Generation Y Investor

Composure: The Key To Risk Tolerance

I’ve already mentioned in a few posts that it’s vital to have an asset allocation that matches your time horizon and risk tolerance. Figuring out your time horizon is simple enough, but things get a little more difficult when it comes to assessing your risk tolerance. Some advisors will point you to a standard questionnaire that is suppose to measure your ability (or inability) to handle risk. The problem with these quizzes is that they try to measure an individual’s emotional response to varying scenarios with intellectual questions. How you respond to a question about a hypothetical portfolio loss of 50% is probably quite different then how you actually responded last year when the markets were plummeting day after day.

The following article examines how the best gauge of risk tolerance is actually the level of composure one has when something unexpected occurs: Tune In, Chill Out

“People say they’re willing to lose 20%, then they lose 2% and they panic. A more meaningful indicator is composure — your short-term, emotional reactions to unpredictable and uncertain events, such as the market’s ugly sell-off on Friday. How will you handle yourself in the heat of battle? Far too many investors discovered in 2008 and early this year that losing money in quick, sharp cuts was more than they could bear. Those thoughtful risk-tolerance quizzes got shredded when stocks went into free fall. Panicked investors sold what they could, often at any price.”

Some comments on Buffett’s, “Be fearful when others are greedy, and be greedy when others are fearful” quote…

“There’s a good reason why there aren’t more Buffetts among us: Buffett is not only more risk tolerant, he’s more composed. When the shooting starts and money is on the line, Buffett comes across as cool and unemotional. And he fires back. Think Clint Eastwood with a calculator.”

On how you can increase your composure…

“First, commit to an investment policy with a long-term or big-picture focus that recognizes there will be major pitfalls along the way. This is your battle plan. The most effective policy statement lays out objectives. These include return goals — how much money you’d like to make — and the potential obstacles to that happy outcome. In this way, you get a sense of how emotions dictate your actions.”

“Second, divide your wealth into different mental accounts with varying degrees of risk. Investors should not be diversifying asset classes; they should be diversifying risk.”

Gen Y Investor Weekly Roundup: Halloween Edition

Happy Halloween everyone! I’m on the porch right now handing out candy to trick or treaters. Unfortunately the rain here seem to be keeping most people inside. The markets looked truly scary yesterday by the way. Looks like we couldn’t get out of October unscathed. Here are some of the best articles of the past week…

And The First $1,000 MBA Giveaway Winner Is…. – Financial Samurai announces the first winner of his $1,000 MBA giveaway. Check it out… There is still one more winner left to be chosen. It could be you! (@ Financial Samurai)

How To Get Your Free Credit Report Online: A Step-By-Step Guide – Here’s a great post that takes you through the process of getting you credit report for free. This is the only real way to get a free report. (@ Get Rich Slowly)

Dollar’s Depreciation Inflates All Assets – If you’ve been following the markets recently you’ve probably noticed the inverse relationship currently present between the dollar and other assets. The dollar rises… the market falls… the dollar tanks… markets rise. This article explores the issue in more detail. (@ Forbes)

State Death Taxes Are the Latest Worry – This piece by the Wall Street Journal says that often individuals are more concerned with state estate taxes as opposed to Federal estate taxes. Obviously, we won’t have to worry about this issue for a couple decades but it could effect your parents. (@ The Wall Street Journal)

Retiring On Investment Dividends & Interest Alone

Investing When one reads typical retirement advice, they’re often told that beginning in retirement they should start withdrawing about 4% of their portfolio for living expenses each year. The 4% rule is standard retirement advice that gets cited all the time since it’s considered a safe withdrawal rate for the average retiree. However, the downside of this plan is that the retiree will be funding his or her retirement by spending down their portfolio’s principle.

Now don’t get me wrong, there’s nothing terrible about following this advice. A retiree who adheres to this plan has a great chance their portfolio will last the remainder of their life. But isn’t there a better option? One where the retiree needn’t worry about outliving their nest egg? Luckily, there is a better plan. Instead of drawing down one’s portfolio, a retiree can simply live off the dividends and interest their nest egg produces. Following this method guarantees that one never runs out of money. It is also easy to stick to, and will eventually leave one’s heirs with a tidy inheritance. The one caveat of living off dividends and interest alone is that it usually requires significantly larger retirement savings. Read More…

Researching Stocks: Finding Shareholder Friendly Companies

This is the second of a series of posts dedicated to properly researching stocks. In my previous post, I examined how to calculate a company’s free cash flow. Today, I’m going to show you how to determine if that cash flow will be put to good use. The company you’re researching can be profitable, efficient and financially sound, however, if it’s not run in a shareholder friendly manner then it’s probably not worthy of your investment.

What’s a shareholder friendly company?

A business that is shareholder friendly always operates with the shareholder’s best interests at heart. They tend to be lead by competent managers who communicate openly and routinely reward investors. Businesses that exhibit these three traits are more likely to have favorable long term investment returns than their counterparts. Let us examine these traits in further detail…

Competent Management

The number one trait that shareholder friendly companies have is a team of great managers running the business. Determining whether or not management is competent can be a subjective process. After all, there are no hard numbers you can crunch to figure this out. Instead you have to look at other more subtle details like experience level and motivation. Read More…

Update: Homebuyer Tax Credit

I was really busy at work today so unfortunately I wasn’t able to finish my next post in the Researching Stocks Series. I should be able to finish it up tomorrow, so be on the lookout for it. Just a quick update on yesterday’s post. It looks like the plans have changed for the tax credit extension.

Here’s what the new details should look like: Senate Close to Deal Replacing Homebuyer Tax Credit

“The deal would reduce the size of the tax credit to 10 percent of the sale’s price, capped at $7,290, the people said. The credit would be available on home purchases that are under contract by April 30, and borrowers would have 60 days more to close the sale.”

“The income eligibility for first-time homebuyers would remain the same at $75,000 for individuals and $150,000 for couples. The income criteria for step-up buyers would be $125,000 for individuals and $250,000 for couples.”

“The credit would be limited to homes costing $800,000 or less. There is currently no price cap on home purchases.”

Senate Plans to Extend, Then Phase Out Homebuyer Credit

Leaders in the Senate are currently working to extend and then systematically phase out the $8,000 first-time homebuyer credit. The credit which was originally destined to expire on November 30th, has helped to boost low-end home sales across the country. Under the proposed extension, buyers closing on their homes prior to April 1st would receive the full $8,000 tax credit. The value of the tax credit would then drop $2,000 each quarter until it expires at the end of next year.

Whether or not this extension gets passed, it will be interesting to see how the housing market acts over the next 6 months. One could argue that even if the credit is extended, it has already used up the majority of its impact. If you think about it, first-time homebuyers who were interested in taking advantage of the credit have most likely done so by now. So the benefits of extending it are probably quite minimal. I’ll be looking out for some deterioration in home sales / prices in the upcoming months. As I’ve stated previously, credits like this one and cash for clunkers boost current demand by pulling future demand forward.

If we get through the next few months without a significant lull in housing activity, it would be a very positive signal that we’re seeing a true recovery; as opposed to a temporary improvement caused by government intervention.

Where do you see the housing market going in 2010?

Art Cashin... The Man, The Myth, The Legend

You’re probably familiar with Arthur Cashin if you watch CNBC regularly. For those unfamiliar, Art is the head of floor operations for UBS and a daily commentator on CNBC. Art is usually on in the morning and provides us with his market insights that are backed by 50 years of experience. Say what you will about other CNBC commentators, but Art Cashin is the real deal. He’s worked through every financial crisis in the post war period and lived to tell about it. He’s also seen bubbles in everything from junk bonds to tech stocks. His words of wisdom are definitely worth paying attention to. Read More…

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