One can see why investors are lapping up Japanese stocks, while they remain leery on Middle East. There has been encouraging words about Japan’s recovery from none other than Warren Buffett:

It will take some time to rebuild, but it will not change the economic future of Japan…Frequently, something out of the blue like this, an extraordinary event, really creates a buying opportunity. I have seen that happen in the United States, I have seen that happen around the world. I don’t think Japan will be an exception.

Natural disasters are not predictable, but human responses to them are, when a stable government is at the helm. And Japan is not the third largest economy for nothing. I agree with the investors that Japan’s massive rebuilding effort will spur rapid economic growth.

By contrast, although geopolitical turmoil in the Middle East could have been predicted, the outcome remains unknown, especially if it leads to regime change as in Egypt. No one knows how the new government would function. So it makes investing sense to tweak your foreign holding, at least for short term.

Today’s article on Apple looked into its market valuation based on the high Price/Sales ratio, which drives its unique pattern of fast growth immediately after launching a new product, followed by a period of normalcy until the next new product comes along.

The author questions the sustainability of such growth for long, considering that new products are often only upgrades of the original:

Bear in mind that for several years now, Apple’s growth has really come from what are essentially line extensions on just one product, the initial iPhone. With all due respect to Steve Jobs as an innovator, how many more times can he mount the big stage, tap icons and re-size pictures by flicking his finger while preaching world domination, before it becomes white noise? Ultimately, how many more 50%-plus sales growth rates are in Apple’s future?

I am not too concerned about Apple’s product line though. A company whose growth bounces between spectacular and normal is doing fine in my book. But, one issue that may have a serious bearing on Apple’s management in the near future, relates to Steve Jobs’ health concerns, and speculations about a possible CEO succession.

Uncertainties arising from CEO change is the topic of the other article on Google, which discusses co-founder Larry Page replacing Eric Schmidt as Google CEO in the next two weeks. The author talks about Page’s lack of PR skills that may seriously affect Google’s ongoing love affair with its investors:

I think he and Google investors are in for a rude awakening.  The next 6 months are bound to be bumpy for him as he figures out what’s required from a CEO. For that reason, I wouldn’t touch the stock until at least October.

Read the Forbes articles on Apple and Google.

Step 1. Time: There is really no shortcut to getting rich. The sooner you begin saving and investing (steps # 2 and 3 below), the faster you get there. If you cannot begin soon enough, retire late – the idea is to give your money enough time to grow.

Step 2. Save: Money does not grow out of a vacuum. You need to start somewhere, and the more you save – by cutting spending, or increasing income, or both – the better.

Step 3. Invest: Locking away your money in a vault will lose its purchasing power to inflation over time. Putting it in a low-interest bank account is not enough either. You should have a smart investment plan, so the interest you earn outpaces inflation.

This just restates one of the most basic formulas of investing, as shown here. “S” is the money you have today, which comes from your saving (step #2). “I” is the annual interest your investing earns you (step #3), which must exceed inflation that typically averages 2.3%. “T” is the time in years (step #1). Raising any one of these three, preferably all of them together, will get you that first million dollars quicker.

Read the CNN Money article here.

I would just have it all in a very low-cost index fund from a reputable firm, maybe Vanguard. Unless I bought during a strong bull market, I would feel confident that I would outperform…and I could just go back and get on with my work.

Coming from the most famous “stock picker” in the world, such drumrolling for index investing may come as a surprise to some. But as I said in this post, he has been advising this for many years, because with index funds you “would feel confident that (you) would outperform” and “get on with (your) work”.

An estimated 30,000+ strong crowd assembled in this meeting to hear from the Sage of Omaha in these troubling financial times. His main message was that it is impractical to expect an earning of 7 to 10% with publicly traded stocks today. Contrast that with past returns: between 1985 and 2004 a simple portfolio of S&P 500 Index fund would have earned 13.2%!.

You can read the meeting excerpt here and here.

Given that the current fixed base rate is 1.20%, it would much better to invest in I bonds this month rather than waiting until May 1 or later. I bonds you purchase today will earn a composite rate of 4.28% for six months, followed by six month of 6.06%. These are much higher rates than are available in bank CDs or even other US Treasury securities

I should also add, this is better than any online money market rate, 6-month CD or 1-year CD you can get anywhere these days. There is a purchase limit though:

Also keep in mind that the Treasury changed the annual purchase limit on Savings Bonds in January to $5,000 per social security number per type of bond. This means you can invest $5,000 in paper I bonds at a bank and another $5,000 in electronic I bonds through Treasury Direct for a total of $10,000 per social security number.

Or, you can buy up to $5,000 gift bond for each member of your family (spouse, children) who has a valid SSN.

Sounds good to me – what about you?

The short answer to this question is that we should invest to be able to shift our purchasing power from the high earning phase of our life to the low earning phase. Many of us earn more than we need to spend in our working life (note the italic – some of us spend more on our wants rather than our needs). It is the exact opposite when we retire – we spend more on our needs than we earn. Therefore, we must have adequate funds available when we retire to live out the rest of our life.

It used to be easy before. Most employers offered pension schemes that guaranteed a steady paycheck for their ex-workers as long as they lived. This concept has almost become a thing of the past. Instead employers today offer various “retirement plans” that encourage workers to sock away a portion of their payment for the future. In short, the burden of supporting yourself in retirement has shifted from your boss to you.

The primary objective of investing is then to have a reasonably comfortable life after retirement. (Increased longevity extends our retired life, not the working life. With the average life expectancy of 78 years in America today, we are talking of almost 20 years in the sunset, and even longer for some.) One way to achieve this goal is to store the “excess fund” during our working period as financial assets, such as stocks and bonds. After retirement, we sell these assets to meet our consumption needs.

We are talking of shifting the purchasing power of money, not the money itself. With inflation steadily eroding the value of a financial asset with time, a dollar 30 years later will buy a lot less than it can buy today (I bet you won’t begin your breakfast with a 99¢ cheese burger then.) So, our asset must at least grow apace with inflation just to preserve its purchasing power. (From the recent CPI data, this means the return of our investment should be at least 2.5%.)

Merely compensating for inflation is not enough, though. Remember that our paycheck reduces drastically after retirement (it vanishes altogether for most). We must have enough assets accumulated by that time to be able to steadily draw out from them for many more years, without facing the risk of outlasting them. So, the derivative goal of investing is to implement a strategy of growing our asset as fast as the prevailing market conditions allow.

I have used the words “asset” and “financial asset” a few times here. In the next post, we will see what they really mean.

69-year old Earl Crawley, while making $20,000 a year as a parking-lot attendant, still amassed over $500,000 in investment asset. His secret? Two, in fact. The first is his good old habit of saving every “nickel and dime”, and the second is his lack of investing knowledge, summed up in his quote that I borrowed above.

Saving and investing, in that order (you must save to invest), are the two essentials for building wealth slow and steady. Saving is common sense, and to people like Earl, almost an instinct. Investing, by contrast, requires some learning. But, knowledge plays a self-limiting role in our investing decision, which in turn affects investing performance.

The two fundamental things of investing are where to invest and how to invest. That is, the assets that make up our portfolio, and the proportions in which these assets are allocated. Unfortunately, there are as many different answers to these two questions, as there are books written about them. The more we know, the more confusing they get, and even drawing up the simplest asset mix can become a difficult task.

Keep it simple.

Solution? Keep it simple. Beyond the basics, knowing more does not help much. It is a bit like the picture here. At first, the return of your investment (solid blue graph) goes up with your knowledge level, but after you are past the basics, your return hits a “saturation point”. After this point, more knowledge causes information overload, and the payoff does not show a commensurate increase; in fact, the return can even decrease, depending on the specifics of your portfolio (in investing, more knowledge is not necessarily better knowledge).

Know the basics

What are these investing basics? There are four steps to it:

1. Depending on your risk tolerance, build a portfolio with the right proportions of risk-free (money market, treasury bills etc.) and risky (stocks and bonds) assets.
2. For your risky assets choose among those that do not move in lockstep with each other (for example, stocks+bonds, domestic+foreign stocks, etc). This way, you can spread out the risk of market downturns, and reduce its impact on the return of your portfolio.
3. Build your portfolio with manageable number of assets. Adding too many stocks and mutual funds is an example of information overload; if you do not understand them, you do not know their return potential, and your portfolio return itself can suffer.
4. Once you set up your portfolio, hold on to it. Do not tweak your asset mix each time the market does something unexpected. As I said in an earlier post, there is no get-rich-quick scheme in investing; a “buy and hold” strategy is the only way to smooth out short-term market fluctuations, and gain from the long-term economic growth.

Again, keep it simple. Earl does exactly that. He is open to suggestions and stock tips, but uses his own common sense and gut instinct to make decisions on which stock to buy. He is a self-made investor. Why can’t we all be like him?

When we fail to find a rational explanation for market swings, biology comes to our rescue. Growing economy dictates the long term market trends, but its short-term fluctuations are directly linked to investor psychology, each feeding off the other. By identifying the specific biological mechanisms operating in our brain, it may be possible to understand why we – rational beings in almost every other aspect of our lives – are under such strong grips of emotion when it comes to investing. Read Jason’s article.

In the long run, investing is not about markets at all. Investing is about enjoying the returns earned by businesses. And the stock market is nothing but a giant distraction in that quest to acquire returns that business earns.

Without telling anything new, this quote still reminds us of the big picture of investing: a buy-and-hold strategy for the long haul is the only way to escape the ravages of market swings, and to benefit from the slowly (and surely) growing economy. I recommend reading the entire interview.

Now you know why I do not like paying extra thousands of dollars for a new car, when a reliable used care can do just as fine. Looking at the larger picture, the used car industry in America is twice the size of the new car industry in terms of the number of vehicles sold each year. Most of these buyers choose a used car because of budgetary reasons. For those of you who can easily afford a new car, I am going to argue in the next couple of posts that it still makes better investing and practical sense to own a used car instead.

If you already made up your mind to buy a new car no matter what, here is a short list of some excellent resources that will hold your hand through the process step-by-step. For the rest of you, picking the right used car demands some time. (We often spend a week planning a $200 vacation; we can surely spare a weekend researching a $10,000 car.) This guide will hopefully make the process easy and relatively painless. It is divided in the following eight posts, and I recommend reading them in sequence (at least from step #3):

1. A close look at car depreciation.
2. Why should I buy a used car?
3. Picking a budget.
4. Making a list.
5. Researching your car.
6. Checking the car out.
7. Wrapping it up.
8. A note on extended warranty.

Let us begin by taking a close look at car depreciation »