to other banks at lower interest rates which, in turn, makes lower interest rates available to borrowers. And when rates are lower, borrowers have a greater incentive to take out loans (to start businesses, for example). This type of policy increases the supply of money in the system.

Conversely, if the central bank becomes concerned that there is too much money flowing around, it will raise interest rates to pump money back out of the system, curbing the risk of inflation.

As you can imagine, as the central bank lower interest rates, more money is printed. This lowers the value of the dollar and, consequently, raises the value of gold. Likewise, a rate increase strengthens the dollar and devalues gold.

Gold’s Current Rally

Gold is in the midst of a great bull market because interest rates have been at historic lows for such a long period of time.

Towards the end of 2008, small businesses sputtered and the economy stumbled. In response, the Federal Reserve cut rates to stimulate borrowing and spending—an attempt to cushion the blow of a souring economy. These low rates have been virtually unchanged since November 2008. In response, gold has enjoyed a run throughout 2009 as investors worried about inflation.

Should You Invest in Gold Now?

This is a tough call. Although inflation concerns are legitimate, gold has been making new highs during the last couple months leading many to wonder if it might be running out of steam. My gut feeling tells me that all the media attention gold has been getting as a safe haven for inflation has put gold into “bubble” territory.

Although inflation is still a concern, Americans are spending a lot less and a stable economic recovery is a much bigger concern at this point than rising inflation. Once the economy shows any signs of surviving on its own without government aid, the central bank will most likely raise rates quickly, to subdue any risk of inflation.

I would advise against investing in gold for now, but if you are interested in gold, the best and easiest way to gain exposure is through ETFs. Make sure you do your research before making an investment!

Read More: How to Invest in Gold

What about you? Are you bullish on gold? Would you consider buying gold despite its recent run up?

How to Choose a Stock Broker

Stan — Mon, 04 Jan 2010 15:18:44 +0000

Finding the right stock broker can be overwhelming. There is a glut of brokerage companies out there—both online and full service—and each service claims to be the best. So how, exactly, can you tell which broker is right for you?

As you approach shopping for a new broker, you need to decide which services you want and how much you are willing to pay for them. Plenty of broker ratings and customer satisfaction surveys exist, but high survey scores won’t matter if the broker you choose doesn’t meet your specific needs.

Before you dive into your stock broker search, ask yourself these questions:

How much do you want to invest?
What investing strategy will you use?
What type of products will you invest in?
How much customer support will you need?

Having these answers will be critical in evaluating potential brokers. Why ask these questions? Let’s look at each one in greater detail.

How Much Do You Want to Invest?

Some brokers have minimum opening deposit requirements, some don’t. (For example, TD Ameritrade has a $2,000 minimum to open an equity account; TradeKing and Zecco do not have minimums). So the more money you have to invest, the more options you have. Conversely, knowing how much you’re willing to invest from the beginning will help eliminate high-minimum brokers right away, saving you time.

What Investing Strategy Will You Use?

Depending on your investing strategy, you may favor one broker over another. Here are a couple points to consider:

The cost of making your trades will vary by broker (commissions). Discount brokers like Scottrade, TradeKing, and Zecco charge less, but often at the cost of inferior customer service, lack of research tools, and/or slow execution, potentially leading to a missed opportunity.

If you’re a buy-and-hold investor and plan to trade infrequently, commission rates should be on your radar, but you should weigh other factors (e.g., customer service) more heavily.

If you’re a frequent trader, however, commissions can add up quickly. Compare discount brokers and consider using one with low commissions to help minimize trade costs.

Also, find out whether a broker’s commission rate is fixed or if it changes depending on the number of trades you make per year. Many brokers offer lower commissions to active traders.

Want to trade after the market closes? Make sure you pick a service that supports it. After-hours trading comes with risks (e.g., less volume and more volatility), but with risks come opportunities.

What Type of Products Will I Invest In?

The kinds of investment products you choose is a part of your investing strategy, so make sure your chosen broker supports the products you want to trade. For example, every broker will have access to the most commonly traded stocks, but many will not have access to thinly traded issues (e.g., penny stocks).

Options trades are also popular, but some brokers have better options platforms options than others. So if you want to trade options, research brokers’ options services thoroughly beforehand so you know what you’re getting. (Finally, don’t forget that options carry an additional fee per contract traded, so if you want to trade options, factor those fees into your trading costs!)

How Much Customer Support Will You Need?

If you prefer to research, select, and buy stocks on your own, a discount broker that offers extensive research platforms will suit you well. Some discount brokers even offer a network for traders to swap trades, strategies and other investing banter.

However, if you don’t feel comfortable making investment decisions on your own (or simply don’t have the time to put in the research yourself), consider a full-service broker. Unlike discount brokers, full-service brokers will work with you on an investment strategy, usually at a higher cost.

Other Factors

Most discount brokers keep costs to a minimum by being “online only”; that means they don’t have local branches. If you prefer being able to walk into a local branch of your brokerage company for whatever reason, factor that into your decision as well.

Also, check with your employer to see if they have specific requirements for employee investing. Depending upon your employers’ involvement in securities or other financial transactions, they may require you to stick to short list of brokers they have approved for employee use.

Choose a broker now: Online brokers compared

From my own experience, I have found that TradeKing has a great balance of customer support, research capabilities, trading execution, and low commissions. I would also recommend Zecco for their lower commissions, although I have had some issues with their customer support in the past. To see more

Happy investing!

Which brokerage service are you using? What other factors did you consider before picking it?

About the Author: Stan is a recent college graduate living in New York City, where he works for a trading firm. Before graduating from college, Stan was already running an investment fund for family and friends. He writes a weekly column providing economic and investing commentary and also maintains his own blog, The Zen Financier.

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GDP as Economic Indicator: Why Q3 Growth Doesn’t Spell Recovery

Stan — Wed, 30 Dec 2009 14:26:21 +0000

Gross domestic product (GDP) figures provide a convenient snapshot of a nation’s economic health. Unfortunately, we too often draw conclusions based upon GDP numbers alone, overlooking underlying factors.

Although a positive GDP report bolsters confidence about the country’s economy, it is important to look beneath the surface to assure that such optimism is supported by reality. The following is a recent example.

Quarterly GDP numbers are always revised three times. The original estimate for third-quarter growth in the U.S. marked the economy expanding at a 3.5 percent annual pace. A month ago, economists dropped the number to 2.8 percent. And most recently, the Commerce Department revised the third quarter GDP figure to 2.2 percent.

These GDP numbers mark the biggest positive growth in a quarter since 2007. On paper, the economy seems to have finally stabilized from the free-fall of the deep recession. Looking closer, however, I’m less optimistic of a fast recovery for a two big reasons.

Growth is Too Government-Driven

The first red flag is the fact that a big portion of the economic growth stems from government stimulus spending. If we were to subtract this government spending, the economy would not show a recovery.

The big sectors that contributed to GDP growth were automobiles (1.45 percent), residential investments (0.43 percent) and government spending (0.55 percent), for a total of 2.43 percent.

What’s wrong with this picture?

Automobile sales were largely boosted by the government’s cash-for-clunkers program, which provided a temporary backstop to Detroit’s woes, albeit inefficiently.

Cash-for-clunkers was a success in the short-term, as consumers rushed to purchase new cars in time for the rebate. However, it remains to be seen whether or not this program can help sustain automobile sales and stabilize the U.S. auto industry. At least for the few months following cash-for-clunkers, we can expect a natural decline in new-vehicle sales when compared to August levels.

Likewise, the first-time homebuyer tax credit temporarily boosted home sales throughout the country. But the stabilization of the housing market—a critical component to an economic rebound—is likely several months away from reaching sustained growth. Economists expect home sales to remain in a slump next year after the housing credit expires in April.

With the government planning additional stimulus plans such as a cash-for-appliances program followed by a cash-for-caulkers, will the benefits outweigh the costs to taxpayers in the long-term? We’ll have to wait and see.

Too Much Private Consumption

GDP is defined, using expenditures, as:

Private Consumption + Gross Investment + Government Spending + (Exports – Imports)

Another reason I am skeptical that positive GDP numbers do not indicate a quick rebound will occur is the high level of consumption in the U.S. that is included in those GDP figures. (Once again, the government stimulus programs contributed to high levels of private consumption).

The weight of each component contributing to GDP varies from nation to nation. A glaring example is the large role private consumption in the GDP of the United States compared to the GPD of other nations. For example, domestic consumption makes up just over a third of China’s economy compared to a whopping two-thirds in the U.S.

Consumption fuels America’s economic growth while other economies, including China’s, are expanding because of increasing exports—a much better foundation for long-term economic growth.

An increased effort to rebalance these figures has been the big theme in talks among the top twenty developed nations (G-20) in the world. In other words, U.S. consumers need to save more while Asian consumers should spend more.

Thus, even though China grew at an astonishing 9.6 percent in 2008 (recently revised from nine percent), China could expand even faster if its population consumed more.

The United States has been able to prop up a fraught economy with government investments and stimulus programs, but only time will tell if these actions will create a sustainable long-term recovery or are a window dressing that’s temporarily masking our ongoing economic weakness.

What do you think? Are you optimistic about the economy in 2010? Do you think the economy can sustain itself without aid from the government?

Why Recessions Are Good For Our Economy

Stan — Mon, 21 Dec 2009 14:59:44 +0000

I know what you’re thinking: How can high unemployment rates, declining stock markets, and having less cash in your wallet be good things? We like to think that in a perfect world, we would never have to endure the hardships associated with economic downturns like lost jobs, watching our 401(k) accounts dwindle, or worrying about how we’re going to keep the lights on and the refrigerator stocked.

But the truth is: recessions are part of a normal economic cycle in capitalist societies. In other words, recessions are necessary evils.

On the bright side, there are three reasons I believe recessions are actually good for the economy:

People’s attitudes change (for the better)
We see growth and innovation in underdeveloped sectors and shrinking of overcrowded, bloated sectors
We have the opportunity for self-evaluation

Attitude Change

Recessions naturally create shifts in our thinking and behaviors. On average, over the course of a recession, we go from being irresponsible, irrational spenders to frugal, prudent savants who make much better financial decisions.

Even ordinarily financially-savvy consumers begin to make even more frugal decisions during a recession. We abstain from making unnecessary purchases, we put in that extra effort to find the same item for a better price elsewhere, or we learn to forgo paying more for expensive, brand-name good. According to a December 2009 McKinsey & Company report, “…in any given category, an average of 18 percent of consumer-packaged-goods consumers bought lower-priced brands in the past two years.”

Such attitude shifts can have lasting impact on consumers.

For example, spend some time with Americans who lived through the Great Depression and World War II, and you will quickly realize how deeply their worldview (and consumption decisions) have been affected by the hardships they endured decades ago. Many who learned resourcefulness and frugality during hard times never unlearn those behaviors.

On a personal level, if today’s recession hurts even a little bit, your subconscious starts telling you work harder and spend more conservatively. That recession mindset might tell you to pass on that cashmere crewneck at J. Crew or to cook yourself a healthy dinner at home instead of eating a fatty Chipotle burrito. And we all know that saving money here and there certainly won’t hurt you in the long run.

Now, imagine what happens when hundreds of millions of people collectively experience a deep recession. These subtle attitude changes on an individual level combine to create a much wiser, financially-responsible populace. Now we’re talking.

Sector Contraction and Expansion

The academic definition of a recession is a period when the excess “fat” is removed from the economy, paving the way for expansion. Until this purging is complete, the economy will be less efficient and will continue to drag along.

In theory, recessions punish both companies that have made bad decisions (by putting them out of business) and incompetent workers who put their employers at risk (by putting them out of work).

In the process, laid-off employees intuitively find other work at firms in underdeveloped sectors that are in need of more labor. Thus, work is distributed more efficiently elsewhere in the economy where there is more demand for labor. Subsequently, the weakest players in bloated sectors do not survive, and the strongest businesses in those sectors become leaner and more efficient.

The recent collapse of the financial services industry is a perfect example. There were too many pigeons fighting for the last bread crumb, which led to firms taking excessive risks and engaging in dubious practices. Something had to give, and it did; first Lehman Brothers collapsed, and soon the entire industry began a quick and forceful contraction.

This cycle of contraction and expansion is not always perfect. Sometimes, contraction within one sector can be so violent, it doesn’t create a small ripple in the economy; it starts an avalanche. In such a case, if nobody stops the avalanche, businesses in every industry are at risk.

Most recessions, however, do us a service by correcting and rebalancing the economy, which helps young, promising industries develop. In fact, economic downturns (including the current one) are often tied to increases in entrepreneurship and small start-up firms. Thus, recessions have a way of sparking innovation as well.

Opportunity for Self-Evaluation

Finally, recessions allow us to step back and reevaluate ourselves. Imagine you started a career in a once-trendy industry for the glamour and big paycheck, but in a recession the industry collapsed and left you jobless. What would you do?

In situations like this, recessions may allow some people to pursue their true passions, which may make their work more enjoyable, which may lead to higher productivity, which may lead to a better lifestyle, and so on. Too many of us get stuck at jobs that pay the bills but don’t really inspire us. We do the daily grind and, before we know it, years have come and gone. Often times, we don’t give our dreams a second thought.

Case-in-point, a friend’s father was a long-time employee at a large investment bank. Over the years, he developed a side-business running a ski lodge, which he loved, but never had time to completely devote himself to the operation. In an indirect way, the recession provided an impetus to retire from the corporate world and focus on his ski lodge full-time, and he’s happier.

Similar stories arising from the current recession abound (like the thousands of laid-off women now making a full-time living selling their crafts on Etsy).

I’m not saying that I love recessions and am looking forward to the next one, but they serve an important role in the larger picture of the capitalist economy. And as those who learned sounder financial habits, found more rewarding work, or began to follow a dream have learned, a recession change that looks like a lump of coal may actually contain a diamond.

About the Author: Stan is a recent college graduate living in New York City, where he works for a trading firm. Before graduating from college, Stan started an investment fund for family and friends. He also maintains his own blog, The Zen Financier.