Ways To Buy Gold

I’m am not endorsing investment in gold as a long term wealth building strategy. However, these days many people want to invest in gold because it can add to their overall diversification. There are many different ways to buy gold. At the very least gold investors should be using the most efficient investment vehicle for their gold!

One of the best ways to buy gold is to invest in the gold Exchange Traded Fund or ETF. The gold ETF trades under the ticker symbol GLD.  One of the worst ways to invest in gold is to buy physical bars or coins!

What happens when someone buys shares of GLD, is that they are getting a share of a company that buys and holds gold as an investment. The changes in the price of GLD are supposed to mimic the changes in the price of gold itself. This means that if the price of gold increases 2% than the price of GLD should also increase 2%. In general this one to one relationship holds true.

The advantage of buying GLD instead of buying a bar of gold is that GLD is highly liquid. This means that if an investor in GLD wants to sell there gold at any time, they can. An investor in a physical bar of gold will have to find someone to buy his or her gold. The transaction of selling physical gold usually takes place at a price that is more advantageous for the buyer than the seller.

Another reason why liquidity is so important for gold buyers, is that an investment in gold could turn out to be a bad investment. There are many smart investors that have a strong opinion of weather gold is overvalued or undervalued. If an investor buys gold in the thought that it is undervalued and he or she is wrong, that investor will want to sell their investment as fast as possible an at the best possible price. An ETF offers this advantage over physical gold.

Another one of the best ways to buy in gold is through investment in a gold miner. This means buying shares in a publicly traded company that mines gold as a business. The world supply of gold is increasing at about 2% per year. With such high demand and high prices, the suppliers (miners) of this 2% increase stand to profit.

Here is a list of some ticker symbols of large gold minors, this is by no means a complete list, and each of the companies that accompany these ticker symbols should be well researched before any investment. Now the list: (NEM, ABX, FCX, GG, AU, RGLD, VGZ, ALTO, AUY, GSS, NMC)

ways to buy gold 2

The best way to invest in any of these companies or investments is through a discount broker. A discount broker that operates on the internet. E-Trade is probably the most well known. These discount brokers can offer the purchase or sale of an investment for less then 10 dollars, while a traditional broker will charge 50 or more dollars to make a trade. Some brokers, like Vanguard and iShares, will allow an individual to trade ETF’s for free as long as those ETF’s are held for a specified period of time, usually 30 days.

Overall an investment in gold can be risky. It is an extremely volatile asset that can trade sharply down or up given the markets attitude towards the metal on any particular day. To protect themselves, investors should buy highly liquid forms of gold with little or no upfront brokerage commission.

about the stock market, or retirement, or to anyone who generally works too hard to have their money be lazy. The following posts are summaries of each of the chapters of “The Warren Buffett Way.”

There are two forwards, one preface, and one introduction, before the first chapter of the book even begins. They are all written by authors who are accomplished investors in their own right and who know Buffett on a personal level. The first forward is written by the famous mutual fund manager and author Peter Lynch. (I would also recommend reading Lynch’s books if you are new to investing.) All of the writings are fantastic and well worth a read, however the real meat of the book begins, as expected, with the first chapter.

(to skip to chapter two click here)

Chapter One: The World’s Greatest Investor

This chapter cites that Warren Buffett has been in the top 5 richest people in the world, according to Forbes Magazine, more than anybody else. Therefore unlike many other billionaires Buffett seems to be one of the few that can consistently stay on the list, showing that he knows not only how to not lose money, a trait that several billionaires seem to lack, he knows how to make money!

At age 25 Buffett started his investment partnership with a 100 dollar investment. He started this partnership after he had worked in New York City for two years under his mentor, Ben Graham. Through management fees and capital appreciation he left his partnership with 25 million dollars. All of this took place within the span of 13 years.

He had achieved an annual return of 29.5%, as detailed here. The other investors in his partnership were cashed out as well, all of them profiting handsomely. The reason that Buffett closed his partnership in 1969 was that he believed that the stock market was overvalued and that it was not possible to find the good deals that he was able to find several years earlier. Several investors in the partnership did not want to cash out their money from their investments, so Buffett recommended to them his trusted friend and former classmate, Bill Ruane, to manage their money. This was the beginning of the Sequoia Fund, a mutual fund that is still around today. Here is the performance of the Sequoia Fund since it’s inception in 1970.

Here is even more information on the Sequoia Fund.

Buffett took his 25 million dollars and purchased a controlling interest in a textile company called Berkshire Hathaway. While under Warren Buffett’s control, Berkshire Hathaway’s book value has grown at a rate of over 20% per year. The book value of a company is the value of the assets financially owned by the company. On a personal level this would be called net worth. An example would be if you have a home that is worth $100,000 and a $75,000 mortgage on that home, your net worth is $25,000. Buffett has grown his companies “net worth” by over 20% per year since the 1960’s.

He made his fortune by valuing an investment and buying the investment below it’s value. In the exact same way that most people buy goods and services, like cars, clothes, and food. Buffett essentially did the same exact thing with financial assets, which usually took the form of an ownership share in a business.

As famous as Buffett is for his money making abilities, he is perhaps more well known for his values, ethics, and modest lifestyle. He has given over 99% of his fortune to charity. He has often spoken out against the extravagant compensation that CEO’s, other executives, and fund managers, grant to themselves. He has even spoken out against the low tax rate, as a percentage of income, that the multi-millionaires and billionaires (such as himself) are required to pay in the United States. For all of these statements, views, and actions he has received both praise and backlash. It would be safe to assueme that Buffett is unswayed, either positively or negatively, by how his views are publicly perceived. He has, after all, made his fortune by taking action with conviction, regardless of what the general public thinks.

Continue to Chapter Two…

Chapter Two: The Education of Warren Buffett

This chapter describes the four men who have had the largest impact on Warren Buffett’s thinking. These four men are Benjamin Graham, Philip Fisher, John Burr Williams, and Charles Munger. Described below is a summary of the investment philosophy of the four men and the impact that they had on the investing style of Warren Buffett.

Benjamin Graham

Ben Graham was Buffett’s teacher at Columbia University while Buffett was getting his MBA. Graham was also the author of the book “The Intelligent Investor”. A book that many, including Buffett, consider to be the best book on the subject of investing ever written. (A summary of the book, and a free audio version of the book, can be found here).

Graham was a brilliant teacher, author, and business man. At age 25 he was a partner in an investment firm and earning a salary of $600,000 per year. This was in the year 1919!!! Adjusting for inflation, Graham was making $7,494,692 per year at age 25!!!! (in 2010 dollars).

However, Graham’s fortune was destroyed by the crash of 1929. The stock market crash and loss of almost all of his money had a great impact of Graham, and therefore had a great impact on Buffett. Graham developed his theories on investment based on a highly conservative approach to investing, and began rebuilding his fortunes.

Dissipate the fact that Graham was personally finically ruined by the market crash of 1929 , the investment business that he co-founded in 1926 remained in business until 1956. Graham and his partner managed to the fund by an average of 17% per year while they were in business, during this same period the stock market only returned 7% per year.

Graham’s considered an investment to only be a true investment if it met his following definition: “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirement are speculative”

To find out more about Ben Graham, I recommend “The Intelligent Investor” or this post (here).

Philip Fisher

The next major influence on Buffet was Phil Fisher. Fisher also wrote a well known investment book, called “Common Stocks, Uncommon Profits.” This book details the famous “15 points” of Fisher, a checklist for investors and businesses alike.

Fisher’s investment philosophy was to identify and invest in great companies with great management. Therefore “Common Stocks, Uncommon Profits” is not just a good read for investors, but it is a great book for all those interested in running a business. This is because Fisher identifies 15 common traits that great business share.

Fisher differed from Graham in that he was much more qualitative, and much less quantitative than Graham. He was interested in the quity of the business and the management. Whereas Graham was much more interested in guaranteeing the safety of his investment, by buying something when it was cheep and selling it when it was expensive. Fisher was much less interested in getting something cheep and much more interested in buying a high quality investment. Buffett managed to bled these two concepts by buying high quality investments at reasonable prices.

John Burr Williams

John Burr Williams got his doctorate in economics from Harvard in the year 1940. His doctoral dissertation is called “The Theory of Investment Value.”  It has become a widely  published and highly regarded book. Warren Buffett has called the book one of the most important investment books ever written.

The very well known theory that came from the book was called the dividend discount model. Today this same model would go by the name of “net present value” or “discounted future cash flows.” Don’t let the boring names fool you, this model can be used calculated how much any investment is worth. Buffett has used this model throughout his investment career to “buy dollars for fifty cents.” This model is important because, if you know how much an investment is worth, you can know when it’s on sale.

Charles Munger

Charlie, as Buffett calls him, is one of Warren’s best friends as well as his most trusted business partner. Munger is the vice chairman of Berkshire Hathaway, and runs many of its most important investment operations. Buffett never makes a major investment division without first talking it over with Charlie.

Charlie achieved outstanding investment returns with his own partnership, (detailed below) before joining Buffet at Berkshire. His approach is similar to Phil Fisher’s, in that he likes to buy high quality businesses run by talented and ethical managers.

Charlie is often very blunt when speaking or writing, and often gets straight to the point of an issue. He is absolutely a brilliant thinker and he seems to have an opinion on just about everything. Many of his thoughts, including those thoughts on investing, can be found in the book “Poor Charlie’s Almanack.”

Warren Buffet has managed to take some of the best ideas from each of the four investors described above and combine them into an investing framework that succeeds.  By following this single comprehensive approach, no matter what the circumstances, Buffet has managed to achieved the best investment record of any investor to date.

For those unfamiliar with covered calls it is a process in which you, the investor, owns an underlying stock and then you sell a derivative product, called a call option on that same stock. A call option gives the holder of that option the right, but not the obligation, to buy a stock at some point within a specified period of time, for a specified price.

The best way to think of a call option is to think of a coupon. A coupon gives you the right to but not the obligation to buy a particular item (lets say a pizza), at a particular price ($5.99 for arguments sake), for a specified period of time (until the expiration of the coupon). A call option is no different except that you have to buy the coupon, it is not free. For example, you could buy a call option that would give you the right to buy a stock for $21.00 until August and today the stock is priced at $20.00. Obviously if the stock doesn’t go above $21.00 before August your option was worthless, but if the stock goes to $25.00 by August you have made $4.00 on your call option. If you bought that call option for $2.00 then you just doubled your money!

A covered call is when you are the person that sells the $21.00 option. You have made $2.00 for selling that option. If you just sold the option and didn’t own the stock at $20.00 then you have exposed yourself to unlimited risk. If the stock goes to $100.00 by  August, for some reason, then you have just lost $79.00! This is because you are forced to sell the stock to someone at $21.00, but in order to sell the stock you must first by it for $100.00…ouch.

The solution to this dilemma is to sell the call and buy the stock at today’s price of $20.00. Therefore if the stock dose go to $100.00 and you are forced to sell it at $21.00 then you are selling a stock that you bought for $20.00 at a price of $21.00 instead of selling a stock that you bought for $100.00 at a price of $21.00. This is what is called a covered call.

Covered calls sound great! The problem with them lies in a very subtle risk. This is the risk of limiting your upside potential, while leaving you with all of your downside potential. In fact because of this one unnoticeable risk, any covered call strategy implemented over the period of 1990 to 2010 on an index such as the S&P 500 would have underperformed that index. In fact using a strategy of selling “at the money calls” each month would have increased the value of your 100% index fund portfolio by only 25% total! This is over a time period where a standard investment in that same index (S&P 500) would have well over tripled your money!

There are other flaws with the covered call strategy, such as the fact that you will have to buy round lots (100 shares of stock at a time) in order for your stock to be “covered,” because options are only sold in 100 share increments. This makes position sizing within your portfolio quite difficult, which makes risk management even more difficult.

In conclusion, a strategy of selling monthly or yearly covered calls to boost you income, will negatively effect the performance of your portfolio. In reality, it will increase the risk of your investment and decrease your income over time, which is the exact opposite of what the strategy aims to do.

I have to apologize, if this post seemed complicated, options can be tricky things, but I just wanted to point out the why this popular option strategy is doomed to fail. If you have any questions or comments please comment. Thanks!

Enjoy! And grow your money!!

Bill Gross is a bond investor mostly. He is often called the “king of bonds” for his ability to consistently outperform the major bond indexes. Without going into too much more detail about who he is, here is what he has to say…

In his most recent letter he wrote about his trip to Washington DC and his proposal that he laid out to help the housing market both now and in the future. His proposal is pretty much this: Right now Fannie Mea and Freddie Mac back (read own) the vast majority of all U.S. mortgages. In fact 95% of all mortgages in the past 12 months have originated at one of these two institutions!

Bill’s proposal seems simple enough. He says that from now on Fannie and Freddie should only back these mortgages if there his been an adequate down payment, proper documentation for the loan (i.e. make sure people have a job, good credit, ext.), and 1/2% to 3/4% added on to the interest rate on the loan, which will be used to create an insurance fund. The idea is to pretty much make sure the loan is made to a real person, who can pay for the loan, and to have a backup plan if they can’t pay for the loan.

At the end of his letter he admits it would be nice not to have the government involved in home mortgages, but going from 95% of mortgages being backed by the government to 0% would cause interest rates to go through the roof.

Overall, I think his letter is a warning to the government and it is this: don’t make the same bad loans that the banks made!

Next Guru (this one will actually talk about investing I promise) Jeremy Grantham. He is a famous investor who has correctly called almost every bubble over the past ten years, from tech stocks in 2000 to housing and banks in 2007 and more.

Here is what he has to say.

He doesn’t think that inflation will be an issue (at least for the foreseeable future). Despite the fact that the government has been printing a bunch of money, demand just isn’t strong enough to cause inflation. And with governments in europe and soon the U.S. making efforts to reduce their debts and deficients he see’s inflation as being even more unlikely and the odds of a small recession being quite high. All that being said he believes the best place to invest right now is U.S. high quality stocks (for the reasons mentioned above and because they are cheep). These are large, low debt companies, that earn money consistently and are affected little by the economy. Examples would be MacDonalds, Wal-Mart, Johnson and Johnson, and more.

His second favorite place to invest is the stock markets of emerging markets, because these economies will continue to grow faster than the larger economies and they are also fairly cheep.

He says that after inflation you can expect these two asset classes to earn about 6.5-7% over the next 7 years. Which is slightly higher than the long term average of U.S. stocks after inflation of 6.5%.

Last Guru on the list: Howard Mark of Oaktree Capital. Manages a 76 billion dollar fund, and has been described as a more philosophical version of Warren Buffet. In fact he will often quote Buffet in his own writings. He made a lot of money by going “all in” in distressed debt and businesses near the bottom of the 2008 financial crises.

Heres what he had to say in his latest letter to investors (it was written lest than 2 weeks ago):

To make a long story short, his entire 10 page letter can be summed up by the following. Bonds are very expensive, high quality U.S. stocks have the best chance of making the most money over then next several years.

This summary is in agreement with the Jeremy Graham said. I would agree also based on my previous post “How to Value the Stock Market” stocks are about 46% cheeper than bonds today. Are they 46% worse? I can’t say for sure, but I doubt it.

There are a lot of myths about how Buffett invested in his early days. His partnership letters help shed some light on what sort of investments he was making at the time.  His early and relatively unknown partnership letters are especially important for many at home, do it yourself, investors. Because let’s face it, most of us are investing less than 1 million dollars, just like Buffett when he first started, but he eventually because the richest man in the world. To many “home gamers” these letters are important because unlike the berkshire Berkshire Hathaway letters of today, Buffett wasn’t managing billions of dollars. And he wasn’t causing the prices of stock to move up or day simply because he was buying or selling stock. Simply put, when these letters were written Buffett was just like most of us, but then he began growing his money…

Warren Buffett’s Value Investing approach to his first million dollars and beyond – The Buffett Partnership Letters

In his now famous letter, the Super Investors of Graham Doddsville, Buffett admits the success of his investment partnership, which was operational over the course of 1957 to 1969. The partnership returned 29.5% annually, limited partners received a compounded return of 23.8% annually. The difference between the two (general partnership and limited partnership) is mainly the management fees (the amount Buffett got to keep for helping to make his investors rich).  During the same amount of time the Dow Jones returned 7.4% annually. This means that before Buffett took a portion of the profits for managing the portfolio, he was able to beet the stock market by 22.1% every year!

Here are the annual results in table format.

I will be posting some super quick summaries of the key points of each of these letters but, if you want to read the letters yourself, they can be found here http://www.ticonline.com/buffett.partner.letters.html.

Most of the best investors are value investors, but not all of these value investors are in the top 1%. So what the difference between the good investors and the not so good investors. Here’s the big “secret”…

Great investors think differently.

Great investors think differently than everyone else…. This makes sense because an investor who thinks differently probably acts differently and therefore he or she gets different results (like being in the top 1%)

Here are the four biggest differences in the thinking of a great investor when compared to the thinking of the rest of the world.

1. A great investor is buying part of a business when they buy a stock.

This of course is true in a legal sense, because when you own stock in a company you literally are one of the owners of that company. If you can understand, I mean really understand, this one thing about investing, that buying a stock is buying a partial ownership in a

company you will be better than most of the investors in the world. However, most people forget this, most people don’t focus on the value of the business they own, most people focus on the movement of the stock price. Which brings me to point number 2.

2. Price is different from value.

In the stock market price and value do not always move in sync, but in the long run they will always converge. Remember, price is what you pay, and value is what you get. For some crazy reason people seem to understand this everywhere except on Wall Street and in investing, where everything is backwards. In the real world people love to buy things when there on sale. They will say “We should go shopping for furniture this weekend because of the clearance sale!” However, when there is a stock market decline creating a clearance sale for many businesses people are actually afraid to buy. This is like saying that you only shop at places when their is no sale.

3. Risk is in the value not in the price.

To a great investor the real risk of buying something when it is on sale is the possibility of buying a lemon. So when you go to the furniture store and your looking for a new bed on clearance sale, the real risk that you run is buying what you think is a great bed at a great price only to later have it fall apart in the middle of the night when you are trying to sleep on it. The same thing goes for the stock market, the risk you have is that you might buy a good company at a good price only find out that it is not such a good company.

4. A great investor doesn’t try to predict the future.

If you go to the furniture store and see the perfect bed that you have always wanted and it is selling at a bargain price should you buy it? Probably, at least if you are a great value investor. But most other investors would look at the bed and say “well it is 50% off last year’s price, I don’t think I’m going to buy it, because it will probably continue to fall in price” (trying to predict the future). Sometimes these other investors will be right and the price of the bed will be marked down farther, other times they will be wrong and all of the beds will sell out at the 50% off price, and the bargain will be lost. This is what usually happens to these “other” investors. They usually miss out on the bargain, because they are trying to time their purchase, so they can buy at the absolute the bottom price, but before they can, all the beds sell out and they haven’t bought one. Then they end up paying full price for a bed from the new set of beds that come in.

In investing, don’t try to predict the future. Remember if you can buy a great product at 50% off or more than its actually worth, is that risky? No, you will probably end up will a bunch off products that you love and you will still have money to spare.

So truly value investing is easy in the real world. It’s simply finding bargains. However in the stock market people seem to forget what investing is all about. I mean we are all used to seeing various products everyday and we know what they are worth. We know how much a certain car should be worth, or how much a pizza costs. Many people know how much a new pair of a Nike’s should be, or how much an iPod is. But in the stock market people mess up, because they don’t know how much the entire company of Nike should cost or how much the entire company of Apple is worth.

But don’t worry valuing a company is not any more difficult than valuing a product you use, despite what Wall Street and other investors tell you. How to value a company is the kind of information that I will be writing about in future posts. But this post had to be written first, because it is your mindset that will make all of the difference in investing.

You don’t have to be a genius to value a company or to make money in the stock market, but you do have to think differently than the rest of the investors out there.

If you can simply think of investing the same why you think about shopping for a bargain you are way way way ahead of most other investors. (by the way, this is how Warren Buffett and other great investors think, hence the title of this post “How to Think Like Warren Buffett”)

Just remember if you can buy a business for less than it is worth, you will grow your money.

Thanks for reading!

True diversification is one of the easiest ways to ensure that you will have more money five years from now than you had this year. Here is what I think diversification really is (it might not be what you think), how it has done in the past, and why I think it give’s you more return on you time and money than almost anything else!

So what do I think true diversification is? 5 stocks? 10 stocks? 50 stocks? NO!!

To me true diversification is this….Having a portfolio of multiple asset classes!

Whats an asset class?  Here’s the definition, but I have to warn you, the definition…kind of … sucks! Asset Class – A particular type of investment vehicle. The reason this is a terrible definition is because it is subjective.  Think of it like this. What if I told you a Food Class – is a particular type of food. See what I mean, a Food Class could be anything. To one person a type of food class is as broad as fruits and vegetables (stocks and bonds), but to someone else it could be as specific as citrus fruits and all other fruits (value stocks and growth stocks).

Now while I have no good way to define what a Food Class out to be, I think an asset class should be this….an investment that zigs while another investment zags. Now you can find out if an asset zigs while another zags a number of ways, one way to do it is to check there correlation to each other, which is great for identifying this zig zag relationship, but only common sense can ensure that the relationship will continue into the future.

For example stocks and federal bonds have almost always been negatively correlated with each other (nerdspeak for one zigs while the other zags). But this relationship will likely continue into the future because of the common sense reason that when investors sell the risky asset class (stocks) they want to use that money to move into something safer (federal bonds). The decrease in demand for stocks will decrease their price and the increase in demand for federal bonds increases their price and the zig zag relationship will continue.
So here is the question…Is diversification for you? I would say that it is most certainly is if you are a “lazy investor.” By this I mean you want to get good and safe returns on you investment, but you don’t have time or what to spend your time analyzing financial statements.
Here is an easy way to be fully diversified. Buy two index funds, put 50% in each, because one of them will zig while the other zags. Here are the two funds that you should invest in..first an index fund that tracks tracks every stock in every stock market in the world, known as a “total world fund” or “total equity fund.” The other fund to invest in is a “total bond fund,” ideally this would track every long term high grade bond in the world. I have tested this concept by seeing how it would have performed in the past using two investment funds, the results are in the graph and table below. The two funds are the Vanguard Global Equity Fund (which is close to a global index), and the Vanguard Long-Term Bond Index Fund (it invests in long term U.S. Government Bonds and long term high grade corporate bonds). Nerd Note – These results assume that dividends and payments are reinvested and taxes and fees are not included, it also the 50%50% portfolio is rebalanced annually. The same goes for the S&P 500 results so that we are comparing apples to apples. (as a side note I want to say that I’m am not endorsing Vanguard in any way and that this is only one way to create a diversified portfolio of multiple asset classes)

Notice how much smother the rise in the diversified portfolio is. It might not be as exciting as the S&P 500 portfolio but it only lost money in one of the 14 years on the graph, which happened to be the worst stock market crash since the Great Depression. Also notice that the diversified portfolio  made money every year between 2000 and 2003 (the second worst sock market drop since the great depression).

With just these two investments split 50/50 you can be very confident that you will have more money five years from now than you have now. I’m not saying that you will beat the stock market, but you won’t lose money or spend much time analyzing stocks, and to many people this ability to sleep well at night because you know that you are growing your money is worth it.

Thanks for reading and I hope that this helps some of you with your investment decisions in the future.

At one point before creating this blog, I thought that I would write a detailed summery of the famous investment book, “The Intelligent Investor”, by Ben Graham (the person who I have mentioned in previous few posts). However, after searching the web, I have found a very well done summery of the book and the full audio recording of the entire book.  So I have decided not to personally write a summary of the book, but instead share with you these two very well done sources of information (one of them after all is the entire book in audio form…I can’t really top that!).

First, a summary of the book from a fantastic personal finance blog, “The Simple Dollar.”

“The Intelligent Investor: Introduction – Chapter 4″

“The Intelligent Investor: Chapter 5 – Chapter 12″

“The Intelligent Investor: Chapter 13 – Chapter 20″

Next, the entire audio recording from YouTube, starting with the first chapter of the series in the video below. Then a link to the YouTube video, so that you can view all of the subsequent chapters of the series.

“The Intelligent Investor – Audio Book Part 2 of 24″

Enjoy!

Here’s the video describing the strategy. If you have any questions about this strategy or any other ideas about strategies that could be designed around the “Ben Graham Market Valuation Technique” please comment below.

Thanks!