Saturday, February 24, 2007

Consumer Debt Continues to Rise

"Despite an economic recovery now in its sixth year, more American households are in debt now than at any point in the past 15 years, particularly the middle class. In fact, in the recent years household debt has risen faster than family income and, on average, exceeds annual income for the first time since the Federal Reserve started surveying consumer finances in the early 1980s. The explosion in debt, fueled largely by mortgage lending on residential housing that rose in value, and then leveled off or declined, has some economists worried that the next economic recession will be devastating to families that already owe so much. But proponents of the expansion in consumer credit say it has helped to democratize home ownership and fuel economic expansion."

(from the Congressional Quarterly, February 2007)

Friday, February 23, 2007

Negative Reactions to Common Stock Offerings

Negative reactions to common stock offerings - does it make sense?

There are two types of common stock offerings - primary and secondary offerings. A primary offering of common stock by a firm on an exchange is a company's first foray onto the capital markets. A secondary offering is a follow-on offering made by a firm whose stock is already trading on a public market.

In the first case, there is ample evidence that initial public offerings (IPOs) underperform the market over the long run (Brav and Gompers, 1997). Initially, there is an "overshoot" in terms of excitement over the prospects of a new firm, which will typically lead to disappointment and negative returns: "investors are periodically overoptimistic about the earnings potential of young growth companies" (Ritter, 1981). "Underpricing" (Brav and Gompers, 1997) contributes to this underperformance phenomenon by driving initial share prices to far higher levels than they should have ever attained at the outset.

When considering secondary offerings, the market will typically react negatively simply because such offerings, by increasing the number of shares traded on the market, dilute ownership - and in the long run this will typically translate into lower market returns, unless the company does phenomenally well and increases value at a much higher rate (so that sometimes such IPOs will be considered to be a signal for better things to come). Research has demonstrated, however, that over the long run secondary offerings significantly underperform the markets. The effect is exacerbated by "managers exploiting "windows of opportunity" by issuing overvalued shares" (Clarke Dunbar and Kahle, 2004).

What should you know as an investor?
Stay away from IPOs...

ragingacademic

References

Brav, Alon, and Gompers, Paul A. (1997). Myth or Reality? The Long-Run Underperformance of Initial Public Offerings: Evidence from Venture and Nonventure Capital-Backed Companies. Journal of Finance, Dec, Vol. 52 Issue 5, p1791-1821

Clarke, J., Dunbar, C. and Kahle, K. (2004). Journal of Business, Jul, Vol. 77 Issue 3, p575-603

Ritter, Jay R. (1991). The Long-run Performance of Initial Public Offerings. Journal of Finance, Mar, Vol. 46 Issue 1, p3

Wednesday, February 14, 2007

Maximizing Lifetime Wealth

Many of us spend (ha ha...) countless hours trying to figure out how to maximize our personal lifetime wealth... Here are some ideas to ponder...

First of all, maximizing personal lifetime wealth will require that one maximize savings and minimize current consumption – because of the power of compounding, the more we set aside for investing early on in life, the greater the probability that these savings will grow into a substantial nest egg. In addition, it’s a matter of simple math – the more we will have available to invest, the greater our potential returns will be.

The second most important thing we must do is to invest these savings strategically. Such investments must be well-diversified in order to minimize losses, and the level of risk undertaken must be commensurate with our investor-type. This may of course impact the potential to maximize returns as a more conservative investment approach will, necessarily, reduce returns and vice versa.

Third, we must rebalance our investment portfolio, at the very least on an annual basis, in order to maintain a consistent investment strategy and an appropriate level of diversification.

Fourth, one should only invest in assets one understands, following substantial research that should invoke both fundamental and technical analysis techniques as well as a perusal of analysts’ opinions.

Investing according to the above guidelines should get you on your way towards maximizing your personal lifetime wealth.

Have other ideas? Share them. Comment.

Raging Academic

Tuesday, February 13, 2007

Five Best Sites on the Web for Personal Finance

The following are the five best free Web sites for personal finance:

1) MSN MoneyCentral - http://moneycentral.msn.com
2) Yahoo Finance! - http://finance.yahoo.com
3) CNN Money - http://money.cnn.com
4) WSJ's SmartMoney - http://www.smartmoney.com
5) Morningstar - http://www.morningstar.com

Up and coming - Google Finance - http://finance.google.com

Top for-pay personal finance sites:
+ www.investors.com (some free content, but all the good stuff requires payment)
+ www.fool.com
+ www.barrons.com

Monday, February 12, 2007

More Methods to Start Saving...

Here are some additional tricks to get your saving in gear -

Did you know that the U.S. savings rate has been negative for most of the past two years? (Commerce Department Bureau of Economic Analysis) Did you know that, on average, U.S. households now owe more than they earn in a single year? Isn't it about time you got more serious about saving?

+ Check Pennies - this is a great little method if you are one of those who still balance your checkbook...everytime you write a check, round the balance down to the nearest dollar; whenever you balance your checkbook, you'll find a small surplus in your checking account - transfer it immediately to some sort of savings account. If you have an interest-bearing checking account make sure to trim off those interest payments at the end of every month and transfer them to a savings or investment account as well.
+ 401k's - max out your contribution every year; there are a couple of potential benefits to this: tax-deferred savings and growth maximizes the advantage of compounding, and matching employer contributions are kind of like a bonus that you simply won't get if you don't use your 401k option.
+ Round Up Mortgage Payments - make sure to allocate the surplus to principal; two benefits: less interest payments over the lifetime of your loan, and earlier payoff (over the course of a 30 year mortgage this little trick could easily knock 2-3 months off your mortgage)
+ Sock Away Windfalls - make a point to save and/or invest any extra money that happens to fall into your lap e.g. a surprise inheritance, a bonus at work or a tax refund.
+ Budget - instead of saving whatever is left over, determine ahead of time what you intend to spend and immediately set aside the difference.

Do you know of any additional savings tips and tricks? Leave a comment!

ragingacademic

Sunday, February 11, 2007

Some Musings On Debt - Advice for the Indebted

Many of you carry various types of debt; the most common and easily accumulated debt is credit card debt.

Merchants love that we have the 'plastic' because it feels so much less like actually paying for something than when we use real, hard, cold cash. Problem is, we use our credit cards too much. The average US citizen has over $8,000 in credit card debt. And, if all you're doing is making minimum payments, you're not putting a dent in that pile of debt you've accumulated. What to do, what to do?? Here are some options to consider - best is to adopt all of the following, of course!!

· First and foremost, stop spending money you don't have. If you're saddled with unmanageable debt, cut up all your credit cards and limit yourself to using cash, debit cards and checks. If you don't want to cut them up, throw them into a freezer bag, fill it with water and put it in the freezer; at least if you do get the urge to splurge you'll have to wait for your cards to thaw, and, well, by then you'll have time to think twice!!

· Work with your credit card companies to reduce your interest rate. Call up customer service and explain that you are experiencing financial difficulties but that you want to be able to continue making payments; ask for a lower rate. Typically, if this is your first time, you'lll get what you asked for. If not, hang up, and call again... You'll get a different customer rep... Try again... If that still does not work, call them up once more and say you want to have the card closed to new purchases - that should work the magic and they most likely will offer you a lower rate.

· Consolidate your debt - if you own a home, best is to get a home equity line of credit from your bank; pay off all your credit cards, that likely carry rates ranging from 12% to 24%, and you'll be left with a single monthly payment to your bank which may run as low as 4%!! You can also consolidate all of your debt under a single card - negotiate with the credit card company first and let them know you would like to transfer balances from other cards; again, they'll usually offer you a lower rate to do so. Cancel and destroy the cards you will no longer be using!!

· Pay down as much debt as you can every month - spend some time budgeting and maximize the debt you pay off every month; this will pay off greatly in the long run. As you pay off your debts, make sure to first pay off those debts that carry the highest interest rates!!

Saturday, February 10, 2007

Finance 101 - Markets are NOT efficient...

One of my famous pet peeves is that - contrary to prevailing academic opinion - markets are not efficient. Kahneman and Tversky are far more "in the money" than Sharpe could ever hope to be... (witness the dismal failure of Long Term Capital Management and the ensuing bailout...)

In my own investing as well as in the finance classes I teach I've taken a "nishtahin nishtaher" approach - i.e. neither here nor there, but rather as a compromise which allows the century long battle between fundamentalists and technical analysts to subside into something manageable. One must carefully analyze the fundamentals - yet make trading decisions based on the basic precepts of technical analysis. Why? Because technical analysis reflects the psychology of the market.

I was glad to come across a series of articles from Investopedia that serve to support my own theory; they are:

Brumley (2006) What can traders learn from investors?

Brumley (2006) What can investors learn from traders?

and...

Vonko (2006) Fundamental analysis for Traders.