Posted by Robert on April 23, 2012
I visited the grade 9 class again to continue the stock market investing lessons. The teacher is always apologetic that I have to put up with the kids, and she doesn’t seem to believe that I’m enjoying teaching them. The hardest part, I told her, was trying to boil down the wisdom that I’ve gained over seven years of work into three one-hour lessons. I may be flattering myself a little bit, but that’s what it feels like. To the kids, it may just feel like drinking from a fire hose.
This week, we looked more closely at how to choose stocks to invest in, and how to trade them (in the simulation software). There definitely wasn’t enough time, and that’s my excuse if it seems a little incoherent here. I told the story of the first time I bought and sold stocks, based on stories in the news. The benefit is that it works well over the short term (a couple months), but over the longer term, they tend to revert to the mean. Besides that, investing in what’s in the news leaves the outcome to luck. So I presented three strategies that can be used with a stock screener.
I presented two stock screeners. There are others, and any will do. Stockhouse.com (under Market Info in the menu) used to be really easy to use, but they’ve expanded it. It’s a little less clear, now, but it produces good results. Morningstar.ca has a good screener, but I don’t recall if it will do US and Cdn stocks at once. If you’re looking for new companies to consider investing in, where do you start? That depends on your style.
Value. Are you the type of person who likes to buy things on sale? Stocks go on sale. The relative cost of a stock can be measured by P/E, the price to earnings ratio. This compares the earnings (per share) of the company to the price (per share) that people are willing to pay. A higher P/E is a company that people are paying a higher price for in the market (relative to the profitability of the company), and a lower P/E is similar to a sale. This is a really good strategy for the long-term investor who believes their companies will come back into favour. Filter on P/E (lowest to highest).
Growth. Are you the type of person who likes to be on the cutting edge? Some stocks are expensive precisely because their future prospects are so bright. If next year’s earnings will be double this year’s, and then double again the following year, the price today might appear high. Earnings that are growing steadily year-by-year should increase the value of the company (proportionately) over time. Filter on Earnings growth (highest to lowest).
Income. Do you depend on your portfolio for income? Companies, especially larger, more stable companies, may choose to use their profits to pay a dividend instead of retaining the earnings for reinvestment. Many companies will pay out 50-60% of their profits, although former income trusts may pay closer to 100% of profits (which leaves little room for error). For these companies, it’s good to look at payout ratios and debt levels to be relatively confident in the ability of the company to maintain dividends.
There’s no reason an investor couldn’t mix these strategies. Growth and income are sort of mutually exclusive, since profits can either be used to pay dividends, or reinvest in growing the company. Value and Income combine nicely, since the yield increases (as a percentage) when the share price falls. Value and Growth can combine (somewhat) to form Growth at a Reasonable Price.
My personal strategy is a value + income strategy. What strategy do you favour? Do you have difficulty sticking to a single strategy? Do you use a journal to reflect on why trading decisions are successful or not?
Posted by Tim Stobbs on April 18, 2012
If you have been reading this blog for a while, you already likely know that I do change my mind about things and often shift plans around as needed. Basically in a nut shell, I’m flexible and I value that. As such, I made the decision to pay off my mortgage faster than I needed even if I could have made more money investing. I valued the flexibility of that plan since not having that payment allows me more options in life and it starting to look like that was a very good idea.
As an example, recently a family member dropped a bomb shell of news on us which involved her moving across the country to the east coast. So know we are in the odd position of having a place to stay and an excuse to take a vacation out east next summer instead of a few more years down the road after the kitchen renovation was complete. So right now we are wondering about planning a three or four week trip to explore New Brunswick, Nova Scotia, PEI and Newfoundland in 2013. This won’t be cheap and will consume a lot of our time, but since we can afford it along with our other plans like a kitchen renovation we will likely still do both.
This is merely an example of the flexibility that I desire so much in life. Without the obligation of debt I’m free to pursue these opportunities that come up in life. While the trip was a personal example, this also applies to investments or business ventures. After all, having cash handy is why I could buy some of my investments and end up with a abnormally high yield in my TFSA account (which is about 12% based on the original contribution amount).
So with others might regret opportunities that pass them by due to a lack of cash I’m starting to seize the day a bit more. While yes if I make too many of these personal choices, it might cost me some time on retirement date. I’m not worried, as I know you have to enjoy the journey just as much as the destination or why bother taking the trip?
So do you often seize opportunities in life? If not, what holds you back?
Posted by Robert on April 16, 2012
I visited the grade 9 business class for our second lesson. I chose to focus on the time value of money. It’s a pretty simple concept. Would you rather have $1.00 today, or $1.00 next month? Most people will answer “today.” What if I offer you $1.00 today or $2.00 next month? The class was split on that question. My guess is that the amount was too small ($1.00 to wait 30 days) to sway some of the students. But it teaches that the time value of money is subjective and isn’t equivalent for everyone.
Financial planning has been described as “a bunch of formulas”. It seems a little dismissive, but it may also overstate the complexity. Most of financial planning can be summed up as the (judicious) use of the time value of money (TMV) calculation. I presented it to the students as Future Value = F( Rate, Number of PERiods, PayMenT, Present Value). In English, the future value can be calculated as a function of the interest rate, the amount of time, the payments (in or out) and the present value. In Excel (or other spreadsheet, I like LibreOffice), we can use the =FV() function to find out how investments or debt will grow over time.
Here are the two practice questions I gave the students. They seemed obvious to me, but I’m very familiar with this calculation. 1. If you start at age 25 with $0, earning 7% per year, how much do you have to save each year to earn $1 million by age 55? In this case, we are looking for the payment, how much we need to save. That means we need to use =PMT() in Excel (which is why I used the funny capitalization above). Simply enter the rate, years, starting amount and ending amount like this: =PMT(7%, 30, 0, $1000000) and press enter. Try it, and find out how much you’d need to save per year. I’ll give the answer at the end.
2. If your aunt gives you $5,000 at age 18, and you invest it at 10% guaranteed (however unlikely), how much will you have by age 65? We’re trying to find the future value, so we’ll use =FV(). This is a little trickier because it’s missing a piece of information: how much is the payment? Not adding to the account means the payment is $0. Try to figure this one out in Excel before I give you the formula. When you see the answer, you’ll see why I’ve been tempted to do this for my kids and nieces and nephews. =FV(10%, 47, 0, 5000) If the answer comes out negative, that’s normal and you can ignore it (or use -5000 for the present value).
The next three questions are related. 1. If you save $200 a month, what rate do you need to earn to save up $5,000 after 24 months for a vacation? The tricky part here is that the payment is given per month, so the result will be an interest rate that’s also per month. =Rate(24,-200,0,5000)*12 I multiply by 12 to get the annual rate. The answer is 4.24%. Note that if a person saves $200 per month for 24 months, they’ve saved $4800. If they earn 4.24%, they can spend $5,000 cash on their vacation.
2. If you pay off a $5,000 vacation over 24 months at 7%, how much did you pay in total? Again, the payments are made monthly, so we need to adjust the interest rate to monthly (7%/12) and find the payments, then multiply by 24 to find the total amount. =PMT(7%/12,24,5000,0)*24 Notice that we started with $5000 and paid it down to 0$. The total amount paid was $5,372.71, much more costly than paying cash.
3. If you pay $5,000 for a vacation on your credit card, at 18% interest, and pay $127 per month, how long will it take to pay it off? Try to figure this one out in Excel before I give you the answer. We’re looking for the length of time, so you’ll use =NPER(). The answer should be 59.97 months (or six years). If you pay $127/mo for 6 years, it cost you $7,616.82. That’s why not paying off your credit card can result in spending 50% more for your purchases. (N.B. technically, credit card interest doesn’t compound this way, but the lesson is valid.)
I also prepared two final questions, but you can see why we ran out of time. 1. If a car costs $25,000, how much more do you pay if your loan is at 5% instead of 3% over 5 years? =PMT(5%/12,5*12,25000,0)*60-PMT(3%/12,5*12,25000,0)*60 or $1,353.81. 2. If a car costs $25,000, how much more do you pay if your loan is 6 years instead of 3 years at 3%? =PMT(3%/12,6*12,25000,0)*72-PMT(3%/12,3*12,25000,0)*36 or $1,175.53. As you can see, it makes a big difference to negotiate a lower interest rate and to afford a shorter repayment. (I buy used and pay cash.)
I hope you enjoyed lesson two. Have you used this type of calculation before to plan your financial future, investments or mortgage? If you enter your current savings and investments (PV), your savings goal (FV), your current savings amount (PMT) and your recent investment (or savings account) returns, how long until you can retire?
