Taking Stock of Your Financial Future, Part 1

Though it takes time to become a seasoned investor, it’s never been easier to become a successful investor. Thanks to falling transaction costs and an explosion in the number of web sites and online communities that are devoted to helping ordinary people make informed investment choices, the traditionally lopsided playing field between bark-a-lounger capitalists and Wall Street’s Big-Whigs has never been more level. To be sure, modern day circumstances have opened up whole new vistas of economic opportunity for people who don't sit on boards, own a mansion, or commute to work in a Gulfstream jet. Computers with blinking lights, once the stuff of campy futuristic science-fiction movies, now rank right up there with the telephone and the microwave as indispensable and commonly owned household appliances. In this bold new financial era--where knowledge is arguably the most valuable form of currency--the widespread availability of financial data (on demand and at little or no cost) is a real game-changer.

Contrast current economic reality with the financial dark ages of the early 1990s--or, worse yet, late 1980s. Back then, obtaining actionable investment data wasn't simple or easy. Moreover, putting this information to work in the stock market required knowing the right people, paying exorbitant up-front fees and waiting hours (sometimes days) for requested stock market transactions to be executed. A decade or so ago, the many spring-loaded gears and cogs that kept the stock market's machinery churning were manually cranked by an unseen army of brokers, floor traders and many other specialists. Nowadays, stocks and the companies they represent can be bought or sold on-the-fly in a matter of seconds with the aid of an Internet enabled mobile phone. Though the old financial gaurd certainly had a good run, its convoluted architecture prevented all but the wealthiest of Americans from accessing the world's stock markets. Clearly, times have changed--and mostly for the better. The old financial regime has been gruffly tossed out on its ear and replaced with a newer and far more inclusive financial order, one that's highly attuned to the needs of a much larger and more demanding constituency: The general public.

In this day and age, when it comes to making informed investment choices, the analytical tools that were once accessible to a tiny and extremely affluent minority of well-heeled financial elites are now available to anyone who has a personal computer, a basic understanding of investment theory, a brokerage account and an Internet connection. But how did this unlikely turn of events come to pass? Why did the old financial guard (which profited handsomely from its role intermediating stock market transactions) cede market share to competitors and ultimately content itself with a shrinking slice of a robust and growing economic pie? To be sure, this unlikely surrender of power and influence didn’t happen voluntarily or overnight. Intensifying competition within the financial sector has gradually eliminated costlier and less efficient firms. The upshot is that consumer friendly forces have, in a remarkably short period of time, transformed how capital markets function. Regardless of their economic status, people can now research and select their own investments. Suddenly, the taxpaying public is less reliant on the advice and hand holding of licensed brokers and alleged "industry experts" when it comes to managing their brokerage and retirement account assets. The Internet, which makes accurate and timely investment information available to all, has been a powerful driving force behind this revolutionary economic change. Tom Friedman, New York Times columnist and Pulitzer Prize winning author of The Lexus and the Olive Tree, refers to this wonderful new phenomenon as the democratization of finance.

Yahoo! Finance, MSN Money, and Morningstar are notable byproducts of the investor-friendly times in which we live; and they offer a tantalizing glimpse of what's yet to come. The torrential user traffic that these and other financial sites generate is a stirring testament to the public's growing appetite for all manner of financial content. Want to know how a particular stock is doing? Simply key in its corresponding ticker symbol, and, viola, you can view late-breaking business headlines, see what financial analysts are saying about it, scrutinize every aspect of its financial performance and examine its stock price over any specified interval of time. No-doubt, having all of this information at your fingertips is empowering. Through the medium of technology and the lens of financial supermarkets, consumers can put their money to work for them in unprecedented ways. For many Americans, it seems that the level of interest and enthusiasm that was once reserved for the sports section of their local newspaper has slowly migrated over to the business section. Because millions of people are directly or indirectly participating in the stock market through employer sponsored pensions, 401K plans, brokerage accounts, IRAs, 529 college savings plans and medical expense savings accounts, they’re as likely to be seen cheering the performance of their investments as they are to root for their favorite sports home team(s). As financial assets like stocks, bonds, commodities and real estate (Yes, even real-estate. To understand why real-estate is as easily bought with a brokerage account as it is with the costly aid of appraisers, real-estate agents and bankers, read What’s in a REIT? & REITs and Investment Property.) become easier to acquire, people from all walks of life can afford to accumulate them.

To help novice investors successfully navigate this new and mostly unfamliar investment landscape, companies like Vanguard, Fidelity and Morningstar offer a wealth of educational content, interactive tools, and a wide range of low-cost investment products to choose from. Mutual funds, exchange traded funds and life-cycle funds are fantastic options for those looking to participate in the stock market but avoid having to expend the time and energy to carefully research, select and ultimately manage their own investment holdings. Nowadays, beginning investors who're armed with only a basic grasp of the stock market and how it works can easily and inexpensively create a well diversified portfolio; something which, a mere twenty years ago, was practically impossible to do. With mutual funds, investors can hitch the financial performance of their investment wagons to the best and brightest minds on Wall Street. Throw in the gale-force tailwind of tax-deferred and even tax-free growth (which can be enjoyed by establishing a 401K or Roth IRA) and the long-term benefits of investing becomes downright appealing.

Capitalizing on the juicy opportunities that these newly favorable circumstances present, however, is another matter entirely. Cashing in on capitalism requires knowing a thing or two about what stocks (whose multi-decade returns easily beat bonds, real estate, cash and commodities) are and how they work. Stocks are widely followed and closely discussed in the business community and financial press because they enable anyone with a brokerage account and a few bucks to pick-and-choose from a dazzling array of proven, and, in some cases, obscenely profitable companies to own. You see, stockholders are legally entitled to their fair share of a company’s current and future profits, something which, in turn, is generally well supported by its operational cash flows, the performance of its management, and the ongoing contributions that are made by its many employees. What's more, through voting rights, stockholders can influence how the companies they own are managed. Ultimately, though, it's the alluring prospect of a hefty return on one's money that attracts people to the stock market. Interestingly enough, there's a strong historical basis for optimism in this respect. Investor Ben Graham once noted that "In the short-term, stocks are a voting machine but in the long-term they're a weighing machine." In other words, one's view of stocks and the market as a whole is strongly influenced by the timescale in which their performance is evaluated. On a daily, weekly or even monthly basis, stock prices are like a popularity contest in that valuations are given to wild short-term fluctuations. Over time, however, this sort of erratic activity gradually fades and a company's stock price begins to more accurately reflect the quality of its long-term economic performance. It's through these dramatic differences in timescale and perspective that a voting machine becomes a weighing machine.

Luckily, investors don't have to fuss over cherry picking good investments and avoiding bad ones. with blunt force instruments like mutual and exchange traded funds, hundreds or even thousands of individual investments can be acquired in a single transaction. To be sure, the old adage about not putting too many of one's investment eggs in one basket is sage advice that's certainly well-worth heeding. Sprinkling money over various asset classes (namely, commodities, real estate, stocks, cash and bonds) is an effective way to reduce risk and optimize returns over the longer term. Imagine how foolish you’d have felt if, back in the day, you staked the entirety of your life savings on a single holding like, say, AIG, Enron, GM or WorldCom. No-load and low-cost mutual funds, though certainly nice, aren’t necessarily your best investment bet either. Nobel laureate William Sharpe calls indexing (that is, buying low cost exchange traded funds) “a dull, boring way to become a better investor than many of your friends.” Index investing offers instant diversification and cost-efficient exposure to almost any conceivable sector and theme. ETF’s can zero in with laser-like precision on companies of a certain size or even those that operate in specific sectors of our economy like health-care (Johnson & Johnson and Pfizer), technology (Microsoft, Intel and IBM), the energy complex (Chevron and Exxon), consumer staples (Procter & Gamble), or banking (Bank of a America). More importantly, since money and the desire to make it has become an increasingly global phenomenon, ordinary investors can lace up their walking shoes and dispatch their hard-earned capital to the furthest regions of the earth in search of remarkable returns. Exciting stuff—no?

This is all well and good, of course, but the likelihood of future appreciation in the value of one’s stock holdings is only part of the reason why stocks are worth owning. Dividends, which are periodic cash disbursements that some companies pay directly to their shareholders, are another way to cash in on stocks. Though, at first glance, dividends might seem downright puny, over time they can add up to a huge pile of money. According to Standard and Poor's Howard Silverblatt, from 1926 through March 2009, reinvested dividends accounted for a whopping 44% of the S&P 500's 9.5% annualized gains. Of course, not all stocks pay a dividend, but many do. And once a company establishes a consistent track record of paying them, management is understandably loath to cut or eliminate them for fear of alienating current and prospective shareholders. Moreover, as a company’s financial outlook brightens, its dividend payout to shareholders is likely to increase at a rate that handily beats inflation. Dividend payments are usually made throughout the year and the amount of a company's disbursement typically ranges from one-to-five percent of a stock's purchase price. This compares rather favorably to the anemic returns that are offered by money market savings accounts. Dividends are dandy for another reason as well. Thanks to the passage of investor friendly tax legislation long ago by plutocrats in Congress, qualified dividends are subject to a skimpy tax rate of just 15%. Is this good? Well, to put this in perspective, consider this: a dollar of earned income (that is, wages) will, after taxes (and this assumes you're in the 33% combined State-Federal tax bracket), put 67 cents in your pocket. However, if that same dollar were earned as dividend income instead, it would be like receiving an immediate and sizeable 27% pay increase. Now, a few measly pennies difference one way or another may not thrill you, but, to reframe the issue, which would you rather have, 85% or 67% of your income?

Remarkably, though stocks have proven to be fantastic wealth-building vehicles over time, lots of people are skittish about owning them. Some are put-off by their wild volatility while others are inexplicably drawn to them by the alluring prospect of higher returns. To the uninitiated, the stock market is an understandably confusing place. For starters, there’s all that pretentious jargon to think about. Things like like profit margins, price-to-earning ratios, market capitalizations and debt-to-equity ratios are, for the most part, a sure-fire cure for insomnia. And it doesn't seem to help matters that these unstable concepts tie to numbers that are constantly changing. Considering all of the dynamic variables that are in play with stocks and their manic price swings, there’s justifiable cause for apprehension on the part of a non-investor.

Ironically, though the idea of spoon feeding money into the stock market on a regular basis might seem scary; investing successfully over time isn’t. In fact, given the vast arsenal of tools that are available, investing—and doing it right—isn’t that hard. Once you're familiar with the stock market's buoyant long-term record and are comfortable with its erratic short-term performance, you’ll someday look back and marvel at what all the initial fuss and consternation was about. Done right, investing occurs automatically, as if on autopilot. Oppinions to the contrary notwithstanding, investing isn’t particularly sexy or exciting. In fact, it's a little boring; sort of like watching paint dry or bread toast. Over one or more decades, however, investing perks up and becomes a lot more exciting. Fortunately, cashing-in on capitalism doesn’t require much in the way of shrewd analytical genius. What you do need is tons of patience, a healthy dollop of initiative and a cast-iron stomach in the face of volatility. On a deeply fundamental level, investing well over a very long period of time requires only a few things: 1) a basic understanding of how stocks, bonds, real estate and commodities work, and 2) the intestinal fortitude to establish and consistently fund a diversified investment strategy—in good times and bad.

Now, despite what the talking heads on CNBC would have you believe—what with their intimidating power ties, vaguely authoritative demeanors and neatly quaffed hair—you needn't be Gordon Gecko (that swaggering cocksure money manager portrayed by Michael Douglas in the 1980's movie Wall Street) to do well in the stock market. Resist the urge to swing for the fences. Don’t be that swashbuckling yahoo who incautiously puts everything on one or even a dozen stock bets because they’re the toast of tinsel town and everybody in the business world is momentarily enamored with them. Beware silver tongued pitchmen touting “can’t-miss” investment advice. Want a stock tip? Don’t listen to stock tips... First off, the well-paid hucksters out there who hawk advice don’t know you. Secondly, they aren’t paid to champion your interests. More often than not, they've got an entirely different agenda in mind and are looking to cash-in on the market activity that their public comments will generate. The takeaway point? Trust no one—except maybe yourself; and even then only after you’ve done your homework, have accumulated emergency savings equal to three-to-six months worth of current living expenses, and are absolutely clear on that fact that, come hell or high water, the money your're investing won't be touched for at least ten years.

As an investor, you shouldn’t even think about owning individual stocks; why should you when you can so easily and inexpensively create a broadly diversified portfolio? Content yourself with getting on first base. Be patient, sit back, and let time do its thing. Of course, when you invest, the money you're risking is yours. Because nobody will take your financial welfare to heart as intensely as you; you’ll suffer the greatest losses if you fail and reap the greatest rewards if you succeed. Once you’ve figured this out, and are acquainted with the basics of investing (the library's a good place to jump-start this process--Ron Muhlenkamp's Harvesting Profits is a decent read) you can safely follow your own instincts. Trust me, this is a better long-term wealth-building recipe than lazily relying on the received kindness and wisdom of strangers.

The stock market is an oft used term that, I fear, isn't particularly well understood by the average investor. To dispel any confusion that may exist on this topic, it's worth examining what, exactly, the stock market is. In brief, the stock market is very much a living-breathing thing whose moment-to-moment behavior is driven by a bewildering assortment of mostly unrelated and largely unpredictable factors. Of these, two of the most important are investors’ shifty perceptions of stocks’ present and future prospects and, from a broader 30,000 foot level, the overall health of the economies in which companies operate. Basically, it comes down to this: for every seller of a stock there must be a buyer—and vice versa. When you multiply this fairly straightforward notion by the trillions of dollars that are sloshing around on the world’s bourses, it's readily apparent why the term “stock market" is so gosh darned complex. But suppose we swept all of this mind boggling complexity aside and reached for a simpler explanation for the stock market’s day-to-day performance. Generally speaking, if the total trading activity associated with those who're buying stocks exceeds the sell side activity, market indexes (the S&P 500 and Dow Jones Industrial Average are notable examples) and the share prices of most companies will rise. Conversely, if net trading activity overwhelmingly favors sellers over buyers, then the process works in reverse and valuations fall. It’s both that simple and that complex. And here's the thing: when you consider the unique motivations of each market participant and the unique underlying circumstances that prompt so many individuals and automated trading program to buy or sell stock, the sum total of this activity cannot be neatly or even accurately compressed into a summary of that day's business headline news. Though, to be sure, this is precisely what market gurus on CNBC and our chatterbox media would have you believe. Ultimately, the stock market is like a referee; it doesn’t offer an explanation for its decisions and its verdict is all that counts. Barron's columnist Michael Santoli somewhat humorously likens the stock market to "an ongoing argument over the future, staged over six-and-a-half hours each weekday, among people who can't even agree on what's most important to be arguing about."

Usually, when people think about investing, it’s within the context of achieving distant financial goals; the kind that seem so vanishingly remote that viewing them up-close would require the use of sophisticated equipment; perhaps something along the lines of a tricked-out Hubble telescope. Rightly or wrongly, for many Americans, the economic burdens of retirement seem to be light-years away. Unfortunately, young-adults and newly minted professionals are especially prone to this virulent strain of fiscal myopia. And there's plenty of research to bear this out. According to a study by Vanguard, less than half (42%) of employees between the ages of 25 and 34 participate in 401(k) plans. It appears that young people aren't terribly concerned about how they’ll make ends meet in retirement. This is a costly oversight because, though bankrolling their golden years may not rank highly among their day-to-day priorities, there are so many reasons why it should.

For starters, unlike life’s other big-ticket purchases--like, say, for a house or a car--banks don’t offer retirement financing. And sadly, this may not change anytime soon. Of course, students and newly minted professionals will (assuming all goes well) age. Chances are, at some point in the not-too-distant future, they'll want to bid adieu to the grueling monotony of the work-a-day-world. Although teens and twentysomethings may not be aware of it, accumulating enough wealth to make this desirable life choice a viable option is a truly humongous challenge. Incubating and ultimately hatching the sort of nest-egg that they will need to support an attractive retirement lifestyle requires unwavering commitment, plenty of economic sacrifice, and more than a few decades of conscientious planning. For reasons that will be glaringly apparent to a good many young people half a century or so from now, they can't afford to snooze through their day-to-day financial lives only to awaken when they're middle-aged to the realization that they should've begun aggressively saving and planning for their golden years in their early 20s. The takeaway point: if adolescents don't discover this untill they're old enough to collect social security (whatever meager sum that may then be) they'll be greatly aggrieved to discover that they've squandered a fair amount of their greatest asset: the wealth building power of time. You see, when one-third to one-half of their economically productive years are in the rear-view mirror, they'll be in an unenviable financial bind. As any money manager worth his or her salt will happily tell you, at a certain point in the wealth building game, it's very difficult to compensate for having not established sound fiscal habits earlier in life. The gravity of this point is perhaps best illustrated with actual numbers. Over the last 100 years or so, money in the stock market has grown at an average rate of about 10% per year. Assuming this return is bankable in the future, how much money must a 20 year-old save every month in order to accumulate $100,000 by age 65? Answer: less than ten bucks. A 50 year-old, however, must set aside at least $239 per month to achieve the same saving goal by age 65. To be sure, the unappetizing prospect of grinding poverty in old age doesn’t elicit much cheer. Nonetheless, given our society’s increasingly prominent ownership bias, this appears to be the default life path for those who don’t aggressively plan against it. Because accumulating enough wealth for retirement--even for those who're blessed with uninterrupted employment, a multi-decade investment time horizon and generally favorable market conditions--is a colossal challenge, this process is best begun as soon as possible.

For adolescents who aspire to a ritzy retirement, an inability to simply borrow the cash necessary to support their future lifestyle requirements is understandably problematic. But, as troubling as this may be, it so happens that there are other equally worrisome factors in play. As many people who're nearing retirement age today will no-doubt loudly attest, simply having enough money on the sidelines to cover life's basic necessities--that is, keeping food on the table, a car on the road and a roof overhead--isn’t necessarily their most pressing economic concern. Inflation, which steadily erodes the purchasing power of a buck (and, by extension, the value of one's life savings) is yet another wild-card in the awkward financial calculus of everyday life. Other nettlesome factors include the buoyant trajectory of local, state and federal taxe rates and steadily rising health-care costs. Collectively, these factors raise the bar a good fifteen feet when it comes to the level of financial acumen young people will need to successfully pole-vault their way over the retirement hurdle 50 years from now.

Though many teens and twentysomethings will cavalierly dismiss the looming enormity of these financial concerns, the greater irony is that many of them will be around to blow out the candles on their 100th birthday cakes. Thanks to rising life expectancies, it seems likely that future generations of retirees will spend as much as a third of their lives in retirement. From a social and economic standpoint, this is unprecedented. In the 1800s, people didn't worry about squirelling away enough moolah for retirement because, curiously enough, life-spans and work-spans were more-or-less one and the same. Nowadays, many people have rosier expectations for their sunset years. But, just as the question of retirement and how to pay for it looms more menacingly on the minds of a graying U.S. population, the government and private sectors have indiscreetly begun to tip-toe away from their grandiose and once affordable socio-economic commitments. The rapid obscolescence of employer-sponsored pensions (according to the Center of Retirement Research, among workers with retirement plans, the percentage of those covered by pensions has fallen sharply from 83% to 30% from 1980 to 2006) coincides rather suspiciously with workers' increasing reliance on tax advantaged and self-funded retirement, education and healthcare savings accounts. Despite a deafening chorus of concern about the post-boomer solvency of pay-as-you go entitlement schemes like Social Security, Medicare and Medicaid, people who're approaching retirement todayare likely to receive much of the economic support that politicians have generously promised them over the years. Subsequent generations of retirees, however, will need to fundamentally rethink how they'll fund their golden years. To which, outraged tax-payers might angrily retort “But how could this possibly be?” Well, interestingly enough, the answer has everything to do with people—lots of them.

In 1930, when the average life expectancy in the U.S. was 60, the number of people age 65 and older comprised a mere 5.4% of the U.S.'s population. Nowadays, this figure stands at 13%, and is swiftly rising. Demographers refer to baby-boomers (the children of World War II veterans born between 1946 and 1964) as the “pig-in-a-python” because their numbers, when plotted alongside those of neighboring generations, produce a noticeable bulge in an otherwise flat population distribution. In 1935, when Social Security became law of the land, its future solvency seemed ironclad because the ratio of workers paying into the system vs. those that drew against it was a lofty 40 to 1. In 2030, this ratio is expected to be 2 to 1. Though some might minimize the severity of this economic problem, in one worrisome sense, they're absolutely right to do so because Social Security is the least of our country's fiscal woes. And a former high-ranking government economist plainly agrees; in a March 2007 appearance on 60 Minutes, David Walker, the United States’ former Comptroller General—a.k.a., Uncle Sam’s chief accountant—warned that the fiscal problems facing Medicare and Medicaid are roughly five times greater than those facing Social Security. Esteemed number crunchers at the Congressional Budget Office predict that, by 2026, Social Security and Medicare obligations will add another $6.6 trillion to our already sizeable budget deficit. If the New Deal era trumpeted by FDR in the wake of the Great Depression elevated living standards for all U.S. citizens through a widespread sharing of social costs, then it seems that the New-New Deal era which has supplanted it—characterized by our society's increasing reliance on tax-advantaged and mostly self funded savings accounts—denotes a wholesale ripping up of a longstanding social contract. Eventually, Baby-Boomers will exit the workforce, and, as they do, it's a good bet that they'll collect healthcare and social security benefits. Though politicians and economists often quibble about the long-term financial implications, it appears that the cost of honoring the entitlement promises that have been made to aging boomers will force our government’s already leveraged financial house into an ever-worsening state of fiscal hawk.

To which, social safety-netters might angrily retort, “But, aren’t U.S. government finances prudently managed?” Swelling budget, current account and trade deficits suggest otherwise. In answer to the straightforward question, “Is the U.S. bankrupt?” Lawrence Kotlikoff, an economics professor at Boston University, dutifully crunched the numbers and answers in the affirmative. In short, he concludes: “The way to judge a nation’s solvency isn’t to measure its’ fiscal inflows and outflows from one year to the next—as our government does it—but rather, to examine the lifetime fiscal burdens of current and future generations. Based on this broadened criterion, the current U.S. fiscal gap is roughly $65.9 trillion—more than five times U.S. GDP and almost twice our national wealth.” Somewhat helpfully, Kotlikoff goes on to suggest that “eliminating the current federal budget and trade deficits would require an immediate doubling of personal and corporate income taxes, or a 66% reduction in Social Security and Medicare benefits.”

The writing, as they say, is on the wall; and the message is clear as a liberty bell struck by a sledge hammer. What are the economic tea-leaves whispering to generations X, Y, and Z? Welcome to the ownership society. Of course, this isn’t a well-kept secret. Uncle Sam, who long ago foresaw the potential for financial hardship for millions of working class Americans, took decisive action long ago by generously rewiring the U.S. tax code and offering tax-deferred (and, get this, even tax-free) retirement investment accounts to those whose incomes fall beneath certain arbitrary limits. The good news is that these wealth building tools do indeed offer conscientious savers a tremendous lifelong economic stimulus. The bad news, however, is that they only benefit those who bother to use them.