The self-serve movement is alive, well, and overtaking our financial well-being. Company-funded pension plans are as scarce as hen's teeth, while employers encourage employees to contribute their own money to 401K retirement plans and make their own decisions about how to invest for retirement. Just when the responsibility shifts, the choices in the personal finance and investing arenas seem to explode. Accounts that defer taxes are great, but the options and fine print can be overwhelming. Fortunately, competition has driven financial institutions to reduce costs while increasing market share, which means more web-based services. These initiatives provide educational articles, training courses, financial calculators, and other valuable financial tools for existing and potential customers alike.
The dark cloud behind that silver lining is the magnitude of available information. With financial institutions wrestling to become the must-have financial bookmark, what you want is probably out there, but finding it is another matter. Online assistance is usually targeted to the masses, so you might end up understanding the concepts without having any idea how to put them to work. Having struggled with all of these issues, I was ready to write Online Investing Hacks. I wanted to take control of my financial life, and that meant finding the best financial web sites and learning how to search for the tools I wanted. In some cases, it meant building a tool to match my requirements and financial circumstances. From the annals of Online Investing Hacks, here are some of the most important things you can do to improve your financial situation and the tools that simplify these tasks.
Paying off debt isn't as exciting as investing in stocks, but more often than not the returns beat the market. With credit card interest rates sometimes running 20 percent or more, don't even think about investing until you've paid off your credit card balances. Investments that guarantee a 20 percent return don't exist, but eliminating credit card debt is like earning the interest rate that your credit card charges.
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Whether you make the minimum credit card payment from laziness or because it's all you can afford, the following techniques reduce your debt with a minimal amount of pain:
For light debt loads, get back on track by hiding your credit card in a drawer for a while. Paying cash or writing checks usually brings your spending back to reality. To remove the temptation of credit card debt, replace your credit card with a debit card, which you must pay off each month.
As long as you have some emergency funds to fall back on, don't contribute to savings until your high-interest debt is paid off. In addition, consider using additional savings to pay down high-interest-rate debt. The few dollars you lose in savings interest saves you a bundle of credit card interest.
If you can't afford to pay off your credit card balances, start by paying off the debts with the highest interest rate first. For example, pay as much as you can afford each month on the card charging 20 percent interest, while paying the minimum monthly payment on your 8 percent credit card. When the balance on the 20 percent card is paid down, switch the monthly payment you were making to the 8 percent card. When that card is completely paid up, apply the monthly payment to your 4 percent home equity loan. (After your debts are paid, you can switch the monthly payment to savings or investing.)
As a last resort, stop contributing to your 401(k). Reducing the taxes you pay on your income, receiving employer-matching, and earning an investment return might be better than saving on credit card interest. By the way, don't start investing in other accounts until you max out the company matching in your 401(k). Company matching is like receiving a 100 percent return on your money. You don't think you can afford to withhold that much of your paycheck? You can't afford not to.
If you're in serious trouble with debt, don't try investing to dig your way out. Instead, contact Debt Counselors of America, a not-for-profit organization that works with creditors to reduce your monthly payments, late fees, and interest. You make one monthly payment to DCA and they handle payments to your creditors for a small fee.
A mortgage with a great interest rate and low fees can save you the equivalent of several years' salary. Why work thousands of additional hours, when a few hours picking the right mortgage nets you hundreds of dollars each month for your investing program? HSH Associates publishes "The HSH Mortgage Survey," which includes everything you need to know about mortgages offered around the country, updated weekly in most cases. In addition, the HSH web site includes articles and pamphlets that explain what you need to know to pick the right loan or mortgage, and calculators that turn your newfound knowledge into hard numbers. For $20 plus $3 shipping and handling, you can obtain the current mortgage survey, as well as the 56-page pamphlet "How to Shop For Your Mortgage." Add any of the other HSH educational booklets for $2 each.
With over 10,000 publicly held companies available as investments, you need some help whittling the field down to a few companies for in-depth study. Some companies don't grow enough. Some don't grow at all. Others grow robustly, but cost too much to deliver an attractive return on your investment. Others are growing and priced right, but might be too risky for your taste. Weeding out these also-rans typically narrows the field considerably. If you're looking for companies to balance your portfolio diversification, you can filter the field even more. Stock-screening tools filter the universe of publicly held companies to only those that meet your criteria. By using the more sophisticated online screening tools, you can not only filter the list, but compare key financial measures to find the strongest competitors.
Don't try to screen all the way to only one stock! By keeping your criteria more flexible, you catch companies that don't quite fit your criteria but are worth watching, such as quality growth companies that are currently overpriced. Besides, stock screens find companies based primarily on historical performance. You still have to do your homework to figure out which ones are positioned to continue that performance into the future.
MSN Money Deluxe Screener and Reuters Investor Power Screener both offer lots of bells and whistles for screening and comparing stocks and both come at a great price -- free. Each tool provide hundreds of financial measures and ratios for building screens. You can define criteria by selecting fields, operators, and values from pull-down menus or by typing values in boxes. MSN Money's Deluxe Screener makes it easy to screen for a specific value or compare a company's performance to the industry average. Reuters Power Screener enables you to define criteria with multiple tests or define your own custom variables. You can save the screens you build to run again. Better yet, you can export screen results to an Excel spreadsheet or comma-delimited file, or export the ticker symbols for the resulting companies to MSN's Portfolio Manager. By specifying the financial measures that appear in the results table, you can evaluate all aspects of the companies that pass your tests. To access the Reuters Power Screener, click Ideas & Screening and then PowerScreener in the navigation bar in the left margin.
Much of the data you need to analyze investments is on the Web for little or no cost, but transferring that data into a spreadsheet where you can work with it is another matter. With Excel's web queries (available in Excel 2000 and later, and Excel v.X for Macintosh), you can capture data stored in web page tables to feed your financial formulas. The only information a web query needs is the address (URL) of the web page and the tables on that page that contain the data that you want.
To add a web query to a worksheet in an Excel workbook, open the Excel file and select the tab for the worksheet you want. To create a new web query in Excel XP, choose Data -> Import External Data -> New Web Query. The New Web Query dialog box opens, displaying the home page you use in Internet Explorer. The toolbar in the New Web Query dialog box includes an Address drop-down list, which is automatically populated with your URL History list from Internet Explorer, as well as other frequently used browser commands, such as Back, Forward, and Refresh.
You can type a URL or navigate to a web page in the New Web Query dialog box. In Excel XP and 2003, arrows point to each table on the page. After you select the tables to query, Excel extracts the labels and values from those tables, and adds them to cells in a worksheet. Although the spreadsheet cells don't look like they have super powers, they are associated with your web query. You can refresh the data from the associated web page by right-clicking any cell in the web query area and choosing Refresh Data from the shortcut menu.
Because web queries correspond to specific web pages, a financial web query returns the data for the same company, mutual fund, or other investment you're evaluating. Wouldn't it be cool if you could make a query download data for a new investment when you type its ticker symbol into a worksheet cell? Well, you can, but it requires a few steps.
To customize a web query, first save it as a file by right-clicking any cell in the web query area and choosing Edit Query from the shortcut menu. Click the Save As icon on the toolbar and save the query file.
Next, you must add the ticker symbol as a parameter to the saved web query file. Navigate to the saved web query file in Windows Explorer and use Notepad to open it. Most URLs for web pages with investment data include the ticker symbol for the investment. For example, the Yahoo! Finance quote page for Lowe's home improvement stores is finance.yahoo.com/q?s=low.
To make the web query download the data for the ticker symbol you specify, replace the ticker symbol
in the URL with ["symbol", "Enter Symbol"] so that it looks like this:
http://finance.yahoo.com/q?s=["symbol", "Enter ticker symbol"]
Save the web query file.
Finally, you must link the web query to the spreadsheet cell in which you type the ticker symbol. Choose Data -> Import External Data -> Import Data and use your saved query file as your data source. In the Import Data dialog box, specify where you want your web query results to go. You must click Parameters, select the Get the Value from the Following Cell option, and specify the worksheet cell that contains the ticker symbol.
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Well, duh! As it turns out, it's tough to hold investments or buy more when prices are plummeting, and equally difficult to wait patiently for lower prices when the stock market is soaring. By assessing the rational price of a stock, you can make the right decisions while others overreact.
For growth companies, the PE ratio gauges whether a stock is over-, under-, or fairly valued. The ratio of price to earnings per share is similar to the price per gallon of gas, except that the PE ratio indicates how much investors are willing to pay for a dollar's worth of a company's earnings.
Because it fluctuates with the price, a PE ratio at any given moment isn't that helpful. However, the average PE ratio for ten years, called the signature PE, is a typical value to which the PE ratio returns from higher or lower levels.
The signature PE represents a reasonable amount to pay for a dollar's worth of earnings, but there are times, sometimes entire years, when investors pay more or less than is reasonable, as illustrated in Figure 1. When the current PE ratio is above the signature PE, the PE ratio eventually declines, most often from a drop in price. If the PE ratio is below the signature PE, the price often increases until the PE ratio is at or above the signature PE.
Figure 1. The PE ratio often reaches significantly above and below the signature PE
How can you put the PE ratio's tendency to return to the signature PE to practical use? When you plan to purchase a stock, compare the current PE ratio to the signature PE. If the current PE ratio is much above the signature PE, the stock is probably too pricey and will likely go down over time. If it's below, you might have a bargain. You can also produce the historical value ratio by dividing the current PE ratio by the signature PE. If the historical value ratio is more than 110 to 150 percent, you should wait for the price to fall into a more reasonable range.
You can also use the historical value ratio to calculate a rational price for a stock. The rational price of a stock is simply the price you would pay if the stock were selling at its signature PE, and is calculated by dividing the current price by the historical value ratio.
Although it's no secret that some companies have cooked their books, you can spot signs of questionable bookkeeping before the results or subpoenas are served. Company books are never cooked evenly -- at least some of the numbers are real. It's more like they've been microwaved on high for a few minutes, rather than baked at 325 degrees until done to perfection. Earnings are the obvious numbers to cook, because that's what the market pays attention to. So a good place to hunt for numbers that don't make sense is the balance sheet. You have a better chance of uncovering the truth about a company's cash flow by comparing successive balance sheets to determine where the money came from and where it went during a particular period.
WorldCom was one company that fudged its financials by capitalizing some costs instead of recording them properly as expenses, which (surprise!) resulted in higher reported earnings. How so? It stems from how capitalization and depreciation affect a company's earnings. When a company spends a big wad of money to purchase equipment or other things that it will use over a long period of time, the big wad of money doesn't show up as an expense on the income statement. If it did, earnings would take a huge hit in the year of the purchase and then would look particularly good for the remaining years when the equipment helps generate income with no expenses to match. Depreciation is an accounting mechanism that, in effect, spreads the cost of a capitalized purchase over the useful life of the asset. The purchase cost appears as a use of cash on the cash flow statement; the value of the asset shows up on the balance sheet; and each year of the equipment's useful life, a depreciation expense appears on the income statement. Let's look at a simple example. If a company has revenues of $100,000 and expenses of $50,000, its net income is $50,000. However, if the company plays games and transforms the $50,000 in expenses into capitalized expenditures, the straight-line depreciation, assuming no salvage value, would be one-fifth of the $50,000 for five years. This ploy increases the net income to $90,000 for the year.
Figure 2 shows a comparison of Worldcom's EPS to free cash flow from September 1998 through September 2000 using Spredgar (http://www.spredgar.com), which shows free cash flow, mostly negative -- and often dramatically less than reported positive earnings.
Figure 2. Worldcom's EPS looks much better than the cash flow it generates
How is this possible? Spredgar's net balance sheet cash flow for the quarter ending December 1998, shown in Figure 3, shows WorldCom's expenses appearing in the Property, plant, and equipment (PP&E) line item (cell D93). During this period, PP&E was more than five times reported net income! This number doesn't represent long-term assets and investments, which are listed on the next line. For eight quarters starting in October 1998, PP&E ranged from 80 to 400 percent of net income. Stuffing expenses into this area enabled Worldcom to report net income as positive, while the correct categorization of expenses resulted in a loss.
Figure 3. Worldcom's cash flow shows results not often seen in legitimate businesses
Because of Worldcom's capitalization games, depreciation (cell D104) is higher than net income for the period. If you're capitalizing expenses, you must depreciate and amortize them, which results in high depreciation and amortization expenses. This is not likely to happen to a legitimate business, because it implies purchases of assets that don't produce sufficient income. However, for the next seven quarters, Worldcom's depreciation and amortization ran between 30 and 100 percent of net income. You can compare financial measures for a company to the industry average to look for numbers that are out of whack, as described in Tip #3.
Some funds are simply dogs, but in a lot of cases, below-par returns result from excessive fund expenses. Fund shareholders pay the costs of operating a mutual fund through fees and the annual expense ratio. Fund expenses are deducted from your investment in a fund so they reduce the return that you earn. The commissions that funds pay to brokers for trades further reduce returns by one to two percent a year, but this reduction doesn't show up in the fund performance figures that funds publish. The returns you receive from your fund investment will be lower than the published performance figures.
The returns for funds with similar portfolios and investment philosophy can vary significantly simply due to a difference in expenses. To get an idea how much fund expenses impact performance, compare a mutual fund's performance to the performance of its peer group or to a corresponding benchmark index. For example, every fund in Table 1 achieves the same nine percent return as the index, but expenses gnaw away at the returns you receive.
Table 1. Mutual fund expenses reduce investment returns.| Fund | Expense ratio | Front-end load | Effective annual return | Value after ten years for $10,000 investment | Ten-year expense costs |
|---|---|---|---|---|---|
| Index | 0% | 0% | 9.00% | $23,673.64 | None |
| Fund A | .5% | 0% | 8.46% | $22,516.23 | $806.79 |
| Fund B | .5% | 5.75% | 7.81% | $21,221.55 | $1,335.40 |
| Fund C | 1.0% | 0% | 7.91% | $21,410.01 | $1,572.31 |
A one-percent increase in fund expenses doesn't guarantee a better-performing fund, nor does it reduce your investment risk, but it does cost you over $1,500 dollars over ten years. Fund B with the hefty front- end load in Table 1 surrenders .65 percent of annual return because of the money paid up front in commission. Managers with higher expenses have to perform better just to stay even with their low-cost cousins. The problem is that very few managers do that over long periods of time. Sales charges or loads are fees that investors pay to purchase fund shares through a broker or financial planner -- for so-called financial advice. These charges cut into your investment above and beyond regular fund expenses, so they increase the damage to your investment returns.
Expense ratios range from as low as 0.18 percent of invested assets to as high as three percent, depending on the type of fund, the frugality of the fund family, and individual fund characteristics. Use the following guidelines to quickly assess a fund's expense ratio:
Only the administrative expenses, management costs and marketing, and distribution fees are incorporated into a fund's published expense ratio. Marketing fees (called 12b-1 fees) are identified separately, whereas the costs of brokerage commissions are typically hard to find. Morningstar's web site provides basic expense information for a fund in the Key Stats section. Look for below average values in the Expense Ratio % field. Ideally, the word None should appear under Front Load % and Deferred Load %. Don't stop there. You can gain some insight into the commissions being paid behind the scene by looking at the turnover ratio further down on the Snapshot page. The higher the turnover ratio, the more commissions paid to trade, and the more taxes you'll owe if you hold the fund in a taxable account. Then, click the Fees & Expenses tab to see whether a fund also charges a redemption fee or 12b-1 fees.
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Low-cost index funds are the perfect buy-and-hold investment for busy investors. What isn't such a good deal are mutual funds that charge actively managed fund expenses for portfolios nearly identical to that of an index fund. Why pay more for less return? You can identify and avoid these closet index funds by inspecting their portfolios under a microscope.
Owning closet index funds costs you big time. The least expensive index funds charge less than 0.25 percent of your assets in ongoing expenses and charge no loads. A closet index fund might charge one percent or even more for the same basic performance. The Vanguard 500 Index fund, the nation's largest mutual fund, tracks the S&P 500 index and charges 0.18 percent of assets, which is far better than the 1.4 percent for the average, actively managed, large blend fund. Translated into dollars and cents, a $10,000 investment in the Vanguard 500 Index fund costs $18 a year, whereas a similar investment in an actively managed fund costs $140 per year -- more than seven times more. Hold that fund for even five years, and you'll pay at least $610 more than the fees for the index fund.
To check for index-hugging, first find a fund's benchmark index, either in a fund report or on the Morningstar web site. Focus on the following prioritized points to spot signs of index investing:
A fund with an R-squared of 90 or higher is a strong candidate for closet index fund status. The lower the R-squared, the lower the correlation between the fund's performance and that of the benchmark index.
A fund with a beta of 1.0 has performance volatility on par with the index. The more the beta value differs from 1.0, the less likely the fund mirrors the index.
Fund-data providers classify sectors differently, but a fund with sector weightings close to the index is likely a index-hugger.
Few funds beat indexes over the long term. Closet index funds might have performance close to the three- or five-year performance of an index fund, but are likely to fall away by 10 years because of the drag of their higher expenses. Managers with a more independent mindset are less likely to closely track index performance. For funds that charge a sales load, compare the load-adjusted returns to the index returns.
Average PE ratios within a point of the index are suspicious.
Average EPS within a percentage point of the index are suspicious.
You can compare either the top ten holdings or the entire portfolio to see how many companies are the same for the fund and its corresponding index, and look for similarities in the largest holdings.
As with sector weightings, a portfolio close to the index in terms of market cap is suspicious.
Indexes followed by foreign and world stock fund managers are strict in terms of the country weightings. Funds that don't go out of bounds are candidates for closet indexhood, while those that venture outside of their limits are run likely by more independent-minded managers.
Before you purchase a stock, the challenge is to figure out what sort of return you might earn based on the price you plan to pay. After you own a stock, reevaluating its future return from time to time can help you weed the slow growers from your portfolio. With a current price and a potential price a number of years in the future, you can calculate the potential return, usually called total return. When you use fundamental analysis to evaluate stock, the earnings growth rate you expect from the company and the potential future PE ratio for the stock both play a part in forecasting the future price.
To calculate a future price, you need an estimate of future earnings and an estimate of a future PE ratio. With estimated this and estimated that, it's clear that your forecast for future price and return are only as good as the estimates that you provide. By erring on the conservative side with your earnings and PE ratio estimates, your forecast will be less exciting but probably more attainable.
Here's how you develop a forecast for a price five years in the future:
Estimate the annual earnings growth rate you expect the company to achieve for the next five years.
Calculate estimated future earnings five years from now based on your estimated earnings growth rate, as shown in the following formula:
EPS (5 years out) = EPS last 4 quarters * (1 + estimated earnings growth)5
Choose a PE ratio that you expect the company to carry five years from now. To be conservative, use the signature PE described in Tip #5.
Calculate your forecast for a future price in five years by multiplying the estimated future earnings by the PE ratio you chose, as follows:
Future Price = EPS (5 years out) * Selected Future P/E ratio
Calculate the annual return based on your forecast future price and the price at which you intend to purchase the stock using the following formula:
Annual return for next 5 years = (Future price / Purchase price)1/5 - 1
If you want to make sure that you achieve your minimum acceptable return, you can calculate a buy price based on the future price and your minimum return. To do this, calculate the present value using the following formula:
Present Value (PV) = Future value / (1 + return)5
With college tuition soaring, parents who want to pay for their kids' education need as much help as they can get. Tax-advantaged education accounts are a huge help, but time is the best thing for college savings, by far. By starting to save for college early, you can invest in stocks and earn returns that can keep pace with the frightening rate of college tuition increases. Because stocks are risky for the short term, you must move your savings into safer investments as your child gets closer to college age.
If you're an overachiever, you can start setting money aside for college before your bundle of joy is even a glimmer in your eye. For many parents, the birth of a child is a wake-up call (even several a night for many months). These early years are great for getting ahead of the college curve. Start investing money regularly in mutual funds that own stocks. Because of the number of years you'll have to save, and the higher returns that stocks or stock-based mutual funds provide, your monthly contribution can be more reasonable. With 12 years of investing at a 10 percent return, you need about $350 a month to reach $100,000. If you don't start saving until five years before school and use safe investments paying four percent return, you'll need $1500 a month to reach the same goal.
The adolescent years bring a host of problems, both psychologically and financially. You're on your own interfacing with your teenager. Fortunately, the financial transformation of college savings will seem easier, by comparison. Because you don't want to lose money in the stocks in your college savings when there's little time for them to recover, the transition to safer investments begins when your child is 12 years old. The conventional advice is to start depositing new savings into safer investments, such as long-term certificates of deposit or zero coupon treasury bonds (also known as zero-coupon treasuries) that mature when your child heads off to college. However, if you make automatic monthly deposits to a stock fund, you could choose to continue that, and sell a chunk of your stocks or mutual funds to meet your target percentage for CDs or bonds. However, if a recession appears imminent, switch your monthly deposits to a secure savings option.
By the time your child is 14, about half of your college nest egg should be in safer investments. Therefore, between ages 12 and 14, you must gradually reduce the percentage of funds invested in stocks from 100 percent to 50 percent. Realistically, you continue to reduce the percentage of money in stocks until all of your college savings are safe by the time your child heads off for college.
Using CDs, traditional bonds, or zero coupon bonds for your secure savings also requires some planning. You want sufficient holdings to mature each year. In addition, if you decide to add your monthly contributions to safe investments, you could end up with numerous CDs for each contribution. Small bond purchases can kill you with minimum commissions. Here's one approach to keep things simple:
When you transfer money from stocks to safe investments, buy a fixed-income investment that matures in time for freshman year.
Continue using stock transfer dollars to buy fixed-income investments that mature for freshman year up to the amount you forecast for freshman year expenses.
When freshman year is covered, start buying fixed-income investments that mature for sophomore year until sophomore expenses are covered. Continue this approach to cover junior and senior years.
When you want the monthly contribution to go into safe savings, deposit the monthly contribution in a money market account, money market fund, or savings account with a decent interest rate.
Twice a year, use the money in the money market to purchase fixed-income investments that mature for the college year that isn't yet covered.
Unfortunately, the money you invest in stocks grows faster than the money in safe investments, and the monthly contributions further unbalance your plan. Trying to figure out how much money to transfer between stocks and safe havens each year might give tax preparation a run for its money as something you'd rather not do. That's why it's a good idea to create an Excel spreadsheet to help you plan your college savings program.
The spreadsheet in Figure 3 assumes a steady monthly contribution from the time your child is born until she graduates from college. $400 a month adds up to well over $200,000 when you save for 22 years. So sending your child to a good, private school requires nothing more than saving the money you would spend on a cappuccino on your way to work and eating lunch at a restaurant each workday.
Figure 4. Calculate the money you should invest in stocks and fixed-income investments
to reach your goal
When your child reaches 12, the example switches to yearly calculations. In this example, the monthly contribution goes into stocks, so the formula for calculating the future value takes into account both monthly contributions and the balance at the beginning of each year. Because the returns you supply for calculations are average annual returns, your year-to-year results almost never match your estimates. For that reason, when you get to the beginning of each year processed in your spreadsheet, replace the values for stocks and safe investments in columns C and D with the actual balances in your accounts.
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