I’ve gone on a lot of interviews, including interviews where I didn’t really want the job just to gain confidence and experience in interviewing. If you are not a senior in college, I would highly suggest at least going to a few interviews for internships even if you don’t ultimately want the job. Preparation is important, and you don’t want your very first interview to be for that job you really want. Here are a list of interesting questions I’ve gotten at interviews and what you might expect for these companies or similar ones:
Wachovia:
This interview was probably my most memorable. Of the two men interviewing me, both were graduates of MIT and made sure you knew that. After a few behavioral questions, they asked me to a valuation…of a bridge. That’s right. A bridge. The question went something like this:
“Suppose there is town A, which is a factory town, and town B, which is mostly residential. Connecting these two towns is a bridge, and the bridge is for sale. You have been hired to do a valuation of the bridge. Ask me some questions to help you do the valuation.”
So I asked if there was a toll, which it turned out there was. I asked about the volume of traffic on the bridge, the annual revenue, the costs of repairs and maintenance to the bridge, and if there were any other bridges nearby. Then one of the interviewers said there was a “news alert” that the factory had closed down.
To me, this was a bit bizarre. But don’t think it can’t happen to you- case studies, whether it’s just you doing the analysis or a group, are very popular.
Unilever:
Unilever has a few different divisions of finance, and currently it was obvious they are looking for diversified employees. This is a good company if you are looking for a corporate finance position. There are only two rounds of interviewing, so if you make it to the “on-site” interview in Englewood, NJ, you are in the final round. You’ll have a few interviews with upper level executives who will ask you mostly behavioral questions. Stress teamwork, analytical skills, and how much you also like marketing (because you’ll work with the financing of marketing food products) and you’ll have this in the bag. Not really a stressful interview, so don’t worry too much. This did include a group case study, where each student was assigned a role and we had to divvy up a budget between each of our prerogatives. Of course, not nearly enough money was provided so negotiation, compromise, and teamwork was necessary.
Cambridge Associates:
Cambridge also has two rounds. The first person you will interview with is from HR, so you don’t need to dazzle them as much with your finance knowledge than you do with your “soft” skills. Of course mentioning finance buzzwords is great, but they aren’t going to be asking you to do a DCF. The next round is with the executives and the analysts as the firm, and you should prepare a long list of questions because you’ll meet with at least 6 of them. I was asked questions such as “Explain the difference between venture capital and private equity” and “Explain what you think the job entails and what alternative assets are”. Always be able to give a synopsis of what you think the day-to-day responsibilities of the job are. All companies want to know you did your homework and you understand exactly what you’ll be getting into, so if they offer you the position there is a better chance of your acceptance.
To be continued next week…
Finance Interview Insider Tips: What to expect
The Finance Interview: What you need to know
Finding a job is difficult- it takes perseverance, planning, and long hours of writing and revision. For finance students, just polishing up your resume is not enough. You need to be knowledgeable about certain finance topics that I will outline later, and you need to be especially sharp in appearance. Most importantly, you need to have confidence.
Before you even step in the room:
- Print your resume on ivory executive resume paper- not the white computer paper you currently have in your printer. The thicker stock is more professional
- Print multiple copies and place them in a portfolio or a professional folder (I like the dark green folders you can find at Staples. Should you be really ambitious and rich, you can purchase 50 custom dark green linen folders at Staples printed with your name on the cover. But for most college grads, the plain folder will do).
- If you are a woman, do not bring a purse. This reminds interviewers that you are a woman (silly as it seems) and can give them a subconscious bias you do not want.
Appearance:
I can’t really help on the guys end other than the obvious shave, wear a black suit, and make sure your shirt isn’t wrinkled. For other interview style tips…you are out of luck.
But for women:
- Wear black pantyhose (a must! Most interviewers are old-school and pantyhose are required in the workplace. They are not going to understand or care about the bare-leg fashion trend). Always bring a spare with you if you can.
- Wear a plain black or pinstriped suit, or a dark grey plain/pinstriped suit. This is not the place for your really cute Chanel pink tweed suit.
- Wear a colored dress shirt to stand out from the other women. White is no longer required. Try french blue, dark purple, or a striped dress shirt.
- I always think that hair up (not a ponytail- try a French twist, or some type of neat simple updo) is more professional than hair swinging down your back. But that’s debatable.
- Don’t wear loud nail polish or loud colored makeup. A French manicure or nude nail polish will do, especially if you normally bite your nails or don’t take care of them. Looking polished is key. Very light, subtle makeup is okay.
- Every businesswoman should have a nice, quality pair of black pumps. If you don’t, go buy some.
Must-know topics to review before the interview:
- Discounted Cash Flow
- Income Statement (also referred to as a P&L), Balance Sheet, and Statement of Cash Flows
- Current state of the economy and current 10-y bond rates
- Bond valuation (pertinent to fixed-income jobs)
- Equity valuation (know metrics on how to value a stock, such as: P/E ratio, Debt/Equity ratio, EPS, dividend yield, and ROE)
- Options and futures
It's important to form your own view of the economy and know about different markets, especially markets you are excited to do research in. It is impressive to an interviewer that you've taken the time to know what is going on with interest rates and to have an opinion on housing stocks- even if they don't neccesarily agree with you, if you have the analysis to back it up, you'll show them how excited and interested you are in finance.
As for every type of job, of course you need to research the company, think of intelligent, well-articulated questions, and get a good night’s sleep. Good luck!
Want answers to your finance questions, or want to know more about my finance interview experiences? Feel free to email me at ejourdan1@babson.edu
IRA's: what's best for you?
When you graduate, your employer encourages you to save for retirement through the 401(k) which I discussed last week. However, the government also offers two tools that encourage retirement savings. The IRA or independant retirement account provides a tax shelter for your retirement savings. There are two types: the Traditional IRA and the Roth IRA.
The Traditional Ira:
- Tax deductible contributions (depending on income level)
- Withdraws begin at age 59 1/2 and are mandatory by 70 1/2.
- Taxes are paid on earnings when withdrawn from the IRA
- Funds can be used to purchase a variety of investments
- Available to everyone; no income restrictions
- All funds withdrawn before 59 1/2 are subject to a 10% penalty (subject to exception).
Roth IRA:
- Contributions are not tax deductible
- No Mandatory Distribution Age
- All earnings and principal are 100% tax free if rules and regulations are followed
- Funds can be used to purchase a variety of investments
- Available only to single-filers making up to $95,000 or married couples making a combined maximum of $150,000 annually.
- Principal contributions can be withdrawn any time without penalty (subject to some minimal conditions).
The biggest difference between the Traditional and Roth IRA is how the monies inside them are taxed. If you earn $60,000 a year and put $2,000 in a traditional IRA, you will be able to deduct the contribution from your income taxes (meaning you will only have to pay tax on $58,000 in income to the IRS). At 59 1/2, you may begin withdrawing funds but will be forced to pay taxes on all of the capital gains, interest, and dividends that were earned over the past years.
Iif you put the same $2,000 in a Roth IRA, you would not receive the income tax deduction. There are no penalties for withdrawing principal at anytime. When you reach retirement age, you will be able to withdraw all of the money 100% tax free. The Roth IRA is the best tool the government provides, however unfortunately not everyone qualifies for a Roth. A person filing their taxes as single can not make over $95,000, but as a recent college graduate you will most likely qualify. It is a great tool to use to save for retirement and as long as you are eligible I urge you to contribute as much as you can.
You can generally purchase any type of investment you would like, either through a brokerage account or a bank. Unlike a 401(k), you can choose any investment offered through the bank or brokerage firm rather than just those funds offered by the adminstrator of the 401(k). This includes index funds, exchange traded funds, or mutual funds.
Job interview basics: valuing a corporate bond
Are you interviewing for a fixed income analyst or researcher? Brush up on your valuation skills before attending the interview. Below is a sample valuation of a corporate bond issued by Chiron Corporation.
Basic Bond Information:
The bond analyzed in this example was issued by Chiron Corp and is graded A- by S&P, meaning it is considered a safer bond to invest in. The bond is currently undervalued and would be a good buy, and matures on 10/28/22. The bond is convertible and the conversion ratio is 14.925. The coupon is 2.75% and the current stock price is 31.64.
Analysis:
First, I calculated the present value of the bond. Merrill- Lynch computes a theoretical value of 97.28, which takes into account the option price currently available on the bond. In this case, the bond is being offered at a discount which is why I recommend it, especially considering its rating by S&P.
I determined that the number of shares to hedge against an upward raise in the stock price is 11 shares, outlined below:
Convertible price = $1,000
Stock price = $31.64
Conversion premium = 5.88%
Stock price conversion premium = $33.50
Option delta = 0.377
Number of shares to short = 11.25
(Convertible Price/ Conversion Premium)*Option Delta
I assumed a 30% rise and decline in the stock price because the annual volatility is 30%. Below outlines the annualized returns based upon hedging the bond through shorting 11 shares and purchasing the bond now. Even if the stock declines in price by 30%, the bond holder would still make a minor return, and on the upside will make a significant return of 23.27%. Thus, the risk of purchasing this bond is low because with the hedge you will not loose any money and have the possibility of making significant returns. My calculations are shown below:
No Change in Stock Price:
30% Rise in Stock Price:
30% Decline in Stock Price:
Recommendation:
As this bond is rated A-, I feel the default risk is low. The bond is undervalued and presently a good buy. I recommend this to clients who do not want to take on a lot of risk however would like the possibility of higher returns. The volatility of the stock is high, but I feel this is a trend in the healthcare industry and is to be expected of a company of this size. I recommend a client considering purchasing this bond purchase 11 shares of options to hedge against the risk of the stock decreasing significantly.
Below is a convertible bond calculator which is available at cfo.com, and I plugged in the data from Chiron Corp to determine the conversion price per share and other outputs. Also, should you want more information about options (which is discussed in this article as a way to hedge against risk) check out cboe.com. The Chicago Board Options Exchange has a myriad of fantastic tutorials on options, many of which are available for free online.
Examining your 401(k) plan! (Part 2 of a 3-part series)
Have you read your employment contract fully? Once you’ve started a new job, most large companies include as part of the terms of your employment contract a 401(k) plan, usually allowing you to start contributions a specified period of time after you begin working. So what is a 401(k) plan? In layman’s terms, it is an easy way to save for retirement. A 401(k) plan is: “A qualified plan established by employers to which eligible employees may make salary-deferral (salary-reduction) contributions on a post- and/or pre-tax basis. Employers may make matching or non-elective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.” [1]
Basically, this means that any money you put into the plan is tax-deferred. For example, see the table below:savings-798968.jpg)
You only pay taxes when you withdraw your money. In the meantime, your principal grows tax-free! For example, let’s say you invest $1 into a mutual fund outside the 401(k) plan. First, before you even invest the $1, it is taxed by the government. So you actually start out with only 72 cents. It would need to make a 40% return to return to a dollar again, and this would take a couple years. Contrastingly, if you invested $1 into a mutual fund through your 401(k) plan, you would start off with $1. On top of that, many employers will match a potion of your contributions anywhere from 25 cents to 50 cents on the dollar. So through a 401(k) plan, automatically you’ve earned a 25%-50% return on your dollar without your investments doing anything!
Also note that you should (as I mentioned in the first blog) start early!! Below is a chart showing your savings based upon a $100 contribution monthly to a 401(k) plan with a 8% annual return.
[2]
With a 401(k) plan, note that if you withdraw any of this money before age 59 ½ there will be a penalty. There is also a limit to how much you can put in pre-tax to your plan- in 2007 it is $15,500. But should you change jobs, you can switch your old 401(k) money to your new one (or an IRA). Even though the investment options through the 401(k) plan might not be as exciting or aggressive as you’d like, most plans have a wide array of mutual funds, bond funds, and money market funds to invest in. You should always contribute as much as you can to your fund, because employer matching is an addition to your salary. If you invest all $15,500 and your company matches 50 cents to the dollar that is a $7,750 bonus! Not only that, but your investment is tax-deferred. So don’t delays in contributing to your 401(k) plan- it can add up to substantial savings for retirement!
Next week: IRA's !!!
[1] Investopedia. http://www.investopedia.com/terms/1/401kplan.asp
[2] Cost of Waiting, https://www.fiserviss.com/pls/portal/docs/PAGE/401K_MAIN/401K_ASSETSLIBRARY/money-chart.jpg
Preparing yourself for the CFA: must-know information
If you plan on having a career in corporate finance, the CFA is a must. CFA stands for Chartered Financial Analyst, and to become a CFA involves three tests over three years, over 250 hours of studying, and a strict code of ethics. It is the industry standard, and if completed successfully your salary potential will increase dramatically. Most employers expect you to begin the process of this exam within 5-7 years of joining the company after graduation, and to not do so is career suicide.
To even register to take the CFA exam, you must first have the fulfilled the following requirements:
· Have a U.S. bachelor’s (or equivalent) degree, be in the final year of your bachelor's degree program, or have four years of qualified, professional work experience or a combination of work and college experience that totals at least four years
· Meet the professional conduct admission criteria. During the application process, you will be asked to sign statements of Professional Conduct and Candidate Responsibility.
· Be able to take the exam in English.
To maintain your candidate status, you must commit to the CFA Institute Code of Ethics and Standards of Professional Conduct — “a commitment that cannot be taken lightly and demands that, above all else, you put the interests of your clients first. There is nothing that CFA Institute does that is more important than promoting and enforcing the use of the Code and Standards among members and candidates.”
Wondering what this exam will cover? The following is a topical outline of all the current subjects in the exam:
CFA Candidate Body of Knowledge (CBOK)
I. ETHICAL AND PROFESSIONAL STANDARDS
A. Professional Standards of Practice
B. Topical Issues
II. QUANTITATIVE METHODS
A. Time Value of Money
B. Basic Statistical Concepts
C. Probability Concepts and Random Variables
D. Common Probability Distributions
E. Sampling and Estimation
F. Statistical Inference and Hypothesis Testing
G. Correlation Analysis and Linear Regression
H. Multivariate Regression
I. Time Series Analysis
J. Portfolio Concepts
III. ECONOMICS
A. Market Forces of Supply and Demand
B. Elasticity
C. The Firm and Industry Organization
D. Supply and Demand for Productive Resources
E. Measuring National Income
F. Economic Fluctuations and Unemployment
G. The Monetary System
H. Inflation: Causes and Consequences
I. International Trade
J. International Finance
K. The Macroeconomics of an Open Economy
L. Aggregate Demand and Aggregate Supply
M. Sources of Economic Growth
N. Government Regulation
O. Natural Resource Markets
P. Relationship of Economic Activity to the Investment Process
IV. FINANCIAL STATEMENT ANALYSIS
A. Financial Reporting System
B. Principal Financial Statements
C. Earnings Quality and Nonrecurring Items
D. Analysis of Inventories
E. Analysis of Long-Lived Assets
F. Analysis of Income Taxes
G. Analysis of Financing Liabilities
H. Analysis of Leases
I. Analysis of Off-Balance-Sheet Assets and Liabilities
J. Analysis of Pensions, Stock Compensation, and Other Employee Benefits
K. Analysis of Inter-Corporate Investments
L. Analysis of Business Combinations
M. Analysis of Multinational Operations
N. Ratio and Financial Analysis
V. CORPORATE FINANCE
A. Fundamental Issues
B. Capital Investment Decisions
C. Business and Financial Risk
D. Long Term Financial Policy
E. Mergers and Acquisitions
F. Valuation Implications of Corporate Finance
VI. ANALYSIS OF EQUITY INVESTMENTS
A. Organization and Functioning of Securities Markets
B. Security Market Indexes and Benchmarks
C. Equity Risk Definition (e.g., statistical, economic, downside, relative, absolute, political) and Measurement
D. Fundamental Analysis
E. Special Applications of Fundamental Analysis
F. Technical Analysis
VII. ANALYSIS OF DEBT INVESTMENTS
A. Debt Securities
B. Risks Associated with Investing in Bonds
C. Global Bond Sectors and Instruments
D. Yield Spreads
E. Introduction to the Valuation of Debt Securities
F. Yield Measures, Spot Rates, and Forward Rates
G. Measurement of Interest Rate Risk
H. The Term Structure and Volatility of Interest Rates
I. Valuing Bonds with Embedded Options
J. Mortgage-Backed Securities (MBS)
K. Asset-Backed Securities
L. Valuing Mortgage-Backed and Asset-Backed Securities
M. Assessing Trading Strategies
N. Principles of Credit Analysis
VIII. ANALYSIS OF DERIVATIVES
A. Derivative Markets and Instruments
B. Forward Markets and Instruments
C. Futures Markets
D. Options Markets
E. Swaps Markets
IX. ANALYSIS OF ALTERNATIVE INVESTMENTS
A. Real Estate
B. Investment Companies
C. Venture Capital
D. Hedge Funds (e.g., characteristics, fee structure, leverage, short versus long)
E. Closely-held Companies and Inactively Traded Securities
F. Distressed Securities/Bankruptcies
G. Commodity Markets and Commodity Derivatives
X. PORTFOLIO MANAGEMENT
A. Capital Market Theory
B. Management of Individual Investor Portfolios
C. Management of Institutional Investor Portfolios
D. Pension Plan and Employee Benefit Funds
E. Endowment Funds and Foundations
F. Insurance Companies
G. Other Corporate Investors (investment policy considerations)
H. Capital Market Expectations
I. Asset Allocation
J. Portfolio Construction and Revision
K. Equity Portfolio Management Strategies
L. Debt Portfolio Management Strategies
M. Real Estate and Alternative Investments in Portfolio Management
N. Risk Management
O. Performance Measurement
P. Presentation of Performance Results
This year’s registration deadline:
For June 2 & 3, 2007:
15 February 2007
15 March 2007
For December 1 & 2, 2007:
15 March 2007
15 August 2007
17 September 2007
Note: there is a fee increase after every deadline, so the sooner you sign up the lower the cost.
The CFA is expensive- here is a chart of initial fees for taking the first level exam. Further fees apply for Level II and III:
Payment deadlines:
27 Sept 06
15 Feb 07
15 Mar 07
Registration Fee(one-time)
US$390
US$390
US$465
Exam Fee: Level I(enrollment)
US$370
US$455
US$690
Total Cost to Enterthe CFA Program:
US$760
US$845
US$1155
Want to try a sample exam? Samples are available for free on the CFA website:
http://www.cfainstitute.org/cfaprog/advantage/06nov/index.html *
Also, at http://ns.allenresources.com/services/gradeTest.do;jsessionid=4AA5F77F8DDB329E725DEF839989F9F4 you can answer “questions of the day” which are taken from past exams and you can immediately check your answers.
The CFA is a difficult exam, and a candidate who wants to be successful must study extensively and focus. The best way to learn the material is not to focus on answering lots of sample questions, but rather to fully understand the Learning Objective Statements (LOS) and the concepts behind them. With a less than 50% pass rate for Level I candidates, the way to success is through planning (setting up a study timeline), sticking to it, and focusing on the concepts you don’t know. Good luck!!
Want an edge up on the competition for your finance interview? Impress the recruiter with your technical analysis skills: the Elliot Wave Theory
Ever wondered about technical analysis? Have you ever thought about patterns in a stock’s price chart? Take a look at one popular technique, deemed the Eliot Wave Theory.
Basic Thesis of Elliot Wave Theory: In 1939, R. N. Elliott established the Elliot Wave Theory, which believed markets had well-defined waves that could be used to predict market direction. It stated that stock prices are governed by cycles founded upon the Fibonacci series (1-2-3-5-8-13-21...). Elliott believed the market moved in distinct waves: five on the upside and three on the downside.
Assumptions of Elliot Wave Theory: market is not efficient
It is a true free market (i.e., prices are set by demand and not by monopolistic price setting).
It provides consistent and regular metrics that can be measured.
It is manipulated by a statistically significantly large group of people. [1]
[2]
Wave Description:
The following description applies to a market moving upwards. In a down market you will generally see the same types of behavior in reverse that you saw watching the stock go up. The description of the wave (ie Wave 1) is shown visually in the chart above.
Wave 1
The stock makes its initial move upwards. This is usually caused by a small number of people that all of the sudden (for a variety of reasons) feel that the previous price of the stock undervalued and therefore worth buying, causing the price to go up.
Wave 2
The stock is considered overvalued. Now, enough people who were in the original wave consider the stock overvalued and sell to make a profit. This causes the stock to go down. However in general the stock will not go down to its previous lows before the stock is considered cheap again.
Wave 3
This is generally the longest wave. It has become a “popular” stock, and more people want the stock and they buy it for a higher and higher price. This wave usually exceeds the peaks created at the end of wave 1.
Wave 4
At this point people again take profits because the stock is again considered expensive. This wave tends to be weak because their are usually more people that are still bullish on the stock and after some profit taking comes wave 5.
Wave 5
This is where most people get on the stock, and is mostly driven by emotion. People will carelessly and without research purchase the stock, and will be hard to persuade not to. At this time, this is where the stock becomes the most overpriced. Then the stock will move into either one of two patterns; an ABC correction, or starting again with wave 1.
An ABC correction is when the stock will go down/up/down in preparation of another 5 way cycle up. During this time frame volatility is usually much less then the previous 5 wave cycle, and what is generally happening is the market is taking a pause while fundamentals catch up. You may have more than one ABC correction- if the fundamentals do not catch up you will have two ABC corrections and then the stock will have a 5 wave down cycle. (An odd number of ABC corrections point to the stock going up, and an even number of ABC corrections point to the stock going down.)[3]
Here is applied example:
Centex Corporation, from November 2005 to February 2006
[4]
After Wave 5, you can see that Centex had 2 ABC wave corrections, and thus the stock continued downwards on another 5-wave cycle.
Criticism of the Elliot Wave Theory:
Many critics believe that the wave principle is too vague to be useful, since it cannot always identify the beginning or end of a wave. They feel Elliott wave forecasts are often subjective and easily revised after the fact. Also, many say that if it actually did work, common knowledge of it among investors would force the pattern useless because all investors would try to profit from the pattern, and the waves would reverse and no longer hold true to the theory.
Sources:
CapitalIQ Charting
http://www.acrotec.com/ewt.htm
Kurganov, Yury. http://www.elliottwavemarkettiming.com/ 2006.
Investopedia. http://www.investopedia.com/articles/technical/111401.asp November 14, 2001
Lott, Christopher. http://invest-faq.com/articles/tech-an-elliott.html 12 Dec 1996
[1] Lott, Christopher. http://invest-faq.com/articles/tech-an-elliott.html 12 Dec 1996
[2] http://www.investopedia.com/articles/technical/111401.asp
[3] Lott, Christopher. http://invest-faq.com/articles/tech-an-elliott.html 12 Dec 1996
[4] Historical Price Data from Capital IQ
Also, check out the new video resume contest from Vault! http://www.vault.com/membership/ibank-video-challenge.jsp
Submit your video resume by February 13th to have the chance to have your resume delivered directly to I-banking recruiters by the Vault staff!
Finance for the Non-Finance Major: Once you’ve made some money, what do you do with it? (Part One of a 3-Part Series)
Concerned about your personal finances after graduation? Worried about loans, retirement, and investment planning? This article will help students who are not schooled in finance how to control and invest their money in a way that is comfortable for them. This is not a stock-picking article, nor is it intended for anyone who actually knows complicated finance instruments like options (you don’t need any help!). This is for the college graduate who knows they need to plan for retirement and invest their money wisely, but has no clue where to start.
If you’re reading this, you’ve already gotten over the first hurdle: realizing that just making money isn’t enough. Once you have it, you have to make your money work for you. One of the first things finance majors learn about is the time value of money.
The concept of the time value of money basically states that money today is worth more than the same amount of money tomorrow. Why? Because you can earn interest on that money. So my advice for anyone starting out is this:
# 1 Invest Early
I know you have student loans, rent, health insurance- things you’ve never had to deal with before. But think about this: in the next 30-40 years, you are going to want to retire.
How will you afford it? Take a look at this scenario:
$100 invested the moment you start your new job, at age 22.
Let’s say you in invest it an annual rate of 4.5%, compounding monthly.
By year 30 you’ve turned your $100 into $384.77
This doesn’t seem like much, does it? But think- you’ve tripled your investment!
So if you do it on a larger scale, investing early will earn you lots of interest income over your lifetime.
Let’s say you invest $100 at age 22, and continue investing $25 each month at an annual rate of 4.5%. $25 a month isn’t a lot, right? That’s one night a month you don’t eat out, or you don’t buy so many drinks at the bar. Here is what happens to your money:
By the end of 30 years, your $100 initial investment and your $25 a month turned into $19,369.42.
You put a total of $9100 into your investment, and earned twice that in interest- and without any extra time at the office!
One of my favorite comparisons is looking at $100 invested monthly between age 20-30, and $100 invested monthly between ages 40-50 (right before retirement).
Think you’ll save money for retirement later? Think again.
$100 invested monthly age 20-30. Never invested again.
Value at end of 10 years: $15,333.21
Value at age 60: $58,997.55
$100 invested monthly age 40-50.
Value at end of 10 years: 15,333.21
Value at age 60: $24,027.02
I don’t know about you, but I’d like the free extra $35,000!
Obviously my advice is not to invest $100 a month now and then stop. My advice is to start early and continue investing, so your nest egg will grow faster and bigger as you age.
#2 You are young- take risks.
A 4.5% return? Actually, this isn’t much at all. In fact, currently you can get a money market account (nothing more than a higher-return savings account) at about 4.8% to 5% today. And you are liquid- meaning you can take your cash out at any time without any penalty. But my advice is to start out with riskier investments, which has a greater potential for significant upsides and much higher returns. It also has the potential for significant downsides as well, which is why you want to choose “safer” investments as you age, so you don’t lose the principal and interest you’ve already accumulated. But at the beginning, taking risks will get you more money to put into risk-free or low-risk investments once you near retirement.
How do you do this?
My advice does not mean buy options of some great new stock your friend told you about. Financial management firms (comprised of very smart graduates schooled in finance!) have all sorts of complicated financial instruments to make money- often at the fool’s detriment. When you hear about Goldman Sach’s making millions of dollars in investments…remember there are always the guys on the other side of this equation who lost millions of dollars. Don’t let this be you.
So how do you take risks without losing tons of money?
You can’t. Or what I mean is, you can’t take risks without the potential of losing money.
So spread your risks out! Don’t put them all in one basket. If you are someone who doesn’t know too much about investments, definitely don’t try to pretend like you do.
My advice is to try index funds. Index funds are similar to mutual funds, except you are not paying anyone for their stock selection skills. Index funds are a sampling of all of the stocks in a particular index (for example, the S&P or the Dow Jones) without any fundamental or technical analysis of the stocks. I don’t particularly like mutual funds- basically managers are trying to beat the index and most of the time they fail. On a rare occasion, there are some that consistently beat the index (such as Peter Lynch), but these are very rare. Why pay someone to pick stocks (mutual funds have much higher expense ratios) when you can buy an index fund and get a much more diversified portfolio and better returns than half the mutual fund world, without paying someone to do it?
Index funds do have expense ratios because obviously someone has to make the trades and run the administration of the fund, but they are minimal. Mutual fund’s expense ratios are on average around 1.5%, and index funds are between on average .15%.
Big difference.
Now if you decide to buy an index fund, here is how you do so AND take on some risk (which hopefully lead to higher returns!). Index funds mirror a financial market of specific parameters, and so there are lots of them- each reflecting a different market. Try a small cap index fund, an international index fund, or an emerging markets index fund. These are all riskier investments made individually (e.g., investing in small cap stock is riskier than a large cap stock because the large cap stock has more money and generally a longer stable history.). However, when you invest in an index fund, you are not putting all of your money in one stock- you are putting it in lots of small cap stocks. So if one falls dramatically, chances are, another will rise dramatically. On the whole, you are looking for this particular index to do well and have the average of all the returns be high.
That is why I like the international index funds- China, Latin America, and Eastern Europe all have the potential to grow in the next decade. I like the Vanguard International Index Fund. The expense ratio is .32%, international stocks have done great recently and I believe they will continue (since inception (1996) 7.78% return, 5-year return 16.08%), and there are no fees if you invest over $10,000. Obviously that isn’t us yet- but still the fee is only $10 per year.
If you can’t find an index fund that covers the market you want (for example, say you want to invest in Home Construction stocks, or the Energy Sector), ETF’s, or Exchange Traded Funds, are an excellent alternative. Lately many ETFs have emerged in areas that have few if any index fund alternatives. ETFs, like index funds, have minimal costs and keep your portfolio diversified. The difference is that the exposure of an ETF is different- if you are investing in an energy ETF and the energy market plummets, your investment value will as well. If you are in an index fund and the energy market plummets, other sectors such as Home Construction will have an impact on your investment value and it won’t necessarily go down. ETFs allow you to further specify the type of stocks you’d like to own without forcing you to select certain stocks.
If you’d like to learn how to buy these investment tools to prepare for retirement (invest early!), tune in next week for my segment on 401(k)s and Roth IRA’s!!
To be continued next week…..
