The Money Post

Wealth building, at least in theory, should be simple. Find a way to save money, invest that money, and give your nest egg time to grow. So why is it so difficult for some people?

Obviously everyone’s situation in life is different, but there are a few wealth building principles that almost everyone can use. So, if you are trying to get your finances in order, consider these tips.

Get your mind right

Changing the way you think about money can be tough. Most people think they need to make more money in order to gain financial security. Most of the time, making more money just leads to spending more money. What you need to do is figure out a way to live below your means.

Set goals

Whether the goal is small or large, short term or long term, crunch the numbers to understand what it will take. Having a set goal will help you get what you want.

Start now

The power of compound interest is something everyone should take advantage of. The earlier you start to save and invest, the more time your money will have to grow. This really is a case of time = money.

Pay yourself first

Take money out of your paychecks and have it deposited into some sort of savings or retirement account automatically. If you take out money for yourself first before you pay your bills, it will become a habit and you will be less likely to miss it. Regular, consistent savings contributions go a long way toward building a long-term nest egg.

Tackle your debt

The objective is to tackle debt, avoid paying fees, and lower your interest rates. First, arrange an automated monthly payment system to cover all of your minimum debt payments. Then, with any extra money you come into, pay the debt with the highest interest rate. Repeat as necessary until the debt is completely gone.

Keep track of your finances

Losing track of spent money is an all too common problem. When paying for things with cash, it’s easy to forget where the money was spent. Keeping receipts, or using some type of personal finance program to track your expenses, can be a great way to identify pricey habits.

In my efforts to learn everything possible regarding finance this year, I have come across some interesting articles. Since I have been rather busy lately, and unable to write as much as I would like, I thought I would share some of the articles I’ve read. I’ve found that quite often, the most interesting articles come from blogs. So here they are…

IRA Changes for 2008
If you are contributing to an IRA, or hope to in the near future, these are some changes you should know about.

How Do Finance Professors Invest?
Post about finance professors not following their own advice.

How to Remain Immune from Economic Downturn
Information about how, and where to invest during uncertain markets. A breakdown of the sectors to invest in, more information about things I brought up in my last post.

How to Make $3 Billion a Year or More
A post breaking down the almost ridiculous amount of money hedge-funder John Paulson made last year.

Take a second job or build a side business?
The reasoning for starting a side business rather than looking for a second job to supplement your income.

What Are Debt Snowballs Made Of? Debt Snowflakes!
An interesting read about debt, and how to pay it off. Sometimes it’s about more than just numbers.

Is the U.S. heading for a recession?

It would seem if you’ve been watching the markets, news networks, or reading the business section, the answer would be a resounding yes. In my daily reading, I have come across two articles that represent either side of the argument.

A bad market? You ain’t seen nothin’
A worldwide decline may be harsher, longer and deeper than expected. Here’s why financials may soon be in even more trouble.

The Economy Is Fine (Really)
An article pointing out the true strength of the U.S. financial system.

While I think the second article made some great points, I’m a little more pessimistic. This brings me to a question I’ve been hearing a lot lately… “Where should I put my money now when the market is so volatile?”

Obviously your investing plan is going to differ from others depending on your age, how you handle risk, and the amount of money you have invested. Regardless, if you are looking to stay in the stock market rather than CDs, bonds, etc., the recent pullback has led to some good buying opportunities. There are a few types of stocks that generally hold their value and outperform during recessions. Look for best of breed stocks in…

• Consumer Staples: Things like utilities, health care, food/beverages, household products. These types of stocks will generally hold up well because they offer products people will always need.
• Dividend Paying Stocks: Look for companies that have paid a consistant dividend in the past.
• International Exposure: U.S. companies with large international exposure, or companies in overseas markets can benefit from a weak dollar and aren’t as likely to be affected during a recession.

Like I said, your investing plan is probably going to be different from your neighbors. If you do your research, set goals, you’ll find the right investment plan for you. Just remember to think long term and don’t panic about the day-to-day fluctuations of the market.

A dividend reinvestment plan (DRIP) is an equity investment option offered directly from the underlying company. The investor does not receive quarterly dividends directly as cash; instead, the investor’s dividends are directly reinvested in the underlying equity.

This allows the investment return from dividends to be immediately invested for the purpose of price appreciation and compounding, without incurring brokerage fees or waiting to accumulate enough cash for a full share of stock. Some DRIPs are free of charge for participants while others do charge fees and/or proportional commissions.

DRIPs have become popular means of investment for a wide variety of investors as they enable them to effectively take advantage of dollar cost averaging with income in the form of corporate dividends that the company is paying out. Some of the other advantages are…

• You don’t need a large amount of money to start.
• Most companies allow investors to purchase additional shares through a dividend reinvestment plan for nominal fees — or often no fee at all.
• Many companies have DRIPs that allow investors to purchase stock at a discount to the current market price. Some as much as 10%.
• It’s automatic, and allows investors to have a more long term investment view.

Why am I bringing up dividend reinvestment plans?

Right now is a great time for value investors to go bargain shopping. The markets have dropped considerably in a short amount of time, and it looks as though the trend will continue. In times of uncertainty, dividend paying stocks generally hold up better than those that don’t. So if you were to buy stock via a DRIP right now, you can dollar cost average into an uncertain market at good prices.

I was reading this article from CNN Money that I found rather interesting. The article is the answer to a question a reader had submitted. The question was “I have $600K in a money market that I plan to invest in Vanguard index funds. Should I put it in at once or dollar cost average in increments over a certain period of time?”

Fist of all, what is dollar cost averaging?

Dollar cost averaging is an investing technique intended to reduce exposure to risk associated with making a single large purchase. The idea is to spend a fixed dollar amount at regular intervals on a particular investment regardless of the share price. In this way, more shares are purchased when prices are low and fewer shares are bought when prices are high. The idea of dollar cost averaging is to guard against losing value shortly after making an investment.

Dollar cost averaging has been widely criticized by economists and academic finance researchers as more of a marketing gimmick than a sound investment strategy (a way to ease cautious investors into a market, investing more over time than they would do all at once). Numerous studies of real market performance, models, and theoretical analysis of the strategy have shown that in addition to having the admitted lower overall returns, dollar cost averaging does not even meaningfully reduce risk when compared to other strategies, even including a completely random investment strategy.

In purely mathematical terms, dollar cost averaging doesn’t seem to make much sense. However, in the article the author makes the point that many people don’t view their lives mathematically. He gives this example.

If you had put $600,000 in the market in March of 2000, it would have taken nearly a 50 percent hit two and a half years later. And if you were like most investors, the pain of this loss would have compelled you to sell long before the recovery began. Had you not sold, you would likely have seen your global set of index funds delivering some pretty decent returns over the total period.

The author makes the point that when investing a large sum of money, there are lots of psychological factors at work. It’s important to get things right when it comes to investing. The more inconsistent we are, the more we tend to time the market wrong. So if you can’t be right, at least be consistent.

Most of the time when I make a purchase, I use my debit card over my credit card. I don’t usually carry much cash, but like the idea of spending money I have rather than racking up a balance to pay later. Lately however, it has been brought to my attention that using a credit card probably makes more sense. Here are some of the reasons why to use your credit card over your debit card.

•  Not Associated with Your Bank Account. When you make a transaction with your credit card, the funds paying for the transaction are that of a lender, not your personal account. If someone get ahold of your card and starts shopping, your personal banking accounts aren’t affected.
• Liability for Unauthorized Transactions. If your card is lost or stolen and somebody racks up big charges, you don’t want to be held liable. With a credit card, you are only liable for $50. Although, you should report it immediately, if you do not notice it for 90 days or more, you still are only liable for $50, unlike a debit card.
• Liability in Disputes. Making a purchase with your credit card affords you the opportunity to dispute a transaction if it goes sour. If something goes wrong, you can simply contact your credit card company and put a hold on payment. You will then follow a dispute process, but you won’t be liable for the transaction until everything is settled.
• Bounced checks. Debit card users are hit with more fees — a lot more. Many consumers don’t realize that a bank will approve debit transactions even if they have insufficient funds in their account. Then the bank tacks on a $35 overdraft fee, which doesn’t become apparent until you get your monthly statement.
• Immediate withdrawal of funds. Smart use of a credit card is like getting a free loan for a month, whereas using a debit card means the money exits your bank account right away. Using a credit card lets you keep your cash in an interest-bearing account for an extra 30 days. Over a long period of time that can add up.
• Rewards programs. Most programs tend to be more generous to credit card holders than debit card uses. Whether it’s free travel, cash back or any other program, credit cards have better offers.

Obviously if you don’t qualify for a low interest credit card, or you have issues with spending or excess debt, using a debit card may be the way to go.