Diversification in your stock trading portfolio can mean different things to different types of investors, or even to the same investor at different trading times. But it always describes the concept of spreading out your investments instead of “putting all your eggs in one basket” which might be a single national market, a single asset class or even a single stock. Here are some ways to accomplish this:
- Diversification by risk. This is where many traders and active investors learn to focus in the classes at Online Trading Academy. If you are interested in greater returns, risk is good because it translates to potential rewards. The economies of the U.S., Europe and emerging nations behave very differently and so do their stocks; if the U.S. markets are flat, an equities investor might look overseas for more volatility.
- Diversification by balance of current income and long term wealth potential. This is the focus of our ProActive Investor curriculum at Online Trading Academy. Investors use our patented supply and demand trading strategy to find opportunities to build significant wealth for the future. At the same time, they use options strategies such as covered calls to generate current income at relatively low risk.
- Diversification by asset class. The major stock markets are highly liquid and easily accessible to any investor. Forex trading provides rapidly changing opportunities around the clock simply by following the price movement of currency pairs. Futures trading lets investors bet on how a drought will affect the price of wheat, or Mideast conflict the price of gold. And options trading lets allows sophisticated traders to work for significant income on a relatively small investment. An educated investor might combine these asset classes to enjoy all their benefits, instead of focusing on just one of them.
- Diversification of growth vs. income assets. This is a more traditional variation of strategy #2, and quite popular with everyday investors. Growth stocks are new companies or companies in growing industries that pay small or no dividends because they are putting all their money into growing their business (and so their share price). Income stocks may have minimal share price fluctuation, but they pay dividends that might add up to 4-5% or more of the share price each year. As retail investors get closer to retirement age they might add fixed income to the mix: bonds and U.S. Treasury bills that pay less income than dividend stocks, but are more predictable (at least until recently) because of the underlying asset.
And why should you diversify your portfolio in the first place? Diversification gives you the potential of making more money while avoiding surprises that can wipe out your portfolio. A well diversified portfolio will have low correlation among its component categories—meaning their prices don’t all move in the same direction. In other words, one category may be appreciating and another slumping at any point in time.
If you’re an active investor you can monitor this process, and shift your portfolio to take advantage of market conditions. Even if you have someone else manage your wealth, you should still review your holdings on a periodic basis and see if you are satisfied with the performance of your investments or if your portfolio needs rebalancing.
One thing that isn’t diversification is owning multiple stocks in a single industry, and thinking you are insulated against risk. This is a common and often costly mistake. Stocks in an industry tend to move in lock step: if one reports a negative earnings surprise, all of them will go down in price even if the other companies have healthy earnings.
You can find out more about diversification, and how to do it, starting with a free Power Trading Workshop at Online Trading Academy. Classes are held on a regular basis at our local financial education centers and online. Complimentary registration for an upcoming class is available here.
A lot of novice traders think that day trading (or day-trading) is risky, but you can make a million bucks. You can get started with almost no money, trading penny stocks. You can do it in your underwear, although you might end up like a zombie staring at a computer screen all day long. Best of all, you don’t need any training to be successful.
Those are some of the popular myths about day trading, also called momentum trading, in which you buy and sell a position in a single day. Let’s look at each of these myths in turn, and find out the truth about day trading.
- Day trading is risky. Truth: it can be, but doesn’t have to be. Day traders who have studied at Online Trading Academy follow the same strategy as our long-term investors. They buy when they see an imbalance of supply and demand which signals a low-risk, high-potential opportunity. If anything, they take on less risk because they always liquidate their positions at the end of the day and are not exposed to an earnings surprise or natural disaster that might happen overnight when the markets are closed.
- Day trading is an easy way to make a million bucks. Truth: there’s never an easy way, though some have succeeded and you can read their stories in various student quotations on tradingacademy.com as well as hear them in the halls of our financial education centers. You’ll also find many people who consider day trading a reliable source of primary or supplemental income, and no more exotic than any other job.
- You can get started with very little money by trading penny stocks. Truth: trading penny stocks is a path to poverty, not wealth; there’s a reason those shares are priced so cheap. You can get started trading low priced (not penny) stocks for a few hundred dollars, but the commissions will eat into your profits. At Online Trading Academy we generally recommend that a new trader start with a minimum of $25,000, which is also the amount required to trade on margin (which involves higher potential profits but also greater risk).
- You can day trade in your underwear. Absolutely true! The ability to set your own hours, spend quality time with your family, and trade from a home office are some of the biggest benefits of day trading. One of our students called it “commuting with my coffee cup” as she travels from kitchen to her upstairs office.
- You might end up looking like a zombie. Truth: only if that’s your lifestyle or fashion preference. Very few traders who have been trained at Online Trading Academy are at their computers every hour the market is open. More likely, they’ll only make a few trades a day and only when the market delivers opportunities that meet their criteria; if the market doesn’t cooperate they might not trade at all that day. Many of our students do all their trading during the first 90 minutes after the market opens, then take the rest of the day off.
- No education is required to become a successful day trader. This is the biggest whopper of them all, and the reason why most everyday investors barely make money (or lose their shirts) while big banks and Wall Street institutions are consistently profitable. Professional traders and investors have a plan, a predefined set of objectives for their trades, and the experience and self-discipline to follow their plan. Education is required to develop all these traits. It’s true you can learn them through trial and error, but that’s a very expensive education because you are in effect paying the market to teach you not to keep making the same novice mistakes.
If you would like to meet some real (not mythical) day traders and learn something about their success, register for a complimentary Power Trading Workshop at Online Trading Academy. You’ll also find out why our patented supply and demand strategy is effective for every time frame, from day trading to retirement investing. Sign up here.
Once upon a time, the U.S. Federal Reserve and other central banks would try to control inflation by manipulating the overnight interest rate charged to institutions that needed quick, short-term cash. If inflation heated up they could raise the rate, thus reducing the amount of money in circulation and causing inflation to slow down. If the economy was struggling, they could lower the overnight rate to encourage more economic activity.
With the crisis of 2008, the Fed had to cut its overnight rate so far that it was effectively zero, and thus regulation of the money supply was no longer effective in stimulating economic growth. That’s when Fed Chairman Ben Bernanke came up with a new way to increase the amount of money in the markets. This was the concept of “quantitative easing”—the Fed would buy a “quantity” of bonds directly to increase the amount of money in circulation and “ease” the restrictions on capital.
Most (not all) economists feel this strategy was effective and successful for the US Bond Market, and as the economy improved the Fed talk turned to when and how the quantitative easing program would end. New Fed Chair Janet Yellen answered these questions early in 2014 when she announced the Fed would start to “taper” its loan purchases but on a very gradual schedule. As of May 2014 the purchases had been reduced from $85 billion to $45 billion a month.
So what does all this mean to the average investor and trader? Based on our patented supply and demand trading strategy at Online Trading Academy, we would assume with less liquidity (i.e. less money) in the marketplace the price of money (i.e. interest rates) will go up. So should you buy U.S. treasuries today as part of your wealth and income strategy?
If you’re looking for interest rates that will give you the kind of returns you can get in other financial markets, the answer is probably not. Those rates are still very low from a historical perspective; you’re not going to retire on a portfolio of bonds that pays 2.5% APR. Plus, when inflation returns and interest rates go up, the price of those fixed income assets will decline. That’s because other, newer bonds will be paying perhaps 3% compared to your 2.5% Treasury. If you should want somebody to take it off your hands then you’ll have to cut the price. (Of course, if you intend to just put the bond in a safe deposit box until maturity—like people used to do with U.S. Savings Bonds—then this strategy doesn’t matter.)
A safer strategy than investing in the US Bond Market is to invest in ETFs (Exchange Trade Funds) or mutual funds that buy baskets of bonds, and are constantly rotating their inventory. If interest rates go up they’ll take a hit on a portion of their portfolio, but they’ll then replace those bonds with others that pay more. You can choose ETFs by quality, from super safe Treasuries to middle grade corporate “junk” bonds, with less quality paying higher rates. And you choose by the average duration of the portfolio—short, intermediate or long term—with risk (and so volatility and potential rewards) increasing as the terms get longer.
The most extreme bet by duration may be PIMCO’s ZROZ, an ETF that tracks the BofA Merrill Lynch Long US Treasury Principal STRIPS Index. A STRIP is a financial instrument in which the holder receives no interim interest payments, just the par value at maturity; interim values are determined by the open market. And the ZROZ is a bet on what that instrument will be worth 25 years in the future, discounting for all the interest rate fluctuations between now and then.
As of May 2, 2014, ZROZ was up 18.19% YTD, compared to 2.56% for the S&P 500. On the other hand, ZROZ on the same date was down 13.52% over the preceding 52 weeks. This is not a “set and forget” market play, in other words. But if you’re an active trader or investor and want to participate in the bond market, then ZROZ and other fixed income ETFs may be worth a look.
Keep in mind that supply and demand among buyers and sellers, in addition to the underlying assets, figure in the fluctuating prices of these tickers. Why are bond funds in general beating the equity markets for the first part of 2014? It may be due to the fact that, even though interest rates have ticked up, the resulting effect (on business expansion and the overall economy) has not been as painful as some expected.
College is expensive, and fees and tuition continue to rise faster than the rate of inflation as reported on College Board Survey by Christian Science Monitor, August 13, 2013. Many students graduate with large amounts of debt that will take many years to pay off. Keeping up payments on student loans compromises their ability to live where they wish and do what they want during the early career years which are traditionally a time for exploration. (It is tempting to simply default on these loans, or try to, but the results can be disastrous. At the end of this article, we’ll explain why.)
However, what about using your investing profits to pay off student loans? If you are a recent graduate with strong cash flow and success in the markets, is this something that makes sense? Or, what if you are the parent or grandparent of a recent graduate and want to help them get out from under their mountain of debt?
The first thing you should know is that the first $2500 of interest on qualifying college loans each year is tax deductible, on IRS Form 456. What’s more, the deduction comes directly off income on the Schedule 1040—there’s no need to itemize deductions and file Schedule B. This is as close to “free money” as the IRS is ever likely to offer you. Assuming the recent graduate is in a bracket where they are paying some taxes, there’s little reason to pay off the principal prematurely. (This does NOT mean you should fail to make all payments when due; skipping payments can have negative effects on your credit rating and may move you into a higher interest loan.)
If you have positive cash flow, and you were tempted to accelerate payments to get out of debt, consider putting some of that money in the investment markets instead with the idea of paying off the loan in the future with your profits. With the interest deduction, you have just lowered your declared income by $2500. Work overtime and make an extra $2500, and you are back where you would be without the deduction, and paying taxes on that $2500 at your marginal tax rate. Make $2500 in the markets and it will be taxed at long or short term capital gains rates, which are likely to be lower.
Now, what if you pay more than $2500 in interest per year—something that is very possible with today’s college costs—so you no longer qualify for the deduction on the full amount of your interest payments? It may still make sense not to pay down the loan, depending on your interest rate. According to the official student aid site of the U.S. Department of Education, the current rates for undergraduate loans can be as low as 3.86%. Perkins loans have a 5% interest rate. Stafford loans, made in previous years, can also have lower than market rates compared to personal loans not secured by real estate.
So, if based on your experience and skill level you are comfortable planning for a 12% gain in your investments (to give a hypothetical number), you will still end up ahead even after paying capital gains and paying the nondeductible interest on that 3.8% or 5% loan. (The same numbers apply if you are a parent or grandparent who wants to help a graduate; you would not qualify for the initial $2500 deduction since it is not on your return.) Obviously this is an aggressive strategy since there’s no guarantee your portfolio will continue to see the same results as in the past. The numbers can work, if it does.
What if you are a parent or grandparent planning for future college expense, and you want to keep that future graduate’s debt as low as possible? There are a number of options open to you. The best known is the state-run 529 Plans which earn interest or market profits free of Federal taxes (and sometimes state taxes as well) so long as the money is used for education. However, there are many restrictions on 529 plans that may not be attractive to a self-directed investor, the most onerous of which is that you can only put the money in mutual funds which are set up especially for this purpose.
You could also make gifts up to the allowable amount each year ($15,000 in 2014) and avoid gift tax while giving the student the opportunity to invest the money and pay taxes on gains at their presumably lower tax rate. You will also be giving up control of the money, so if they decide to buy a car instead of save for college there’s nothing you can do about it. A better option may be to hold onto your money until they get into college and then pay their tuition. There is no gift tax regardless of the amount of this gift so long as it is paid directly to the institution.
Finally, what about simply defaulting on a college loan? People of baby boomer age may know someone who did this successfully; at one, time record-keeping was primitive (and done with paper), enforcement was lax, and ultimately some institutions decided to just write off the loans as uncollectible.
However, this strategy is obsolete because of far tighter enforcement today, and the electronic databases to ensure you can no longer slip under the radar. According to finaid.org you cannot get out of student loan payments even if you declare bankruptcy. You will still have your wages garnished, suffer from a poor credit rating and be legally obligated for collection expenses—and you will still have to pay the full amount of the loan. Their article “The Horrors of Defaulting on Education Debt” contains a number of chilling first-person stories. Just do not do it.
For many of us, no matter how old we are or what we do – the most important person in the world is and always will be – mom.
Though moms deserve to be celebrated every day of the year, there’s no time like Mother’s Day to remind us how truly remarkable these women are. Moms are fearless. Moms are brilliant. Moms keep order. In fact, moms are capable of pretty much everything
In honor of Mother’s Day, Online Trading Academy found some undeniably cool moms who are savvy, successful investors and businesswomen ruling a male dominated field. We interviewed over a dozen women who have made their mark on the financial industry while successfully parenting their amazing children.
It’s not easy being a mom in finance. The mothers in our piece discuss the obstacles they have faced, the challenges they have overcome, and the constant tug they felt between work and home. In spite of any difficulties however, they persevered.
Help us celebrate moms in finance and business this Mother’s Day by reading these inspiring stories. Learn from their mistakes and their successes.
Happy Mother’s Day to those in finance and beyond!
Apple recently announced a 7 for 1 stock split; for each share an investor currently owns they’ll get seven shares. The share price of AAPL immediately increased. Was the stock split the cause of the rise? Or was the rise the cause of the stock split?
In a word, yes. Both answers are right. A stock split makes the shares more attractive to retail investors because of the reduced outlay to own a piece of the company. The total capitalization does not change; $1000 worth of AAPL is still worth $1000. But it’s now easier to get in without throwing a small portfolio out of balance. And it’s easier to buy even lots of 100 shares, which are more liquid than odd lots.
A stock split is also a sign of financial health at a company. It reminds investors that the price of a company’s shares has increased substantially and tells them that management does not expect the shares to go down again. That’s why the simple announcement of a split can create an immediate bump (usually small) in its price.
There’s also such a thing as a reverse split in which a company reduces the number of outstanding shares in order to make its share price increase. A low price usually is not a good thing since companies rarely go public at single-digit prices, so an under-$10 stock has likely seen a significant decline. The reverse split may even be necessary to keep the stock from being delisted on an exchange.
Not everyone loves stock splits—famously, not Warren Buffett, whose Berkshire Hathaway Class A stock has never split and was recently worth about $190,000 per share. In a 1983 letter to his shareholders, Buffet explained: “Splitting the stock would increase [transfer costs], downgrade the quality of our shareholder population, and encourage a market price less consistently related to intrinsic business value. We see no offsetting advantages.”
At Online Trading Academy, we have a preference for stocks that trade under $50 a share, so AAPL will still be a bit pricey for us. That price allows our students to trade the vast majority of listed tickers and buy reasonably sized positions which can be moved quickly; it’s also easier psychologically for a new investor to trade the smaller share levels because there’s less capital at stake. Yet we have many instructors and students who are avid followers of AAPL—you may be one of them. Its volatility and visibility make it an ideal candidate for our patented supply and demand trading strategy that provides the opportunity for making money on any market move, up or down or even sideways.
By the way, historical records of stock prices are automatically adjusted to reflect stock splits. (Volume records are also adjusted accordingly.) So the investor who says “I wish I’d bought AAPL when it was 30 in 1995” could actually have had several shares for that price because its historical value reflects stock splits up to that time.