I just checked my bank statement and I had been given $4.16 in interest for one month’s amount put into that account.  That account gets 5% interest yearly.  What’s inflation for a year?  The nationally published inflation rate is supposedly 3%, which means that you are making $30.00 less in dollar value per thousand dollars every year.  Sure, you will hopefully get raises that deal with inflation (and hopefully more) but you’ll also need to be looking to not spend or save that amount to get ahead of the game with any new income or at least get that money into an investing tool that makes up for it.  Practically speaking a five percent return on money that is losing value at three percent means that 1,000 will get you $1018.50 in value when all is said and done.  Rinse and repeat.

Looking at inflation like that helps explain why financial advisers are always talking about investments that make 10% or various other amounts: you can’t afford to retire on a 5% interest rate and have any losses!  Take a look at your investing strategy in light of your own practical inflation and see where you can shore up any losses and keep making progress - but don’t forget about inflation because its very real and it can be very costly!

You’ll want to read this article about making smart investing choices.  If you’re handling your own stocks and buying and selling is reactive you’re going to be hosed anyway.  Reactive investing is always after the fact.  It is important to look at the tools that you have and determine your investing strategy - winging it is like a controlled crash!  You may come out alive but you’re not in control.  I lost a big chunk of money winging it and that’s part of what is pushing me to learn and write on this very site.  If you’re trading your own stocks or options use the tools that your online broker offers - at OptionsXpress.com, where I have traded in the past, they have various tools that will trigger a sell order upon certain events, its not reactionary, its pre-determined.  Its reactionary in the sense that the software reacts to events, but its not you doing it because the guy on the elevator mentioned to someone else that they sold, or that your broker calls up after you’ve lost 5% of your portfolio value and says, “I’d like to limit your losses by selling out now.”

Figure out your strategy, I recommend developing a pyramid investing strategy for diversification and safety reasons, and stick with it, put safety measures in place and don’t get flaky, emotional or inconsistent with your investments.   Read the article I linked to above and see the mistake that thousands and thousands of people made just last week, avoid the mistakes others have made and get smart.  Don’t take on risky investment strategies in an already risky market (because the market always has risk, not because this time or any other time is better or worse), be methodical, strategic and determined.

What safety precautions do you have in place?

Risk and safety are twins in the world of personal finances. It all comes down to you and I needing to know and understand risk in the various areas that we find our finances interacting with the unknown. You know the inherent risk of spending a dollar on your credit card: it is a small amount. But what about a large High Definition Television? Is it worth the risk to put it on your credit card? What about investing in bonds? Is that safer than investing in gold? What about options? I’ve learned some things in these areas and its something I hope you’ll find useful in your own life.

Risk in Debt

Many people are aware of the risk of debt in that it can be an easy habit to get into, but how much do they understand about getting out of debt?  If you get into a debt cycle the cost could be tens and hundreds of thousands of dollars.  I’ve talked to people in all walks of life that have been in thousands of dollars in debt and that debt has cost them many, many tings.  There are times when you can buy stocks on margin and risk and already risky investment with a greater risk in debt funded investing.  I have debt not because I understood the dangers of debt but more because I ignored the risk in debt.  Take it from the many, many people I have talked to who understand, just like me, from experience: don’t get into credit card debt or other unsecured forms of debt unless you want to suffer for it.

Other debts like car and home loan debts can be major risks as well if you’re not prepared to tackle the carefully and have a contingency plan for lost jobs or injuries (I will be doing more research on these two topics for the future and for future posts or podcast episodes).  Any money that you are contractually obligated to pay is a risk given the unknown nature of the future.  That isn’t to say that you shouldn’t take out a loan on a house, but more that you need to calculate the risk.  Don’t get a home loan that is high risk - that includes a mortgage payment that is more than a safe percentage of your budget (my step-father-in-law recommended to me 25% as the max, and I agree).  Car loans are not always bad, but the risk of driving a brand new car off of the lot is that you could potentially get in an accident and the immediate depreciation would mean that you could get insurance money for only 90% of what you just signed a loan for if you financed the entire vehicle.

Risk in Investing

Investing is an area where I have personally lost a lot of money.  There is nothing that can guarantee a stock investment.  Google stocks may be up today, they may be up next month or next year, but they are not invincible.  The dot com boom of the late 90’s caused great wealth to reach investors… only be blown up at the crash of the dot bomb bust.  The reason I lost the money I lost was because I didn’t know the risk of my investing and I didn’t know enough about the investments I was making.  For the investor to increase their chances of successful investing there are several elements that need to be in place:

1. Invest what you can afford to lose - if your money earns you great wealth, fantastic, but because investing is not a certainty but instead a risk-taking proposition, you need to be aware that loss could take place.
2.  Gain as much knowledge about your investment as you possibly can.  I didn’t understand how options trading really worked and it cost me a large chunk of money.  If you’re investing in options or stocks learn how options and stocks work, learn about charting the market tickers, and learn about the companies that you’re investing in or against or the markets that you’re going to invest in or against.   If you can’t invest with confidence in your knowledge and a very strong chance of a financially positive outcome for you - this is high risk: don’t do it!
3. Know how much time you can afford to put into the investment tracking and monitoring.  You can’t just set all investments into drive and walk away, the stock market is often volatile because of the second-by-second trading that can take place.  You need to know about the type of investment you’re making and then be able to react accordingly.  Stocks can often be traded moment by moment, mutual funds can often have different buying and trading requirements (usually you must by or sell during one time or another - and those windows matter) and you as a trader or investor need to be ready to monitor these things to limit your risk.

Risk in Time

As has been said before in various quotes and truisms: those who don’t learn from history are doomed to repeat it.  I don’t reiterate that to cause fear and consternation but instead to draw attention to the fact that different times bring on different markets and different opportunities.  What has often been stated in investing books I’ve read is that slow-minded consumers often buy at the end of a market direction, or sell after the best time to sell, because they don’t know that time has risks associated with it.  Don’t buy a stock because you see that its gained 45% in the last year and every neighbor on your block has some stock in the company.  That’s risky.  Due diligence indicates that you should do some research and discover the state of an investment within its normal trend cycles [Google Finance has some good charts that you can look at for free]

Risk in Knowledge

As indicated earlier with investing knowledge of your investment is important.  Knowledge is a powertool in anyone’s arsenal.  Knowing about your investment will include quality, quantity, time and trends.  Knowledge may have to do with products, pricing and production.  Apple iPhones were predicted to sell well, but few people speculated that 1,000,000 phones would sell within the first month let alone the first several weeks [admittedly Apple & AT&T have not released figures, but estimates have certainly reached that level].  Those with deeper market familiarity have built up a a greater knowledge base and can guess closer to how the consumer base may react due to that knowledge.  Watching industry trends will help, but knowledge gained is important!  Lack of knowledge can be a risk and holding onto old knowledge without new knowledge can be risky as well.

Areas to Understand to Gain Safety

Because risk is all around you need to evaluate  where the greatest risk is.  There is no risk like blindly throwing yourself at something, an investment, or event without evaluating all of the details.  Consider each one of the areas of risk outlined below and any others you can think of.  Evaluate things and keep searching for risks, opportunities and success with careful attention to detail.  in my own life I lost money due to ignorance, emotional attachment to some ideal outcome, and a lack of will power.

Have self control, have focus and discernment.  Risk isn’t as risky when you’ve got all of the details.

I’ve been listening to the HBR Podcast (not free music, but a podcast nonetheless) and today I’m listening to an interview with Paul Saffo (Six Rules for Effective Forecasting). Several quotes and concepts stand out to me:

“Effective forecasting means rather than racing to a certain answer, you’re looking at the full range of uncertainty. Effective forecating is all about understanding the uncertainty that lies ahead and not rushing to a conclusion.” - Paul Saffo

In the world of investing you’re basically forecasting on how well some business will do with some thing.  Whether that thing is a contraption, software, a service or a concept matters little.  You’re taking a guess at what will take place.  When you invest in stocks, options, bonds or housing you are making predictions about how things will do.  The article linked to above is incredibly interesting as it relates to forecasting.  Having lost my shorts in the past in bad investing strategies (that weren’t based on any of the rules listed and in many cases flew against them) I’m interested in regaining my feet in the world of investing and making sound choices.  After reading this article, what do you think?

What do you do with extra money that you weren’t expecting? I had a side project come up that will be giving me some extra revenue and I’ve been pondering how that many should be used. There are a few areas that this money could go to and I wanted to publicly explore those different areas and 1) lay out some ideas and 2) get some feedback from folks to see what your inclination would be.

Add It to the Planned Budget

This would definitely pay off some debts that I have incurred (and am attempting to pay off rapidly) and it would allow us to invest money to our gain later on. This would mean less free money now, but more free money later. By free I mean not in bondage to the debt, not free as in unearned. This plan could mean using money for earning interest in investments later due to not having debt later.

Spend It on Something that is Currently Outside of our Budget

This plan would be fun for the short term. Its not a bad plan if you have a system in place and a budget that should achieve your financial goals. This plan may be the new television, the fun vacation or the spinner rims that you wanted (not really). If I had money to burn I might buy some musical instruments, a new road bike or a new computer. It would be selfish money and it wouldn’t be thinking long term. That’s OK in some situations, but its not my first choice.

Fifty-Fifty

Its possible that we could spend some of the money on some things we want, and use some of the money for debt reduction. Those would be nice things to have and it would be a good thing to do with some of the money. It doesn’t mean that we go crazy with all of it, and it doesn’t mean we don’t get to have some “fun money,” it just means that we have a compromise. This could also be split some other way instead of down the middle. If a new toy costs $200.00 and I have $2,000.00 I could get the new toy and also put the rest down on some other debt reduction area.

Invest The Money

The other side is the all-investment approach. The money could be put into an IRA or a high interest savings account or some other investment and turned into a long term gain. The strength of this is that the money will quadruple in 30 years at a 5% growth rate resulting in roughly $8,643.88 at the end of the 30 years if you didn’t add to the investment. At a 10% growth rate it would reach nearly 35,000.00 in value. If you had a budget and a plan that was going to take care of debt and other financial needs in a time frame that you felt good about this would give you a great long term ‘bonus.’ Your needs would be taken care of and your interest in the long term would really gain you a leg up for much bigger items down the road.

Final Thoughts

I don’t know exactly what I’m going to work out with my wife as we discuss the immediate needs of our family but I suspect this will fit into our regular planned budget to help pay off debts faster. We’ve got some savings going on for now and we need to build up more savings in the long term but right now the debt pay-down is going to dominate our focus until its gone (and hopefully never to return). However, we’re going to discuss each of the possibilities above and we’ll make a choice we feel good about.

Did I miss anything? Is there an option I haven’t listed above? What would you do if you had (for example) $2,000.00 windfall?

I’ve been pondering the best way to handle to achieve my goals long term and it seams that the best approach is going to be through a blended mixture of several things:

• Looking for ways to not spend money
• Looking for ways to earn extra money
• Looking for ways to use the money I already have as a tool or sets of tools

It is easy to get caught up in the mindset of making more money (and this blog’s title indicates that, but it was intended as a play on words and for humor purposes rather than a philosophical statement), but instead of just one leg to this stool, lets embrace as many aspects as possible and look at the problem from all angles.

Not spending money on frivolous things, or being frugal, is one important aspect. Not to the point of suffering, but to the point of discerning needs, wants and the in between elements and knowing what needs to go. Know whether or not you need to spend that money and also know the long term consequences of saving that money, with interest.

Looking for ways to earn extra money will involve your knowing what you have time for, what you can get done in that time, and also evaluating the cost and return on investment associated with making that extra money.  Sometimes that is moonlighting, sometimes that will be a side-business and sometimes it will be short-term projects that you know will be money makers.

You’ll want to make sure that you’re maximizing the money that you do have.  One of the ways that you can do that is to find the best accounts available for the different financial institutions available.  Trent at The Simple Dollar suggested getting a high yield savings account.  I’ve got one set up now.  In many cases there’s a minimum amount that you have to have in the account to make the 5% (or whatever the account is offering), but if you can keep that amount in there and use that account as a holding account to before passing the funds to other accounts (such as an IRA for tax savings) then you’ll get the earned interest, plus the tax savings before the tax season is over.

Think about how you’re using your money, be wise with it, know its current value, its future potential value, and think outside of the box as you look for ways to improve your estimated net worth.

The investment pyramid is a concept my father showed me when I was younger. This pyramid shows three different levels of risk and a pyramid showing the different percentage levels affiliated with each risk level. For example if you had $10,000 to invest you would want a larger chunk around $5,500 invested in lower risk investments like CD’s (or any other lower risk investment, but probably not just a savings account). The next level up is the medium risk investment section. You might choose to invest in some medium risk mutual funds because those funds will have a higher return than a CD will have. To prevent yourself from losing all or most of your total $10,000 you’d want to make the medium risk chunk closer to $3,250. At the top of the pyramid is the high risk section. This section has the highest amount of interest you might earn on an investment, but because of its high risk you might want to invest $1,250 (or less) here.

Investing requires you to know where you are comfortable investing, you’ll definitely want to have someone you trust such as a financial adviser who can help you find the right investment in each section. Because my own knowledge is limited it would be unwise for me to invest in things beyond mutual funds at this point in time. By throwing my money at stock or options I might just blow all $1,250.00 because I don’t have competence on that level. Because I can’t babysit various investments due to my full-time work requirements there is greater risk for me to invest in such marketing tools - they’re a double edged sword and if I lose control the blade will cut my investment money rather than increase it.

Another aspect of this pyramid is that differently aged investors may want to adjust the angle of the pyramid, you might feel that at a younger age higher risk investments can take a larger percentage of your total investment strategy because you’ll have more time to recover if the investments go sour. You’ll want to talk to a financial adviser in this case because you’ll need to evaluate your goals.

A look at those numbers will show you the rough percentages that I’ve used:

Low risk: 55%
Medium risk: 32.5%
High risk: 12.5 %

You may want to adjust those numbers in some cases, but that’s for another article