Best Buy

After selling my AAV, I didn't want to let my money sit around for too long so I started looking for new stocks to buy. After a lot of reading, I stumbled across an article comparing Best Buy, Radioshack, and Circuit City. The author concluded that all three are good buys. I checked them out and, using the wonderful research tools at TD Ameritrade, concluded that the author was pretty much right. As luck would have it, Best Buy fell pretty significantly right before I did this research (last week). So I bought some. I am excited that Best Buy is making forays into China and the news of the stock buyback was of course welcome.

Now my IRA is composed of 20 shares BBY, 20 shares GE, and 5 shares AGG. The AGG is there in preparation for my bond-options strategy, which I'm investigating still. Hopefully TD Ameritrade will be more generous than Sharebuilder with their options policy for IRAs.

Sharebuilder's Options policy for IRAs

I applied for options trading in my Sharebuilder IRA account and was approved. However, apparently it is Sharebuilder policy to only allow options "level 1" trading in IRAs. That means you can only "write" (sell) covered calls. In other words, the only thing they let you do is buy, say, 500 shares of GE and then sell 5 call option contracts on those shares. They say that is the least risky options play. BS! Now, granted, if you do not have a lot of discipline, uncovered options can be very dangerous. You can easily lose 100% of your investment on just about every options deal. However, like I said in a previous post, the conservative play is to only invest about 5% of your money in options. The incredible leverage that options provide turn that paltry 5% into a serious investment. The other 95% of your money can be in a safe investment like bonds, getting around 5% interest. That would mean that in the worst case, you lose NOTHING over the course of a year, and in the best case, you get about the same return as if you had been invested 100% in stocks. Just think how useful that would be in times like stock market crashes... just the sort of thing you worry about with your IRA. Because you can't pump a bunch of extra money in if the market goes way down!

Ah well, I'm learning why IRAs need more conservative investment strategies than normal stock trading accounts. I'm just disappointed that I can't play around with the option-bond strategy, which to me sounds like just about the safest possible investment strategy that still gives you some decent return. Ever since I learned about options, I've realized that they are one of the tools of the rich. Little things like Sharebuilder's policy keep this valuable tool out of the hands of small investors. If I had $1 million in net worth I'm sure I could find a broker willing to let me trade any type of option I want in my IRA.

Sold AAV today

Well I sold my AAV today. The very high volume (2.9 million shares, average volume 870k!) combined with the slow decrease in price from the morning made me feel too nervous. It's remarkable that it didn't fall more, so maybe I made a mistake. My theory is that a lot of people like me who got in at $10 or so are taking profits, plus the people who got burned by the fall even earlier are saying "Hey let me get out now before it goes down AGAIN."

I thought I'd be getting into this stock for slow growth with a great dividend but it didn't work out that way. Getting the equivalent of nearly 3 years' worth of the dividend in 2 months was too attractive to pass up. I still really like the stock though, so hopefully it will fall some in a big sell-off and I'll get back in! If it doesn't fall within a week I'll get back in anyway. I can't wait until I'm approved for options trading so I can hedge against this sort of thing without dumping all my shares!

Now if I were following deminvest's "free stock strategy" I would have sold only enough shares to get back my initial investment, then kept the remaining shares forever, earning a nice dividend. I like his strategy because it helps you get out of a stock at a good time and not be too greedy. It's also got a mixture of rational trading and long-term holding that is very good.

I haven't come up with a rigorous exit strategy for my stocks yet so I'm just going by my instincts, which may of course be very dangerous.

The emergency fund

I've been reading a lot of personal finance blogs over the past few weeks and one of the most common recommendations is to establish an emergency fund. I don't have an emergency fund so I've been getting a little worried about it since I've seen how important it is to others.

On the other hand, I don't fully understand them yet. Most people seem to keep their emergency fund in a savings account, which is one of those "lessons from dad's generation" that I want to avoid. Savings accounts exist to make banks richer after all. If you get one of those high-interest saving accounts, things are a bit better... but still, your money is making more for the banks than for you.

I was thinking today on my drive home from work about what to do. One thought was to keep my emergency fund in the form of bonds in my stock account. Not even bonds, but a bond ETF like AGG or SHY. These funds invest in bonds so they're very very stable. If you look at AGG's chart, you'll see it's varied only a few percent in the last 5 years. In the meantime, it returns a 4.78% dividend, divided into monthly payments. This is better than most savings accounts, except the high-interest ones that can have 5% or even 5.05% (the highest I've seen). So why not do that? Well, the biggest advantage of having it in your stock trading account is equity. It's like a big chunk of gold sitting in your account giving it weight. One day you'll say, gee I want to buy a few shares of XYZ and hold onto them for a few days -- but I have no money! No problem, you can use margin to buy them, and the margin will be secured by your bonds.

An even better strategy is to say, ok I have $2000 in my bonds, so I'll get about $100 interest this year. Therefore I'll buy $100 of options in XYZ! Downside: you make nothing in interest (about the same as keeping your emergency fund in a major bank... I'm looking at you Wachovia!). Upside: you'll make more than 5% overall, maybe significantly more. That's why options are cool, if you use them responsibly. They let you limit your downside (you can only lose your small investment) while having an unlimited upside. Because of the massively high leverage that options provide, combining them with a backbone of bond funds for guaranteed income means that your account will basically never *lose* money but will generally do much better than 5%.

I've been reading about options for a while but have never actually bought or sold them. I am very excited about using that strategy, however.

If an emergency comes up (which should be very rare) you can get out of the bond fund pretty quickly since it's traded on the stock exchange (yay ETFs). From there, a lot of brokerages let you write checks against your account; some even have debit cards. To me, it's no more trouble than going to the bank in person to withdraw, or transferring your emergency fund from the savings account to your checking account online.

I don't think it's the accessibility that defines the emergency fund, but rather the guarantee of availability, which I think this strategy provides adequately.

Strange price movements

Today, AAV and GE both were up over 3% at one point. I thought, "Gee I should sell before they go down," but I stopped myself. Yes, you heard right. I'm already worried about stocks that I've owned for less than 3 months. Some patient investor I am! On the other hand, I did stop myself.

But what is patience? Must a patient man have slow reflexes? I think the most important quality of being a patient investor is to buy and sell based on reason and not on panic.

First of all, with AAV, if I'm up 35% or 38%, what difference does it make? Even if it goes down significantly and I'm only up 20%, is that so bad? I am happy with the stock at these levels and as long as I think AAV can successfully pay that dividend, I will stick with it. I know this will hurt me with AAV because I can see the speculation happening right before my eyes. There's no reason it went up so much in the past week. People are simply gambling that they will raise their dividend or be bought out. New investors are probably getting into the stock in the hopes that it reaches the $20 level it enjoyed not long ago. As a rational investor I want to take advantage of that speculation badly, but as a patient one I will just see what happens. I tell myself, I don't need to make every last dollar; I need to train myself to make good long-term decisions so that when I *do* have a lot of money in the stock market, I won't lose it all.

With GE it's much the same. I have no idea why it moved up today -- none of the recent news seems to justify it -- but I won't let it scare me into selling. I accept that it will probably go down again in a few days. I am in GE long term to make 1000%, not short term to make 3%. Hopefully!

Lessons from dad's generation

Well it's Father's Day today and of course that made me think about my dad. A lot of people (including me) look to their dads as an example of financial responsibility. He worked hard for his whole life and even though he started off without a whole lot, he's always provided for his family and made it comfortably into the middle class. A person like that can really change the course of a family line's destiny. If I had been born poor, would I have made it as far?

One of the bits of advice from his generation that I'm a bit conflicted about is with regard to debt. They don't like it. Maybe it's a result of *their* parents' generation growing up with things like WWI/II and the Great Depression or just a generally more conservative outlook. In any case, the people I'm talking about are characterized by: making extra payments on their mortgage; putting as much money down for a new house as possible; saving up cash in a special savings account to buy a car with a huge down payment; getting life insurance for their kids when they're like 5 years old.

I see the value in owning your own house, of course. But making extra payments on your mortgage is not good I think! It doesn't reduce your future monthly payment, it just makes the payments end more quickly. If you lose your job or otherwise can't make payments anymore, the bank doesn't say "Oh well you paid extra so we'll let it go for a few months!" For security it would be better to put whatever extra money you would pay towards your mortgage and put it in a high interest savings account. Then towards the end of your mortgage pay it off early if you really want.

With cars, if you can get a special APR from the manufacturer, I think the interest rate is too low to justify putting down more than the minimum. For instance, Honda is having a special right now for APRs from 2.9% to 4.9%, depending on the length of the loan. Hyundai is offering 1.9%. I'm looking for a new car right now so this is an important issue to me -- should I put $5000 down and get a 3 year loan, or put $2000 down with a 5 year loan and leave the remainder in AAV earning a 15% return? I'm leaning strongly toward the latter.

I feel the same way about a mortgage. Rather than pay $200 extra each month, I would stick that $200 in my IRA or regular stock trading account and watch it grow. When you're talking about mortgage time spans, money will REALLY grow. $200 a month has a good chance of being worth more than your entire house after 30 years. That way after 30 years I'll have the house paid off, plus a huge chunk of cash. If I paid $200 extra a month, I'd have the house paid off after maybe 25 years, but I'd have no extra cash. Right now I rent so it's more of a hypothetical issue, but I want to buy a house in the next few years. Wow, I just found a mortgage calculator which lets you test this hypothesis. Indeed, it looks like investing rather than prepaying is the way to go for the situations I tested. Another advantage I didn't even think of is when you prepay you lose a bit of the tax advantage a mortgage gives you, since the extra money you pay goes toward principal and not interest (so it's not tax deductible).

The issue of the down payment is as true of houses as of cars. Let's say you save up for a few years and you expect to get some cash from your parents (and inlaws if you're married). Let's say $15000 total. Then at the last second you say, hey I'm going to just put this money in the stock market for 30 years, and use no money down for the house. Ignoring the ethical implications of re-routing gifted money, what would happen? I don't know. I guess some banks require a minimum down payment so it's a non-issue. I talked to Bank of America recently about the mortgage process and they suggest about 5% down. Let's look at what would happen to the $15k being used on a $120k house in two ways: the minimum down payment and the maximum. We'll assume a 6.4% interest rate (the current average for a 30 year fixed loan according to a Google search I just did). 5% down would be $6k, so the loan amount would be $114k. The monthly payment would be $713.08 a month, for a total payment (after 360 months) of $256,758.80. (Yes, compounding sucks when it's working against you!) With your down payment, the total cost of the house is almost $263k.

In the meantime, the extra $9k that you didn't put towards the down payment has been growing... and growing... let's say at 10% a year (under the long-term average of the stock market, but oh well). We never added anything else and let's say we just put it in an index fund so we never had to manage it or worry about it. After 30 years you would have $157k! So since that money basically came from the house we'll say the net cost of the house is 263k - 157k = $106k. So we got a $120k house for only $106k! Plus the house has probably appreciated since then. Not bad.

Now if we took the entire $15k and put it towards the down payment, what would happen? The monthly payment would be $656.78 and the total payment would be $236k. Add in our down payment and the total cost of the house is... $251k!

So blowing all your cash on a down payment is not a good idea. In this case it more than doubled the net cost of the house. We've also ignored the increased tax deduction that the higher payment gives you, yet another benefit of the first scheme. (But we've also ignored the tax on the investment, which would probably make a huge difference unless it's in a tax-deferred account.)

What I really like about it is that if you lose your job after 10 years and have trouble finding another one for a while, you'll have a nice stockpile of $9k * 1.1^10 = $23k, which, even if it's in a tax deferred account and you pay a penalty to get it out, will definitely give you a nice cushion for those monthly payments.

The search for a discount broker

Summary: Scottrade is bad, Sharebuilder is great, TD Ameritrade is great

When I started investing this time around, things had changed significantly. I used to use Charles Schwab and they charged $29.99 per trade! Now I'm with Scottrade and I have to say... I'm not happy. $7 trades are nice, sure, but all too often their website is frozen for up to a minute. I really mean frozen, not just slow. You click on the "My Account" tab or what have you and it just sits there. No matter what you click, nothing happens. Then a minute or two later, everything works quickly. Their site is never slow, it's either frozen or fast. I've experienced it from multiple locations with multiple ISPs, so I'm pretty sure it's not a problem on my end. It's not a huge deal since I'm not a day trader, but I find it very annoying. I also found it annoying that I sent them a complaint and they never replied, even to say "Only you are having this problem" or something.

The other reason I don't like Scottrade is their lack of an automatic, commission-free, dividend reinvestment program. I was going to open up an IRA with them but that, in combination with one of my favorite stocks AAV, a dividend work horse, stopped me. In the early years, even low $7 trades are going to eat a big chunk out of my IRA's measly holdings. It would also mean that I would have to let dividends just sit there as cash, earning 0.1% interest (gee thanks Scottrade!), until next time I made a contribution. AND it would mean I would have to invest significant amounts of money in the same stocks every year, unless I wanted to forgo share growth in that company.

No, thanks. So I looked around for a more suitable broker. The two I came up with are TD Ameritrade and Sharebuilder. Sharebuilder is, of course, awesome. The $4 trades are pretty much unbeatable, unless you go with a shady startup like Zecco. One problem with their IRA accounts is they have a $25 maintenance fee, but at least you can have that paid from your linked banking account and not from your IRA. The other problem is the "real-time" selling price, which is about $20 -- a bit ridiculous in this day and age. Sure it encourages you to be a long-term investor, but come on. Sometimes you actually do need to sell.

So I went with TD Ameritrade. They have dividend reinvestment with fractional shares, pretty low prices, no maintenance fees, and (I think) better research tools than Sharebuilder OR Scottrade. In fact I like them so much more than Scottrade that I think I will soon transfer my regular account to them as well.