Should I Invest in Facebook?

If you follow any news sources, you have definitely heard about the stock market debut of Facebook, the social networking giant.  Although I never give specific recommendations about individual stocks, the IPO of Facebook is a good opportunity to review some basic principles of sound investing.

Facebook became available for purchase to the average retail investor this morning after a long period as a privately held company.  The social networking site has over 900 million active members worldwide and is extremely well-known and broadly utilized.  For these reasons alone, many people assume that it would make a great investment.

Investing is using money or capital in order to gain profitable returns, such as interest, income, or appreciation in value.  How does a share of Facebook fit into this definition?  Facebook debuted on the NASDAQ exchange today with a market capitalization (share price x shares outstanding) of over $100 billion, representing approximately 100 times its profits from 2011.  Most publicly traded companies trade for 10 to 15 times their annual profits.  Facebook shares do not currently pay any income.  In order to achieve a profitable return, the share price would have to continue to increase.  Anything could happen in the short-run, but a long-term appreciation of Facebook shares is only possible with dramatic increases in revenue and profitability of the company.  This will require charges for services that are currently free, additional advertising that could drive away users or other new sources of revenue that don't currently exist.  Although I will never claim to predict the future, Facebook has a long ways to go until it pencils out as a sound investment in my view.

Prudent investing requires appropriate assessment of risk, diversification and discipline.  Invidividual stocks come with a risk that is too high for most common investors.  Diversification requires that an individual own many different types of investments in order to spread risks across various companies, sectors and economies.  Discipline is also required to achieve consistent, positive, long-term investment returns.  The unpredictability and short-term, emotional movements of individual stocks do not cater to the sound discipline of a prudent investor.

There are other investment considerations that I haven't discussed here, but my simple recommendation would be to use Facebook as the great social networking tool that it is and only use it as an investment in a broadly diversified portfolio.

Happy New Year!

Although the new year is just another date on the calendar, it does give us an opportunity to reflect on the past twelve months and how we might make the coming days better.  Many parts of our financial lives do reset with the beginning of the year, so I would like to offer some recommendations for improvement.

1)  Keep better records - This isn't just for the detailed personalities out there.  There is a lot of insight and power that can only come from accurate recordkeeping.  There are even simple solutions like Mint.com that will do most of the work for you.

2)  Accept the past and start fresh - Although real estate troubles or job changes might have changed your financial situation, you can reboot and develop a new financial plan for your current realities.

3)  Reduce clutter - This might include closing some unused accounts or consolidating some old investments.  Less clutter in the practical areas of our lives allows us to focus more on the things that matter most.

4)  Live life more efficiently - There are lots of small things that can be done here.  Reducing unnecessary shopping trips, replacing inefficient light bulbs or appliances and programming your thermastat are just a few.

5)  Insure the important things in life - You should not take insurable risks that could cause harm to your family in the event of an accident or disaster.

6)  Establish an estate plan - This can include a will, health care directives, and a trust.  The first step is to think about it.

7)  Think about your investments - This is an area that can be very costly when ignored for a long period of time.  Each investment involves risks and these should be carefully reconsidered periodically.

8)  Reduce unnecessary debts - There are good debts and bad debts.  Debts should be reviewed, prioritized and paid down in a smart way.  For example - pay down the debt with the highest interest rate first.

9)  Do some math - You might not enjoy numbers, but some basic arithmetic can help your financial security.  Basic assessments of income and outflows and projected future savings balances have to be done periodically to have a sense of realistic goals.

10)  Share what you have learned - Family and friends can benefit greatly from the financial lessons that you have learned through your experience.  Be a good example of healthy habits that will be observed by others.

I could list many more, but this should provide some ideas for many of you.  If this is seems overwhelming, contact a fiscally-minded friend, family member or financial professional.  They would be happy to help!

Are the Markets Making You Nervous?

Stock markets have been more volatile lately, largely due to U.S. and European debt problems.  Although these are significant problems in need of long-term, structural changes, I view investing as a long-term, disciplined process.  That being said, how does one invest for the future but also take advantage of short-term opportunities to strengthen ones financial situation.

As explained by Andrea Coombes in a MarketWatch article posted on September 23rd, there are five things that should be the foundation of any long-term investment portfolio:

Minimize Taxes - Although investment income and capital gains are taxable, there are ways to structure a portfolio to minimize or defer these taxable events.  Gains can also be offset by losses in certain instances.

Control Costs  - Any investment has a cost associated with it, but these costs can be controlled by evaluating management fees and consolidating assets to reduce fees.  Costs can often be hidden or difficult to quantify, so an independent investment professional can assist in evaluating the true costs of various investments.

Diversify - This is as simple as "Don't put all your eggs in one basket."  Investments should be across various asset classes, company sizes and economies.  A large amount of an investor's portfolio in one specific investment, concentrates too much risk in one area, unless that investment is broadly diversified itself.

Rebalance - Different asset classes will perform differently in a portfolio.  Outperformance of one asset class should be realized and then reinvested in an underperforming asset class.  This rebalancing can contribute significantly to the aggregate performance of a portfolio over time.

Be Proactive, But Patient - A plan should first be developed before investing significant amounts of capital.  This plan should include goals and the amount of risk that you are comfortable with.  Portfolio performance should be monitored versus this plan over time and changes can made, if needed.  Accomplishing long-term financial goals is a patient process, though, and no rash changes should be made based on emotions.

Although the news headlines will always affect our emotional well-being, a long-term investment plan with a strong foundation provides a stable backdrop to the ups and downs of our daily lives.

Do you have control of your finances?

As I talk to family, friends and prospective clients, I often hear about financial challenges. Most people have financial challenges. If not, they would almost always like to be in a better place when it comes to their financial well-being. I try to remind people that the challenges aren't always the problem. The problem is often the fact that people don't have a clear picture of their financial situation. Many people aren't even aware of what parts of their financial lives they are in control of. I'd like to review a few areas and offer some suggestions.

A good starting point is a net worth statement and a income statement. In plain English, a net worth statement is a listing off all positive and negative account balances in order to come up with the net positive or negative "net worth." An income statement is a listing of all income and expenses over a chosen period of time. Once you have pulled together a basic summary of where you are, you can start to look at what you can control to improve your financial situation.

Bank Accounts - Are you paying unnecessary fees or missing out on earning interest? Do you have adequate savings?

Investments - Are you taking inappropriate risks considering your stage in life? Do you know what you are investing in and why you are doing it? Are your investments diversified? Have you had a professional assessment of your investments?

Real Estate - Do you have the lowest rate available on your mortgage? Is your mortgage balance appropriate? Are you maintaining your home and only spending money on it in "smart" ways?

Credit Cards - Do you pay more interest and fees than is necessary? Do you even need to use credit cards to begin with? Can you reduce the balances that are incurring interest?

Other Loans - Borrowing money for purchases should be well thought out and should not be a frequent behavior.

Salary - Are you living up to your potential at work? Have you evaluated your career path and what type of spending that supports over the long run?

Monthly Expenses - Which of these are necessities and which of these are luxuries? Can you really afford all the luxuries?

Taxes - Do you take advantage of all available deductions? Do you consider the tax impact of your large financial decisions?

The Bottom Line - Are you living within your means? Is more coming in than is going out?

Gaining control of your finances takes work, just like keeping your body healthy, keeping your marriage strong and teaching your children correct principles. Like all of these things, increased financial control will expand your options in life and lead to greater peace of mind. We are all faced with challenges we can't control, but we also have the ability to take charge and chart the path we want to follow in life.

What is a Fiduciary?

I had a prospective client inquire the other day about my fiduciary duty. What is my fiduciary duty in my profession and why would a prospective client care?

A fiduciary duty can be defined as the highest standard of care at either equity or law. A fiduciary is expected to be extremely loyal to the person who he owes the duty (the principal) and must not put his own interests ahead of the principal. Personally, I expect this type of care any time I am entering into an agreement with someone to oversee something of value for me. I have also aligned myself with professional organizations and standards boards that require this level of professional conduct. Unfortunately, it can be difficult to find professionals who will agree to this level of care. We are all inherently selfish beings and tend to look out for ourselves first.

Regulations in the financial world allow for various types of arrangements between professionals and clients. Not all of these arrangements require the financial professional to act as a fiduciary. Because of the sensitive nature and the significance of financial matters in all of our lives, I encourage anyone I come in contact with to consider the types of arrangements they enter into with various professionals to ensure that their needs are being considered first instead of someone else's needs. Feel free to contact me if you are ever in question about a financial relationship and how it should be structured, considering all involved. I have also included a list of valuable websites on this blog that provide resources for finding ethical financial professionals.

Balance & Compromise

As I read the news headlines and follow happenings in the U.S. and around the world, I realize that many of our problems would be solved with more willingness to keep things in balance. We are seeing battles in Congress between taxing and spending. We see disputes between those preferring economic development versus those who want to preserve the environment. We also see fights in families and governments that can lead to heartache and sometimes even violence or wars. As I ponder the problems around me, I wish that more people could consider both sides of the story and compromise to solve problems and move forward.

When I work with individuals to develop a financial plan or manage an investment portfolio, it often comes down to the ideas of balance and compromise also. There are often choices to be made between short-term spending and long-term savings. There is balancing that needs to be done between asset classes in an investment portfolio. Compromises also have to be made between spouses about financial goals. Finally, a compromise is needed in determining how much risk can be tolerated and how much potential reward that might lead to.

A basic understanding of financial principles is something that all Americans could use. As we work to solve some of our state and national economic problems, we could all benefit by taking a look at our individual lives to see how we can bring things into better balance. A more realistic view of finances on the individual level would have significant benefits in solving some of the more significant problems in our country and around the world.

The Efficient Market Hypothesis

So what is the "Efficient Market Hypothesis" and how does it apply to investing? This theory states that it is impossible to "beat the market" because the "efficiency" of the stock market causes existing share prices to always incorporate and reflect all relevant information. If this theory is true, it is nearly impossible to outperform the overall market, and higher returns can only be obtained by buying riskier investments.

A common perception about investment managers and "Wall Street" is that there are some super-smart people out there that know how to make money from investing in ways that no one else does. History has proven that the vast majority of "active" (those who use expert stock selection or market timing) managers do not outperform the markets as a whole. In most cases, the higher than market returns are obtained by taking on additional risk. Many on "Wall Street" also become wealthy by charging unnecessarily high fees for their advice.

If this hypothesis is correct, then what is the best approach to investing? For most people, index funds, exchange-traded funds, or low-cost mutual funds are the answer. Diversification, portfolio rebalancing and reducing costs are the three factors that can best increase portfolio values over time without taking on more risk than the individual would normally be comfortable taking. Like most fields, there are some true principles of investing, and I believe that the "Efficient Market Hypothesis" is one of these principles. I recommend that you look at this article and video for more discussion and advice on this topic.

The True Principles of Investing

There are numerous sources of investment information in the world, many claiming to have something that will provide an above average return or provide access to exclusive, profitable information. Although I'm open to new sources of investment information, I often view these sources somewhat skeptically until I understand the source of the information and how tried and tested it is.

Although things are changing in the world every day, there are some principles of investing that are as close to truth as it gets in the financial world. First of all, markets work. Various types of investments provide an expected return based on the risk of the investment and markets price these securities commensurate to the risk and expected return.

Second, and related to the first principle, is that investors are rewarded in proportion to the risk they take. This may not seem true in the short run, but over longer periods of time, this is almost always the case.

Third, diversification is a critical investment tool. It allows investors to capture risks that generate expected return but reduce risks that do not. The common phrase for diversification is "Don't put all your eggs in one basket."

Fourth, the appropriate risk or asset allocation is unique to each investor. The various rules of thumb do not apply to every investor. A customized approach considering the risk the investor can tolerate is best.

Finally, costs are variable and should be considered. Although two similar investments may provide similar returns, two investors could end up with vastly different sums of money because of the costs related to accessing these two similar investments. As consumers, we should be aware of the various costs of investing and comfortable with their appropriateness to our situation.

I seek for true principles in any area of my life that help me make more informed, reliable decisions. The investing world has been analyzed and researched for many years in order to uncover what things work when it comes to capital markets. I welcome feedback and discussion as I continue to seek and implement the true principles of investing in my profession.

Uncertainties & Opportunities

The one thing that I become more certain about as life progresses is that life is uncertain. Unexpected illnesses, financial volatility, natural disasters and irresponsible politicians all contribute to this reality. So if this is the case, what is one to do? Considering that this is a financial blog, how does one navigate the uncertainties in the practical areas of life?

1) Expect the unexpected - No matter how certain or predictable something is, consider the alternative. Certain things that were considered reliable in the economy are not as reliable right now, so have a back-up plan in mind.

2) Leave some wiggle room - The American way is often to live life on the edge, take risks and focus on the here and now. America is unique because of our founders' willingness to take risks, but we should consider the risks we are taking on a day-to-day basis and determine if they are really necessary.

3) Accept reality - It is easy to deny dramatic changes in our lives and refuse to adjust to a new reality. When it comes to financial matters, accepting the new reality and making adjustments to it is better than sticking to an outdated way of thinking. This allows for more flexibility is working through challenges and a more reliable plan for the future.

4) Keep a positive attitude - The news headlines and other negative influences can make it easy to get down and give up the fight. We are all better off when we focus on what is in our control and take positive steps to improve our situation. Life might not always turn out how we imagined, but a positive frame of mind is often the key to conquering practical challenges.

I enjoy the challenge of assessing a financial situation, collecting the relevant information and developing a workable plan to move forward. Let me know your questions and challenges and I am happy to see where I might be of assistance.

Risk & Diversification

The headlines have been dominated recently by the BP oil disaster in the Gulf of Mexico. This story and the dramatic effect it has had on the value of BP stock are yet another example of the risks inherent in investing. Considering these risks, why do people invest and how can one invest without exposing oneself to too many of these risks?

Many people consider large, established companies to be good investments. There are several reasons that this is true, but putting too much of ones investment portfolio into the stock or bonds of a single or small number of companies is still a risky proposition. BP and GM are dramatic, recent examples.

So how does one reduce the risks of investing in the "wrong" company? The simple answer is diversification. The common phrase used to define this term is "Don't Put All Your Eggs in One Basket." By owning stocks and bonds from a variety of companies, large and small, domestic and international, the risk of losing large amounts of wealth is reduced.

Some people have questioned the value of diversification because nearly every type of investment lost value during 2008. While this is true, a 40-year study that was presented at a recent financial planning conference showed that a year like 2008 was truly an anomaly. Diversification has provided significant protection in 38 of the last 40 years. Although disasters and market shifts will continue to pose risks for companies of all types, diversification is one way to have exposure to the upside of investing, without taking on too much risk.

Risk & Volatility

Anyone who follows the news headlines heard about the dramatic drop in the stock market yesterday. Although it was followed by a significant recovery, there was a point yesterday where the Dow Jones Industrial Average was down almost 1,000 points. What caused this to happen and what does it mean about the risk of investing in the stock market?

There is speculation about the exact cause of yesterday's volatility, but it was most likely caused by a combination of global economic uncertainty, computerized trading programs and human trading actions. All of these factors confirm that investing in equities does carry risk and this risk becomes more apparent when uncertainty exists. Our world economy has become more volatile and uncertain in recent times and the changes in the market show this.

Despite the volatility, developing a well-diversified, long-term investment portfolio is still the way to achieve returns that stay ahead of inflation and to build real wealth over a long period of time. Recent events confirm the need to have a well-thought-out financial plan and appropriate investments which support the risk this financial plan allows. Having a plan like this in place allows the short-term emotion of the markets to be viewed as "noise" and the long-term goals remain the primary concern.

What a Difference a Year Makes!

Although unemployment remains high and the media may continue to focus on the negatives of the past couple years, things have turned around dramatically in the stock markets. For example:

S&P 500 (Large U.S. Companies)

Down 38.49% in 2008

Up 23.45% in 2009

EAFE Index (Large International Companies)

Down 45.09% in 2008

Up 27.75% in 2009

MSCI Emerging Markets Index (International Companies from Developing Nations)

Down 54.48% in 2008

Up 74.50% in 2009

The trend is quite similar for many other stock indices in 2008 and 2009 and the positive returns are even more dramatic from the point the markets bottomed on March 9, 2009.

Pessimists might say that although we have seen positive returns in the markets of late, we still aren't back to the 2007 peak and we don't know where we're going from here. Both of these points are valid, but a more positive view would be that we've made great progress in coming back and the markets (which typically forecast 6-9 months forward in the economy) are forecasting significant economic improvements.

A couple conclusions from this short analysis would be that markets are volatile (2008-09 were an extremely dramatic example) and that investing is a long-term proposition with bumps along the road. This recent period once again confirms the need to have a realistic, diversified investment plan and to stay disciplined through the ups and downs.

Will America Still be No. 1?

The recent economic times have caused some to question whether America will continue to be the economic superpower it has been in the past. The World Economic Forum recently ranked the United States number two behind Switzerland amongst the world's most competitive economies. While I'm a strong believer in a free-market economy and the uniqueness of America rooted in the ideals of our founding fathers, no one can say how the American economy will compare to other world economies several generations into the future.

As an investor, what should you do to adjust to this potential new reality? It really comes back to one of the basic principles of investing - diversification. Any well-designed investment portfolio should take a world view and include more than just U.S. stocks and bonds. Developed and emerging international markets should also be considered. European and other developed economies, along with emerging markets like China and India, can diversify the risk of a portfolio while potentially increasing the return.

Which countries should be invested in and in what ratio? More emphasis should be put on developed economies because of a longer track record and stronger government regulation and controls. Emerging markets offer enticing potential returns, but they bring increased volatility and the added risk of unstable governments or unethical practices. Limited emerging market investments are appropriate for most investors. The world economic landscape is always changing, but these changes create opportunities to adjust a portfolio to capitalize on the new economic realities.

Is it different this time?

The significant economic events of the past year have caused many to proclaim that traditional buy and hold investing is no longer valid. Supposed experts have also proclaimed that modern portfolio theory is dead. I've also read that the efficient market hypothesis no longer works. Have things changed in the U.S. or world economies so much that the tested, proven and researched tenets of modern investing no longer hold?

I would argue that things haven't changed and the modern ideas of investing are still correct. History has changed. Although history tends to repeat itself and what we've seen recently has happened before, many of us are seeing economic events occur that have not happened in our lifetimes. The reaction to these recent events by individuals and our government has been somewhat unprecedented, but that is a political discussion I don't want to get into at this point.

The efficient market hypothesis states that markets are efficient and asset prices reflect all known information or instantly change to reflect new information. The enormous amount of market volatility that we've seen recently has been due to the enormous amount of economic uncertainty. Once the uncertainty starts to recede, the market will react, as we've seen with some of the positive information being reported recently and the corresponding positive move in the markets.

The efficient market hypothesis is the best working model of how world markets function. The best way to invest in markets is to develop a diversified portfolio (Modern Portfolio Theory) with the appropriate amount of risk exposure. As opposed to markets "failing," much of recent economic history has been due to investors reassessing their level of risk and making appropriate adjustments. Despite the economic pain that has been inflicted on many, recent events have been an opportunity to really experience market risk and why the return premiums from holding equities (stocks and mutual funds) exist. Can we learn valuable lessons from this or are we bound to repeat these cycles again some time in the future?

Watch this eight minute video to hear Eugene Fama, the father of the efficient market hypothesis, share his views.

What is Investing?

The dictionary states that investing is "to put (money) to use, by purchase or expenditure, in something offering potential profitable returns, as interest, income, or appreciation in value." Somewhat similarly, I like to define investing as an investor supplying capital to an investment market with an expectation of a future return. The expected return is dependent upon the market that is invested in and the risk commensurate with that market.

Many investment "managers" or "professionals" use the term investing to disguise purchasing of a product, gambling, or other types of irrational speculation. They claim to know better than the aggregate knowledge of publicly traded markets or have access to pricing "mistakes" that few others are aware of. Achieving investment returns greater than the market are only possible when taking on above market risk. This increased risk often becomes inappropriate to the point that investing has morphed into speculating or betting. The majority of the investors I know do not have the means or desire to take these type of risks with their savings or future retirement assets. As I continue to share my thoughts on investing, I will expand on ways to actually implement these ideas.

Life is a Risky Proposition

All parts of life involve risk. We all take risks with our travels, our relationships, our health, our purchase decisions and our investments, among others. Recent history has proven to be an especially risky time in the world of finance and investing. Despite these risks, we all turn to our inherent values or attitudes and move forward in life. My personal experience, education, struggles, training and common sense has taught me a bit about how to quantify these risks and deal with them in a sensible way. I have decided to begin publishing this blog in order to share some of my "sage" ideas and advice in the world of investments, financial planning, taxes and various other practicalities.