Tuesday, December 15, 2009

Some Important Factors Related To Debt Consolidation

If you wish to lower your debt burden and enjoy a single monthly payment for all your debts at a reasonable interest rate, then debt consolidation might be a helpful choice for you. It is important for you to know how you can reduce your debt with debt consolidation. The steps given below would help you get a better idea about the procedure.

  • Debt consolidation is the method of combining your various debts from your different creditors into one debt, usually to one lender. There are plenty of resources where you can search for a trustworthy debt consolidation company. Locating the right debt consolidation program and company is essential to becoming successful in debt consolidation.
  • Prior to researching consolidation companies, you must have a clear idea of what you’re going to do. You must precisely figure out how much you’re obliged to pay your creditors. Establish a goal of becoming debt free. Don’t make decisions in a hurry. If you have fallen into debt and shift to another location, this does not signify you can make a new beginning and resume borrowing once more. You have to change your spending habits and stress on getting out of debt. Remember you can’t become debt free by acquiring further debt.
  • Know that if you go for consolidation, it might ultimately cost you more. For reducing payments, if you go for a more extended repayment term, the outcome would be paying a higher amount of interest. Once more, having the reduced payment might encourage people to assume that they have more money and they again fall into the vicious debt cycle.
  • Perform some cautious research and look for inspiring anecdotes. You would obviously search for a company that provides debt counseling and the most reasonable terms and rates for debt consolidation.

Debt is not a pleasant thing but sometimes, you cannot avoid debt. Debt consolidation can be the way out for your debt problems. However, choose a company carefully and check their background with the BBB (Better Business Bureau).

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Monday, December 14, 2009

What is a penny stock?

As the name suggest a penny stock that is worth pennies or is quite cheap. The definition varies but any stocks that is very cheap compared to price of solid companies may be considered as a penny stock. That compared to stocks like Microsoft that may worth hundreds of dollars. Since a stock’s price is a reflection of the future earnings of the company then in theory a penny stock is the stock of a company whose earning’s prospect is quite tiny to be respectful.

So what is the fuss you may ask. The penny stocks is composed of two types:

1. The first group of stocks is made up of the stocks of companies that that are going out of business. Think of a company of  camera with reels, a magnetic tape company, or a company that makes floppy disks, etc. These companies may once have been mighty, but their products are now obsolete or their business model have failed and as a result they will certainly go out of business unless they reform or restructure. So any stocks of these companies is throwing money out of the window.

2. The second groups consist of tiny companies that have just started up but do not have the recognition of the bankers. So they are craving for you to give them the chance  that they need. Think of Microsoft or apple in the 70s.However you also know that 90% of small businesses will go out of business in the next 2 years. So it is still quite difficult to spot the company that will make it big.

Now that you have understood what penny stock is you can see that it is quite risky to invest in them but if you are able to spot the one then you can multiply you money by a lot.


Let us look at the factors that makes these stocks risky.

1. These stocks are generally not listed on an exchange. This may be because to list on an exchange a company have to abide to some strict conditions such as financial reporting guidelines, directors have to abide to some rules, etc. If these companies cannot abide to these rules that are there to protect shareholders or other stakeholders, then it is not a good idea to invest in them. Financial statements will enable you to analyse the company’s performance other several years and see if they are worthy of your money. The companies may be run by convicted directors. Companies run by convicted companies will not be allowed to list on exchanges and if they are not listed on exchanges they will not provide reports and as a result you will not know about the directors. As you can see there are a lot of risks.

2.If you have bought these stocks then someone out there may be thanking all the gods of the earth. You do not get an idiot everyday to buy a stocks that no one want. This is because penny stocks are illiquid that is they are difficult to sell. There are a lot of sellers but a few buyers. The only way people can sell their penny stocks is only if someone is foolish enough to buy it.

3. These stocks are easily manipulated by fraudsters. Since they are illiquid and hard to sell, some people buy them cheaply and then make a hype about the stock so that unsuspecting buyers will but them at a higher price.

As you can see it is quite risky to buy these types of stocks. Although you would make it big if you can buy in the next apple or the next Microsoft it is more likely that you will lose your money. So just like I advise investors to avoid derivatives, I would advise them to avoid penny stocks. Invest in healthy companies. Also if a listed companies is delisted or is about to delisted get out immediately.

Good luck to you all in your investing.

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Thursday, November 26, 2009

Strategies of the successful investor part 3:Do not follow the herd

If there is one thing that I have learned during this 2008-2009 recession is that following the herd is pointless and a waste of time. Hence while everyone was selling in the stock market and buying in the money market, I have been buying stocks on the cheap. the same thing goes for the bond market.

The reason for this is an old instinct from when humans were still like animals, the crowd effect or the herd effect. This instinct meant that when you see a whole bunch of people running in a certain direction, then it must mean that they are running away from a danger and as a result you must run with them.

So how does this translate in the investing world? If you see a lot of investors buying or selling a particular stocks then it must mean that they are right and as a result you must buy that stock too. The second reason is that as people buy that particular stock its value increases and the gain or return on investment increases. As the gain increases those that have not yet bought the stock would be pressured to buy the stock either by the investors that they work for or by their employers. This is a vicious cycle that few could resist.

Guest what I have done it and you can do it also.  How so you would ask.

First of all the only way you could make money on such bull market is to buy it first when it is cheap and then selling to the herd followers when has risen to a high enough value. I would say that this is difficult to do. If you have seen it the surely a lot of people would have seen it. However if you have been able to see it early and get on the bandwagon just wait until it is high enough and wait for some time and sell it so someone else. Do not wait for the top of the ride because when people realised it is all bullsh_t then they would be selling and you would not be able to get your money back.

Apart from such herd following tactics I have my own way of buying stocks. Research is important and as a result you must educate yourself in economics and some basic accounting. Certainly you can watch TV or read newspapers but only to get information on the economy and on spotting trends in the economy that you can exploit by investing in companies that are in that sector.

When you have learned some basic knowledge you can use that knowledge to research companies. You would analyse their financial statements, their future probability and the market they are in. For example you could see that KodaK and their future in the photo reel market is a dead end as they are entering the digital photography market fast enough.

If you want to go into mutual funds, index funds and Exchange traded fund then you could use your knowledge to research the different companies that are offering them. You would make research on historical return, management, commissions and fees and so on.

Very often you would come across the internet websites that promises to teach you how to invest and as a result you would obtain great return. Most of the time you would have to buy a report or a document that promises to give you tips on how to invest and as a result you will make great return. Most of these are false promises and a complete waste of money. Imagine if you have discovered a stocks that promises great return, would you make it public? Certainly not! you would secretly buy it little by little so as not to arouse suspicion. You would keep it a secret and earn the return alone. That is why you should keep to your plan and not buy all the crap documents that are being sold on the internet.

Sure I read on the internet but only information websites like the BBC, Yahoo money or famous economics like Paul Krugman. These website will give analysis on the economy as a whole and will give you indications on what the economy is going to do.

The last advise that i would give is to make your own research and follow your investment plan. Never never follow the crowd. Stick to your investment plan and to you asset allocation and you would stay on tract to meet your objectives.

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Tuesday, November 24, 2009

strategies of the successful investor part 2 :Time is your best friend

As I have written in an earlier post, time is the best friend of the investor. As we have seen in the first post you will have to draw up a plan. this plan will contain information about for objectives, risk tolerance, risk tolerance and asset allocation.

However the time that you have will impact on these four aspects on you investment life.

I am going to take the examples of a person saving for sending his child to university and for retirement and talk about how the time aspect would affect the achievement of these objectives.  

Suppose that a person who is 20 years old want to retire at the age of 60 years old and also to save money for a child who has just been born. Such a person has 40 years to grow his portfolio for his retirement and 20 to send his child to university. Such a person has time on side.

This person can afford to be risk averse and conservative and invest in a greater amount of safe assets. This person can also invest a smaller amount  of money every month because he has the advantage of compounding. Compounding will ensure that his money will grow with time even with small monthly investment. Such a person would be able to achieve his objectives with no problems.

On the other hand if a person is 35 years old and want to retire at 60 years old and want to send his child to university in 10 years then this person will not have time on his side. This person will have to invest more aggressively and cannot afford to be risk averse and must choose assets with greater riskiness but with greater return. Such a person will not also have the advantage of compounding and as a result will have to invest more every month. This person may have no choice but to delay retirement or the time set to attain the objectives.

The lesson that we can learn today is that if you have time on your side then you are a lucky guy. But if you do not have time on your side then it would be harder.

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Strategies of the successful investor Part 1: Set up a plan

This is the first part of a series of post which would be about the strategies of the successful investor. As we have previously discussed the only way to be secured financially is through investing. However there are some very important things the the beginner investor must keep in mind so that his portfolio will grow with time.

A plan is the cornerstone of your investing journey. The plan is simply a document that would guide you and make sure that you do not get off-track.

It contains firstly your objectives.Each person may have different objectives and to state them clearly and the time available is crucial to your plan. You may want to retire in 35 years or to send your child to college.

After having written your objectives you would thus try to determine the amount of money that would be required to achieve these objectives.

After having identified your objectives and the money that would be needed, you would then be able to identify the return that would be required to reach that amount of money. Your portfolio will thus have to have a certain annual return so that you will be able to reach that objectives. If you cannot reach that return then you would be unable to achieve your objectives.

However the return is also related to another term and that is your risk tolerance. This is related to the different component of your portfolio and the return of your portfolio. You have to understand that some investment instruments are risky in that you can lose your money especially if the company go bankrupt but if you can hold on to it and the company stays afloat you would have greater return. The higher the riskiness and the greater the return. Some people have a low tolerance and as a result would want safe assets. However safe assets would result in low return. Hence if you want higher return you would have to invest in riskier assets.

After having chosen the return that you want and the risk that you are prepared to tolerate you would thus be able to choose the investment instruments that you need to invest in to achieve the return that you want. 

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What is a money market?

The money market is one of the markets that companies and government used to raise funds. What is special about the money market is that securities with a maturity of less that one year are traded in it.

In general all of the money market are debt instruments issued government, banks and companies. These instrument are very liquid and quite safe. As a result because of this safety they have a relatively low return. You would understand that generally instruments that are quite risky have higher yield and vice versa.

The following are the different money market instruments that you can invest in:

  1. Treasury bills
  2. Banker’s acceptance 
  3. Negotiable certificate of deposits
  4. repos and reverse repos
  5. Commercial papers
  6. Eurodollars

However compared to the stock market whereby individual investors can buy individual stocks, money market instruments are issued in high denominations and as a result it is quite difficult for individual investors to but them. The only way for investors to invest in them is through mutual funds and exchange traded funds. However if you have a lot of money you can buy treasury bills from the reserve bank offices.

These money market instruments are like instruments in the bond market in that they are not traded in a stock exchange like shares but are traded over the counter.

There are various reasons for an investor, a bank or an institution to buy securities in the money market and they are as follows:

  1. The securities in the money market are very secure and as a result investors that have some money for a short period that they cannot lose prefer to invest in the money market and get a small return until they need the money. They can when needed sell the securities easily to get their money back since money market securities are highly liquid.
  2. Some banks are obliged by law to hold a certain amount of money market securities to use as collateral in repo transaction with the central bank. These banks must also have assets that they can easily convert to cash in case money is needed to satisfy liabilities. Since these money market securities are highly liquid they are easily sold in the secondary market.
  3. Some type of financial market institutions like short term insurer need by law to hold a certain amount of highly liquid money market instrument so that they can   meet their liabilities.
  4. Some investors are risk averse and as a result they have a low risk tolerance. These investors prefer to forgo the high return associated with stocks and prefer to hold safe money market securities that however have low return.
  5. Investors and financial institutions that have excess cash, for example after selling stocks and bonds that are falling in value or are about to default and are waiting to invest in other securities, can invest in money market securities and have a small return instead of holding cash with no return.

There are also many other reasons for investing in the money market and as time go by I would increase and refine the list above. So if any of the reasons is appropriate to you then go ahead.

However keep in mind that in the long run investing in the money market is not advised as the return is low. However there is a type of investing strategies called the permanent portfolio that relies on investing in the money market. I would write on it in another post.

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Thursday, August 6, 2009

How to borrow from prosper?

I must say that ever since Grameen started giving small loans to people, no other organisation has been able to replicate that except may be prosper.

What is prosper?

Proper is an organisation that link those that have money to those that needs money. In a way it is a financial intermediary but with one difference. It is not like one of those greedy banks that give loans at high interest rates and give small interest to savers. It gives the person with money control over who receives his money and at what interest rate. It also allows borrowers with good credit rating, but who have not been getting loans from banks recently, to get some decent loans at reasonable interest rate.

How to borrow from prosper?

In order to borrow from prosper i must be clear from the beginning that not everyone that are not receiving loans from the traditional banks will get it from prosper. If no body is giving you a loans it may be because you have not been paying your loans properly in the past and have a low credit rating. Prosper lends to people with credit rating 520 and above. If you have a lower credit rating you might want to improve it until you are above 520. I will write about credit rating and improving it in future post. If you qualify for prosper read on.Step 2. Complete a loan application.

You will start by filling out a form at prosper.com. You will give all your details and prosper will use these details to check your credit rating. Based on your credit rating prosper will classify you from AA - the best through E and HR (high risk). If you have a rating below 520 your application will be rejected.

Once you have been approved and registered you can now apply for loans. You will fill a form telling lenders how much you want, at what interest rate you are prepared to borrow and what you will do with the money. It is appropriate not to lie and to tell. Since many people lend after having read the application, the better your story the better your chance of getting the loan. Remember that depending on your credit rating, the interest rate at which people are prepared to lend to you will vary. So follow the table provided by prosper. If you deviate too far from the suggested rate, lenders will not lend to you.

Once you have filled your loan application, it will be listed. People will bid on portions of the loans. This is better because if you default then the loss will be shared by many lenders. This s called diversification. After 10 days if the loans have been fully funded then your loan will be approved. The interest rate will be the average of the interest rate that the lenders are offering.

After the loan has been approved the money will be credited to your account and prosper will charge a fee ranging from 1% to 2% of the loan.

After the loan has been granted you will have to pay every month the same amount for three years. If you default then it means that the last company that was prepared to lend to you is closed to you now. So be careful. Be on time.

If you have any experience to share with us or a question leave a comment below.

Stay away from credit card?
The snow ball. A better way of reducing your debt.
How to live within your means
Good debt or bad debt. Can you make the difference?
Invest or debt reduction
Credit card debt - The investors worst nightmare
What is debt consolidation?
How to consolidate a debt??

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Monday, August 3, 2009

How to calculate compound interest on an investment

This calculator will enable you to calculate the compound interest on an investment. This is applicable if you invest a sum of money but do not remove the interest for use. As a result you will earn interest on the interest that was earned in previous years.

This is in contrast to simple interest that you earn when you remove the interest for spending and do not allow interest to accrue on it.

Please click on "click to edit" and then enter your information.

I hope that this calculator has helped you. If you have any question or idea about any calculator leave a comment.

What is compounding?
How to calculate the interest in your loan
Fixed and variable interest.
How to calculate simple interest on an investment

Simple and compound interest

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Tuesday, July 28, 2009

How to calculate simple interest on an investment or a loan

This calculator will enable you to determine simple interest on a principal and the amount that will be left after a certain time. This is applicable in case you remove the interest for spending.

For example if you have a fixed deposit and every year you remove the interest and spend it.

Please click on "click to edit" and then enter your information.

How to calculate the interest in your loan
Fixed and variable interest.

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Thursday, July 16, 2009

The different types of mutual funds

This is the second part of a series on mutual funds . Like i said on the previous post, mutual funds are the investor's best friend. Especially if you want the easy approach to investing. However mutual funds come in a range of flavour ranging from the safe and conservative one to the risky and high yield ones. As a result in order to understand what type is better for you, you will need to understand the concept of risk and risk tolerance. That is how much risk can you accept in you investment.

The simple rule goes like this. The riskier the mutual fund the higher the risk and the more conservative and safe it is the lower the return.

What are the types of mutual funds?

1. Equity Funds

Equity funds invest only in equities. However you may have funds that invest across the board or you may have funds that are more specialised. Some funds invest in all different types of companies and of all sizes and as a result offer some diversification. However some mutual funds invest in special sector of the economy such as green, gold or technology. Others might invest only in large, medium or small caps companies. While these funds may offer some potential for growth it is unwise to invest all your money in a fund that invest in one sector or one type of company only. If you are really interested i would suggest investing only a small amount like 5 % of your money.

I would strongly suggest investing in a fund that offer some diversification in different sectors and in different company sizes. If you are really interested invest a small part of your money in a fund like gold, green , etc that has some growth potential.

2.Bond Funds

as I have mentionned in the post on deversification and in the post on bonds, bonds offer some advantage to the investor. Bonds can bring some stability to your portfolio and bring regular income in opposition to stocks which may not give regular payment as dividends payment depend on management. A bond fund would thus invest in bonds and since bonds pays biannual coupon payment the bond will give you regular payment.

A bond fund is thus the ideal investment for a retiree for example who would have had to invest in bonds so as to be able to generate regular income. Otherwise he would have had to design a bond ladder which may be beyond the normal investor's capacity.

Like equity some mutual funds invest accross the board in a wide range of bonds of various maturity, risk and issuers. This afford some diversification and risk reduction.

However there are also a lot of mutual funds that invest in a lot of different types of bonds. some would invest only in corporate bonds, muni bonds, government bonds, junk bonds, etc. These bonds may offer some great returns but because they are specialised there is greater risk. I would advise you to invest only in a general bond fund or to invest only a small amount of money in a special fund that you like. However remember that the most fund you invest in, you increase the fees and commissions that you have to pay annually.

3. Money Market Funds

The money market is the market that deals in the trading of short term securities. That is securitie that mature in one year or less such as treasury bills, cds, etc. As you might guess such securities would offer the lowest yield but are the most secure and safe. There is no chance that you can lose your money with a money-market mutual fund. If you have some money that you cannot afford to lose but you want to earn something with it until you need it then the money-market fund is ideal for you. It gives more earning than the CDs or savings accounts.

4. Balanced Funds

The balanced mutual fund can be said to be a mixture of the equity and bond mutual fund. It provide the advantage of long term growth and gain from stocks and the possibility of regular income with bonds. I would therefore strongly reccomend this type of fund for the average investor since it provide the advantages of both stocks and bonds.

Or you could buy in one general bond fund and one general equity fund.

5. Index Funds

The index is simply an index fund that is trying to emulate another index. For example an index fund can have the same shares of all the companies in the Dow Jones. The fund will thus rise and fall in value with the Dow Jones. You can read a post here on index fund.

This is also a good way to invest. Since stocks grow in the long term an index fund will grow in value with time.

6. Speciality funds

These mutual funds invest in stocks or investment instruments of a particular kind. You might have an african stock mutual fund, a chinese stock mutual fund, a gold stock mutual fund, a chinese companies corporate mutual fund, etc. The list is long. I would however strongly discourage investing in those funds as you lack diversity and they are generally riskier. If you really have to invest, invest only a small part of you money.

If you would like to share your experience with us or to ask a question, leave a comment below.

Introduction to diversification
What is an index fund?
What is a mutual fund?

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What is a mutual fund?

I think that one of the average investors' best friend is the mutual fund. So What is it and why is it that good for you?

The mutual fund is a group of investors who pool together their money and with the help of a manager buy a collection of stocks, bonds and other investment instruments. Each investors will then own a share of the collection of investment instruments.

So how do you go about investing in mutual funds? You will how to find a company that manages a mutual fund. You will then buy invest your money in the company and you will be given share in the mutual funds.

For examples if you invest $ 100 dollars in a mutual funds that has a total of $ 1000 invested. It means that you own 10 % of the mutual fund and as a result you will have a right to 10 % of the profit after expenses has been paid.

So how does the mutual fund obtain its profit?

The mutual fund get its profit in three ways:

1. The dividend on stocks, coupon payment on bonds and profit on other investments.

2. The mutual fund can sell investment that has been bought at a cheaper rate and that would result in a capital gain.

This profit is then used to pay expenses and after that the remaining profit is distributed among the members.

Another way you can get money is to buy shares from the mutual fund and then when the mutual fund's value increases you can sell the shares for a profit.

Advantages of mutual funds

Investing in a mutual funds has a lot of advantages.

1. Experience manager

The fund will be managed by a seasoned investor with a lot of experience. Most likely if you are investing in a mutual fund it means that you are inexperienced or you do not have enough time to manage your portfolio. Hence the mutual fund is good for you, the manager will invest your money for you and you just have to sit back and watch you money grow.

2. Diversification

You would remember my post on diversification. It is important that you do not invest in stocks or bonds from one company only. Investing in mutual funds will ensure that you are sufficiently diversified because the mutual fund will buy all sorts of stocks, bonds, and other instruments. Hence by investing in a mutual funds it is as if you own shares, bonds and other instruments in those companies. Hence if one company go under it would have limited effect on the mutual fund.

3. Lower cost

Because mutual funds buy investment instruments for a lot of people the cost of buying these instruments decreases considerably. If for example one person was to buy some shares by himself he would pay lets say $ 4. However if the mutual fund was to buy the shares it would also pay the same fee. It would thus mean that the cost to buy these shares will be distributed among the members of the mutual fund. This cost advantages is a definite advantage if you want to invest small amount of money and you do not want to lose a lot of your money in fees and commissions. Read this article for more details.

3. Money back easily

You would remember from bonds or stocks that it is not easy to get your money back. In the case of bonds you will have to wait for the maturity, trade it in the secondary market at a loss or pay a premium up front that will allow you to redeem you bonds before maturity. For stocks on selling the stocks you will have to pay a fee and if you have a portfolio for each type of stocks sold you will pay a fee. However for the mutual fund you just have to contact the mutual fund and you get your money back. It is as easy to get in or get out.

Disadvantages of Mutual Funds:

1. "Experienced manager"

As you can see we have the same advantage and disadvantage. Why is that? That is because a professional investor is not necessarily a good mutual fund manager. On the one hand when he is an investor he is managing his own money on the other hand when he is a mutual fund manager he is managing your money and he is paid whether there is a profit or a loss as he is only an employee. In this case it is better to invest in a mutual fund where the manager has his own money invested in the fund. It could also happens that the manager may be running a scam as the Bernie Madoff scandal showed. So shop around. I would suggest that if you want to diversify have two three different mutual fund with different companies. You could have a stock fund, a bond fund and a money market fund with three different companies. If one goes under you will not lose everything.

2. Higher Cost

Again it might mean that i am contradicting an advantage but there some mutual funds that have a lot of cost so that it would have been better if you have managed you money yourself. First of all a mutual fund is a business who has to have a profit. The mutual fund need to pay fees and commissions when buying and selling securities, postage and other administrative fees, rent, wages of employees and manager, advertising fees , etc. In some mutual funds these fees may be considerable and as a result can really reduce your earnings. So be careful when choosing your mutual fund.

3. Overdiversification

Since the mutual fund will buy into a lot of companies and a lot of bonds it may happen that you are overdiversified. If you invest in a limited number of securities it is easy to spot one that is a drag on your profit and remove it. However in a large basket of securities it is more difficult to do so and you will have some good investment that will hide some bad investment. Furthermore you may invest in a lot of companies in the same category which is not a good strategy.

So as you can see the mutual fund can be a good investment but it may have some disadvantages if you are not careful.

Please read the next post on the different types of mutual funds.

If you have some questions or want to share your experience with us, please leave a comment.

Introduction to diversification
What is an index fund?
What are the different types of mutual funds?

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Wednesday, July 8, 2009

What are the different type of bonds?

The last few days I have been writing on bonds. I wrote on what a bond is and what are the differences in yield and risk associated with bonds that are issued by various entities.

There are different types of bonds. You would remember from my first post that a bond

(i) is issued at a price that may or may not be different from the face or par value,
(ii) pays coupons or interests at different times of the year,
(iii) has a maturity date and
(iv) at maturity the issuers will pay you your principal back.

However not all bonds are the same. Some bonds would have one or more of the characteristics change to either the advantage of the issuer or the bond holder. If the advantage is to the issuer the bond will be cheaper,have a higher yield or heavily discounted. If the advantage is to the bond holder the bond will be more expensive to buy, have a lower yield or issued at a premium.

Here are the different types of bonds that i know.

1. Fixed rate bond also called straight bond or plain bond.
This would be the most common type of bonds. This bond will be issued and will mature after a period of time. It will pay coupon or interest twice a year at a given rate that would remain fixed until the bond matures. The principal or the face value will be paid upon maturity along with one last coupon.

2. Zero-coupon or Accrual bond

This type of bonds would pay no coupon or interest. It would be issued at a big discount and at maturity you would get back your principal. If the bond has a par or face value of $ 100 it might be issued at $ 60. And at maturity you would be paid the sum of $ 100.

This is not good for the investor since if the issuer default you would lose everything especially if the bond has a long maturity. So better avoid this one.

This is a type of bond that makes no coupon payments but instead is issued at a considerable discount to par value. For example, let's say a zero-coupon bond with a $1,000 par value and 10 years to maturity is trading at $600; you'd be paying $600 today for a bond that will be worth $1,000 in 10 years.

3. Perpetual bond

A perpetual bond is a bond that has no maturity date. It will continue to make coupon payments from the time it is issued for ever. However there is a trick in it. It is also a callable bond. See below for what a callable bond is. It means that after a period of 5 years or depending on the stipulations of the bond the issuer can recall it at any time and give you back your principal.

However if it is not callable, then it would be similar to stocks with the exception that you will not have voting rights. However you coupon rate will be fixed compared to shareholders who are not certain to receive dividends

This is a nice bond to invest into since you have the possibility to get coupon payments for a long time. However this type of bond is rarely issued and personally I would discourage this type of bonds since it give some uncertainty in your portfolio. It is better to just invest in a long term bond or medium term bond if that is your wish.

4. Inflation-indexed bond
This is a bond that is protected against inflation. It is going to have a coupon rate that is a few percentage point above the official interest rate. This will ensure that you do not lose money in high inflationary times when the rate of inflation will be higher that the coupon rate of normal bond.

5. Convertible bond

A convertible bond is one that will give you the right to convert it into a certain number of shares of the issuing company. You would however remember from above that stocks and bonds each has its own advantages so think well before converting your bonds.

6. Reverse convertible

This bond is the reverse of the convertible bond in that it gives the issuer the right to convert the bond to cash or stocks of a company. As you may have guess this is not good for you since it gives the company more rights than you.

7. Callable bond

A callable bond gives the issuer the right to call the bonds before maturity and pay the bond holder his principal.
This is not advisable for a bond holder, because if you have locked in a high coupon rate, you would not want the company to call it back and then be forced to buy a bond with a lower coupon rate.

8. Puttable bond

A puttable bond gives the bondholder the right to sell the bond back to the issuer before the maturity date. This is advisable if you are buying bonds at a low coupon rate and you are anticipating a rise in bond coupon rate.

* Inverse floaters pay a variable coupon rate that changes in direction opposite to that of short-term interest rates. An inverse floater subtracts the benchmark from a set coupon rate. For example, an inverse floater that uses LIBOR as the underlying benchmark might pay a coupon rate of a certain percentage, say 6%, minus LIBOR.

9. Exchangeable bond

Such a bond is similar to the convertible bond except that it gives the bondholder the rights to convert the bond into stocks of a particular company at a particular time in the future and in certain condition.

10. Floating rate bond

A floating rate bond is one whose coupon rate will vary with a certain index such as the rate on the 6 month treasury bill. So if you think that the 6 month treasury bill rate is going to rise you can buy a floating rate bond and linked it to the index.

11. Inverse floating rate bond

This bond will have a coupon rate that will be as in the floating rate bond above except that the coupon rate will be a number minus the index. For example you might want the coupon rate to be (10 - yield on a treasury bill )%. Hence if you are anticipating the rate on the treasury bill to fall you can buy an inverse floating rate bond linked to it.

One last piece of information. These bond flavors are not without effort. For those that comes at an advantage to the bondholder a fee must be paid with the cost price. For those that come at an advantage to the issuer a discount or an increase yield is needed.

If you have any questions or you think that i have missed one please leave a comment below.

What is a bond?
Stocks have higher return than bonds
Introduction to diversification
What is a bond ladder?
The importance of the bond issuer?

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Tuesday, July 7, 2009

What is the exchange-traded fund?

It seems that these days everybody wants to invest. The question that has to be asked is what instruments you are going to buy and why.

Because investing is a risky venture, I have often advised investors to go into mutual funds in the past. Another way is to go through the exchange-traded fund.

An exchange-traded fund is similar to a mutual fund except that it is traded in the stock exchange. Just as the mutual funds has many advantages over buying individual stocks, bonds and other investment instruments, the exchange-traded fund offer additional advantages that might interest the average investor.

You would remember that the mutual fund will buy a large portfolio of investment instruments. The net value of the mutual fund will be the market value of the all the stocks, bonds,etc of the portfolio of the fund. Thus the value of the mutual fund will increase if the value of the shares,bonds, etc increases and vice versa. However there is a problem with this. The market value of the a mutual fund portfolio is not an indication of good return. A mutual fund portfolio can be expensive but can have meager return while one that is quite cheap can have a good return.

This problem can be reduced by investing in exchange-traded fund.

What is the exchange-traded fund?

The exchange-traded fund is a mutual fund that trades on the stock exchange.Think of an exchange-traded fund as a mutual fund that trades like a stock. The company will buy a portfolio of shares and then will "go public". The company will issue stocks and these will be sold to the public. These shares of the exchange traded fund will then be traded on the stock market.

Hence the value of the exchange-traded fund will not be the total value of the portfolio like a mutual fund or the index fund. It will be the market capitalisation of all the value of the shares of the exchange-traded fund.

This is different in the fact that the value of the shares can fluctuate even if portfolio do not fluctuate. This will happen if the portfolio has a reduced learning potential. Hence the value of a mutual fund can remain constant in value while an exchange-traded fund composed of the same shares can fall in value.

So what are the advantages of investing in an exchange-traded fund?

1. Diversification

Since the exchange-traded fund invests in a wide range of stocks, then by buying the stock of an exchange-traded fund you already have the advantage of diversification. However the problem here is that if the exchange-traded fund goes down like in a sort of Madoff-like manager running away with the money, then you lose all your savings. Hence it is unwise to invest all your money in a single exchange-traded fund.

2. Advantages of a stock

Since the exchange-traded fund is traded in a stock market the everything that you can do with a stock you can do it with the exchange-traded fund. You will buy it like a stock using a stock broker and pay.fees and commissions, You can also call it, put it, etc. I would however discourage such exotic and risky style of investing.

3. Lower cost

The exchange-traded fund is usually cheaper to invest in compared to the mutual fund. That is because you need to pay only the broker commission when you buy it. Hence if you are using an online or discount broker

4. Diversity in a single stock

This might seem the same as the first one but it is a little bit different. Imagine that you have a portfolio of 15 stocks diversified in different sectors of the economy. In the traditional way of investing it is impossible to buy a lot of stocks in the same category. Imagine if you buy five stocks in each sector and you have 10 sectors of the economy then you have 50 different companies to monitor. This will be a huge task for the average investor. Also if you buy one or two in one sector and one of the companies go bankrupt then your exposure in that sector will disapppear.

The solution will be exchange-traded funds. Each exchange traded fund will specialised in one sector. For example you can have one in telecommunication that will be a basket of telco companies. If one of the companies in that sector go bankrupt then your stock will not be affected. Hence by investing in exchange-traded funds that are sector specialist instead of single stock in a sector you reduce your chance of losing your exposure to that sector.

5. Passive investment

Most exchange traded funds are passive investment

hence your return will be greater compared to a mutual fund that is actively managed. A normal mutual fund will have a lot of fees and commissions to pay as a result the profits will be less.

As you can see if you were thinking of investing then a mutual fund is good for you. Whether it is an exchange-traded fund, an index fund or a simple mutual fund the decision is yours. If you have any question leave a comment and me and my readers will try to give you an answer.

Introduction to diversification
What is an index fund?
What is a mutual fund?
The different types of mutual funds

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Friday, July 3, 2009

The importance of the bond issuer?

In one of my previous post i introduced the bond. You would remember that a bond is a security which is similar to an IOU. You are the lender and the entity is the borrower.

However, not all bonds are equal and some are more risky than others. Please read this post on risk and risk tolerance to familiarise yourself with the concept. Because bonds may sometime be long term investments, you need to be sure that the issuer will be solvent and has not gone bankrupt before you can get back your principal.

We are going to see below the different type of bond issuers and see which one is risky and which one is safe. But remember that the riskier the bond the greater the return. So if you are lucky and the bond issuer has not defaulted on you, it would mean that you are going to get a lot of interest or coupon payment along the way and your principal at the end.

Bond rating

Each bond has a rating associated that is provided by rating agencies. These agencies analyse the government and the company and give a rating which is simply their ability to remain solvent until the bond reach maturity. Hence a company/government with a good rating has a small chance of going into default while a poor rating means that the company/government has a good chance of going into default. The following table are the ratings that two main rating agencies associate with bonds and examples of companies.

Bond Rating Grade Risk
Moody's S&P/ Fitch
Aaa AAA Investment Highest Quality
Aa AA Investment High Quality
A A Investment Strong
Baa BBB Investment Medium Grade
Ba, B BB, B Junk Speculative
Caa/Ca/C CCC/CC/C Junk Highly Speculative
C D Junk In Default

Investment grade - Major developing countries, multinational, profit making companies,etc
Junk - Loss making companies, third world countries, etc

Generally as the bond moves from the highest investment grade to the bond grade rating, the interest rate increases. This is because the company/government issuing the bond has a greater chance of going into default and as a result you must be compensated for the risk that you are taking.

1. Government Bonds

These bonds are issued by government to finance budget deficit. This takes place when government has less tax than the money they want to spend. Generally governments obtain money by raising taxes and as a result the possibility that a government will default on its bonds is low. However with countries like Zimbabwe the possibility of default is quite high. However for most developed countries bonds are quite safe. As a result of this the interest rate on government bonds is quite low with practically no risk premium.

Even though the yield is low, it is generally advised to invest at least 10 % of your money in government bonds to minimise the risk of losing all your money in a stock market crash.

2. Municipal bonds

These bonds are the second safest behind government bonds because towns and cities can also raise taxes. However they have a lesser number of tax payers and as a result the have a higher chance of going into default. It may happen on the long run that the population of a town decreases and make the servicing of its bonds difficult. A more recent example is the towns in Michigan that are having lower population because of the demise of the car industry. Hence because the bond is a little bit more risky, the yield on it is higher. It is therefore advisable to have some municipal bonds in your portfolio. May be in the form of muni index fund.

3.Corporate bonds

The corporate bond is the most risky of all bond. The bond is the second way that a company can raise fund. One is to issue stock and the other is to issue bonds. You can read about the difference between bonds and stocks here. The reason why corporate bonds are the riskiest is because companies goes bankrupt every year. They cannot raise taxes like municipalities or governments.
As a result corporate bonds offer the highest yield. However in order to minimise risk, you need to diversify your corporate bond portfolio. Read here on diversification. Better still, if you are unable to diversify a bond portfolio by yourself invest in a corporate bond index fund.

Do you have any question on bonds or want to share your experience? Leave a comment below.

What is a bond?
Stocks have higher return than bonds
Introduction to diversification
What is a bond ladder?

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Wednesday, July 1, 2009

How to buy and sell stocks using a broker?

In my two previous post here and here I wrote about what a broker is and how to go about to have a brokerage account.

If you have a full-service broker chances are that you will not need to know these information as the broker will do every thing for you. However it is wise to learn so that you can become more knowledgeable about investing.

If you are have a discount broker then you need to tell him what you want him to do. To be able to do this properly you need to know certain terms so that he will do what you want. You will then communicate this to him by phone or by any previously agreed means in your agreement or brokerage contract.

Here is how things goes. On the market there are people who want to sell stocks and other securities and those who want to buy.

Let say that three people want to sell stock of company x at the following prices. These are the sell prices or the ask prices.

Person A $50
Person B $51
Person C $52

Now three people want to buy the same stock at the following prices. These are the bid prices.

Person D $48
Person E $47
Person F $46

Note that those that are selling are always offering a higher price than those who are buying. The difference between the two is called the ask-bid spread.

In our example the ask-bid spread is $2. This information means that the buyer will have to raise his bid price by two dollars to be able to buy his security or the seller has to lower his ask price by two dollars to be able to sell his security.

What is important is that the person who is ask the lowest price will be given priority and his stocks will be sold first. The same is for those who want to buy stocks, the person who bid the highest will be given stocks in priority.

However if there is a deadlock and that no stock is changing hands, the the seller can suggest the highest bidding price and his stocks will be sold. Using the example above if person A decreases his ask price to $48 then his stocks will be sold to person D. The opposite is also true. Person D can increase his bid price to $ 5o dollars as a result he will be able to get the stocks that person A is selling.

Now what orders are you going to give the broker?

1. Market Order: The broker will buy the stocks at the best available price. In this case if you are person D you will be giving the broker the instruction to buy shares at $50. This order will be executed immediately.

Limit Order: This will be for the broker to buy only when stocks are available at a given price or to sell only when there are buyers that are prepare to buy stocks at the price that you want.

Stop Order: This would mean that you are giving your instruction to stop buying once stocks are exceeding a level and are being too expensive to buy. This is called a stop-limit. You can also give a broker an instruction to sell your stocks once the value of the stock fall below a certain level. This may be because the stock has been bought at a higher price and that the lower it falls the more loss you are going to make on it. That is why such an order is called a stop-loss.

All or None (AON): This means only to buy stocks if all your order can be fulfilled. Sometime if you want to buy 500 stocks of company x at $50 and that there is a seller of 400 stocks at $50, normally the broker will buy the 400 stocks for you. In the All or none the order will be executed only if there is a seller of 500 stocks.

Day Order: This order will be only for the day. That is because some order can continue until the condition for the order is satisfied.

Good Till Canceled (GTC): This order will remain valid unless it is executed by the broker or cancel by the person.

Fill-Or-Kill: If this order is not executed immediately then it is to be canceled.

This now end the three part series on the broker and the service that they offer.

Do you have any question or you want to talk about you experience on using a broker? Leave a comment below.

How to start investing with a small amount of money?
Fees and commissions and how they affect your portfolio.
How to choose a broker?
What is a stock?
Stocks have higher return than bonds
How to be rich buying stocks!!
Should i sell my stock and hold cash?
Introduction to diversification
How and when dividends are paid?
what is a stock exchange?
How to choose a broker - part 2?

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How to choose a broker - part 2?

In the first post that you can read here, I talked about the different types of broker and what type of broker would be appropriate for your situation.

Today I will tell you about how to go about creating a brokerage account.

At this point you have analyzed your situation according to the first post and have decided whether you want a discount broker or a full service broker. You have most probably chosen a broker according to the factors mentioned in part one.

How to set up the account?

When setting a new brokerage account it is important to follow the following steps.

1. The broker should understand clearly what your objectives are. You may simply want him to execute your orders as you will do all the thinking or research. However you may want him to do more than that. You may have some long term objectives such as retirement, your children studies, etc. These objectives should be clear to him as he will devise an investment plan for you that will enable you to attain these objectives.

2. The broker should understand what is the level of risk that you can bear. That is your risk tolerance. Read this post to understand and determine your risk tolerance. The broker should know this so that he can recommend the type of securities that fit the level of risk that you can bear.

3. The broker should know your complete financial situation.He should know your income so that he and you can determine the amount of money that you can invest monthly so that you can reach your objectives. However this may help him determine whether investing is appropriate for you. Remember if you have any debt, investing may be inappropriate for you. Read this post on the subject.

4. The power of the broker. If you are unable to make proper assessment of securities, then it is appropriate to let the broker assess the securities and then take the decisions for you. But this right should be in written form, and any decision should be such that it goes toward reaching your goals. A decision by the broker should never be such that it is against your interest or towards reaching your aim.

5. Every time you buy and a security it must be in the prescribed form that is recommended in the contract. If the contract states that orders to be in writing then only written orders will be accepted to buy or sell securities. Also every time a securities is bought or sold you must have written confirmation of it.

If trading is done electronically then you will not have a certificate but simply a notice. If trading is not electronically then the broker can send you the certificate or keep it at the brokerage firm if that is in your contract or agreement.

6. Make sure that everything that we have talked above is in writing and that you have a copy of the contract. You should keep a copy of this for future reference. Everything that the broker can do should be according to this contract.

Now that you have a broker learn how to buy stocks here.

Do you have any questions on choosing a broker? Do you want to share your experience with us?Please leave a comment.

How to start investing with a small amount of money?
Fees and commissions and how they affect your portfolio.
What is a stock?
How to be rich buying stocks!!
How and when dividends are paid?
what is a stock exchange?

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Monday, June 29, 2009

What is an amortisation schedule?

Following my two post on the consolidation of debts here and here, I felt the need to talk about the amortisation schedule.

The amortisation schedule is a document that you obtain from your lender. It will give you important information on the payment of your loans. It is similar to the one below. This amortisation schedule is one to repay a debt that has a high interest rate. If you want you can generate your own here or choose any other here.

An amortisation schedule must contain the following information.

1. The principal. That is the amount that has been lent to you and that you need to pay back.

2. The The monthly payment. This is the amount of money that you will pay monthly. This will consist of the the interest payment and the the principal payment.

2. The interest rate on the loan. This will determine the the monthly interest payment, the monthly principal payment and hence your total monthly payment. If you want to learn how to calculate the interest in your loan read this post.

3. The monthly interest payment. This is the interest that you need to paid every month. Most loans use the diminishing balance method. This means that as you pay the loan, the principal on which the monthly interest payment will be calculated will decrease, hence the monthly interest payment will decrease.

4. The principal payment. This is the payment that you do monthly that would result in the reduction of the principal. As you can see initially the principal payment is small. It then increase gradually as the interest decreases.

5. The number of repayments and hence the time that it would take to pay back the loans at the given interest rate and monthly payment. This can change depending on the changes in interest rate or monthly payment.

As I have said in the post ondebt consolidation, knowing how to read an amortisation table have the following advantages:

1.You are able to compare two loans and determine which one is better for you in term of lower interest payment.

2. You are able to tweak your loan and determine what is better for you in term of payment time and monthly payment.

3. You are able to analyse how payment of several different debts is compared to payment of a single monthly sum of money. This way you will find out if debt consolidation is better for you.

I hope that this post have been of help to you. If you have any questions or comment please leave them below.

The snow ball. A better way of reducing your debt.
How to calculate the interest in your loan
How to live within your means
Good debt or bad debt. Can you make the difference?
Credit card debt - The investors worst nightmare

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Saturday, June 27, 2009

How to consolidate a debt?

Earlier I write on a post about what debt consolidation is. You can read about it here. You can also go to this nice web site to learn about debt consolidation.

So how do you go about consolidating your debt?

1. Separate bad debt from good debt. Read here about what debt is necessary and what is not. You can read about that here. To make things simple, debts such as home loans are considered good debts and are generally long term debts that have lower interest rate. These debts will not be a problem for you.

However those credit card debts, consumer loans,student loans or loans that you have taken to to buy the latest trendy items are considered bad debts. They are generally have high interest rate and are the ones that will give you the most difficulty.

2. Take all your bad debts and make a summary of them. It will be easier if you have the amortisation schedule for all your bad debts. The amortisation schedule is a document that you can obtain form your lenders. Determine the capital and the interest that you are paying every month and the total capital and interest that you will pay until you have paid all the debts. You will also need to find how long it will take you to finish paying those debts. Calculate the total monthly payments that you have to make every months.

For examples: Lets say that you owe $ 25000 from various lenders and that you will pay it all in 5 years. In all you will pay $ 10000 in interest. You also find out that you pay a total of $ 500 of which 300 is capital and 200 is interest. ( Ok I make this example out, the maths may not be correct)

I am assuming at this stage that you are not going to take on additional debt.

3. I am assuming at this point that you have make a budget and that you have tried out to pay your debts by yourself but have not been able to do so. But it is good at this point to determine what is the maximum amount that you can pay every month.

4. Now is the time to get your loan consolidated. You will have to shop around for the best loan. The company would consolidate all your debt and as a result you would now have only a single debt with a single monthly payment. This debt is a secured one since it will be backed by an asset that you have such as your house, as a result it would have a lower interest rate. The process is simple. The company will either act as an intermediary between you and the lenders or will just buy the debts and as a result you will now be their debtor.

5. Norma
lly when you consolidate your debt you will pay it back in less time than if you would have paid all your debts individually. You will also pay less interest on the debt.

A piece of last warning though, if you are too deep in trouble, consolidating your debts may not make any difference. Especially if you have a lot of debts. So be careful.

Did you have your debts consolidated? Was it easy or difficult? Please share your experience with us so that you can help others. Thank you.

Stay away from credit card?
The snow ball. A better way of reducing your debt.
How to live within your means
Good debt or bad debt. Can you make the difference?
Credit card debt - The investors worst nightmare
What is debt consolidation?

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Thursday, June 25, 2009

What is debt consolidation?

In those difficult times, a lot of people are finding it difficult to pay back their debts. Probably you have a lot of debts and are finding it difficult to meet those monthly installments. And as you miss those monthly payments, you are having penalties and increases in interest rate. These increase in interest rate and penalties will drain precious dollars and make it more difficult to pay other debts.

Now there are tow types of debts that you need to take into consideration.

1. Secured loans

These loans are backed by an asset such as a house or a piece of land. It may even be backed by a valuable asset. The asset that is backing the loan is called a collateral. Such loans normally have low interest rate as their is little risk that the lender lose his money because if you fail to pay the monthly installment he would seize your house or collateral and sell it to get his money back.

2. Unsecured loans

These loans are not backed by any assets. Hence their is a greater chance that the lender would lose his money. Such loans are thus riskier and have higher interest rate. Personal loans, credit card loans, student loans, car loans, etc are examples of unsecured loans. These types of loans can have the interest on them increase rapidly if you miss one payments. The interest payment will quickly get out of control.

What can you do?

As I have written already on this blog you can start by doing a few things.

1. Stop taking new credit cards. Credit card debt is very bad for the average investor and for everyone in general. Read here and here.

2. Distinguish between good and bad debt by reading this post.

3. Make a budget and slowly try to live within your means. Read this post.

4. Reduce your debt by reading this post on the snow ball method.

If these methods do not work, then you can try debt consolidation.

Debt consolidation

Debt consolidation is a simple process whereby you are going to take all you unsecured and high interest loan and converting them into a single secured and low interest loan. This single loan will be backed by a fixed asset like a house and as a result the loan will be a low interest rate. This is because if you failed to pay this loan the the company can sell your house and get its money back. Hence you are going to pay a single monthly payment. Because the interest rate on this loan is lower you will pay lower interest and as a result you will finish paying the loan faster than if you were paying the different loans separately.

Please read the next part on this topic here.

Have you had a debt consolidation? Were you satisfied with it? Please share your experience with us.

Stay away from credit card?
The snow ball. A better way of reducing your debt.
How to live within your means
Good debt or bad debt. Can you make the difference?
How to consolidate a debt?

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Monday, June 22, 2009

What is a bond ladder?

A bond ladder is an investing strategy that try to maximize and create a regular revenue stream with bonds. Read my post on bonds here. As you know bonds are debt instruments that pay a coupon or interest on a regular basis in fact twice a year if you are buying the regular one. This is particularly important for people who are retired or who depend on a regular income from their investment.

The bond ladder has another advantages. It is like dollar-cost averaging. As you will be buying bonds on a regular basis you will avoid buying at times of too low interest rate. Imagine buying all your bonds in a recession. You will be locking low returns on your fortune for a long time to come.

A bond ladder has the following characteristics:

1. Bonds with different maturity period. This would mean that the different bonds would mature at different times and that in case you have an emergency you would have access to funds. For example you might have bonds that have a maturity period ranging from one year to twenty years. The key is to have a bond that matures in the next year so that you are able to be able to redeem your capital and use it in case you have an emergency or buy another one to replace the recently matured bond.

2. Bonds that matured at different months of the year. The key here is to have bonds that mature at different months of the year and as a result pay coupons or interests at different months of the year. If you are a retired person, then you would have regular income.

How to build a bond ladder?

Now suppose you have 1 million dollars in you retirement account and you want to build a bond ladder. The ladder will have the following characteristics.

1. The number of rungs. This would be the number of lots that you want to divide your $1million. If you divide the money into ten lots then you will have will have 10 rungs. If you divide the money into more lots then you will increase the number of different types of bonds that you can invest in. See this post on diversification. However the more lots you have, the more would be your cost when you will have to reinvest a matured bonds. The less you divide your money into lots, this would decrease your reinvestment cost. However this would increase the chance of losing a large percentage of your portfolio in case one of the bond issuer default on your bond.

2. The length of the ladder. This would be the longest maturity length that you want one of your bond to have. You might want to have your bonds to have twenty years maximum maturity. The longer the length of the ladder the more return you will have because remember you will have to be compensated for the increased uncertainty. However keep in mind that twenty years is a long time and it increases the chance that you will lose your capital because of default. But keep in mind that too short a maturity will means that you will have to do will low return. That is also not good.The conservative investor might choose twenty years while the aggressive investor might choose twenty years.

3. The length between the rung. You have the chance to make the time between two bonds attaining maturity long or short. If it is too short then it means you are dividing your money into too many lots or have only short term bond maturity. Either way it is not good. The best way is to have the time between maturing bonds of about 1 year. Hence if you have emergency you would be able to survive on the coupon payments until you are able to redeem the materials.

4. The bond ladder should be composed various types of bonds ranging from government, state, municipal and corporate bonds. This is to avoid placing all your money in a single type of bonds. Please read here and here on the importance of diversification.
However, I would strongly discourage against anyone having only a bond ladder. This investment will need to be supplemented with other types of securities to meet true diversification even though you have a bond ladder that is well diversified. You never know what could happen.

Do you have a bond ladder? Please share your experience with us or ask a question by leaving a comment.

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Saturday, June 20, 2009

How to choose a broker?

The broker is the second most important person in your investing life. The first one is you of course. So what is the broker? He can be described as an intermediate between you and the market. You will use him to buy the different instruments on the market. Even though you can buy some instruments on your own, it is time consuming and you might not have access to a wide range of investment instruments as you would if you have a broker. so for all practical purpose i will advise anyone to invest through a broker.

What are the different type of brokers?

There are mainly three types of brokers:

1. Full-service broker

A full-service brokerage as the name suggest will provide all the services that one can need. The broker will provide you with a wide range of securities, they would provide recommendations and advices on the securities that you can buy. The broker can also tailor-make a portfolio for you that is appropriate for your situation. This type of broker is ideal for if you are new to investing because it will reduce the risk that you can commit a costly mistake. This type of broker is generally costly but it is worthwhile for you until you are able to invest on your own. You will pay the broker a fee for advices and a commission as a percentage of transactions.

2. Discount broker
The discount broker will give you access to investments instruments but will not give you advices or give you information, He will only take your instruction on what to buy and what to sell. Your instructions will be through fax, email or telephone. You will have to use your own experience, researches and knowledge on what instruments to buy and to sell. Normally an investor will start with a full-service broker and the later on move to a discount broker. This type of broker is usually advised for experienced investors. This type of broker take a small commission and as a result is better for those that want to increase return.

However if you want to be a couch potato investor and invest in bond fund, index funds, etc it is better to use a discount broker.

3. Online broker
The advent of the internet has come blurred the distinction between the two types of brokers. Now both traditional discount broker and full-service broker are offering online services to cater for the investors that want do things for themselves and who want to have access to real-time information. However it is increasingly common for discount broker to offer online research reducing further the difference between an online broker and a full-service broker. The online broker is the cheapest of all and as a result it is advisable for someone who can manage his investment by himself and who need access to the latest information.

Factors in choosing a broker

1. Make sure that the broker is a registered broker. It must have a good reputation. You can do this by talking around with friends, colleagues and making your own research. The broker must also have a good reputation in the financial world. Only after this has been done that you can go forward. I choose the brokerage arm of my bank.

2. Your financial goals, If you have goals such as retiring, sending your children to school, etc then it is better to choose someone that can give you advice. He will advise you on the portfolio composition, what instruments to buy and sell and what investment strategies to adopt. Then a full-service broker is advised.

3. Your risk tolerance. If you have a low risk tolerance then you will be scared to make mistakes and lose your investment. Then a discount broker is not for you. It would be better if someone else do all the work and take the important decisions for you. Read this post on risk and risk tolerance.

4. The fees and commissions charged by the broker. Remember on the long run fees and commissions reduce your return, so it is important to choose a broker that offer the lowest rate. Discount broker generally offer the smallest rate.
Read this post on fees and commissions on your portfolio.

The brokerage account:

There are two types of brokerage account

1.The cash account

The cash account is like a regular account. You deposit money in it. when you give the broker an instruction to buy a security, the broker will use the money in the account. You can buy securities worth not more than the amount of money in the account. Note also that the dividends that you receive from companies will be deposited in the account.

2. The margin account

The margin account is like a credit account that the brokerage give you to buy securities. When you buy a security you will have to pay the money back with interest. This type of brokerage account is recommended only for the experienced investor. Those involved in option trading or similar risky transactions. I would strongly advised the average investor to invest using a cash brokerage account.

3. Option account

This type of account is for those who want to trade in options. Remember that option trading is very risky. Please read this article to understand risk. I would recommend this type of trading for the experienced investors only.

Please read the second part of this post here.

How to start investing with a small amount of money?
Fees and commissions and how they affect your portfolio.
What is a stock?
How to be rich buying stocks!!
what is a stock exchange?
What is market capitalisation?

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