Turning Down the Noise

Question of the week:I want to learn to become a better investor, but I'm kind of overwhelmed by the amount of investing information out there. Can you recommend the best expert or publication? I'm especially interested in finding out which direction the market will be going. --K.R., Dallas Dear K.R., Given the incredible deluge of financial information on the Internet, television and the newsstand, you can hardly help but be overwhelmed. But you need to realize that the media needs to sell headlines to stay in business, and that nothing sells headlines better than "investing noise"--claims about where the market is headed in the near term and which investments your must buy (or avoid). This noise creates uncertainty, even fear, in some investors, prompting many of them to try to constantly chase a better return or find a better fund manager. This is the exact opposite of how a successful long-term investor behaves. When we asked members of the Armchair Millionaire community about where they got their investing information and how they used it, we heard some nuggets of wisdom: "Variety of sources, such as CNNfn, CNBC, CBS, ABC, Prudent Bear, newspaper, magazines, weekly finance publications, etc. Each has a perspective, and some have an axe to grind." --Alan and Kay "I read a lot and subscribe to Business Week, Kiplinger's, and Fortune. I skim for ideas and seldom bite. My portfolio turnover is of the order of 5 percent a decade ... These sources are useful, with a lot of filtering." --Duke I was at a recent investing seminar and the speaker, whose job it was to "wow" the crowd, said it best: "Don't accept forecasts. No one knows the future. Use only historically-proven investing methods." The theme here? These smart investors recognize that there are many sources for investing ideas but no substitutes for using common sense. If someone tells you they know something that's going to happen in the future, you would do best to regard them with skepticism. Rather than being a "noise investor," focus on becoming an "information investor"--someone who knows how the financial markets work, who uses a common sense, long-term investment strategy, and who doesn't chase the latest hot investment. My guide will help you filter out the noise as you journey towards becoming an information investor. The Armchair Millionaire's Guide to Tuning Out the Noise Focus on quality, not quantity. More is not always better when it comes to financial information. Choose one or two quality publications or programs that address a wide range of investing and personal finance topics, and that focus on education to help you be a better investor. Consider the source. Who is making a particular recommendation? Is it an analyst that is mainly concerned with the short-term direction of a stock? If so, such a recommendation offers little for an investor building a portfolio for the long term. Resist any calls to immediate action. Be wary of headlines that scream, "Sell Stocks Now!" Sudden about-faces have no place in any well-considered, long-range investment plan. Beware of anyone making forecasts. No one has a crystal ball. For every pundit who says the market or a particular stock is heading one direction, you can find another who swears it's going in the other direction. What we do know for sure is that the market goes up and down from one day and year to the next, and that over longer periods of time it goes up. Stick with the enduring rules. No matter which direction the market is heading, there are timeless investing principles that will see you through. Save a portion of each paycheck. Invest regularly to take advantage of dollar cost averaging. Take advantage of all tax-advantaged investing opportunities, like your 401(k) or IRA. Buy and hold low-cost investments that track the stock market, such as index funds. THE BOTTOM LINE: The reality is that there is no single expert or publication that will consistently provide you with an advantage when it comes to choosing particular investments or deciding when to invest. But the good news is that you don't need this kind of advantage to be a successful investor.

Real-World Number Crunching

Question of the week:I recently received an inheritance big enough to pay down my home mortgage. I have a great mortgage interest rate and monthly payments I can afford comfortably. I have no other large debts to deal with because I keep my credit cards clear and I don't plan on having children. Should I pay off my house? Or should I invest it? --Gus B. Dear Gus, Yours is certainly a nice dilemma to have, and you're to be congratulated for considering your two very attractive alternatives so seriously. We recently asked members of the Armchair Millionaire community to weigh in with what they would do if they were in your shoes. Here are just a few of the comments we heard: "Pay down the mortgage early. It's a guaranteed savings, risk-free, and if necessary, the money is there to borrow against at a later time." --Craig "Do both. Put 25 percent of the extra cash towards paying down the mortgage and invest the remaining 75 percent in stocks and bonds. Consider your home a partial 'investment.'" --Jeff "Invest, especially if you can do it through an IRA. You'll get the tax advantage of the IRA and still have the tax advantage of the mortgage." --Gregory As you can see, people hold widely varying opinions. Who's right? Actually, everyone. Because everyone is in a different financial situation, there's no single answer that works for everyone. This means that you'll need to do some thinking and run some numbers. At the heart of it, you need to do a cost-benefit analysis--something every MBA student learns inside and out. But don't be put off by the fancy term. It's really just means figuring the benefit of a particular course of action, subtracting the costs, and deciding if it's worth it to you. In your case, the benefit in paying off your mortgage would be the interest you would save and the peace of mind you'd achieve from being mortgage-free. The cost would be the lost opportunity of not investing your money elsewhere. Would the benefit outweigh the cost? That's for you to decide. My guide will help you crunch the numbers. The Armchair Millionaire's Guide to Crunching the Numbers State the alternatives clearly. Break your choices down into manageable parts that you can assess individually. Define each possible outcome and look at all the factors that will impact each. For your decision, some of the factors to consider will be the rate of return you might get on an investment, how long your money might remain invested, the interest rate you're paying on your mortgage, your job security, and any other financial goals you might have. Look for the hidden costs and benefits. Don't overlook the impact of both taxes and inflation. For example, you receive a bit of a tax break when you pay mortgage interest (assuming you itemize your deductions). Likewise, when figuring how an investment might grow, remember that inflation erodes that value of a dollar over time. For example, to have $100,000 in today's dollars, you'd need to have $134,000 in ten years (assuming 3 percent annual inflation). Be sure to include these factors in your calculations. Be realistic about investment returns. Many people look at average annual returns of a major market index like the S&P 500 and assume that they can earn the same returns over time. In the real world, though, most people actually earn less. A better way to estimate what your returns might be over the next ten years would be to look at what your returns actually were over the last ten years. Honor the intangibles. The major challenge in working any cost-benefit analysis is accounting for the intangibles--the things you can't measure in dollars. For example, how do you figure the value of the feeling you'd get from knowing your mortgage is paid off? For some people, it would be worth a great deal; for others, much less. Leverage online tools. There are plenty of online calculators that will do the math for you as you run different mortgage pay-off and investment scenarios. Good places to start are www.cnnmoney.com and www.bankrate.com. THE BOTTOM LINE: There's emotion involved in any big financial decision, but you also need to be clear-headed about the math. Be as rational as possible in considering all the variables and you'll have a great basis for making a sound decision.

Are REITS for Real

Question of the week: I've always invested in plain vanilla stock funds, but lately I've been thinking of branching out a bit. I've noticed that REITs have really done well lately. What do you think about them? --O.L. Dear O.L., Real estate investment trusts (usually known as REITs, but also called real estate stocks) enjoyed a total return of 37.5 percent last year, according to the SNL Equity REIT Index. So you're not the only one paying attention to this unique investment. Not surprisingly, when we asked members of the Armchair Millionaire community about their experience with REITs, we heard some positive responses. Here are two: "I invested in a group of REITs designed by my broker 19 months ago and am up by 20 percent, so I am very happy." --Posted by Jean L. "I have invested in REITs and have been pleased with the dividends and the increase in the value of my shares. If they continue to do well I will add more shares next year." --Posted by John T. REITs offer an easy way to invest in real estate without having to deal with the hassle of actually buying, maintaining and selling property yourself. If you think they might be right for you, read on. My guide will help you learn more. The Armchair Millionaire's Guide to REITs What they are. In a nutshell, REITs are companies that own and usually operate income-producing property. This can include everything from shopping malls to office buildings to resorts, although many REITs specialize in one type of property, and some may specialize in one region of the country. According to the National Association of Real Estate Investment Trusts, the REIT industry trade group, there are about 180 publicly traded REITs available today. Who they're for. Because they are required by law to distribute at least 90 percent of their taxable income to their shareholders every year in the form of dividends, REITs can be attractive to people who are looking for current income from their portfolios (such as retirees), as well as people who want the diversification that real estate provides. How to buy REITs. You've got two alternatives here. First, you can buy shares of REITs just as you would buy shares of stock. To do so, you'll need to go through a broker. Your second choice (and in my opinion, the better choice for someone just getting started investing in REITs) is to buy a mutual fund that invests in REITs. Real estate funds are offered by many of the big mutual fund families, so you'll have plenty of choices. REITs in your portfolio. One attractive feature of REITs is that they tend to have a low correlation with stocks. In other words, even if stocks--as an asset class--are down, REITs may be up or down, and vice versa. In this way, REITs add balance to a mostly stock portfolio. However, if you already own a home, consider that you may already have effectively diversified your portfolio with real estate. Digging deeper. I've only scratched the surface of a fairly complex type of investment. Before you invest, I urge you to learn more. A good starting place is the Web site of the National Association of Real Estate Investment Trusts, found at www.nareit.com. THE BOTTOM LINE: While it's true that REITs had a banner year in 2003, they should still only be considered as one part of a common sense portfolio. Just as you shouldn't chase a hot stock, neither should you buy REITs just because they've enjoyed great returns lately.

Putting Every Penny to Work

Question of the week:I was lucky enough to get a nice holiday bonus of $2,000 this year. Any suggestions on how to make the most of this extra cash? --J.S. Dear J.S., Lucky you are, given that most businesses these days do not give their employees holiday bonuses. In fact, according to a survey last year by American Express, just 43 percent of business owners planned to give bonuses. That's all the more reason to make the most of your extra cash. When we asked Armchair Millionaire community members about how they planned to use their holiday bonuses, we heard from some with generous--and not so generous--employers: Baby bucks. "I got a $100 bonus, or basically, one day's pay. Since I was getting new glasses the same week (I used my last pair for 6 years!), I just put the money toward those. After the way my stocks have performed lately, I'm ready to take a second job and can't afford to put any 'bonuses' toward luxuries." --Erin Big bucks. "I got a $15,000 (pre-tax) bonus. Breakdown of where it's going: $3,000 into an IRA, $4,000 to pay down personal debt (almost done!), $2,000 towards a new (used) car we need and the rest into a new PC and home repairs." --Bob Regardless of the amount of your bonus, you still want to leverage the money in the best ways possible. My checklist provides my top recommendations for putting your money to work. The Armchair Millionaire's Checklist for Turning Casual Cash into Serious Bucks Zap your consumer debt. Carrying a balance on your credit cards? Use that extra cash to get rid of it, or at least to put a big dent in it. If you have a $2,000 credit card debt charging 18 percent interest, it will take you more than seven years and over $1,700 in interest to pay if off if you just make the minimum payments. But pay it all off now, and that's like cash back in your pocket. Secure your retirement. Ready to get your retirement plan on track? Consider putting that cash into an Individual Retirement Account. You can put up to $3,000 into an IRA this year, money that will grow on a tax-advantaged basis right up until you withdraw it during retirement. If you put $2,000 each year into your IRA over the next 25 years, and it grows at an average annual rate of 10 percent, you'll end up with about $233,000. While most people are eligible to contribute to an IRA, check with your tax advisor to make sure you are. Save for college. Have a college-bound child? An annual contribution of $2,000 to a college fund earning an average return of 10 percent will grow to just over $36,000 in 10 years. There's a nice range of college savings programs now available, most of them offering substantial tax advantages. One of my favorite Web sites for learning about your college savings choices is www.savingforcollege.com. Pay off your mortgage early. Want to get out from under the mortgage burden? An extra $2,000 payment each year on a $200,000 30-year mortgage with seven percent interest will knock off more than eight years of payments--and save you nearly $90,000 in interest. THE BOTTOM LINE: Creating a real and positive difference future your financial future doesn't require you to be a money whiz or even to have a huge amount to begin. Just commit to a plan and get started.