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Successful investing starts with saving
To profit as an investor, you need to regularly divert money into your investment account. Here are ways to save -- and the best ways to invest the cash.
By Jim Jubak
Whats the key to successful investing? That question shows up frequently in my e-mails and I always answer the same way: Saving.
Whats the best way to get started in investing? Thats probably the second most frequently asked question I see in my e-mails and I always answer the same way: Saving.
I never hear from most of these e-mailers again. Id guess they were disappointed in my answer. They wanted a hot stock pick or a foolproof investing system. And, Id guess, they simply dont feel the connection between advice on how to save $10 and investing.
I cant recall a single e-mail follow-up asking for more detail. Too bad, because my specific saving strategy is exactly the investing strategy these readers were looking for.
Saved money is worth more
In my last column, What happens if nobody retires?, I tried to make clear that in the future, a dollar saved out of then-current income will be worth far more than a dollar earned. A retiree who cuts $100 out of then-current living expenses will be way ahead of the retiree who works a post-retirement job in order to make $100. Thats because the earned $100 will be reduced by taxes to far less than $100. Thats especially the case if the coming crunch in Social Security and Medicare funding requires substantial hikes in payroll taxes.
But the benefits of saving dont stop there if you link saving in the present with investing right now, as well. That way, every dollar saved now not only lowers the size of the income you think youll need in retirement (after all, if you can live without it now, you can live without it when youre retired too, right?) but, through the power of annual compounding, it increases the size of the nest egg youll have for retirement.
I cant think of any other strategy that will give you this kind of long-term, very low-risk twofer. And frankly, looking at trends in inflation, interest rates and the dollar over the next few decades, I think all investors will need every edge they can get -- and not just those contemplating retirement soon.
OK, so what is this miracle savings strategy? I knew youd ask.
First, find dependable savings
It starts where all savings strategies start: with you poring over your budget, actual or mental, exact or vague, looking for places where you can spend less or nothing at all. But in this search, youre looking for something very specific, a savings annuity.
Most savings advice suggests you start with easy substitutions that will reduce your spending. Bring lunch from home instead of buying it near the office a couple of times a week, for example. Advanced savers move up to actual denial. Skip that double latte at Starbucks.
I understand this advice. Saving is hard work. Its easier when each individual sacrifice is small. And small sacrifices do add up. Consider: In October, the personal savings rate in the United States fell to just 0.2% of disposable income, the lowest monthly level ever recorded stretching back to the start of the survey in 1959 (with the exception of the statistical fluke in October 2001 caused by Septembers terrorist attacks). At that rate, calculated Lehman Brothers economist Drew Matus, an individual with a take-home (after taxes) income of $40,000 saved, on average, $1.50 a week. Saving the cost of a Starbucks latte would represent a huge improvement.
But this kind of savings isnt well suited to an investing strategy because the cash flow it generates is so undependable. The decision to save has to be made over and over again, week after week, in order to amount to an investable amount like $50. And the money saved has to make it from your pocket into some kind of investment account without being hijacked by some other consumption temptation.
(Dont misunderstand me. I think this kind of savings is great and crucial: Its the difference between buying holiday presents for cash and putting them on a credit card. And it can add up to really big sums. But this kind of saving is better suited to saving for delayed purchases, where missing a week or $10 wont throw off the whole system, than it is for investing.)
A savings annuity, on the other hand, is a larger (minimum $50), regularly repeated cash savings that can be automatically diverted to an investment account.
Make saving automatic
Heres an example from my own recent personal budget. Last month, as I sat down to write a check for the two storage rooms I rent to stash the accumulated overflow of things from my New York apartment, I stopped short. I hadnt visited either room in months, so how much did I really need all the stuff I was paying to store? After a hard and dirty days labor I managed to throw away enough that I could consolidate the two rooms into one. Savings: $74 a month. Month in and month out. And once the room was turned back to the storage company, it was hard to undo the savings.
Im sure you can find similar savings annuities in your life. Im looking at my phone and cable bills to see if I can cut the costs of those services, at my homeowners insurance to see if I can find a cheaper policy, and at my brokerage services (where Ive just consolidated and moved two accounts to save monthly service fees).
Of course, that $74 isnt saved yet. If it just gets commingled with the rest of the money in my checking account, Im pretty sure Ill wind up spending it without even noticing it.
So, the next step is to make sure it goes automatically into an investment account. My employer, Microsoft, has set up its payroll system for electronic direct deposit and I can allocate my paycheck among several accounts. To make sure the $74 really does get saved, I set up my electronic direct deposit to put the entire amount straight into an investing account. (If your employer doesnt offer you this alternative, you can set up an account with ShareBuilder.com that will take the money automatically out of your checking account each month.)
Putting that money into an investment account as quickly as possible is a key step. Its the start of the kind of positive feedback loop you need to build if youre to become a successful saver in a culture that loudly and incessantly blares, Spend! Spend!!
My method has a built-in positive re-enforcement mechanism: By setting up a dedicated investment vehicle, I can watch the savings increase every pay period. That activity, in turn, transmits a positive message back to the saving-pleasure center in my brain that keeps the stream of savings going.
Mind the costs
There is a hitch. I havent found the ideal cost-effective vehicle to execute the strategy. The tradeoff is between paying too much in transaction fees and needing too much money to open an account.
So, for example, most stocks and ETFs cost too much in commissions if you buy them through a traditional or even an electronic broker. You certainly dont want to be buying $74 worth of stock each month even if the commission is just $8 a trade. Thats almost 11%.
You can use a service like Sharebuilder.com to buy shares cheaply even if the company doesnt have a direct purchase option. Sharebuilder charges just $4 per transaction (and remember, you can set these up so theyre automatic). But thats still 5% on a $74 savings investment, not small change.
Sharebuilder has expanded its services to include low-cost purchases of exchange-traded funds (ETFs). It still costs $4, or 5% on my $74 monthly purchase, but it does give far more diversification than youd get by buying a single stock. Two ETFs that look good for a savings-investment strategy are the Vanguard Extended Market Index Viper (VXF, news, msgs), which tracks the entire market, and the Standard & Poors MidCap 400 SPDR (MDY, news, msgs), which tracks the Standard & Poors MidCap 400 Index ($MID.X).
4 no-load funds to consider
Many mutual funds, which provide the diversification you want, dont make the cut on costs. Certainly none with sales commissions do. Paying 5.75% in commissions on your new investment every month is sure going to slow down the growth of your investment (and reduce your incentive to keep on saving).
The few no-load funds with performance histories that I like all require $2,500 minimum investments. If you can afford to jumpstart your saving-investment account with $2,500 to get over the initial minimum investment, theyre a solid choice.
On the bond side, American Century International Bond (BEGBX) doesnt charge a commission and has a low 0.84% annual expense ratio. Youll need $2,500 as an initial investment, but the minimum additional investment is just $50. Dodge & Cox Income (DODIX) also charges no commission and has an even lower 0.45% annual expense ratio. The minimum initial investment is again $2,500, and the minimum additional investment is $100. Morningstar rates the two funds four and five stars, respectively.
On the stock side, Dodge & Cox International Stock (DODFX) has no commission charge and a low 0.82% expense ratio. The minimum initial investment is $2,500, and the minimum additional investment is $100. Fidelity Export & Multinational (FEXPX) is commission-free and carries a low 0.84% expensive ratio. Minimum initial investment is $2,500, and the minimum additional investment is $250. Morningstar rates both funds with five stars.
If you cant rustle up that $2,500 minimum investment, Id suggest combining the two alternatives by using Sharebuilder for your initial savings-investment vehicle and then shifting over to one of these mutual funds when youve built up the minimum. That way, youll only pay that flat $4 (but 5%) commission on new-money buys for two years or so.
Of course, you could simply find more savings annuities. That would drive the cost of using Sharebuilder.com down, too.
New developments on past columns
10 best stocks for the rest of 2004
I added Smithfield Foods (SFD, news, msgs) to Jubaks Picks on Aug. 20 to replay a very successful trade from 2003. So far, the 2004 version is up 18% (compared to the 30% gain in 2003) and after the companys Nov. 30 earnings report, Im going to let this one run for a while longer. Smithfield Foods reported earnings of 57 cents a share, about 10% above Wall Street projections. Thats led to a round of estimate revisions that have pushed projections higher for the fiscal year that ends in April 2005. The new estimates of $2.20 a share, up from $2.09 a share, reverse the drop from $2.16 90 days ago to the pre-earnings report $2.09. Looking into 2005, I think the company can count on growth in pork demand (the weaker dollar will help exports) and steady pork prices. Theres a good chance, too, that beef markets that have been closed to U.S. exports due to fears of mad cow disease will reopen over the next 12 months. As of Dec. 6, Im raising my target price to $33 a share by March 2005 from the previous $28.50 target. (Full disclosure: I own shares of Smithfield Farms.)
Changes to Jubaks Picks
Sell Marvell Technology Group
I think its time to give shares of Marvell Technology Group (MRVL, news, msgs) a rest. The reason? Wall Street looks like its starting to discount the relatively slow earnings growth its projecting for the company in the first half of 2005. For example, on Nov. 18, Marvell Technology Group reported earnings of 22 cents a share, a penny ahead of the Wall Street consensus. But although several analysts raised their earnings projections for the quarters ahead, none that Ive been able to find raised their price targets. Wedbush Morgan, in fact, downgraded the shares from buy to hold. Im going to take my profits here and wait for the usual Wall Street over-reaction if earnings growth does indeed drop, as Wall Street now projects, to 23% in the fiscal year that begins in January 2005 from the 72% projected for the fiscal year about to be concluded. I have a 30% gain in Marvell Technology Group since I added these shares to Jubaks Picks at $25.99 on June 29, 2004. (Full disclosure: I will sell my own shares of Marvell Technology Group three days after this column is posted.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in none of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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