Why I don’t like TIPS

One simple reason – when I’m buying a derivative, I don’t want the payer to be in control of the underlying.  IN ENGLISH:  The government gets to pick the formula for “inflation” when paying you for how much inflation has gone up.

In case you don’t know what TIPS are, in short, they’re a note or bond you buy from the US government whose payout goes up when inflation goes up.  So some advise owning some of these to protect yourself against inflation.  This sounds great in theory, except when you read about stories like the government counting the “price” of cars in the “cars for clunkers” program being $4500 less than than before. This is artificial deflation and screws over those with TIPS.

So back to the main point – no way I’m lending someone money and letting that person control the interest rate charged whenever they want.

-Tim

Understanding Options For Newbs: Expiration

This is episode 3 of Understanding Options for Newbs, so by now we know what options are and what they mean. This is going to be a short, but important post. Plus, the next one’s going to be a doozy. =)

The next exceedingly important and fundamentally basic thing you need to know is that options contracts expire. Yes, that’s right, at some point every option will be rendered completely worthless regardless of the price it was originally purchased at. So that Under Armour option you just purchased, assuming it was a May option, will be worth exactly $0.00 once that closing bell sounds on Friday, May 15, 2009. What does that mean for you? Apart from the expiration date affecting the price of that option on a daily basis, it means that you had better know if you want to sell, exercise or hold the option (and let it expire) well before the expiration date.

Oftentimes it’s better to hold the option and let it die (if you’ve gotten to that point) than to exercise it. I mention this specifically if you’re the kind of person to convince yourself, “Oh I’m going to throw away all that money I spent on that option if I let it expire, I’ll just exercise it and it will have been partially worth it.” What’s really worse, holding an expiring option and losing $200, or exercising the option and spending $2,000 for one hundred shares of a stock that is probably not even gaining in value (otherwise you should have sold it, hopefully, for a profit!).

Next time we’ll discuss how options are valued. Without understanding why those contracts are valued at what they are, you might wonder why that call option you bought is decreasing in value even though the stock itself hasn’t gone down, or may even went up a little. Stay tuned, same Roaring Time, same Roaring Channel!

Understanding Options For Newbs Part Ia: What is an option?

In the last post I discussed what an option is most in terms of money. But you should also know where these options are coming from, because when you buy an option someone else must be selling that option to you. When you hear about CEOs getting millions of dineros in stock options, these are exactly what they sound like. One of those millions of options might just be the one you’re buying!

Basically, when someone owns 100 shares of a stock and wants to sell them, he/she “writes” the option. You can think of it as writing up the contract to purchase shares. That might well be where the terms “options contract” and “writing an option” came from, because no one ever says I want to buy a stock contract. That’s just silly. =P This is the most common way option contracts are created, by having someone who owns hundreds of shares sell off the options to them. We call this a covered call or covered put, depending on the type of option being written.

There exists, also, UNcovered calls/puts. In these cases, people borrow shares from their brokerages to write options. I hope you became wary upon reading the word “borrow” because this is a very dicey game to play. To write an uncovered option you really are borrowing money that you don’t have in your account in the hopes that you turn a profit off these options and can then repay your brokerage. If you don’t turn a profit you still have to pay back the brokerage. And if you bought 100 shares to write an option contract for Under Armour, the example we used last time, then you’ll have borrowed about $2,000 worth of UA shares. That would not be fun to pay back if you didn’t have the money to cover your bets options in the first place!

This just about covers what an option is, in the most technical sense. Please comment and let me know if you have any questions!

Also, a quick note: employee stock options are always call options. It makes sense if you think about it, how could they give you put options? That would mean they give you the right to sell options that aren’t yours… now that doesn’t make much sense, does it?

– RT

Understanding Options For Newbs Part I: What is an option?

This is the first post in a series where I’ll be explaining stock Options: what they are, how they work, and how to understand them well enough so you can try your hand at buying and selling them. And hopefully turning a profit. ;)

An option contract, better known colloquially as just “an option,” is technically just the right to purchase or sell shares of a stock at a given price – the option’s strike price, which I’ll elaborate on further down. But here’s an example: Let’s say you want to buy a call option for, say, Under Armour, Inc. (yeah, the sports clothing company, did you know they were publicly traded? Don’t lie!), which is priced at $21.39 per share as I write this (closing price on April 23, 2009). The call option gives you the owner the right to purchase shares at the option’s strike price. If you buy that call with a strike price of 20.00, which is valued at $2.00 right now, what you’ve effectively done is buy the rights to purchase 100 shares at $20.00 per share. So the strike price is the price that you can actually buy/sell shares at.

Here’s what an options chart looks like (I know, it can be damn intimidating at first, but take a breath and chill out for a second. I’m going to walk you through this over the course of this Options Series):

In this chart, the “Strike” column shows each option’s strike price. The actual value of the option is the “Last” column, which is the price that that stock option was last traded at. The “Chg” column is how much the value of the option has changed that day, by percentage. Don’t worry about the rest of the columns for now, we’ll get there in a future installment.

By now you might be asking yourself, “Where the hell did these 100 shares come from!? I just wanted to buy ONE option!” Here’s the deal: each option contract is actually a contract to purchase 100 options. In other words, you’re purchasing the ability to have 100 options of buying shares of a stock at that strike price, but you don’t have to buy those shares. It’s an option, not an obligation. If you do buy those shares, that’s called “exercising an option.”

This 100-shares-per-contract concept is the hardest thing to wrap your head around at first, in my experience. In the options chart you just see the regular strike price. Brokerages advertise their commission fees as $7-12 per single transaction PLUS $0.70-1.25 per one contract. They never talk about these things in plural, but that option that costs $2.00 (remember, this is not the strike price) is actually costing you $200! That’s $2×100 for you math whizzes out there. ;)

Oh by the way, options are always traded by the hundreds, so you can’t decide to buy one share and have 99 options left. It just doesn’t work that way.

On the other side of the ticker, a put option is one in which the strike price is the price at which you have the right to sell 100 shares. So if you buy the Under Armour put option with the strike price at 20.00, and then the actual stock price dips to $19.00/share, then that put is very valuable. The option owner can theoretically buy 100 shares at $19 each and then turn around and sell them at $20 each for a profit of 100 big smackers! Of course, there are quite a few details I’m leaving out here that make exercising your option potentially unprofitable (or less profitable than just selling the option).

In fact, only about 30% of options get exercised before their expiration dates. Oh right, those options you just sank $200 into will be rendered worthless in a few short weeks. This is reflected in the above options chart in the upper right hand corner where it says, “Expire at close.” This will also be covered in a future installment. Did I mention stock options are quite complex? I mean, you have to sign extra forms just to be able to trade them(!) because you can lose a lot of money very quickly if you don’t know understand what’s going on.

If the market were cut and dry then any time you could turn a profit by exercising your options you would invariably do just that, right? But the market is more like a crazy twelve-headed beast of Greek mythical proportions that you have to figure out, disfigured face by disfigured face, until you think you’re ready to tackle the she-witch.

So what have we learned today? Well, we learned that an option contract translates to the ability to purchase 100 shares of a stock at the option’s strike price. A call option gives you the ability to purchase 100 shares at the option’s strike price, and a put option lets you sell 100 shares at that option’s strike price. Dems da basics! Please make sure you understand this well because everything that comes after this is based on the fundamental understanding of what an options contract is. If you’ve got questions, I’ll see ya in the comments section.

*If you’re curious, Under Armour’s stock symbol is UA. Creative huh? Personally, I was surprised that that wasn’t already taken by a huge company like United Airlines or something.

Invest in Your Life… Spend Less, Be Happier.

twentySomething #1: “Hey looks like there’s still a lot of good snow, but it probably won’t last much longer so we’re thinking of going on one last snowboarding trip for a weekend before the season ends.  You in?  The snow will be great, and so will the weather.”
twentySomething #2: “That sounds great! Count me in!”

twentySomething #2 is a typical present-day young professional, nervous about his financial security due to the current economic situation.  He has seen his portfolio plummet in the past year and is unsure about the stability of his current job.  All of his fears and insecurities come to a head one week before the snowboarding trip and although snowboarding is one of his favorite hobbies, he decides, regretfully, that he absolutely must back out of this trip and save the money he would have spent.  Snowboarding weekend rolls around, and he finds himself sitting at home thinking about how much he wishes he was having fun in the snow with his friends.

Then, a casual friend of his calls him up and asks him to go bar hopping that night.  “I haven’t seen him in a month since the last time we had some drinks… I should go,” twentySomething #2 thinks to himself.  Feeling down that he isn’t out snowboarding, he agrees to go out and ends up spending $100 on drinks and greasy late night food, resulting in a wasted weekend recovering from the throbbing hangover the morning after…. realizing he probably should have just gone snowboarding.   Though he had fun during his night out, he probably wouldn’t have spent that much more money snowboarding  (if at all), and he would have ended with a much happier weekend doing something he loves much more with close friends.

Does this situation sound familiar to you? From my observations, this type of situation is not uncommon.

These days, with all the attention drawn towards the recession, and saving money, resisting splurges… people are scrambling to eliminate expenses left and right. During this process, it is easy to put aside what makes you happy for the sake of saving a little money before thinking these decisions through.  That means, it is also just as easy to end up spending some money for some instant (and probably short lived) gratification.  I’ve realized that it is beneficial to take a little time and come up with some guidelines/a plan for “investing” in myself and my happiness.    Therefore, in a tight money situation, I’d be able to think rationally about where to spend my money to maximize lasting gratification.  This is a good time to ask yourself, Are you skimping too much?

In the aforementioned article, Personal Finance columnist Liz Pulliam Weston writes about finding a balance so that you don’t find yourself spending money on things you’ll regret later but at the same time you don’t look back regretfully on missed opportunities. I’ll leave it up to you to read the article (it seems to generally be geared towards a slightly older crowd), but I did want to highlight the a few of the questions she suggests thinking about:

• What would you do in a day, from the time you get up until the time you go to sleep? Account for every hour.

• Whom would you spend time with?

• What interests or passions would you explore?

After figuring out some answers to such questions, it’ll be easier to make commitments that maximize happiness and reduce guilt.  This is what I have realized.  At this age, we enjoy things like going out for drinks, for coffee, for meals.  A friend calls us up on a Friday night to go downtown, and we’ll end up going out and spending $50 before we really have a chance to realize how doing this weekend after weekend really adds up.  And really, how much happier are we after a month and -$200 later?    However, these small occasions are needed to maintain a healthy and happy twentySomething lifestyle.   We’ve all got to get out and let loose every once in awhile.  So I’ve learned to make to make these decisions more consciously.

I give myself a “budget” for these type of outings and keep a mental tab of how often I’ve been out recently and how much I’ve been spending. If a friend asks me out for drinks, and I haven’t been out in awhile/I haven’t spent much money out, then I’ll go out and enjoy myself.  Otherwise, I’ll politely decline… and feel okay about it because I had just gone out and enjoyed myself not too long ago.  It probably isn’t a decision I’ll look back on and regret.  As someone who naturally hates the thought of missing out on anything, I got to a point where I was stretching myself much too thin until I learned that nobody expects me to say yes all the time and that’s okay.  Additionally, when the chance to go on a well deserved luxurious vacation with close friends come up shortly after,  I’ll be able to commit wholeheartedly because it is within the guidelines I’ve set for myself.  I’ll know that it is an experience I truly want to take part in, with those that matter to me most.  And, I’ll have that much more money saved up towards it.

On a smaller scale, I’ve also learned to be conscious of smaller expenses that sneak up on you and add up such as going to the vending machine at work (guilty at least two/three times a month), getting Starbucks (3 coffees a week = $12 a week, or $48 a month or $576 a year!)… you get the idea.  These are things you don’t think twice about because it’s just a couple dollars at a time, but they sure do add up.  The main idea is to make money decisions more consciously so that you don’t make a mistake and find yourself eliminating random costs last minute because you’re freaking out.

Much like the way I maintain my financial portfolio, I also maintain a life portfolio. I figure out what’s important to me, what I want to do, what makes me happiest.  I try to diversify my time, money, effort into work, fun, personal enrichment, etc. similarly to the way I try to diversify my money in stocks, funds, and bonds.  I don’t hastily jump into one stock without thinking it through… and I accept small losses here and there when things don’t go the way I envision.  I make mistakes from time to time.  But I have faith that sticking with this strategy, I still come out stronger and happier than ever while wasting less time stressing out about things I don’t need to be.  I encourage you to take a little time to similarly evaluate your life and happiness too, especially if you find yourself in a bit of a bind when it comes to time and money. :)

– debs.

p.s.  If you have a lot of debt, or have little to no savings, I’m not in any way suggesting that you risk going broke.  In this case, you’ll probably want to make paying off debt and saving a high priority in your goals/guidelines and refer to “Savings, Investments, Retirement… Where Do I Start?”

Edit: Here is another related article I stumbled across right after I wrote this entire post: “Oversaving, a Burden for Our Times“

Savings, Investments, Retirement… Where Do I Start?

We here at the Roaring twentySomethings unite strongly under the simple goal of enjoying life.  We don’t lose sight of the importance of maintaining a high quality of life, and therefore do not let work manipulate the qualities of our lives solely based on the fact that our jobs fund the fun in our lives.  This does not mean we lack motivation when it comes to our careers and achieving a successful future- it is true that sometimes sacrifices need to be made and extra hours need to be put into work in order to stay on top of your game – but it does mean that we are driven by the desire to live life rather than the notion of working hard and earning money so that maybe we can live life.

As roaring twenty-somethings, we are not yet overflowing with the extra cash, so we’ve had to look beyond relying on unnecessary extra overtime work just to ensure our financial security in the present and future.  I’d like to share a few basic things I first learned when I became interested in saving and the only account I had was a checking account.  Just because you are a “poor college student,” or were one not too long ago, doesn’t mean you are incapable of being financially well off.  A little known secret is that becoming wealthy has just as much, or even more, to do with how you manage your money as it does how much you have or make.

Open a high yield savings account or CD – even though these high yield accounts aren’t as “high yield” nowadays as they once were, it is still much better than letting your money sit in a checking account and not getting anything from it at all.  A CD generally has a higher interest rate – but the money you put in a CD cannot be withdrawn penalty free for a period of time until it matures.  MyMoneyBlog has a great list of the best savings accounts that is constantly kept up to date.

Start saving for retirement – Open an individual retirement account.  There are two options here – a Traditional IRA and a Roth IRA.  I generally think that a Roth IRA is more beneficial and  “Why You Need a Roth IRA” on Kiplinger’s is a must read article that highlights all the benefits of having a Roth IRA.  Just the fact that it is tax free growth alone is reason enough to look into it.  The article includes some rough calculations to show how you will come out with more money in a Roth IRA, and how a Roth IRA also doubles as a great emergency fund because you will not be penalized for withdrawing money you put into a Roth IRA account (just the interest). It is also a great account to have when saving up for your first house because a Roth has special exceptions set aside for that. The last thing I want to highlight regarding the Roth IRA is to start early. I assume that those who are reading this are highly motivated and will one day earn a respectable salary.  There is a salary cap on those who qualify for a Roth IRA and when you’ve reached that salary- you’ll be glad you have some money put in a Roth IRA come retirement.  A 401(k) is also another great way to save up for retirement – and sometimes this includes free money from your company. We will expand on this in a future discussion on workplace benefits.

Investments – Once you have a solid foundation that your savings are built upon, looking into investing is a great step to take.  There are ways to invest conservatively – your money will grow at a slower pace but there is less risk. And there are ways to be aggressive and accept the larger risk for a chance at a greater return.  However, a few basic points to start you out here is to know that: 1) the younger you are, the better it is a time to invest in stocks (given that you’ve got the money to do this) 2) Bonds are good for short term investments 3) Mutual/Index funds are generally good for long term investments.  Exchange Traded Funds (ETFs) are somewhere in between stocks and mutual funds.  To learn more, I highly recommend checking out the Morningstar Classroom.  “Morningstar” may become more familiar to you as you research investment options – and that is because Morningstar has created a system for rating mutual funds that is typically widely taken into consideration when choosing a fund to invest in.

If you have dug yourself in bit of a ditch when it comes to managing your money, I recommend first paying off your debt, opening up a Roth IRA if you’re working, start putting some money into a savings account, and when that is all stabilized – look further into investing.  No matter where you are, start early. Do not use the fact that you’re still young and all young people have the same money woes as you as an excuse to be lazy.  If I haven’t convinced you enough yet, maybe the power of Compound Interest will.  Take a look at the following excerpt from another Kiplinger article that illustrates this point:

Consider this: Amy, a 22-year-old college graduate, saves $300 per month into an account earning 10% per year for six years. (That’s the average annual return of the stock market over time.) Then at age 28, she starts a family and decides to stay home with the children full time. By then, Amy had kicked in $21,600 of her own money. But even if she doesn’t contribute another cent ever, her money would grow to a million bucks by the time she turned 65.

Compare that to Jason, who put off saving until he was 31. He’s still young enough that becoming a millionaire is within reach, but it will be tougher. Jason would have to contribute the same $300 a month for the next 34 years to earn $1 million by age 65. Although Amy invested less money out-of-pocket — $21,600 over six years vs. Jason’s $126,000 over 34 years — her money had more time to grow, or compound.

Another little equation that you might find useful is the “Rule of 72”:

72/interest rate = number of years it will take
for your money to double
Example:
You have money in an account earning roughly
8% a year.
72/8 = 9
It will take 9 years for that money to double.

Lastly make use of wonderful, FREE money management resources that are readily available to you nowadays.  Services such as Mint.com and Yodlee automatically link up to all your accounts and update them automatically for you so you can log into your account and quickly get a quick snapshot of how you’re doing.  They have tools built in to set goals and alerts; charts to let you see what you’re spending money on and how your investments are doing.  Kiplingers has a lot of useful tools and calculators too.  Best of all, these resources are FREE!  Take advantage of them!

I know times are tough money-wise these days, and it is always wise to proceed with caution.  However, with a little patience and careful planning you will be ahead of the game when the market bounces back.  It is always unpredictable so I understand that things like the concept of Compound Interest may seem a bit inapplicable right now.  However, there are still savings account out there that will earn you interest.  There are countless numbers of resources for you to turn to in your research, and I really encourage you to start now.  Happy saving!

– debs.

My “Investment” Portfolio

I’d say that my investment portfolio is up. My financial portfolio? A massacre. My Roth IRA bleeds. My taxable account has been laid to waste. My bonds and CDs provide the only sustainable lifeline, ensuring that my portfolio doesn’t fade into oblivion. But aside from my financial portfolio, there’s the other side of my investments – myself.

“Why don’t you play the bass for me?” she asked. I was practicing with my headphones on in the corner of the room.  My girlfriend’s textbook sat neglected on the pillow of my bed. Apparently she had been watching me for awhile.  My friends and I had a band, but it wasn’t really a band since we only played cover songs and we didn’t have a singer. At the moment I was practicing a Cake song. I tried to explain that the bass isn’t like the guitar, that it would sound like a random melody since it was a support instrument and not a leading instrument. Plus I was terrible, but I omitted this from my explanation. She bit her lower lip and slowly placed her hands in her lap. “Please?” she asked. I was rendered powerless. My eyes focused on the frets as I placed my fingers on the strings. I imagined my friend on the drums and when my queue came up, I played. The melody for the verse and pre-chorus flowed out effortlessly – my two days of practice had paid off. But an incomplete third day and likely fourth day led to a broken chorus and ending. After I finished, I raised my eyes to look at her. She squirmed. “I see,” she said.

I’ve had many hobbies over the years – bass guitar was one of them. The instrument currently rests at the corner of my bedroom, an expensive decoration. My alarm clock and my cellphone sit on the top of the amplifier, now an end table. This was one of my failed investments. The same year I quit playing bass, my girlfriend and I broke up. I guess it was a down year for me. Other investments sit around my room. On a table at the far end of the room in front of the bed, a vintage record player and collection of vinyls entertain me once a week. I’m still holding onto this one. My snowboard helmet lays awkwardly at the bottom of my closet. I think it fell when I was looking for a thicker blanket when it got colder a few days ago. My doctor told me that I can’t snowboard this season because I broke my foot late last year, even though it seems to be healed. A stack of books grew out of my nightstand as a result, a winner in my portfolio. And a used DSLR full of pictures from a recent trip to New Orleans with a close friend rests on the floor next to my bed – due a bout of nostalgia the night before for times away from school and work – a combination of a new hobby and a favorite pastime.

Saving money is important. But lost in the sea of posts like “$3 daily lattes will cost you more than you think!”, “Clothes at outlets: same or different?” and “How the Rule of 72 will change your life!” (all good topics which may someday be covered by this site) there is also another kind of capital that should be monitored as carefully as any bank statement: personal capital. And even though there’s no indexes or numbers which detail the gains and losses, you will know when an investment pays off big.My portfolio isn’t aimed at getting the most money. So I probably won’t be partying with Diddy on a yacht off the coast of Monte Carlo with empty bottles of Cristal at our feet. But I don’t want that (except the yacht). I’d rather be eating grilled mystery meat from a street vendor in Asia with a friend. And I want to security of knowing that I can do what I want this year and for the next 80 years (maybe). Money is important. But why live a money-driven lifestyle? Instead, let’s try something else. Let’s aim for the lifestyle-driven-lifestyle.

– Vince