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?

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.
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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.

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?

Risk and return

One of the most important concept in investing is the concept of risk and return. The lower the risk the lower the potential for the return and conversely the higher the risk the greater the potential of return. In order to be a successful investor you should be able to assess what is your risk tolerance and what is the level of risk in your portfolio. Finally you should be able to decide what is the level of risk that goes with your risk tolerance.

Riskiness of investment

Investments can classified in term of risk. Some investments are quite safe and as a result the possibility if losing your capital is low. Others are riskier because the possibility of losing your capital increases and as a result the person in need of the capital will have to compensate you for taking the risk and hence you will obtain the higher return. Probably the person that raised the capital is doing an activity that has a chance of failing.

The table below shows the different investment instruments in term of the risk associated with them.

As you see, the different instruments can be classified in three different categories depending on the level of risk associated with them and the potential for return.

Group one investment instruments are relatively safe and as a result there is little possibility of losing your capital. Even though on rare occasions relatively safe companies and banks can go bankrupt and make you lose the money in your bank account or the capital of your bonds.

Group two investment instruments are moderately safe and as such give average return. Their is always the possibility of a company going bust or than a town or a state will default on payment. For example if you hed stocks in Leyman Brothers your share will have no value as of now. Also states like California may default on payment of bonds in the future if the deadlock on budget expenditure is not resolved.

Group three investment instruments are highly risky and speculative. There is a great possibility that you will make great return or great losses. You can have bonds from Iceland for example that are highly speculative and you can lose your capital if you invest in these but if the country can hold until the bond reaches maturity, the interest earned will be high and you will get your capital back.


Risk Tolerance

Before jumping in with your hard-earned money and starting to buy investment instruments you need to determine your risk tolerance. The risk tolerance is simply how much risky investment you can hold in your portfolio and you are comfortable with. After you have determined your risk tolerance you will then be able to determine the type of investment instruments you will be able to buy.


Three factors will affect your risk tolerance.

Time

When you invest, you will need to determine your goals. And the time left to attain these goals. If the time left is long then you can afford to take more risk because should you suffer a loss you will have time to recover the loss. You will invest heavily in stocks, company bonds, real estates, etc. You will be an aggressive investor.

However if the time left is short, then you would want to invest in safe instruments. You will not want to risk losing in your money. May be your son will go to university next year, or you will retire in the next ten years. These people will probably shift out of shares and company stocks and invest in safe instruments such as CDs, government bonds and debentures, blue chip stocks or bonds. You will be a conservative investor.

Acceptance of loss


Some people even though they know that they have a long term investment plan, they are not satisfied to the idea that in the short term their investments can decrease in value but keep on increasing in value over the long run. These people will thus choose to be conservative investors. They will contend themselves with measely and mediocre return.

If you want to know how to allocate your portfolio read this post.

You will probably want to read this post on diversification.

Credit card debt - The investor's worst nightmare

A few days ago I wrote a post on whether it is possible to invest and to have debt at the same time. I wrote that someone who is on a credit card debt should preferably pay back the debt first.
You can read the post here.

So I have decided to make a few calculations in order to convince you of the above. Suppose that two persons spend $3000 on a credit card. Bob decides to pay it back by monthly payments of $ 100. while Tom decides to pay it back by monthly payments of $75. Suppose the credit card company charged at an interest rate of 20 % per year.

Below is table on how the two of the paid the balance on the credit card.



So what are the information that we can deduce from the table.

For just 25 dollars more per month Bob reduces the time needed to pay the debt by two years and also reduces his interest payment by half compared to Tom.

What is more shocking is the fact the return of the credit card company is roughly 60 % for Tom and that falls to roughly 30 % for Bob.


In order for any investment to pay off with such interest rate payments you would need to have return on your portfolio that is greater than 20 %. I must say that unless you are a very good investor that is not possible for the average person. Unless you invest in a credit card company.


Having a credit card is a definite drag on the investor. If you are unlucky enough to have a credit card balance. try to pay it in the shortest possible time because as i said it in my earlier post the earlier you start investing the better, and you cannot invest with a credit card balance. It is as simple as that.

Please read my post on how to reduce debt and how to live within your means.

Active trading - The key to beating the market

As everyone who has been reading this blog know I am a fan of buy and hold. You can read about arguments for buy and hold here. However some people argue that they are able to beat the market. This type of investment strategy is called active-trading.

I must be clear here that active trading is not for the novice. In order to invest using active trading you need to have a lot of experience and knowledge in the working of the stock market, So if you are new to investing for now you must stick to buy and hold and at the very most trading once in a while.

What Is Active Trading?

As you know over the long run the market go up even if from time to time in recession it goes down, However the trend is always up. Even if the market can go down in the short run, it will always recover and go up. You can see why some people prefer buy and hold. You invest and because you are sure that in the long run it will go up you just wait and watch your portfolio increase in value.

However some people cannot wait for years and they try to take advantage of the short term fluctuations of the stock market. I must say that to predict what the market will do in the short run is quite difficult but not impossible. For example a trader might feel that the price of oil will go up and as a result hedge it, or another one might feel that the shares of a company will fall in vale and short sell it. The strategies that the active trader uses are numerous. However i must say that whatever the active trader do he is increasing the probability of a gain but he also raises the probability of a loss.


So can anyone become an active trader?

I must say no. You need expensive computers and softwares to start. You also need some knowledge in the analysis of data so that you can make sense of the information available. You need to identify trends in data and identify peaks and bottom in the trends so that you know when to buy and when to sell. You need to have considerable knowledge of the factors that can influence the price of a stock and how they influence the price on a daily basis and predict the price of that stock in the short term.

Furthermore active traders used borrowed money in order to increase profit. For example someone who is sure that the price of a stock will double in the next week, might borrow money in order to maximise his gain. Many active traders have made a fortune doing this. But keep in mind that money borrowed must also be returned and if your bet is proved wrong then you might have to sell everything that you own to pay back the money.

Furthermore frequent trading, means that you have to pay commissions and capital gains tax. When taking the taxes and commissions into consideration the return that you have to make above the normal buy and hold return is considerable.


To summarize i would say that active trading is risky, difficult to do in the long run and not for the average guy. I would say that even if you have some experience, active trading is reserved for a select fews that are very good. So guys I would recommend that, as a beginner, you just keep to the buy and hold, index funds or government bonds.

Here are some post that can help you on index funds and on bonds and stocks.

Invest or debt reduction?

One of the questions that i hear most often from people that have debt is whether they should invest. Is it not better to pay the debt first and the start investing?

I beg to differ. I think that,while debt reduction is important, you should also invest. Of course it would have been simpler if you had no debt, but hey do you know a lot of people who are debt free?. The key to resolve this issue is a good investment plan and a monthly budget. First you would have to analyze your debt structure so as to determine your investment strategy.


Types of Debt

1. High-interest debt

If the debts have high interest on it then the return on the investment must be more than the interest that you will pay. It is as simple as that. If you have high interest debts like credit card loans then it is better if you pay the loans fast unless you can have a high yielding portfolio. It is very hard for the average investor to build such a portfolio and risky.

2. Low-interest debt

These debts are only a few percentage above the rate of inflation or the repurchase rate. It is still difficult to invest with these types of debts but it is possible to build a portfolio that can have a return of about 10 % to cover the interest of the debts.

3. Tax deductible debts

This the best debt that you can have. You can usually claim a deduction for the interest paid on these loans. As a result you pay only the capital. With such types of debt you can invest in peace as you do not have to build a risky and high yielding portfolio.


So is it not better to pay all debts and then start investing later? That would be a mistake since a lot of debts are long-term debts. As a result you would never start investing. Further investing require discipline, sticking to a budget and to have a plan. I am certain that with a plan and a budget you will spend your money wisely and pay your debts faster or even avoid taking unnecessary debt.

Just like paying debt take time, investing also take time. In fact the earlier you start investing the better your return. I talked about this in this post about compounding. Compounding is simple.

By sticking to your investment plan you can invest small amounts monthly in stocks, bonds or even better in mutual funds and index funds. Investing is a great way to still discipline your spending and help you to live with better debts.

Please read this post about living within your means and how to reduce your debt.
You can also read this post on investing small amount of money.