Our Clueless Investor, Sarah, asked a series of great questions about the stockmarket and investing in her last blog, so I’m going to kick off the discussion with some answers of my own. Feel free to chime in below in the comments, SprinkleBit Nation!
The first of Sarah’s questions stemmed from Clueless Investor reader, Logan, and his statement that he generally stays away from resources because they tend to fluctuate a lot.
This prompted Sarah to ask:
How do resources fluctuate?
Well, Sarah, resources (or commodity futures as the guys in suits call them), demonstrate the purest form of supply and demand. Resources fluctuate most when the products that they are used in are shown to be in increasing or decreasing demand.
For example, when the production of electronics sky-rockets, so does the demand for copper (which is used heavily in electronic manufacturing) as can be seen in this graph.
When the market crashed in 2008, so did the demand for copper, but as the consumer electronic market recovered, copper resources were back in full production again and commodity traders were buying and selling it again for a profit.
Is there a generally safe investment?
Finding a consistently safe investment is harder to pin down, Sarah, but I’ll take a stab at it for you.
All investors have to be aware of the fact that with every investment there is inherent risk.
This means that if you want to make more money off of your existing cash investments, you will have to be willing to risk them.
Depending on the return you want, the bigger the return, the bigger the risk. To put it another way, you have to risk more to make more.
To the novice investor, this can seem daunting.
But that’s why it also pays to be well-informed on potential investments, and to do your homework. And that’s why you’re here, so kudos to you for taking that first step.
Banks & Savings Accounts
One of the safest investments today is your savings account. There is usually a small interest rate that you gain by keeping your savings with a bank, but it’s usually no more than 1% these days.
It’s important to remember that even when you put your money in a generally “safe” investment like the bank, you’re still putting your savings at a small amount of risk.
Unlike stocks, which are not insured, your bank savings are protected up to $250,000 by FDIC insurance, which means that if the bank goes bankrupt, your savings will be paid back up to a maximum limit of $250,000.
If you are a member of a credit union, your credit union uses a different kind of insurance, called NCUSIF, or National Credit Union Share Insurance Fund, which also insures your credit union savings up to $250,000.
This insurance actually takes away from the return that you could have got from the bank, and it’s not a huge return to begin with, so if you’re looking for greater gains, you have to risk more.
How about Treasury bills?
In this case, you’re lending your money to the US government for the chance to earn a small return. For example, if you gave the US government $1000 today you would get $6.5 per year. Only problem is if they go bankrupt, you lose your entire $1000.
My General Strategy
It’s important to know those basics, and your questions were on the right track. And I think we’re getting closer to a general answer for you. The best thing I can do is show you my strategy. My basic rule of thumb is to spread my eggs into different baskets.
I start with my goal in mind. If you want consistent income, look for dividend stocks, the first egg in my portfolio. Dividends are desirable, because if the company does well, they will give you a dividend, or payout (usually) every quarter. It’s like getting a regular income that you can count on. That’s why dividends are typically how people who are nearing retirement will choose to invest their savings. Dividends are low-risk and usually low-payout, but that regular income is nice to count on.
My favorite dividend stock is McDonalds, who would pay you $30 a year (or higher) for a $1,000 investment—plus the money you would make if the price of the stock goes up. Not too shabby.
You see, dividends provide this regular income that you can choose to spend on your lifestyle or you can choose to re-invest back into the stock for potentially more gains down the road.
Another egg in my mixed portfolio are the risky-but-potentially-higher-return investments, such as stocks in more volatile markets. For example, four months ago, I invested in a company called Pulte Group ($PHM) right around the time when the housing market was on the rebound, and I have made 119% on my investment so far. Using our $1,000 example, that would have been $1,190 for risking $1,000. I spotted this opportunity by noticing the broad trends the market was taking.
By mixing my portfolio with these and some other investments, I could build a moderate-risk portfolio, right in line with my risk tolerance.
Regarding fossil fuels, or more specifically, petroleum, Margaret is right. Fossil fuel prices are artificially inflated, but not always due to the environmental externalities, or marginal external cost (MEC) as the “guys in suits” call it.
This artificial inflation is mainly due to how OPEC decides to set their fossil fuel prices. OPEC, or the Organization of the Petroleum Exporting Countries was formed in 1960 with headquarters in Vienna to keep the oil prices “stable,” but their operations have been highly criticized as they have effectively pushed up the oil prices.
Prices of petroleum can also go up based on how much your home country taxes a barrel of oil. Governments impose taxes on petroleum to cover the marginal external costs such as pollution, as we said above. Each country experiences this cost differently; for example in the United States, the price of one gallon of gas is less than half the price of that in Sweden—simply due to the amount of taxation imposed on a barrel of petroleum imports.
The Stock Market Visualizer
Back to the fun stuff, our Stock Market Visualizer is a perfect example of how we’re trying to inject some color into the gray and cold world of investing.
It gives you a visualized overview of how the market is doing for the day. The size of the box shows you how large the company is relative to other companies in that market.
You should pay attention to sectors that are generally green. A sector, for example, is “Technology” or “Healthcare.” A grouping of companies from the same category is called a sector. Reading the SprinkleBit Stock Market Visualizer, if you see a sector with all green, that indicates that the sector is doing well. Since high tide floats all boats, you might want to start your search for an investment in that sector to find something worth investing in.
Conversely, a red sector means stay away, since there is something less-than-positive happening in that sector.
This looks like a good stopping point for now. Look for part 2 of my follow-up coming soon! In the meantime, SprinkleBit Nation, what sorts of answers do you have for Sarah?
And if you are just catching up on Sarah’s journey on the road to being a better investor, you can get started with her series here:
- The Clueless Investor Part 1: NASDAQ is a Stock Car Race, Right?
- The Clueless Investor Part 2: Learning with Monopoly Money
- The Clueless Investor Part 3: Call Me Ahab, Sorry Ishmael