401k Loans Just Don’t Pay

I had lunch with a friend the other day and somehow we got on the topic of weddings (I know, strange topic for a couple of manly men), and in particular his wedding almost 10 years ago. He shared with me that they withdrew $15,000 from his 401k to pay for it.

He seemed surprised when I mentioned that in the long run they likely paid close to $100,000 for that wedding when considering how that money would have grown.

I showed him a little investing tool called the Rule of 72. In a nutshell the Rule of 72 is a quick calculation used to determine how long it will take for an investment to double in value. There are a few presumptions that need to be made when assessing this, but it is close enough for an estimate.

Years to Double Investment = 72 / Estimated Compound Interest Rate

Lets use my friends example of the 15k they removed from his 401k to pay for their wedding. As it stands today, his money would have likely doubled since he removed it roughly 10 years ago.

We can assume a compound interest rate between 8% – 10%, as this is generally the rate of return for the S & P 500 over multiple decades. Here is what the math looks like:

9 Years = 72 / 8

My friend seemed a bit surprised to learn that his $15,000 wedding would likely be worth a little over $30,000 today. I think 8% is a conservative number, but it works for this example. He then asked me where I came up with the 100k, since this is a far cry from $30,000.

The $30,000 represents the first doubling, we still have more to go. In reality we have a few decades before we can retire so a few more calculations will reveal:

First 9 years: 30k

Next 9 years: 60k

Next 9 years: 120k (Retirement Age)

The completion of the last 9 year block will place him at about the age of retirement, roughly. Considering this, the day he retires, he will be 120k behind because he withdrew funds from his IRA. This did not calculate the penalty and taxes they paid when they originally withdrew these funds.

So I can already hear what some of you are thinking, what if they borrowed this money instead of withdrawing it? That’s a fair question, however it is still not good news.

When people borrow from their IRA, the tank empties by whatever value they withdraw. Unless the borrower replaces the funds within the first year, they are now into year one of the situation described above. There are a few more considerations though.

Borrowing from your 401k means you are locked into your employer until this is paid back. If there is a job loss for whatever reason, they will call for repayment immediately, if you can’t come up with the cash, you will likely be on the hook for a 10% early withdrawal (If you are under 59 1/2) penalty, taxes, along with any other fee the institution may pose.

Repayment of your 401k loan will likely mean that you are not able to contribute to your retirement, as the investment funds will be going to loan repayment. Depending on the amount borrowed and the time needed to repay, this could last years. Translation: the borrower will not be able to contribute any funds toward retirement for several years. As we all know, the younger they are, the more detrimental this loss will be in the long run.

I think we can see that either way, a 401k withdrawal/loan, simply doesn’t pay.



Trump’s Tax Plan: Can it Make America Great Again?

In a previous post, I discussed current tax bracket falicy and the amount of tax we all pay each year based on this, or what we think we pay. President Trump has just announced his tax revision strategy, albeit a skim overview.

Right out of the gate, Trump wants to reduce the tax brackets from seven to three. So far so good. The proposed bracket structure will now be 10%, 25%, and 35%. There is little indication as to the income levels of these brackets yet, but there have been opinions based on Trumps original thesis.

President Trump also wants to increase the standard deductions for single ($12,700) and married ($24,000) filers. This roughly doubles the standard deductions of the most recent tax year. However, increasing the standard deduction will mean most deductions that were previously itemized, will no longer be eligible. Interestingly, Trump has agreed to continue the pre-tax investment, mortgage interest and charitable contribution deductions. According to an article on Doughroller these deductions will be allowed in conjunction with the standard deductions. There is some discussion as well for allowing some form of incentive or savings plan for child and elder care, but information on this is limited.

The Trump tax plan also wants to eliminate the 3.8% net income investment tax paid by individuals making over $200.000 and married families making $250,000 that is used to subsidize Obamacare. This is important, however I don’t know of too many folks that will be impacted by this.

Trump also wants to eliminate the “Death Tax” (Estate Tax). This tax does not come into play for folks who inherit assets under ~5.5 million dollars, and in fact according to the Congressional Joint Commission on Taxes, only 0.2% of Americans pay this tax and another data point from the Tax Policy Center stated that in 2013 only 20 small businesses and farms paid an estate tax.

I take data points like this with a grain of salt, but it is clear, the average farmer and small business family is rarely being impacted by the estate tax. This tax is simply to prevent frugal folks like us who are building wealth and saving for our families future from becoming the next Rockefeller or Mellon. So forget all of the nonsense and scare tactics spewed by our politicians saying that the death tax will hurt our farmers and small business owners, it simply is just more political positioning.

Corporate tax rates will drop to 15% for all businesses, this can mean a savings of up to 20% for a business and that money can be put right back into the business, passed on to the consumer in lower costs for services, or paid to shareholders. Trump also plans to bring back the 2 trillion dollars held overseas by American companies by offering a one time fee for doing so which is likely very enticing to most companies. These are funds that can be put to work right away for the American economy.

So what does this all mean for you and me? Let’s do a little math. To keep this exercise reasonable lets take two families, the first making 75k a year and the second making 150k a year.

The $75k a year family will deduct $24k (standard deduction) from their taxable income right away leaving them with a gross tax burden of $51k. If they own a home paying mortgage interest ($2k), and contribute 10% to their employee retirement fund ($7.5k) and make charitable contributions, i.e. tithe, at 10% ($7.5k) these are also eligible for deduction of tax burden in addition to the standard deduction, according to Michael Pruser. After it’s all said and done, this family that made a gross income of $75k is now on the hook for an estimated $34k adjusted federal tax liability. According to Pruser, this family will fall under the 10% tax bracket, whereas without tax reform, they are in a 15% bracket.

Considering the family making $150k a year will likely look like this: $150k minus the standard deduction leaves $126k. Subtract mortgage interest ($4k), tax deferred investments ($15k) as well as charitable contributions ($15k) and this leaves a final tax burden of $92k a year which would currently put them in the 25% (realized tax likely a little lower) tax bracket. The same income will put them on the hook for around a 10% tax burden (realized) under the Trump plan.

At this point these calculation are all conjecture, because we really have no idea what will happen at this point. Barring a few minor arithmetic errors it should be clear that anything close to what Trump is proposing should be helpful to most Americans.

These are typical examples of families that I know. Of course not everyone will have the same deductions, give or take, but it does present a better picture of the incentive for the middle class to urge these reforms on.

Critics of this plan are saying two things: 1) This plan will increase the deficit by as much as 2 fold in 10 years, and 2) This is a tax break for the rich. I say, HOGWASH!!

Point #1 Increasing the Deficit.

Yes I agree the deficit may likely increase during the next 10 years based on Trumps tax reform plan, but we all seem to forget several important facts. The national deficit nearly doubled under the Obama administration while increasing every Americans tax burden. If the deficit is going to increase, at least Trump will ease the pain for most Americans. We are also forgetting what these tax incentives will do for the economy, putting this much money back into the pockets of the American people and bringing businesses back will only stimulate the economy to higher levels.

Point #2 This is a Tax Break for the Rich.

I completely agree, but it also helps the middle class as well and the economy which will likely circle around and help us all. Don’t get me wrong, I sympathize with the burdens upon Americans who are struggling with their finances and are low income earners, I grew up in one of these households, but when almost 80% of the taxes are paid by 16% of the people, and considering 45% of Americans will pay no income tax at all, I think the “rich” deserve a break. God only asks for 10% from us all, not 0% from the poor and 40% from the rich, so we can all serve him equally.

There are other considerations as well, tax reform is only half the picture, there has to be a tightening of the belt and reduce (or eliminate!) the frivolous government spending. We have all heard of the $500 hammer, and this nonsense just has to stop. Government spending is outrageous  and the politicians who are funding their pet projects need to stop and be held accountable.

Considering Trumps plan for tax revision and simplification, I see no reason why most Americans would be filing anything other than a version of the 1040EZ. By simplifying the tax code, I cannot envision the need to continue spending 12 billion dollars a year on the IRS. In fact, I see no reason why this department could not see a cut in services by at least 50% initially and work toward a 90% reduction in 4-5 years.

I have seen enough of the Trump machine to realize that this tax plan will likely not come to fruition as it sits now. Trump has a track record of making big, bold statements and then scaling them back to get something in the ballpark. Having said this, I am all for this plan, but even a scaled back 50% version of Trumps tax reform only makes American families and the middle class great again.

Thought Experiment: Buying on the 20 Day SMA

I had a thought. Generally speaking I like to buy any equity on the dip, however there are a few exceptions, like AAPL, MTN, etc. Good, solid companies that are fairly valued and keep going up and up.

I have been fairly successful when I buy on the dip, provided I am able to keep my whits about me and not put any emotion into it. I am obviously able to track companies that I have ended up buying and selling, but what about the companies that I have not purchased? Until now I have not had a way to track these equities so I came up with the bright idea to track my watch list, keeping a record of buys and sells as well as ones I have passed over.

A few ground rules before we get started. In order to make this DIP watchlist, any company in consideration, must be financially stable. Tesla and Snap Inc. will not likely make the cut anytime soon.

Ground Rules:

ROE > 15%, ROA & ROI > 5%, Positive earnings that are growing, positive balance sheet (showing growing cash flow, revenue, and operating income), PE (present and forward) under industry average, low 5 year PE range, reasonable P/S & P/B, PEG < 2.5, positive margins (gross, net, and operating), sales growth, debt to capitol ratio < 70% (if more must show reasonable quick ratio and positive cash flow), safe dividend (payout < 80% and EPS to cover).

A one year daily chart must show some significant pullback or mimic a previous bottom. Other considerations would include adequate volumes, and favorable MACD-OBV-RSI. A buy signal is when the price crosses above the 20 day SMA at the close of the day. If the 20 day SMA is crossed a limit order may be placed for the following trading day for a buy. A sell will occur when the 20 day SMA is crossed on the downslope at the close of the day. If a buy and sell occurs within 2 weeks of each other, a hold or sell may occur depending on the situation, but if sold this equity cannot be purchased again for 30 days as it will be deemed too volatile for this type of trading.

Obviously there wil be very few stocks that completely follow these guidelines, but many will come close. There is some subjectivity to this, but if they don’t approach these standards, I likely would not consider them a buy anyway.

Now then, here are the qualifiers.

Stocks that made the cut and the entry price:

AKRX- $20.54
BMY- $52.00
CRI- $83.01
DUK- $78.90
ELY- $10.40
ETH- $28.35
GIL- $24.78
JNS- $12.45
KO- $41.46
RGR- $50.55
RH- $31.34
SIMO- $41.36
VFC- $50.37

So there we are. Let’s see where this little experiment gets us. I don’t actually expect much from this to be perfectly honest. I’m not the sharpest tool in the shed, and if this actually works someone would have written a dozen books on it by now…..

IPO’s: The Average Investors Nightmare

I had a discussion with a friend the other day regarding investments and the topic of (Initial Public Offering) IPO’s surfaced. He had been trying to convince me that this new IPO that just came out is a fantastic opportunity and he thought I should get on board. My stance on IPO’s has always been, and always will be the same: just don’t do it.

In a nutshell, an IPO is a company that is making the transition from private industry to the public sector. The IPO is generally looking to expand their business through public support and will hire an underwriter to evaluate the company in order to establish the type, price and amount of shares to be issued to the public.

This process can be quite complicated, but here is how I generally see it:

Company A wants to expand so they go through the IPO process. They establish their market cap and offer a number of shares at an established price. Sounds reasonable so far huh? This is where it gets tricky. The IPO price is rarely the price offered to you and I, the average investor. Often only investors that are able to get in on the initial public offering price are large institutions such as mutual funds and large brokers. When the offering eventually comes down to the little guy (you and me) it is often well above the established IPO price.

When the average investor is able to buy into the IPO, they usually must do so when it hits the market and is available for trading for everyone, the big guys already got their slice of the pie. The real kicker in my opinion is what happens over the next several months. After the IPO has been publicly traded for 6 months, the big name players (initial investors, insiders, etc) are now allowed to sell their existing shares, which often creates a sell off and drops the price of the stock significantly.

Let’s look at a recent example of an IPO. This IPO opened at $27 a share. And is now $22 a share after only 3 days. The real IPO investors got in for around $17 or so. So then, where does this leave us? The average guy has already seen an 18% drop in the initial offering. The big guy has seen a roughly the same percentage, albeit in the black because they got in at a significantly lower price via the real IPO pricing.

So now lets actually take a look at the fundamentals of this new IPO. Currently this IPO is showing negative earnings, and will do so at least for the foreseeable future. In fact, a major administrator in this company has said that they can’t say if this company will ever show profitable earnings. What?!?!?

OK lets continue, this IPO currently shows a Price to Sales (PS) of 68 and a Price to Book (PB) of 18. Earnings, growth, ROE, ROA, ROI are all in the negative digits. This company has NEVER made any money.

I know what you are saying, this is some little rinky dink company that has a microscopic market value and I am using it to skew the data and make my point right? Wrong. The market cap was evaluated at 33 billion dollars when it entered public trading. After roughly 3 days of trading, the largest cap is around 20 billion.

At an evaluation of 33 billion dollars, this IPO is bigger than Lockheed Martin, Morgan Stanley, Colgate, Netflix, GM, Ford and Kraft-Heinz, just to name a few. It is twice as large as Boston Scientific, Exelon, Activision, Deere, Target and Allstate. How can I possibly consider this evaluation anything other than a joke considering a new company, with no earnings and such poor evaluations has a higher market cap than Ford, GM, Deere, Lockheed Martin and Morgan Stanley?

What is the name of this IPO you ask? Snap Inc. (SNAP). That’s right, snapchat has an evaluation higher than all of these companies and sits roughly in the top 1/3 largest companies traded in the US, hasn’t made a dime, and may never do so.

In six months there will be a lot of average Joe’s like you and I sitting back, scratching their heads and saying “Where did my money go?” I’ll tell you, right into the pockets of the management of Snap and the initial investors. Don’t get me wrong, I doubt Snap will fall below the $17 entry price that the big guys had access to, they will simply throw more money into it thus supporting it until the big sell off later down the road.

Well the Snap enthusiast may argue that “Apple, Amazon and Facebook were IPOs once and look what happened to them? You would be rich if you got in when they first started.” This is true, but there have been a lot of people who significantly increased the value of their portfolio, and continue to do so today using these companies, with infinitely less risk. I’m interested to see where Snap will fall to in another year or so. If I am wrong I will certainly admit it, but this simply makes no sense to me.

“You can never hit the game winning home run in the bottom of the 9th inning to win the World Series if you never get up to the plate.” This is true, but the ball boy (average investor) will never have the opportunity to take the swing. We have to work hard, save and invest wisely and not swing for the fences. Consistent dedicated investing is the way to grow wealth for the Average Joe, otherwise you might have better luck with lottery tickets.

Value Investing Part 2: Compounding

Warren Buffett said “Risk comes from not knowing what you are doing.”

I say: Agreed. So let’s get to work.

The day you retire, you will have likely just hit the lottery, and everyone is eligible for this prize, almost guaranteed, to be a millionaire. Let me try to explain.

I have commented on the value of compounding interest several times in previous posts. I would like to share one more example of compounding interest in a slightly different manner, one that had shed a little more light on the subject for me.

I wish I could recall the podcast I had been listening to, but I can’t. The name of the speaker is not as important (other than giving credit for his work) as the message itself. He had been speaking about compound investing and how a majority of the money is made over the last few years. Superficially this should be obvious to anyone remotely interested in the subject, but he explained it in a way that made the concept tangible for me.

Image result for eye dropperThe speaker went on to explain: Imagine that you are in the largest stadium that you know of, in the very top nose bleed section, looking down at the field. You can see someone on the 50 yard line holding an eye dropper. This is not an average eye dropper, it has magic water in it. When he places a drop of water into the cup, it will double every minute.

How long do you think it will be before the water reaches your level? Apparently this talk is being given to a live audience and he entertains guesses: Four days, twenty four hours, two weeks, there are a variety of answers. The speaker tells everyone that they are all wrong, it will take fifty three minutes for the water level to rise and overflow the stadium.

As interesting as this is, it is the next question that really makes me think. How long does it take to fill two stadiums? Just sixty seconds more. How long to fill three stadiums? Only 30 more seconds, because in one minute the water will double in volume from two stadiums full to four. In the last thirty seconds, more stadiums were filled than the first fifty three minutes. You may be asking at this point, where is he going with this…..Don’t worry, there is a moral to my story.

I remember sleeping, I mean, sitting through a microbiology lecture in college in a similar topic discussing the exponential growth of bacteria in a Petry dish. Luckily I had a re-awareness of the discussion, just before the whiteboard eraser flew by my head, allowing me to duck. I understand exponential growth, logarithmic values and compounding, but the stadium discussion pulled it all together in a tangible way for me and helped me relate the value of compound and value investing, and comprehend their true benefits.

What do petry dishes, drops of water and flying erasers have anything to do with making money? In the past I have discussed compounding in relation to investing long term. The goal of that post was to put a face on the lifetime investment model and see how someone can reap the rewards with very little work.  What I failed to do, was finish the thought, and add the mental exclamation point!

Let me revisit my thought process here. I discussed the benefit of making investments at a very early age and watching them grow to retirement. I’ll expand on the example I used of investing $200 a month from age 18 to retirement at 59 1/2. Saving this money in a reasonable investment manner averaging 8% interest each year (we all know historically it is likely to be more or less but lets be conservative) will net roughly $675,000 at eligible retirement age. Not bad for a minimal amount of monthly investment during that time frame. My hope is that you would be wisely investing more, but again let be conservative for argument sake.

Now, to add the exclamation point!  What happens to that money if you decide to wait an extra year to retire?  What if you choose to retire at 65?  While we are considering retirement, lets also set up a scenario of full retirement at age 67, what will happen to that money. You do not have to postpone any retirement to enjoy the benefits of this scenario, I only suggest this to keep the math pure.

Age 59: Value of investment = $675,000

Age 60: Value of investment = $730,000

Age 61: Value of investment = $791,000

Age 63: Value of investment = $927,000

Age 65: Value of investment = $1,080,000

Age 67: Value of investment = $1,272,000

Age 70: Value of Investment = $1,611,000

The last seven years of growth, doubled what it took the first 42 years to achieve. There is no other way to do this at these levels, reasonably speaking, unless you are investing young, and compounding.

A few things to think about:

  • This exercise is is based on minimal investments of $200 monthly. Imagine of you were actually putting away $300 a month, $400 a month, better yet, 15% a month to grow proportionally as your salary grows putting even less burden on your financial position.
  • $300 a month looks like this:
    • Age 59: $1,000,000
    • Age 63: $1,391,000
    • Age 65: $1,630,000
    • Age 67: $1,909,000
    • Age 70: $2,416,000 
    • Almost an additional $1,000,000 simply for an extra $100 a month @ age 70.
  • $400 a month looks like this:
    • Age 59: $1,347,000
    • Age 65: $2,173,000
    • Age 70: $3,222,000

These calculations assume that you are not removing any funds through distribution and that you are reinvesting any dividends. Of course when you decide to retire and start living off your investments, the forward projections will decrease slightly.

Now, I am about to really blow your mind. Imagine that you put this money into a Roth IRA. Remember the benefit of a Roth? Think about it, think……keep thinking…….you got it! This money will all be tax free when you decide to withdraw. It is all yours to spend how you see fit, with no more interference from government theft under the guise of taxation.

As I mentioned in the beginning of this post, we all have a chance to retire a millionaire. It is relatively painless over an extended period of time (granted, it will be difficult at in the early years), but it just takes discipline, the willingness to learn, and motivation. It’s never too late to start on your first million dollars, remember this process is a marathon, not a sprint.



My Tax Bracket is….Think Again.

When I comment that paying taxes is government theft, I am saying this tongue in cheek, sort of. This may be difficult to comprehend, but I believe in paying taxes, as long as they are fair and equitable. The problem is, as it stands today, taxation in this country is horrendous.

I don’t need to go into the details of the inequalities of tax brackets, but I would like to discuss taxation on a slightly different perspective. The first question is, what tax bracket do you fall under?

Bankrate.com has a nice summary of current and projected federal tax brackets. Keep in mind, this writing has been completed shortly after the Trump election, so any tax reform he plans to implement hasn’t happened yet. Currently there are 7 different tax brackets for households. Depending on how you file, i.e. single, head of household, married filing separately, etc., you will fall under a 10%, 15%, 25%, 28%, 33%, 35%, and 39.6% tax rate.

According to the Tax Foundation 77% of Americans will fall under the 15% tax bracket or lower while the remaining 1/3 of Americans are in the 25% or higher, or so we think. I’ll explain in a minute.

Considering this data, one would expect that this group of 77% would pay the bulk of the income tax in this country, however this is far from true. Family units making over $100,000 a year actually pay almost 80% of the tax base in this country, far from fair but this is a story for another day.

So there you go, the bulk of Americans will pay 15 cents on the dollar in taxes, or do they? What about the “rich” in the 25% category, they only pay 25 cents on the dollar right? Not exactly.
Let’s use a practical example of why I call taxation in this country government theft. Lets assume I am in the 25% bracket, for every dollar I make the government takes 25 cents, the Federal government that is. My state of PA charges a 3.07% state income tax. My local government charges a 1% rate on top of this as well. All in all, the government is now taking 29% of my money every time I get paid. Well I guess, that is a fair rate to pay for our “freedoms.”

Let’s dive a little deeper. I get up in the morning and make breakfast before I go to work in the house that I pay roughly 3.5% in property taxes every year, simply for the right to live here. I put on clothes that cost me 6% sales tax when I bought them.

I get in my truck that the government charges me over $100 a year to drive via yearly vehicle registration (tax). I’m running a little low on fuel, so I stop and pay a 30% gas tax every time I fill up.

I’m on a travel day, so I have to visit various sites associated for my job, so I need to hit the turnpike and pay roughly $10 in turnpike fees to go less than 30 miles.

Everywhere I turn, there is a government official holding a stick up, robbing me of more money in the form of taxation. I stop for lunch and guess what, another 6% sales tax on food. I have never smoked, but if I did, it wouldn’t last long because the government charges $2.60 for every pack.  I don’t drink alcohol either, but I’m sure the government would take a piece of this as well. In fact, in my home state of Pennsylvania, the government OWNS the liquor stores!

I wish I would just hit the lottery and not have to worry about money at all, guess what……playing the lottery generates revenue for the government at a rate of approximately 35 cents on every dollar you spend.

It makes me ill to think about all the taxes I have just paid, all before lunch! After everything is said and done, the government takes about 35 cents on every dollar I make with a 29% tax in the form of federal, state and local taxes, and then I pay the ferryman for just about everything else I do.

God only asks for 10%, so why does the government feel they deserve 35%?

Mark 12:17  “And Jesus answering said unto them, Render to Caesar the things that are Caesar’s, and to God the things that are God’s. And they marveled at him.”

Value Investing Part 3: Stock Selection

In part one of this value investing string, I discussed some pitfalls of self investing, primarily buying high /selling low, leaning too heavily on past performances to make stock selections, and most importantly not being prepared to to make value selections.

Part two went into a little more detail of the value of compound investing. I gave a more tangible example of the perks of long term investing by maximizing the benefits of compounding, as well as giving specific examples of how this makes your money work for you.

Finishing up this series, I will review some of the thought processes that I go through when I am researching stock options. Before I go any further, I should explain my thoughts on value investing.

Value, in my opinion, is buying anything that you find useful at a cost below the generally accepted price of that item. Value does not mean cheap, nor does it mean “good to have.” In order to have true value in something, it must be something that you genuinely need, and not simply want. Value does not mean buying something just because it is cheap nor does it mean buying an inferior product simply because it is low cost. Mr. Buffett has been quoted yet again “It’s far better to buy a wonderful company at a fair price, than buy a fair company at a wonderful price.”

For example, lets say I found a terrific deal on widgets. I was able to buy ten of them for 40% of their accepted value. I am able to use one of them leaving me with nine remaining. The first widget was purchased at a great value because I have a use for it. The remaining widgets were not a value because I now have nine very expensive pieces that offer no value to me because I can’t use them. Sure, I can try to resell them at 60% of their value and make a nice profit, but without a plan prior to the purchase, what do you think the odds are of me actually reselling all of these and making money. It certainly sounds like I may have purchased an item or items at a great price, but of no value to me. If I owned a widget shop, this story has a totally different meaning, because this purchase now has value to me.

Value investing is purchasing a stock (mutual fund, ETF, etc.) with a price below the intrinsic worth of that stock. Another term that is often used to identify these types of stock is one that is undervalued. Some may say that a low P/E Ratio is a good indicator of a value stock, and I would agree in some respect, but this is only part of the story. Remember Warren Buffett says “Price is what you pay, value is what you get.”

One of the most popular, and often misunderstood ratios is the P/E ratio, so lets start there. The P/E Ratio values a company by measuring its current share price relative to its earnings. Currently the P/E Ratio for the S & P 500 is roughly 19 – 20. It would therefore make sense that any stock with a P/E Ratio below 20 is a good value. Well, not necessarily. When trying to assess the true value of a P/E Ratio, we must also take into consideration the industry average as well. For a more detailed explanation please review this article on investopedia.com. Generally speaking I love to see a company’s P/E Ratio in the single digits as this typically is equivalent to a bargain basement price, but do remember to make some exceptions for certain securities as long as it is below the industry average and/or below its historical average. In my opinion, a forward P/E is much more valuable than the current P/E, looking retrospectively.

When I research a  potential company to invest in, I pay particular attention to the P/E Ratio as it gives a wealth of information, but it is not the only parameter that I review. I will identify what I feel are the some of the more important considerations when evaluating stocks. I will attach a link to the Investopedia site defining each parameter, simply because they do a much better job at defining and explaining these terms than I ever could. Here is a list of other considerations that I use to identify value stocks (in no particular order):

(1) Debt Ratio (D:E):  I’m looking for low leveraged companies here. The lower the debt the better. The NYU Stearn School of Business posted the average sector debt ratios for stocks based in the U.S. as of January 2016. As you can see, these ratios vary greatly depending on sector, so it is important to distinguish the sector that your stock is in to guide your evaluation.

(2) Current Ratio: The current ratio is used to measure the ability of a company to pay back its liabilities. Generally speaking a current ratio less than 1 is not good, as this infers that the liabilities outweigh the assets of that company. I look for companies with a current ratio above 1.5.

(3) Earnings (EPS): This is probably the easiest parameter to review but is often the most over looked. At the most basic level, I do not invest in companies that do not make money (show consistent earnings) Companies that do not make money go bankrupt. Graham expands on this further saying he looks for companies that have progressive positive earnings quarter after quarter. I am not so rigid in this category as I like to see upward trends, therefore a hiccup now and then doesn’t bother me as long as I can explain the reason for the drop and that it is a rarity, not the norm.

(4) Book Value (P/B): The book value of a company can help determine if the stock is over or under-priced based on assets that a shareholder would receive if the company were liquidated. I have seen some estimates that call for P/B’s below 1.20, but I feel this is too restraining. I like to look for values under 2.

(5) Dividends:  I love dividends. If used correctly, dividends can be your friend, if used incorrectly they can be a nightmare. Essentially, dividends are good for the value investor because you are purchasing these companies at a rock bottom price and they may take some time, often feeling like an eternity, to have their share price start moving up. While you are waiting you can be collecting dividends on a fairly safe investment. I like to see at least 2.5% but anything over 2% has significant value. Be wary of high dividends with elevated payout ratios, as they may be purposely set high to attract investors and mask deeper issues within the company. Companies that pay dividends, in my opinion, are considering the investor’s stake in the game as well.

There are other advantages to dividends, especially consistently performing dividends. Do your own research on dividend aristocrats, I think you will find it interesting. A great read regarding the benefits of dividends is Shareholder Yield, A better Approach to Dividend Investing by M. Faber.

(6) Return on Equity (ROE): ROE is the amount of net income returned as a percentage of shareholder equity. It tells how much money a company has turned by the use of shareholders funding. My favorite podcast Investtalk likes to use 17% as a base measurement, and I would tend to agree.

(7) Price Earnings to Growth Ratio (PEG): Some would actually say that the PEG may be a better indicator of a companies value than the P/E Ratio. I wouldn’t agree, nor would I disagree, it’s the same only different. The PEG evaluates price and earnings but adds growth to the mix as well. I like the PEG to be less than 2 as a value indicator.

(8) Price to Sales Ratio (P/S):  A price to sales ratio compares the companies stock price to its revenue.  I like to see a P/S less than 2 as a general indicator, but I also like to compare this to the sector average as well. For my evaluations price to P/B and P/S are minor indicators.

(9) Chart Technical Data: A true value investor should not be concerned with the actual price of a stock, but they should understand when is the best time to buy. I look at a few technical aspects of the charts to make a decision when to buy, not if to buy.

I like buying when the chart is sideways or starting an uptrend. There are also some consideration regarding simple moving day averages and when to pull the trigger. If I have decided to wait until an uptrend to purchase, a 10 day sMA is a good place to start, with a decision likely around the 20 day sMA and I would hope to make a decision before it hits the the 50 day sMA otherwise you will see a lot of profit go out the door.

The bottom line though is, don’t buy on the down-slope, otherwise you are catching a falling knife. Don’t be afraid to wait for a pull back or a dip in the market. Technical data should never be used to determine value of a stock, however it does help you decide when to buy. I also like to use MACD, RSI and OBV as indicators of when to buy.

(10) Moat: The moat is the story behind the company you are considering. What makes it special when compared to all of the others, a competitive advantage as Warren (yes we’re on a first name basis now) calls it. The economic moat is literally the body of water (competitive advantage) surrounding the castle (stock) protecting it against invaders (volatility). The wider the moat, the safer you are.

I certainly did not invent or create this concept myself. I did my due diligence in research and looked to the masters of value investing, Warren Buffett and Benjamin Graham. All I do is simply apply their work and adapt it to suit my needs, experience and resources. There are many other fundamental aspects to consider like ROI, ROA, Revenue, Growth, most certainly the balance sheet, etc., but these 10 elements are what I use to get me started, all of the other stuff is fine tuning a decision.

I’ll end this series with another quote from, you guessed it, Warren Buffett “It’s better to hang out with people better than you. Pick out associates whose behavior is better than yours and you’ll drift in that direction.” I like to think that I hang out with Warren and Benjamin on a daily basis, they get absolutely nothing from me, but I have learned a great deal from them.

Personal Finance: Retirement Savings

In the last several posts, I have been discussing methods of personal finance, the basics as I see it anyway. I have tried not to make this series into a playbook of financial freedom, or even worse some kind of “Financial Freedom in Three Minutes per Day” foolishness. I tried to write about what I thought were the most basic of concepts, and what I thought were the most frequent mistakes that people choose to rob themselves of financial security. Financing a car (or worse leasing), depending on social security, living beyond ones means, etc., are the pitfalls I see most often with friends and family who do not own financial security for themselves.

What I would like to show with this post is that people do not need to be born with a silver spoon in their mouth, or make a six figure income to become financially secure. Being dedicated to financial freedom and treating debt like the four letter word that it is, is half the battle. Appreciating that you don’t need the latest and greatest gadget that just hit the store shelves (that will eventually be lost in a corner in the basement in 6 months) is just the first step in recognizing the downward spiral that is making you a slave to debt.

You have to start somewhere, and becoming debt free or never entering into serious debt is a key concept for future investing. If you haven’t read my Get Debt Free post, you may want to start there. Once debt freedom is achieved, investing will be less of a burden on you and your finances, and give you little excuse not to do it. In all honesty, investing toward your financial freedom will be fun in the respect thou you will get to watch your hard work turn into your future security.

Lets start off with a few simple illustrations of what money saved now can do for your future. I’m not saying that investing can’t start when you are very young (remember your piggy bank?), in fact it should,  but I want to show a more realistic example of somewhere that we all have been, and where we all can be.

Let’s imagine you are finally out of school (military, trade school, college, whatever) and have a few years of working under your belt. Hopefully you are living with minimal debt, but lets assume that you are not.  What does $100 a month do for you in the future.  Well, lets first define what does $100 mean in a practical sense other than 5 Andrew Jackson’s in your wallet.  As of today, $100 will buy you:

1. 4-5 new books

2. A few shirts or a couple pairs of jeans

3. 2-3 video games

4. 100 songs for your iPOD

5. A tattoo, a small one I imagine, I have no relevant experience here.

6. A few dinners out with friends

7. A handful of movies in the theater, DVD’s, or downloaded from pay per view

8. A pair of shoes

9. Several Starbucks lattes

10. Gym membership for a year that you will never use

11. A year of Netflix or Amazon Prime

12. The latest gadget “that you just neeeed.”

13. All of the great accessories for you iPhone

14. Cable for 3/4 of a month

15. I’m really struggling now, so I’ll just end with that, but you get the point.

So what I am not asking you to do is give up eating out every month or never buying a pair of shoes again.  What I would suggest is a few less dinners out, books from the library instead of buying, coffee brewed at home, and a few less iPOD songs per month and BAM!  $100 in your pocket with really very little sacrifice.  Obviously this would be a recommendation for the person who is not already saving, and is trying to work the excuse that they can’t afford to invest right now.

Now, lets put that $100 to work for you.  A simple compounding calculator will Show that $100 a month invested properly (Roth, IRA, etc.) from age 25 – 65 with a reasonable rate of return (8% – 12% on average per year) will make you a lot of money at retirement.  At 8% you will accumulate over $320,000 and at a rate of 12% you will be very close to $1,000,000.  The average rate of return of the S&P 500 since 1926 is 11.69%. By the way, this time frame includes the great depression, two of the worst recessions this country has ever seen…yada, yada, and it still averages almost 12%.

If you were to put that $100 into a Roth IRA, your money grows tax free for you to withdraw at 59 1/2 years old. No taxes, no penalties, $300,000 – $1,000,000 for you to spend at retirement for just giving up a few lattes, and a couple of extra meals out every month.

Lets say that you can afford a little more, or that you added a little extra each month with bonuses, salary raises, birthday money from Grandma, whatever.

$200 a month @ 8% = $620,000

$200 a month @ 12% = $1.84 MILLION

$300 a month @ 8% = $932,000

$300 a month @ 12% = 2.76 MILLION

$400 a month @ 8% = 1.24 MILLION

$400 a month @ 12% = 3.68 MILLION

Here is a novel thought, just save $25 a week, and put it in a jar, at the end of the year, invest it or even better sign up for automatic deduction into a Roth IRA, etc.

The cold reality of it all is that if you do not retire a multi-millionaire, you really have no one to blame but yourself.