MONEY investing strategy

Most Americans Fail This Simple 3-Question Financial Quiz. Can You Pass It?

piggy bank with question marks on it
Peter Dazeley—Getty Images

These questions stump most Americans with college degrees.

Following are three questions. If you’ve been around the financial block a few times, you’ll probably find all of them easy to answer. Most Americans didn’t get them right, though, reflecting poor financial literacy. That’s a shame — because, unsurprisingly, the more you know about financial matters and money management, the better you can do at saving and investing, and the more comfortable your retirement will probably be.

Here are the questions — see if you know the answers.

  1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After five years, how much do you think you would have in the account if you left the money to grow? (A) More than $102. (B) Exactly $102. (C) Less than $102.
  2. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After one year, how much would you be able to buy with the money in this account? (A) More than today. (B) Exactly the same. (C) Less than today.
  3. Please tell me whether this statement is true or false: Buying a single company’s stock usually provides a safer return than a stock mutual fund.

Did you get them all right? In case you’re not sure, the answers are, respectively, A, C, and False.

Surprising numbers

The questions originated about a decade ago, with Wharton business school professor and executive director of the Pension Research Council Olivia Mitchell, and George Washington School of Business professor and academic director of the Global Financial Literacy Excellence Center Annamaria Lusardi. In a quest to learn more about wealth inequality, they’ve been asking Americans and others these questions for years, while studying how the results correlate with factors such as retirement savings. The questions are designed to shed light on whether various populations “have the fundamental knowledge of finance needed to function as effective economic decision makers.”

They first surveyed Americans aged 50 and older and found that only half of them answered the first two questions correctly. Only a third got all three right. As they asked the same questions of the broader American population and people outside the U.S., too, the results were generally similar: “[W]e found widespread financial illiteracy even in relatively rich countries with well-developed financial markets such as Germany, the Netherlands, Switzerland, Sweden, Japan, Italy, France, Australia and New Zealand. Performance was markedly worse in Russia and Romania.”

If you think that better-educated folks would do well on the quiz, you’d be wrong. They do better, but even among Americans with college degrees, the majority (55.7%) didn’t get all three questions right (versus 81% for those with high school degrees). What Mitchell and Lusardi found was that those most likely to do well on the quiz were those who are affluent. They attribute a full third of America’s wealth inequality to “the financial-knowledge gap separating the well-to-do and the less so.”

This is consistent with other research, such as that of University of Massachusetts graduate student Joosuk Sebastian Chae, whose research has found that those with higher-than-average wealth accumulation exhibit advanced financial literacy levels.

The importance of financial literacy

This is all important stuff, because those who don’t understand basic financial concepts, such as how money grows, how inflation affects us, and how diversification can reduce risk, are likely to make suboptimal financial decisions throughout their lives, ending up with poorer results as they approach and enter retirement. Consider the inflation issue, for example: If you don’t appreciate how inflation shrinks the value of money over time, you might be thinking that your expected income stream in retirement, from Social Security and/or a pension, will be enough to live on. Factoring in inflation, though, you might understand that your expected $30,000 per year could have the purchasing power of only $14,000 in 25 years.

Mitchell and Lusardi note that financial knowledge is correlated with better results: “Our analysis of financial knowledge and investor performance showed that more knowledgeable individuals invest in more sophisticated assets, suggesting that they can expect to earn higher returns on their retirement savings accounts.” Thus, better financial literacy can help people avoid credit card debt, take advantage of refinancing opportunities, optimize Social Security benefits, avoid predatory lenders, avoid financial scams and those pushing poor investments, and plan and save for retirement.

Even if you got all three questions correct, you can probably improve your financial condition and ultimate performance by continuing to learn. Many of the most successful investors are known to be voracious readers, eager to keep learning even more.

MONEY Warren Buffett

Warren Buffett Just Predicted the Next 50 Years for Berkshire Hathaway

Warren Buffett
Lacy O'Toole—NBCU Photo Bank via Getty Images

While the days of Berkshire's amazing 20% average annual returns are likely a thing of the past, Buffett expects Berkshire to outperform the market.

Berkshire Hathaway is one of the most fascinating stories in the history of investing. In the 50 years Warren Buffett and his management team have been running things, a struggling textile company has transformed into one of the largest corporations in the world, with dozens of household-name subsidiary companies and an equally impressive stock portfolio. In the process, early investors have gotten very rich, with the per-share book value rising from $19 to $146,186 during the past half-century.

In Buffett’s most recent letter to shareholders, he discussed his thoughts on Berkshire’s next 50 years. Here’s what Berkshire investors can expect — straight from the pen of the Oracle of Omaha:

Berkshire will not be a good short-term trade, ever

Buffett said that the chance of permanent capital loss with Berkshire is the lowest among any single-company investment. But he added a caveat: If the company’s valuation is high, say approaching two times book value (it’s at about 1.5 times book value now, so not too far off), it could be years before investors realize a profit.

In other words, Berkshire has never been, and will never be, a good “traders’ stock.” The company has one of the most shareholder-friendly business models in the world, but it is geared exclusively toward long-term investors. As a result, Buffett recommends that investors should look elsewhere for investment options if they plan to hold their shares for less than five years.

Berkshire can survive the “thousand-year flood”

Not only will Berkshire be prepared to withstand any economic storm, but the company is positioned to capitalize when things go bad. The company maintains a huge earnings stream, a great deal of liquid assets, and virtually no short-term cash requirements.

This combination keeps Berkshire immune to virtually any adverse market conditions. This is illustrated by the company’s performance during the financial crisis of 2008-09, when Berkshire not only survived, but took advantage of “discounts” in companies like Goldman Sachs.

Berkshire will maintain rather large stockpiles of cash (at least $20 billion at all times, according to Buffett) in order to weather any storm and capitalize on developing opportunities. As Buffett said, “if you can’t predict what tomorrow will bring, you must be prepared for whatever it does.”

Earnings power will continue to grow

Perhaps Buffett’s boldest prediction is that Berkshire can build its per-share earning power every year. This might sound like a lofty expectation, considering he’s talking about a five-decade period. However, it could be achievable.

Now, this prediction doesn’t mean earnings will increase every year. It does, however, mean that each and every year, Berkshire will create the potential to earn more than it did the year before. Actual earnings gains (and declines) will depend on the U.S. economy, but the company will keep moving forward no matter what the economy is doing.

Past performance will not be duplicated

Many casual observers were put off by the following line from the letter: “Berkshire’s long-term gains … cannot be dramatic and will not come close to those of the past 50 years.”

However, this really shouldn’t be much of a surprise. There is only a finite amount of money and investment opportunities in the world, and as companies grow, it gets tougher and tougher to maintain a high growth rate. For example, Apple has increased in value by more than 100-fold since 2004. Would it be reasonable to expect the same over the next decade? Of course not! That would make Apple a roughly $70 trillion company.

The same principle applies to Berkshire. Repeating its performance of the past 50 years would produce a book value per share of roughly $1.2 billion, along with a market capitalization of more than $900 trillion, which would be completely impossible in the absence of extreme inflation.

But the right people are in place to deliver for shareholders

While his time at the helm might be nearing its end, Buffett reassured investors that over the next 50 years, no company will be as shareholder-oriented as Berkshire. Buffett is completely confident the company will have the right CEO, management team, and investment specialists in place, as well as safeguards to protect shareholders in the event that the wrong person is put in charge.

As Buffett stated in a past letter to shareholders: when the market soars, Berkshire may underperform; when the market is down, Berkshire will outperform; and over any full economic cycle, Berkshire will outperform the markets. While the days of Berkshire’s amazing 20% average annual returns are likely a thing of the past, the company’s winning philosophy and business model remain the same, and will deliver for shareholders for decades to come.

MONEY financial advice

What Every Investor Should Know About Schwab’s “Free” New Advice Service

Charles Schwab logo on window
Paul Sakuma—AP

Robo-Chuck Has Landed! Do you want this free new online service to design your portfolio?

A new group of financial websites has been making investment advice cheaper and cheaper. Now the brokerage and mutual funds giant Charles Schwab is getting into the game, with a new online service called Intelligent Portfolios that can design a portfolio for you without charging any fee at all. You’ll need only $5,000 to open an account. But, as you might well have guessed, there’s an asterisk on that “free” price tag.

We’ll get to the asterisk in a moment. First, here’s why Schwab’s entry into online advice is such a big deal.

Every financial firm in America is fighting to offer investment advice to the middle-class, especially about what to do with their IRAs and rollovers from 401(k) retirement accounts. But the cost of getting a financial pro to sit down and help you design a personalized portfolio of stocks, bonds, and funds is often high—think 1% of assets per year or more—and the minimum required investment can be forbiddingly steep.

New web-based companies like Betterment, Wealthfront, and FutureAdvisor have lately been chipping away at this model. They don’t let you talk to a person. Instead, you go to their sites to answer questions about your age, financial position, and how much risk you are willing to take, and computer models generate a portfolio of stock and bond exchange-traded funds (ETFs). These “robo-advisers” often charge investors razor thin fees of 0.2% to 0.5% of assets per year, with low (or no) minimum investments.

The investment advice robo-advisers give isn’t terribly complicated. But for most people, that’s a good thing. You typically end up in a handful of broadly diversified index funds, which you buy and hold for the long run. This service can be a simple entry point to investing for those who don’t know how or where to get started, and they can automate chores like annual rebalancing and adjusting your mix as you age. And, again, they are cheap.

And yet, Schwab’s new version appears to undercut even the other robo-advisers’ slender fees by charging nothing.

Does that make it a sure winner? Not necessarily. As with all such programs, you have to take a look under the hood.

In addition to whatever investors pay for online financial advice, they also have to pay the fees of the underlying funds. The robo-advisers Schwab will compete with don’t offer their own mutual funds, but instead typically rely on Vanguard and iShares products. Those are very cheap funds that usually charge less than 0.2% of assets per year, so the net cost of investing with an online adviser stays low.

Schwab’s approach looks a little different. While Schwab is offering its investment strategy gratis, the company has said it plans to recommend some of its own funds, as well as third-party funds.

Schwab hasn’t made clear specifically what ETFs it plans to use with Intelligent Portfolios. Schwab spokesman Michael Cianfrocca told MONEY the investment strategies it uses “have nothing to do with generating revenue for the firm.” But a quick glance at the kinds of portfolios it recommends suggests that some of its underlying investment will be relatively costly.

For instance, Schwab appears to make liberal use of “fundamental” index funds. Some investors think this type of index fund, which tends to tilt its weightings toward value-priced stocks, may outperform the market in the long-run. But fundamental index funds are pricier than plain-vanilla stock index funds, which simply hold stocks in proportion to their market value. Schwab’s fundamental large-company stock fund charges investors a fee of 0.32% of invested assets annually compared to just 0.04% for the plain-vanilla index funds the company offers. (A 0.32% fee is still low compared to actively managed funds.)

Schwab also stands to earn money from investors’ cash positions, since they will be held in Schwab cash vehicles, which Schwab makes money on by collecting a spread between what it earns reinvesting the money and what it pays out to Schwab customers. In one scenario, for an investor in his or her 40s with a moderate risk appetite, the Schwab product recommended putting nearly 9% of the money into cash. The Schwab spokesman said that was typical for other types of accounts housed at Schwab. But it’s far more cash than some other investment managers recommend. To take one example: The Vanguard target-date fund designed for a similarly-aged investor would put less than 1% in cash.

In the long run, Schwab’s new product may prove a convenient tool for some investors. But don’t assume you’re getting something for nothing.

MONEY Investing

Two Charts That Show This Bull Market Is Truly Historic

Bull statue on Wall Street
Murat Taner—Getty Images

The bull market is six-years old, and it's looking like a truly historic run.

If you hear music in the air, particularly from the direction of the financial district, that’s because the six-year anniversary of our current bull market has arrived.

According to the S&P, this particular run has lasted 2,191 days, the fifth longest since 1921, only surpassed by a 3,452 day stretch from October, 1990 through March, 2000; a 2959 day period from August 1921 to September, 1929; a 2067 day stretch from June, 1949 to August, 1956; and 2248 day run between October, 1974 and November, 1980.

But while today’s bull market might rank fifth overall, it’s even more impressive when compared to similar economic recoveries. The six-year rally following the financial crisis is topped by only by the recovery following World War II (2,607 days) and the 1919 deflation (2,959 days).

Screenshot 2015-03-09 10.31.01

And when it comes to price gains during the first six-years of a recovery, the current market is second to none. Between March 9, 2009 and March 9, 2015, the S&P 500 has increased by 202%. The only other market run that comes close is the postwar expansion, where the S&P returned 192% in the same time period.

The bad news? Valuations now look high.

Screenshot 2015-03-09 13.42.36

As of February, the Shiller price-to-earnings ratio, which measures the S&P 500’s price against the average of the past 10 years of earnings, was nearly 28. That’s almost twice as high as the P/E six years into the “Great Bull” market of the 1980s and 1990s. That’s lead many commentators to speculate about whether the market is overvalued and due for a correction.

Of course, the Shiller P/E climbed above 40 by end of the Great Bull in 2000—so it’s not much of a guide to when the market will turn. But even if you aren’t trying to time the market, high valuations do suggest that future long-term returns may be comparatively muted. After all, a high P/E means each dollar you spend on stocks is now buying a smaller pile of earnings.

All data from MONEY’s Investor’s Guide 2015 by Penelope Wang with Kara Brandeisky.

MONEY stocks

3 Simple Equations All Investors Should Know

hand doing math equations on chalkboard
Getty Images

You might be wasting money on high fees in your 401(k) or chasing the wrong stocks. This easy math will bring you back down to earth.

Whether you love to buy and sell stocks or barely understand what’s going on in your retirement account, there’s a good chance you could benefit from learning more about the math behind the stock market.

Here are three fundamental equations that the savviest investors know. Relatively easy to understand, they will help you choose the right stocks and funds and, most important, keep your expectations about future returns grounded in reality.

Equation 1

S&P 500 dividend yield + about 4.5% = the expected long-term return on stocks

This formula, known as the Gordon equation, assumes stocks get their ultimate value from being able to one day return earnings to investors. (That’s true whether or not a company currently pays a dividend or reinvests in the business.) Anything above or below that is a result of investor sentiment.

You can look up the current S&P 500 dividend yield, which is about 2% now, at multpl.com; the 4.5% is how much you can expect dividends to grow based on the past. So today the expected long-run return is 6.5%. Adviser and author William Bernstein says thinking about this number brings you down to earth in boom years, and can reassure you when the market is down.

Equation 2

A 1.5% expense ratio = more than 40% of your money after 40 years

Mutual fund and adviser expenses seem so tiny— just 1% or so. But math professor Jordan Ellenberg, author of How Not to Be Wrong, says that over many years “expenses add up—or, more mathematically precisely, they multiply up.”

Put $100,000 into a fund with a 1.5% expense ratio, assume a 6% underlying return, and you’ll get about $560,000 after 40 years. With the same pre-expense return in a very low-cost index fund charging 0.1%, you’d have $990,000. To see for yourself the true long-term costs of a fund you are considering, use the mutual fund fees calculator at Bankrate.com.

Equation 3

Net income / shareholder equity = return on equity

Return on equity is a classic measure of a company’s ability to put shareholders’ money to good use. (Equity is roughly the cash investors put into the business, plus retained earnings.) Calculate a stock’s ROE using the balance sheet and income statement.

Looking for consistent ROE of 15% or more “helps steer you toward profitable companies and away from speculation,” says Robert Zagunis of the Jensen Funds, which screen for stocks with 10 years of high return on equity, like 3M.

Read more investing fundamentals from Money 101:
How do I know if I should buy a stock?
Should I invest in stocks or in a stock mutual fund?
How often should I check on my retirement investments?

Correction: This story has been updated to reflect the current S&P 500 dividend yield.

MONEY Investing

The Low-Risk, High-Reward Way to Buy Your First Investment Property

150306_REA_INVESTPROPERTY
Fuse—Getty Images

These four questions will help you be a more successful real estate investor.

When I first read Brandon Turner’s article, “How to ‘Hack’ Your Housing and Get Paid to Live for Free,” it was like a light switch flipped in my head. That was the first article that truly made sense to me as a wannabe investor. It seemed so clear, so right, so obvious that everyone’s first real estate investment should be in a small multi-family property.

I immediately set out to implement this strategy — to buy a property, to move into it, rent out the accompanying units, and to start living for free. Unfortunately, I quickly ran into a little problem: I had set myself up to attempt to meet four seemingly impossible criteria:

  1. The property needed to be affordable with conventional financing.
  2. The property needed to be in a location that I wanted to live in.
  3. The property needed to generate positive cash-flow.
  4. The property needed to offer a reasonable chance at appreciation.

After spending six months looking for an investment property to acquire house-hacking style, I’m not convinced that the truly difficult thing for a first time investor is in getting financing, or even in finding properties that cash-flow sufficiently. The truly difficult problem for me was deciding on where I wanted to make that commitment. Buying a rental property that you intend to live in and actively manage is more than just a financial commitment. You are likely going to live, work, and invest in that area for at least the next few years.

I actually feel that I had plenty of opportunities to purchase duplexes and fourplexes that would have been decent from a cash-flow and appreciation standpoint within 20-50 miles of Denver. Those opportunities seemed almost too easy. The real trick in my opinion is buying those types of properties right downtown. I’m talking inside the city limits.

I’ll admit it, I’m a spoiled, immature 24-year-old, and I refuse to live in an area that isn’t near the heart of my city (Denver, CO). I want to be close to where my 20-something friends live — by Coor’s Field, downtown restaurants and nightlife, convenient to I-70 (the highway that grants easy access to the awesome Rocky Mountains), and, of course, right by my workplace.

In this article, I want to walk through why I believe that all four of those previously mentioned criteria are so important to first time investors and explain some of the basic things that I did to buy a property that I believe meets each of them. I think that this approach is possible for many people who live in urban environments and are willing to be patient and methodical.

Here are four questions that I believe every first time house-hacker should ask themselves, and how I personally answered them.

Question #1: Can I afford the property with conventional financing?

There are two obvious followup questions to the “can I afford this?” question:

  • How much money do I have?
  • How much money does property in the area I want to buy in cost?

If you want to house-hack and still live in a reasonable place in an urban area, you need some cash. Even with great owner-occupier financing terms, you’ll need a substantial amount for the downpayment if you want to live in a somewhat desirable spot near a happening city. I’m not interested in living in Detroit and putting down $500 for that $10,000 home. I want to live and invest in Denver, CO, where a comparable structure might cost 10, 20, or even 50 times more than that.

I spent a full year working hard and living frugally to save up an amount that would comfortably cover a 5% down payment on properties in the area that I wanted to live in. If you don’t like this strategy for gathering funds for your first downpayment (the “save more money” strategy), then I’d suggest that you seriously question whether you want to get into real estate investing in the first place.

Another critical thing to keep in mind is that if you are purchasing a property that needs repairs, minor or major, you will need cash to pay for them. Among other expenses, I’ve shelled out thousands in plumbing and electrical work, appliances, and DIY tools and materials. If you are transitioning from renting to an owning property, then there might be a chance that, like me, you don’t own a robust set of tools and don’t have familiarity with the materials needed to work on even relatively simple projects like painting and drywall repair. By ensuring that I bought the property with a good $10,000 cash cushion, I was able to easily cover all the little repairs and contractor costs that came up, and I now have a pretty solid little toolset that has proved to be much more enjoyable to work with than I previously would have thought.

Related: A New Way to Look at the Concept of “House Hacking”

Question #2: Will I be happy living there?

I think that many of us as investors, new and experienced alike, have to acknowledge that we are investing to improve our financial position and in doing so, to improve our lives. I believe that house-hacking does not work if it means that you have to live in an area that you don’t want to be in! For me to be happy with my living situation, I needed to live in the city. It was not acceptable to purchase property in the boonies and move far away from the places I enjoy going to on a regular basis just to get a good return on my first investment. For me, that meant I had to limit my purchasing area to properties close to the heart of downtown Denver, CO.

Buying property actually downtown (less than 5-10 blocks away from Coor’s Field in my mind) was simply not a reasonable option — the only properties that most newbies can reasonably purchase might be condos, which are not a traditional type of investment from which one can generally expect great rental cash-flow. It’s just too expensive in the true heart of the city, and the only properties that are being purchased there are multi-million dollar homes and swanky apartment complexes. There’s a reason why buildings go straight up in big cities.

Fortunately, Denver has several surrounding neighborhoods with properties at price points affordable to folks making less than $50K per year. These neighborhoods are convenient to downtown with good bike routes and cab/Uber rides that are less than $10 a pop. I ended up picking two areas to search for property. Both areas were roughly equidistant from downtown Denver and my workplace (BiggerPockets HQ happens to be about 5 miles directly Southeast of Lower Downtown Denver).

Question #3: Will the property cash-flow?

Here in Denver, CO, we’ve got a little bit of a tough housing situation. Houses and investment properties are being listed for less than one day and then selling for ten, fifteen, or even $20,000 more than asking price. I’ve heard from some readers that cities with similar characteristics, like Austin, TX, have similarly tough markets for investors.

Luckily, as an owner-occupier looking to buy multifamily property, I had a couple of serious advantages over the competition. First, I was looking at properties that most other would-be homeowners weren’t interested in; first-time buyers usually aren’t looking to purchase a duplex, triplex, or fourplex. Second, I had the opportunity to bid on properties before investors that did not intend to inhabit the property because of a special government program — the First Look program from Fannie Mae.

In my opinion, these two advantages that I had as an owner-occupier house-hacker are the trump cards that gave me an edge in looking for great multi-family deals in an urban environment. After months of searching, my agent suggested a duplex to me. This property was listed on the MLS and was like a lot of other opportunities out there that I had looked at, but with one small difference: this property was part of that “First Look” program.

Because investors couldn’t make offers on the property for several weeks, and because the demand for duplexes, triplexes, and fourplexes among first-time homeowners is very small, I had little competition. I was able to run the deal by my friends, family, mastermind group, and by investor friends I’d met through BiggerPockets. That window gave me the confidence I needed to pull the trigger and make the largest financial commitment of my life to that point — while competing investors never even had a chance to offer.

Question #4: Is there a reasonable chance at appreciation?

If you read around on BiggerPockets, you are going to learn that experienced investors refer to appreciation as the “icing on the cake” — it’s usually not even considered in the purchase of investment property. While it’s still a good idea to look at cash-flow first as an owner-occupier, putting in the extra time to look for investment properties that offer a good chance at appreciation as well can reward you handsomely in the long run.

As a house-hacker, appreciation can produce a more powerful financial impact for you than it can for a traditional investor, because of a special tax-law that benefits owner-occupiers:

Assuming that you live in the property for more than two years, when you sell property, much of the capital gains are tax-free.

This tax break is incredibly powerful for those looking to house-hack with small multifamily properties because we have the opportunity to take advantage of appreciation as it relates to both income properties AND smaller residential properties:

As multi-family properties, increasing the income of the property can force appreciation.

As hybrid properties, duplexes – fourplexes can also benefit from appreciation caused by an improving local market.

I carefully selected properties that I felt offered me the opportunity to get both types of appreciation:

  • Forced Income Appreciation: I chose a property that needed what I considered to be a reasonable amount of cosmetic work and that had multiple opportunities for improvement. Since moving in, I’ve had the entire plumbing system overhauled, I’ve added appliances like washer/dryer units and refrigerators, and I’ve put in substantial cosmetic work, Do-It-Yourself style. These improvements should reduce the operating expenses of the property over the long run and give me an advantage in attracting and retaining tenants, hopefully improving the property’s long-term income potential.
  • Market Appreciation: One of the benefits to purchasing properties in an area that you yourself want to live in is that, generally speaking, other folks want to live there, too. This presents a decent opportunity for appreciation in itself if you have personal reasons for desiring to live in a certain area that are applicable to large demographics. However, I didn’t stop there, as I looked for properties within these neighborhoods that were also in the path of government sponsored infrastructure projects.

In my case, a light-rail project is currently under construction and will offer convenient and low-cost transportation options to my neighborhood. It is my hope that infrastructure projects like this one, coupled with the overall tremendous growth of the Denver local economy, will allow me to benefit from market appreciation, though I understand that having purchased the property, this is now out of my control.

The hope here is that I can leverage both types of appreciation to create substantial value from this property over the next few years. I then hope to cash out on that increase in equity, tax-free, and reinvest it in a larger income producing real estate asset.

Related: BP Podcast 086 – House Hacking Your Way to 97 Units (While Holding a Full Time Job!) with Cory Binsfield

Conclusion

This is my first investment property. There is every possibility that I’ve made a huge mistake somewhere along the line. I could be way off in my estimation of expenses, long-term rents, desirability of the neighborhood, or I might have simply gotten ripped off on the purchase in general. I hope that none of those things are true, and I certainly feel that I did my due diligence at each stage of this investment — but only time will tell if I correctly analyzed each critical input.

Maybe I’m slower than other investors, and maybe I suffered from a great deal of “analysis paralysis.” It took me a long time to pull the trigger and finally make a serious offer on my first investment property. I had been researching my market and defining my criteria for at least 6 months — not to mention the full year that I had been saving up for such a purchase!

That said, I believe that my first investment is by far my most important. A bad choice could cripple me financially, discourage me from investing again, or at the very least, significantly slow me down in accumulating the funds to make a second investment. But, in spite of all the potential negative outcomes, because I did just one thing right, I can sleep well at night:

That one thing was buying in an area that I am happy to live in.

At the end of the day, it doesn’t truly matter whether I’m able to keep my unit rented out, or if the market tanks. Worst case scenario, I get an expensive education in real estate investing and live in a place that is slightly smaller than I could have otherwise afforded.

I’ve got the ultimate exit strategy.

This article originally appeared on BiggerPockets, the real estate investing social network. © 2015 BiggerPockets Inc.

More from BiggerPockets:
I Quit My Day Job, Retired Early & Started a New Venture Using Real Estate: Here’s How
3 Smart Ways to Make an Extra $1,000 a Month Through Real Estate Investing
5 Habits of Highly Miserable Real Estate Investors (and How to Kick Them)

MONEY

Keeping Calm When the Market Goes South

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iStock

A financial adviser shares tips for easing anxiety in a rollercoaster market.

“It’s been too good for too long,” my client said.

She had every right to feel suspicious. With the markets appearing to be at an all-time high, she was justified in having that waiting-for-the-other-shoe-to-drop instinct. I understood her desire to tread cautiously.

The majority of baby boomers are at a crossroad in their lives: They want to retire, they should retire, and it’s time to retire. But they are extremely nervous nowadays about the markets’ record-breaking levels.

Over my many years of experience working with clients in this situation — they’re ready to retire, but they can’t quite pull the trigger — I’ve seen how scary it can be to make that potentially irrevocable decision. What if markets go down? Should they have waited? What if this, what if that?

It is human nature to question ourselves at times like these, but then again, times are always a bit uncertain.

I have found that the most important step in keeping clients calm in a volatile market is to have an investment education meeting regarding their risk level and market volatility at the start of our working relationship and routinely thereafter. Our clients are actively involved in assessing their own risk tolerance and choosing a portfolio objective that suits their long-term goals.

We also want to set the right expectation of our management so our clients know that we never sell out of the market just because things are starting to go bad. Market timing has not proven to be a successful growth strategy, which is why we work with our clients upfront to establish a portfolio and game plan they can live with.

Unfortunately, the inevitable will happen: The markets will go south, and clients will panic. How can financial planners ease clients’ anxiety? Here are a few suggestions:

  • Discuss defensive tactics. Show clients the dollar amounts they have in bonds and other fixed income. Translate that into the number of years’ worth of personal spending that is not in the stock market. Have an honest conversation about if that number will be enough over the long-term.
  • Leave emotion out of it. Talk to them about the danger of selling at the wrong time and illustrate how emotional decisions tend to do more harm than good. Remind them of how quickly markets can turn around after a big drop. It’s been known to happen on more than one occasion, so share your knowledge of these experiences. Let them know that you don’t want them to miss the upside.
  • Look at the positives. Reinvesting dividends and capital gains? Are clients making monthly contributions to a 401(k) or other investment accounts? Remind your clients that when markets are down they are buying at lower prices, which can work well for their strategy over the longer term. A down market also often makes investing easier and less frightening to buy, so that might be the time to purchase any equities they once worried were too expensive.

The markets will always have some level of volatility. As an adviser providing regular guidance and support, you want to do everything you can to help clients not overreact to the daily news, hard as it might be. Urge them to continue to think long-term. It may not always be easy to see, but today’s bad news may just be a client’s big buy opportunity, and they won’t want to miss that!

———-

Marilyn Plum, CFP, is director of portfolio management and co-owner of Ballou Plum Wealth Advisors, a registered investment adviser in Lafayette, Calif. She is also a registered representative with LPL Financial. With over 30 years of experience in the financial advisory business, Plum is well-known for financial planning expertise and client education on wealth preservation, retirement, and portfolio management.

MONEY stocks

10 Smart Ways to Boost Your Investing Results

stacks of coins - each a different color
Alamy

You don't have to be an investing genius to improve your returns. Just follow a few simple steps.

Recent research shows that people who know their way around investing and finance racked up higher annual returns (9.5% vs. 8.2%) than those who don’t. Here are 10 tips that will help make you a savvier investor and better able to achieve your financial goals.

1. Slash investing fees. You can’t control the gains the financial markets deliver. But by sticking to investments like low-cost index funds and ETFs that charge as little as 0.05% a year, you can keep a bigger portion of the returns you earn. And the advantage to doing so can be substantial. Over the course of a career, reducing annual fees by just one percentage point can boost the size of your nest egg more than 25%. Another less commonly cited benefit of lowering investment costs: downsizing fees effectively allows you to save more for retirement without actually putting aside another cent.

2. Beware conflicted advice. Many investors end up in poor-performing investments not because of outright cons and scams but because they fall for a pitch from an adviser who’s really a glorified salesman. The current push by the White House, Department of Labor and Securities and Exchange Commission to hold advisers to a more rigorous standard may do away with some abuses. But the onus is still on you to gauge the competence and trustworthiness of any adviser you deal with. Asking these five questions can help you do that.

3. Gauge your risk tolerance. Before you can invest properly, you’ve got to know your true appetite for risk. Otherwise, you could end up bailing out of investments during market downturns, turning paper losses into real ones. Completing a risk tolerance questionnaire like this one from RealDealRetirement’s Retirement Toolbox can help you assess how much risk you can reasonably handle.

4. Don’t be a “bull market genius.” When the market is doing well and stock prices are surging, it’s understandable if you assume your incredible investing acumen is responsible for those outsize returns. Guess what? It’s not. You’re really just along for the ride. Unfortunately, many investors lose sight of this basic fact, become overconfident, take on too much risk—and then pay dearly when the market inevitably takes a dive. You can avoid such a come-down, and the losses that accompany it, by leavening your investing strategy with a little humility.

5. Focus on asset allocation, not fund picking. Many people think savvy investing consists of trying to identify in advance the investments that will top the performance charts in the coming year. But that’s a fool’s errand. It’s virtually impossible to predict which stocks or funds will outperform year to year, and trying to do so often means you’ll end up chasing hot investments that may be more prone to fizzle than sizzle in the year ahead. The better strategy: create a diversified mix of stock and bond funds that jibes with your risk tolerance and makes sense given the length of time you plan to keep your money invested. That will give you a better shot at getting the long-term returns you need to achieve a secure retirement and reach other goals while maintaining reasonable protection against market downturns.

6. Limit the IRS’s take. You should never let the desire to avoid taxes drive your investing strategy. That policy has led many investors to plow their savings into all sorts of dubious investments ranging from cattle-breeding operations to jojoba-bean plantations. That said, there are reasonable steps you can take to prevent Uncle Sam from claiming too big a share of your investment gains. One is doing as much of your saving as possible in tax-advantaged accounts like traditional and Roth 401(k)s and IRAs. You may also be able to lower the tab on gains from investments held in taxable accounts by investing in stock index funds and tax-managed funds that that generate much of their return in the form of unrealized long-term capital gains, which go untaxed until you sell and then are taxed at generally lower long-term capital gains rates.

7. Go broad, not narrow. In search of bigger gains, many investors tend to look for niches to exploit. Instead of investing in a broad selection of energy or technology firms, they’ll drill down into solar producers, wind power, robotics, or cloud-computing firms. That approach might work, but it can also leave you vulnerable to being in the wrong place at the wrong time—or the right place but the wrong company. Going broader is better for two reasons: it’s less of a guessing game, and the broader you go the lower your investing costs are likely to be. So if you’re buying energy, tech or whatever, buy the entire sector. Better get, go even broader still. By investing in a total U.S. stock market and total U.S. bond market index fund, you’ll own a piece of virtually all publicly traded U.S. companies and a share of the entire investment-grade bond market. Throw in a total international stock index fund and you’ll have foreign exposure as well. In short, you’ll tie your portfolio’s success to that of the broad market, not just a slice of it.

8. Consider the downside. Investors are by and large an optimistic lot, otherwise they wouldn’t put their money where their convictions are. But a little skepticism is good too. So before putting your money into an investment or embarking on a strategy, challenge yourself. Come up with reasons your view might be all wrong. Think about what might happen if you are. Crash-test your investing strategy to see how you’ll do if your investments don’t perform as well as you hope. Better to know the potential downside before it occurs than after.

9. Keep it simple. You can easily get the impression that you’re some kind of slacker if you’re not filling your portfolio with every new fund or ETF that comes out. In fact, you’re better off exercising restraint. By loading up on every Next Big Thing investment the Wall Street marketing machine churns out you run the risk of di-worse-ifying rather than diversifying. All you really need is a portfolio that mirrors the broad U.S. stock and bond markets, and maybe some international exposure. If you want to go for more investing gusto, you can consider some inflation protection, say, a real estate, natural resources, or TIPS fund. But I’d be wary about adding much more than that.

10. Tune out the noise. With so many investing pundits weighing in on virtually every aspect of the financial markets nearly 24/7, it’s easy to get overwhelmed with advice. It might make sense to sift through this cacophony if it were full of investing gems, but much of the advice, predictions, and observations are trite, if not downright harmful. If you want to watch or listen to the parade of pundits just to keep abreast of the investing scuttlebutt, fine. Just don’t let the hype, the hoopla, and the hyperbole distract you from your investing strategy.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

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MONEY Oil

3 Reasons Gas Prices Could Rocket Higher

150304_INV_GasPricesHigh
Scott Olson—Getty Images Members of the United Steelworkers Union and other supporting unions picket outside the BP refinery.

Unfortunately, the days of $2 gas appear to be in the rearview mirror.

Well, we had a nice run. After 123 straight days of falling gasoline prices, sending it below $2 a gallon in many states, we’ve come back to reality a little bit. In fact, gas prices have now risen each and every day for about a month. Unfortunately, gas prices could go a lot higher because of three storm clouds that appear to be on the horizon, which could combine to send gas prices rocketing higher.

Storm cloud No. 1: Rising oil prices

The dramatic drop in the price of oil in late 2014 caused gas prices to come down as well. We see this correlation in the following chart:

Brent Crude Oil Spot Price Chart

 

As we see there, the price of oil is down 45% over the past year, while the price of gasoline is down 32%. However, we can also see that both have bounced off of their bottoms from earlier this year. That’s because the price of oil has stabilized and is now starting to head higher as the oil market starts to see signs that it is working out some of its supply/demand imbalance issues.

Because those issues are being addressed, the oil market is now starting to point to a higher oil price later this year. That’s a recipe for higher gas prices, which is just what the U.S. Energy Information Administration is predicting, as we can see on the chart below.

Storm cloud No. 2: The big switch

One other thing you might have noticed from that above chart is that the price of gasoline is notably more lumpy than the price of oil. It’s something most of us notice at the pump each year as gas prices almost always rise in the spring. That’s because summer driving season is upon us, which leads to more demand for gasoline.

However, what really drives the price of gas up isn’t so much increased demand for gasoline in the summer, but the fact that oil refineries need to shift gears in the spring to focus on refining summer-blend fuels as opposed to winter-blend gasoline and home heating oil. Along with this switch, refiners also tend to undergo routine maintenance in the spring, which reduces their refining capacity. This adds up, and over the past few years on average, this has added $0.54 per gallon to the cost of gasoline each spring.

Storm cloud No.3: The picket line

This year, there’s a new wrinkle that could throw a wrench in the spring refinery maintenance season. The refining industry is currently at odds with the United Steelworkers union as the two have failed to reach an agreement on a new contract. As the dispute grows, workers at a dozen U.S. refineries have walked off the job, putting 19% of U.S. refining capacity at risk. The strike could continue to expand, as neither party is giving much ground on the disputed issues. This could lead to up to 63 refineries, which represent two-thirds of refining capacity, being affected by the strike.

So far, the strike has only resulted in one refinery in California being shut down, and that’s just because it was already undergoing maintenance, and its owner decided not to run the plant. However, shortly thereafter, an explosion at another California refinery took that facility offline, too, and cut the state’s refining capacity by 25%. This resulted in gas prices spiking in Los Angeles by $0.50 per gallon. This suggests that should the growing labor dispute lead to refineries across the nation shutting down, it could cause a big spike in what we pay at the pump.

Bottom line

Unfortunately, the days of $2 gas appear to be in the rearview mirror. Even without the rally in the oil price over the past few weeks, gas prices would have headed higher because of the normal spring switchover at refineries. However, this year, the price of gas could be under even more pressure to rise because of the possibility of a continued increase in the price of oil, and the possibility that the refinery strike causes a big portion of refining capacity to be taken offline.

I know that’s not the greatest of news, but if gas prices do spike, at least you’ll know why. And it’s a good reminder that instead of complaining about gas prices, an investment in the oil industry could offset some of the extra costs we’ll be paying at the pump and take away a bit of the sting of spiking prices.

MONEY Food & Drink

5 Reasons Why McDonald’s Will Win in 2015

McDonald's golden arches signs
Kristoffer Tripplaar—Alamy

McDonald's may not look so hot now, but it's in great shape to beat the market in 2015.

It’s so easy to kick a mustard- and ketchup-colored clown when it’s down, and McDonald’s MCDONALD'S CORP. MCD -1.18% has certainly earned the dissing.

It’s coming off of five consecutive quarters of negative comps, and lately it’s been blasted for everything from the quality of its grub to operational snags.

Instead of piling on, let’s take a look at a few of the things that either have been going right or should start to go right for McDonald’s this year.

1. Domestic comps are growing again

The market wasn’t impressed when McDonald’s announced that global comparable sales decreased 1.8% in January. It’s just something that the market has grown used to since the chain’s fundamentals began to slip in late 2013. However, the entirety of that decline was the result of fallout in Asia as a supplier scare in China and brand perception issues in Japan weighed on the overall performance.

The world’s largest burger chain held up better closer to home. Sales in the U.S. rose 0.4%, with an even better 0.5% year-over-year uptick at the register in Europe. Boo birds will argue this still means sales aren’t keeping up with inflation, but let’s frame this correctly. This is the first month in more than a year that McDonald’s has posted comps that are north of breakeven.

2. The new CEO could be a game changer

The Don Thompson era is coming to a close, and now the board is tasking Steve Easterbrook with turning the chain around as its new CEO. Yes, he’s an internal hire. That may not seem very exciting at a time when McDonald’s needs to think outside of the Happy Meal box, but he seems like the perfect candidate.

Easterbrook helped turn around the chain’s operations in Europe before moving back to head up the restaurant’s marketing department. He seems to have a firm grasp on the right message to woo back customers, and January’s bounce could be the first sign.

3. Higher wages could benefit McDonald’s

Consumer-facing chains are under fire for their low wages, and it wouldn’t be a surprise if we see restaurant operators start to pay more this year. This will naturally inflate prices, but McDonald’s may have a technological advantage in the form of automation.

McDonald’s and its franchisees have been investing in machines that perform many mundane tasks. Smoothie machines get going at the press of a button. Updated drive-thru windows have soda fountain carousels that sort out cups and fill them with beverages as they are ordered. Smaller chains can’t afford these high-tech automations, but it also means that McDonald’s will be able to get by with fewer employees in the future.

4. The improving economy will raise all chains

Have you noticed the drive-thru lane at your local McDonald’s getting longer in the morning? I have. With job creation on the rise again we’re seeing more rushed commuters hitting the road, taking lunch breaks, and having more money at the end of the day to take their families out to dinner.

This is a trend that should be beneficial to all chains. McDonald’s will be there.

5. The fundamentals are strong

McDonald’s may not seem cheap for a mature and slow-growing company. The stock is trading at 19 times this year’s expected earnings and a still steep 18 times next year’s target. However, there’s something to be said about a company with a predictable stream of fat royalty payments from franchisees. Net profit margins at McDonald’s hovered around a juicy 20% for several years before last year’s stumble, according to S&P Capital IQ data.

Along the way we have a company donning a chunky yield of 3.5% with a history of annual hikes dating back to when it started paying out dividends 39 years ago. McDonald’s may not look so hot now, but it’s in great shape to beat the market in 2015.

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