The Bond Part of Your Portfolio

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The last post explained general decisions in creating a portfolio, what financial professionals call asset allocation.  This post focuses on the bonds in the portfolio.

Bond decisions focus on two main considerations, maturity risk and credit risk.

Maturity Risk

 This is the tradeoff between yield and the term to maturity of the bonds. Long-maturity bonds tend to pay higher yields than short-maturity bonds, but their prices are also more sensitive to movements in interest rates, falling as they go up and rising as rates fall. (See the box in this post for a more complete discussion.)  Unless you have strong convictions on the future direction of interest rates (always a problematic prospect) you should aim to balance the higher current yield of longer-maturity bonds against the risk of a price decline should rates rise.

Hint:  Be aware that some bonds have a call provision that permits the bond issuer to call the bond back before it runs its full term to maturity.  If interest rates fall below levels that prevailed when the bond was initially sold, the issuer may decide to borrow anew at a lower interest cost and use the money to call back your holding.  You would get your money back and the interest due you to the date of the call, but you would lose the benefit of having a long-maturity bond appreciating in a falling rate environment.

Credit Risk

 As we mentioned in an earlier post, there is always a chance that the bond issuer will go bankrupt and fail to meet its obligations.  The greater this risk, the higher yield the bond pays, but you must decide, based on your life cycle/life style needs, how much of this risk you are willing to assume. Even if there is no bankruptcy, the prices of bonds with a greater risk might suffer on bad economic news.  With this trade-off in mind, we can identify three basic types of bonds:

  1. Treasuries: These are the obligations of the federal government.  They are issued in different maturities and carry the same maturity risk as all bonds, but they never have call provisions.  Because they are considered entirely secure credits, they generally offer lower yields than other bonds.
  2. Investment grade corporate bonds: These are issued by companies with strong finances. All else being equal, they generally pay a higher yield than U.S. treasuries.  There is only a small chance that they might have problems meeting their obligations. Credit rating agencies (of which more in a later post) show this risk on a relative scale.  (See the box at the end of this post.)  Investment-grade bonds have little risk that they will fail to pay the holder all they owe.  But they do have maturity risk, and many have call provisions.
  3. Junk bonds: Despite their colorful name, such bonds can play an important role in a portfolio.  Because they either have low credit ratings or none at all, they are considered more vulnerable to failure than other bonds and accordingly pay higher yields than other bonds of comparable maturity.  As with all bonds, these also carry maturity risk and often have call provisions.

Municipal Bonds

 This is a fourth type of bond that doesn’t fit neatly into any of these categories.  “Municipals” or “munis” are issued by states, cities, and other municipalities.  Their appeal is largely because their interest earnings are exempt from federal income tax as well as from state tax for the state in which they were issued.  Because of that break, they generally pay lower yields than bonds on which interest earnings are subject to tax.

Hint: Except in rare circumstances, the only reason to buy municipal bonds is for the tax break.  If you have a combined tax rate of less than 25-30 percent, you shouldn’t consider them.  The tax break you would enjoy would not compensate you for accepting the lower yield munis pay.

If your tax situation warrants buying them, be aware that municipal bonds are otherwise much like other bonds.  They carry more maturity risk at longer maturities and accordingly pay higher yields at longer maturities.  Their credit ratings can vary from good down to junk status, depending on past behavior and the finances of the issuing municipality.  As with other bonds, the less credit-worthy bonds tend to pay higher yields.  Many munis carry call provisions.  Municipal bonds come in three types:

  1. General Obligation Bonds (GOs): These are the safest because the full taxing authority of the issuer backs them.  They finance roads, schools, and other government projects.  They remain exempt from tax as long as no more than 10 percent of the money raised by them goes to finance a private enterprise, not pay for its services.
  2. Revenue Bonds: These pay from the income earned by a specific project or government agency, for instance the tolls from a road or a publically financed operation such as a hospital, a stadium, or convention center.
  3. Industrial Development Bonds: These bonds finance the construction of facilities that are then leased to a private corporation.  Their tax-exempt status follows the same rules as GOs.

A Last Word

 Remembering the necessity of  diversification explained in the last post, the object here is not to settle on one bond or type of bond but to construct the bond portion of your portfolio with a variety of bonds that, when combined, both diversify your bond risk and meet your specific needs.










Bond Ratings


Moody’s   S&P
Aaa Best Possible AAA
Aa1 High Grade AA+
A1 Higher Medium Grade A+
Baa1 Lower Medium Grade BBB+
Ba1 Non-Investment Grade BB+
Ba2 Speculative BB
B1 Highly Speculative B+
Caa1 Significant Risk CCC+
buildingC Near Default CCC-
D In Default D





Tailoring a Portfolio

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This post and the next two are devoted to constructing an investment portfolio.  This first post takes up broad divisions – the mix of cash, stocks, and bonds — what professional investors refer to as asset allocation. The next post will focus on the portfolio’s bond assets and the third will discuss its stock assets.

Typically, a broker’s portfolio report begins with the overall amounts you have in cash, in stocks, and in bonds.  The report then gets into intricate detail, listing all the bonds, who issued each, the original “coupon” rate as a percent of the bond’s face amount, and its maturity date.  (See this earlier post for an explanation of these terms.) The broker’s report will probably also show how much you paid for each bond, its current value, and perhaps the interest payments you earned from it since the last report.  A comparable listing of the stocks in your portfolio will show the name of the issuing corporation, the number of shares you own, what you paid for them, their current value, and possibly dividend payments since the last report.

While these reports are useful to brokers, bankers, and accountants, portfolio managers look at holdings more broadly to consider how they can achieve two key objectives for you:

  1. Good diversification: An effort to avoid having too many eggs, meaning dollars, in one basket, that is too many of one security or type of security. If you could always pick the best, you would not need to diversify.  But perfect foresight is impossible, so spreading your wealth among different types of stocks and bonds will protect the portfolio from setbacks by ensuring that its different parts respond to events in different ways.  Such diversification of exposure allows your portfolio to secure the most gain with the least amount of risk.
  2. Serving the specific goals of the investor: Are your portfolio’s assets meant to provide retirement income?  To buy a vacation home? Or to pay for a newborn child’s college education? These and other long-term objectives will determine what sorts of stocks and bonds your portfolio should hold and how it should mix the types of securities to get the greatest prospective return for the least risk.

So think of the stocks and bonds in the portfolio not necessarily as individual holdings but rather as the best possible representatives of the sort of security that serves these basic aims.

There is no perfect mix.  Your right combination will depend heavily on your particular circumstances and preferences — what many in the investment business term your life-cycle/life-style situation.  Some people cope better than others with risk and occasional loses.  Those more suited to a riskier life style feel comfortable reaching for gains in a more volatile portfolio.  The mix you choose should also reflect where you are in your life cycle.  Young people investing for retirement, for example, will not need the money for years, so they can take more risk to earn greater returns than can older investors who are approaching the end of their working lives and have less opportunity to make up for an investment loss or time to wait for a market rebound after a setback.

Portfolios need to reflect such differences.  Young people, who will not need the money for years, particularly risk-takers, may want few or no bonds in their portfolios. They may want to concentrate on stocks, particularly smaller, less established stocks, because these, though more volatile than other investments, tend over time to gain more than bonds and more conservative stocks.  To be sure, stocks generally and particularly those of less established companies may suffer severe occasional reverses.  But as a group they eventually always come back.  An investor with a long time horizon can count on that recovery.  Someone older, with less opportunity to wait out a temporary setback, may want more bonds and stable, dividend-paying stocks. Retirees, who are already living off investment income, may also prefer bonds and dividend-paying stocks because they also tend to generate more immediate income than less established stocks.

There are many ways to combine stocks and bonds to meet portfolio goals. The aim is to learn their characteristics and create a good investment fit for your critical needs.  The next post will explain the role of bonds and the one following will do the same with stocks.


When You Read the Financial Pages

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Many readers have asked me about sources of information — newspapers, TV, radio, and web newsletters, to name some.  These can offer the investor invaluable guidance. They all enable you to keep up with events as well as the buzz in the investment community.  When reading, watching, or listening you should keep four questions in mind:

  • Does this information affect my holdings?
  • How does it affect them?
  • Does the information require action on my part?
  • If so, what action?

You should aim to stay current with the media every day and from as many sources as you can without driving yourself crazy or detracting from your other important obligations.

Some sources are better than others.  Here are ten especially popular sources with my comments on each:

  1. The Wall Street Journal ( appears daily except Sunday, in print and on-line. It offers excellent U.S. coverage, but its international news is less complete than a global investor would want.  The Journal’s writers do a good job of separating news from editorial, and the editorial pages frequently do a fine job of analyzing the news and government as well as corporate policy, but always remember to allow for the paper’s pro-business bias.
  2. The Financial Times ( appears daily except Sunday, in print and on-line. It offers excellent news coverage, though it sacrifices depth on its U.S. reporting for superb global scope.  The FT has a more liberal editorial bias (in the American sense) than the Journal and offers some fine analysis.  It does a good job of separating news from editorial.
  3. The New York Times ( appears daily, seven days a week, in print and on-line. It once rivaled the Journal for U.S. business, economic, and financial coverage but in recent years has slipped in this regard.  The Times makes less effort than either the Journal or the FT to separate news from its editorial bias, which is most definitely liberal.
  4. Reuters ( and Yahoo Finance ( update their content continually on the web and are picked up by many other media outlets. These sources offer thorough, unbiased, and succinct reporting on all developments, domestic and foreign, but provide no analysis.
  5. Barron’s ( appears weekly, in print and on-line. It offers a cursory review of the prior week’s developments, mostly in the U.S., and also highly useful, in-depth analyses of specific subjects of financial interest.
  6. The Economist ( appears weekly, in print and on-line. It offers a comprehensive look at global economic, business, and financial developments, including the U.S.  It also does a good job of analyzing economic policies and their underlying causes.  It editorial bias is strongly free-market.
  7. Bloomberg ( updates continually on the web. It offers good news coverage and a lot of analytical and explanatory material. Its many contributing writers have varied editorial prejudices.
  8. Investopedia ( updates continually on the web. It offers thorough explanations of investment questions as well as analyses of economic and business developments.  It has a North American bias but also offers considerable global coverage.  Like Bloomberg, its many contributing writers have various editorial biases.
  9. Forbes ( appears weekly in print and updates continually on-line. It, like Barron’s, offers a concise review of the previous week’s news and in-depth financial as well as business articles, especially but not exclusively focused on the U.S.  Its strongly free-market editorial bias is evident throughout.
  10. Broadcasts, whether on television, the web, or radio, can help keep you keep up with the news, but because this is a fast-moving medium, they frequently fail to offer the depth necessary to make even simple investment decisions.

A Warning and Some Further Guidance

 Even with the highest quality news sources, the media tends to exaggerate the importance of whatever is happening at the moment, frequently at the expense of useful perspective.  Why? Because all writers want you to read their articles, so they make their subject appear urgent and pivotal.  Also, media are in the business of selling advertising, and by making their subject seem urgent, they keep you reading, ensuring that your eyes are exposed to as many ads as possible.

Here is an illustrative example.  Once a month the Department of Commerce reports on the construction of new housing units. For a number of reasons, these monthly numbers are extremely volatile.  An investor with related holdings might try to discern trends by averaging out the pattern of growth or decline over several months and take each particular month’s leaps and dives as just one piece of the picture.  But journalists have little interest in presenting the latest information in this way. They generally, want to create drama, even if it contributes little to overall understanding.

The investor must then peel away a good deal before safely extracting usable investment insight from an article or broadcast.  This might involve five steps:

  1. Distinguish between the journalist’s tendency to sensationalize and any real-world significance of a particular news item.
  2. Be aware of editorial bias that might slant how the news is reported.
  3. After you have allowed for bias, use what remains to think about how much of the news was expected and therefore already built into asset prices.
  4. If the news contains nothing surprising, then no action is required.  If it contains a significant surprise, you must judge its likely impact on prices.
  5. From that you must determine whether it warrants a buy, sell, or hold decision.

You can now see that hours of following financial news does not often require an immediate phone call to your broker, although you may learn enough to keep your eye on a developing trend.



Other Ways to Buy and Sell Stocks and Bonds

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The last post explained buying and selling stocks and bonds through brokers.  Now I will look at other popular ways to put your investment dollars to work through online services, direct purchases, mutual funds, and registered investment advisors (RIAs).

Online Services

More firms now offer ways for you to trade stocks and bonds with a click of the mouse.  Some are connected with long-established brokers; others are only online.  Many offer you tools to help. Mostly these tools process information.  With them you can organize your thinking, but none can offer the key ingredient of any investment decision: judgment in the face of uncertainty.  These firms typically make their money from trading fees that are sometimes lower than full-service brokers and sometimes even lower than discount brokers.  Some fees are set as a flat amount per trade instead of a percentage of the total value of stocks or bonds traded.  The drawback of online brokers: like discount brokers, they offer no advice beyond their online information management systems.  Many limit the choice of securities you can buy and often do not trade bonds or have severe limitations on what sorts of bonds you can trade.

Direct Purchases

You can also buy securities directly from some issuers.  The U.S. Treasury offers a way to buy bonds in addition to the savings bonds mentioned in an earlier post. There are no fees, and you can buy online through Treasury Directat This system does not enable you to sell your treasury bonds back to the government.  Should you need to sell, you would have to transfer the bonds into a brokerage account and use that broker’s services.  Nor does Treasury Direct give you a full accounting of your holdings.

Some larger companies allow you for a small fee to buy their stock issues directly. These arrangements may also offer direct reinvestment plans (DRIPs) wherein you can buy additional stock by reinvesting the dividends paid on your existing holdings.  Some of these purchase programs may even offer a discount from the market purchase price, sometimes as much as 3 to 5 percent.  You can find out about these from the company’s website.  Each company has its own rules about how many shares you must buy initially.  If you already own some of that company’s shares, they usually offer a way for you to transfer them into the plan.  All these direct plans have ways for you to sell back your shares, usually only at set intervals determined by the company.  For a complete list of companies that offer DRIPs and their terms see

Mutual Funds

 These are a popular, efficient, and usually cost-effective way to invest in stocks and bonds (and sometimes more exotic financial instruments of which more in a later post).  Mutual funds enable you to employ professional management services at relatively little expense and with relatively little in assets.  They do not substitute for a broker.  Rather, they hire a broker to put through the trades the funds make on your behalf.

Mutual funds effectively offer you a share of a professionally managed portfolio of stocks or bonds, sometimes both.  They spare you the need to do any trading on your own.  For this service, and of course their investment expertise, they charge fees, including a small or fractional percentage of the value of your holdings.  Funds come in four varieties:

  1. No Load Funds: You buy these directly from the fund company, which charges nothing to buy into the fund, but does charge a management fee, a small percentage of the amount they hold for you.  (There may be other fees as well: see the box at the end of this post.)  Most brokers will not buy these funds for you, though many full-service brokers will provide custody and accounting for those you have bought for yourself.
  2. Load Funds: In addition to management fees, as in no-load funds, these also charge a fee when you buy into or out of the fund. The fees are levied in various ways. (See the box at the end of this post.) Load funds claim superior performance to justify these expenses, though many studies show little performance difference between load and no-load mutual funds.  You can only buy load funds through brokers.
  3. Closed-End Funds: The two kinds of mutual funds I just discussed are called open ended.  They buy and sell stocks and/or bonds, and their size, called net asset value (NAV), expands and contracts according to the market value of all their holdings.  In contrast to the previous two, closed-end funds manage a portfolio of securities that then trades on the market just like the stocks of corporations.  Think of it as buying a share in a highly specialized investment company, but one in which you have no voting rights.  The value of these shares can rise and fall, sometimes exceeding and sometimes falling below the market value of their holdings.  These, too, can only be bought or sold through a broker.
  4. Exchange-Traded Funds (ETFs): These are a subcategory of closed-end funds. They are established on the stock exchanges and based on a particular investment style or sector — energy stocks, for instance, or small companies or a segment of a market index or an entire market index.  They, too, are bought and sold only through brokers.  Some online brokers specialize in ETFs.  These specialists can offer a discount in trading because they recieve fees from the issuers of the ETFs.

Registered Investment Advisors (RIAs)

RIAs are independent teams of investment professionals whom you can hire to invest your funds.  They communicate frequently with their clients to explain what they are doing and why.  They usually impose relatively high minimum investment amounts and relatively high fees for what amounts to a personalized service.  They have to work through brokers to buy and sell for you, and you pay the brokerage costs.  RIAs are best suited to people with large pools of assets with either complicated investment needs or complex administrative and ownership structures.


Mutual funds have many different styles, some aggressive, some more conservative, and many different investment objectives.  Some funds specialize in bonds, some in stocks, some in combinations of the two.  Some seek income, while others stress price appreciation.  Some focus on small stocks, some on large stocks, some on growth, some on value.  Some have an aggressive approach, some a cautious one, and some a passive structure. (More on these distinctions in coming posts.)  Some specialize in sectors or industries.  Others specialize in different sorts of bonds, such as junk, municipals, high-grade credits.  A complete list would go on for pages.  Deciding what is right for you takes study and hard thinking about your risk tolerances and your needs.  One could build an entire portfolio out of specialized funds.  By contrast, RIAs generally take a broader approach.  Deciding which to use depends in large part on whether they are flexible enough and responsive enough to fit your needs.

Your choice of a mutual fund or RIA should depend on three criteria:

  1. How well its objectives fit yours.
  2. How well it accomplishes its goals, the performance of the fund relative to other funds and the index of stocks or bonds that best matches its objectives, or as financial people would say, it benchmarks itself.
  3. What fees it charges (to see whether the performance can justify the cost.)

With mutual funds, all this information — including their style, limitations, objectives, emphases, and performance — is available in the prospectus they are required by law to make available to you.  With RIAs, judgments on flexibility and levels of service rest with you, but otherwise they should provide you with an audited record of their investment track record so you can decide if they are worth their fees.  It is not just how well they do in absolute terms. Because all investment portfolios are built around different objectives and levels of aggressiveness, all performance must be benchmarked against portfolios with similar mixes of objectives and risk levels.  (More on these important considerations in a later post.)


Load Mutual Fund Expenses:

  • Front-End Load: You pay a sales commission when you buy the fund.  These fees can range widely, and you would be well advised to find out what they are before you buy.  Your broker can inform you, as can the fund’s prospectus or the mutual fund company’s website.  Such mutual funds usually charge less if you buy larger quantities.  The industry calls these points of difference break points.
  • Back-End Load: In lieu of a sales commission, these charge a fee if you sell before a specific period, usually some number of years. The fund company frequently waives this fee if you change to another one of their funds.  Back-end fees are less popular today than they once were.
  • Redemption Fee: This is a fee to discourage frequent trading and is charged, in addition to other fees, when you sell, typically if you do so in less than a year after purchase.
  • 12b-1 Fees: Named after the section of the federal law that allows these fees, these are charged to you to pay for some of the fund company’s sales and advertising expenses.  These, too, can range widely.
  • Fund companies charge fees for different classes of holdings. Check to see which fees apply to you.




Other Alternatives for Savings

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I have used other posts to describe several alternatives for the saver.  In one, I focused on commercial banks, in another on savings banks and credit unions, and a third post on investment clubs.  Here I offer yet another option: U.S. government savings bonds. This post also includes a note on on-line banking.

U.S. Government Savings Bonds

Savings bonds are about as safe an investment as exists.  They guarantee repayment plus interest at a set future date. You can also redeem these bonds, including the accrued interest, before the stated maturity date. Called Series EE bonds, they pay a rate that the Treasury sets each May and November. Once you have bought the bond, that rate is guaranteed for its stated term — up to 30 years on some bonds.

Savings bonds are sold at a discount.”  This does not mean a special low price, but rather that the bond sells at a substantially lower price than the repayment amount to account for all the interest it will accrue over its term to maturity.  Unlike savings accounts at banks or credit unions, which pay interest out at regular intervals over time, the earnings on savings bonds come in one lump sum when the bond matures.  For example, you may buy a $50 bond for only $25.  The $50 the Treasury gives you at maturity repays you your original $25 plus all the interest earned on it during the time that the Treasury held the money. The Treasury sells bonds of various maturities in denominations of $50, $100, $200, $500, and $1,000.

At one time, you could buy paper savings bonds at banks for no fee.  You got a piece of heavy, elaborately printed paper indicating the amount due to you at maturity.  The bank also registered you as a holder with the U.S. Treasury.  But now, for the sake of economy and security, the Treasury sells EE savings bonds directly to the purchaser though its “TreasuryDirect” program: the entire transaction is electronic.  Holders of paper bonds can transfer them to their digital counterpart free through the Treasury’s “SmartExchange” program.  You can learn more about these programs, including the prevailing rate the government pays on savings bonds, on the Treasury’s website, There you can also learn about the Treasury’s inflation-indexed savings bonds, called I-bonds.  Unlike EE-bonds, these come with a guarantee they will keep up with inflation.

Here are some of the tradeoffs between savings bonds and the other savings options we have already discussed:

  • The rate of interest is similar to that of a savings account, either at a commercial bank, savings banks, or credit union. If anything, EE-savings bonds offer a marginally lower rate because they are so safe.
  • The fixed interest rate to maturity can cut two ways. On the positive side, you know exactly what you are getting.  Should market rates fall, you will continue to earn at the original stated rate.  With other accounts, the rate goes up and down — “floats” in financial jargon — depending on variations in Federal Reserve policy and financial markets.  On the negative side, the savings bond will only pay you the stated interest rate even if interest rates rise, whereas the rates paid by a savings account will eventually float up to where market interest rates are.
  • Liquidity is limited. You can get back your money on EE-bonds or I-bonds before maturity, including accrued interest, but doing so is a lot less convenient than having an account at a savings bank, credit union, or commercial bank, especially one that has a network of ATMs.
  • Government savings bonds have tax advantages that savings accounts don’t.  The interest earnings on them are free of state and local income taxes.  You must pay federal income tax on the income from the bonds, but you can elect to defer the tax bill until the bonds mature.  Government savings bonds also have tax advantages if you use them to pay for a child’s education.  If you put the bonds in the child’s name, set to mature when the money will be needed for college, the interest on the bonds is taxed at the student’s presumably lower income tax rate.  (More on these and other tax-advantaged investments in a later post.)

A Note on Online Banking

 Recent years have seen the appearance of online banks.  They offer banking services, including saving accounts, solely through the Internet — they have no physical presence.  Theoretically, their lower overhead costs should allow them to pay higher interest rates than brick-and-mortar establishments, but recent (admittedly unscientific) surveys reveal little difference in those rates. Although some people might feel uneasy about entrusting their savings to an entity with no physical presence, the record thus far shows no greater problem with online arrangements than with others.  Keep in mind that most banking, even in the oldest of institutions, is now more electronic than physical.  The list of firms offering on-line arrangements is growing, including some that are large and well established.  Make sure that any online bank you are considering has the same insurance – especially Federal Deposit Insurance — and safety checks that traditional firms do.


Shams, Scams, and Frauds: The Ponzi Scheme

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An earlier post looked at the “Pump and Dump” scam.  Now we’ll look at a gimmick of equally long pedigree in the world of fraud and theft, one made famous not too long ago by so-called financier and criminal, Bernie Madoff.  Unlike the pump and dump, the Ponzi scheme is harder to detect — so much so that Mr. Madoff and others who perpetrate such frauds frequently do so for years (decades in Madoff’s case) without any action or even suspicion by the Securities Exchange Commission (SEC) or other agencies that police financial markets and practices.  In Madoff’s case, the market found him out before the SEC even looked his way.

How Does the Scheme Work?

Named after Charles Ponzi, who ran a particularly famous version of the scam in the 1920s, this fraud really only looks like investing.  Little investing is involved.  The schemer presents impressive but fake investment returns in order to con new victims, whose money he uses to pay generous “dividends” to earlier investors, after, of course, taking a handsome rake off.  A Ponzi schemer can only keep up the scam as long as he can entice an ongoing money flow from new “investors.”

Ponzi criminals are usually exposed when they can’t get enough new victims to pay those “dividends” to the earlier “investors” or when enough people to try to remove their assets to meet some perhaps unexpected financial need.  At that point, everyone loses out.  The Ponzi scammer goes to jail and, because there are seldom any assets, the victims have no way to recover their funds.

Bernie Madoff

  This was the case with the famous and more recent Ponzi run by Bernie Madoff.  He managed to carry on his show for decades and seduce many presumably experienced financial people who should have known that his dazzling advertised returns were too good to be true. No doubt Madoff succeeded in getting many new clients, because he could boast about all the prominent people he had already taken in and whose money he had already captured.  Madoff not only tricked investors, but he also fooled the authorities and financial journalists who also should have known better.  He was quoted frequently in the financial media and even served for a time as president of the American Stock Exchange.

It all unraveled in the financial crisis of 2008.  The huge financial strains of that time exerted two different pressures on Madoff.  First, fewer people had money to “invest” with him, and second, long-time customers, facing their own financial problems, needed cash and tried to withdraw their funds. Of course, Madoff had nothing for them, especially because he was having trouble finding new “investors.”  When it became obvious that he could not honor their withdrawal requests, the SEC became involved and only then did criminal prosecution begin.  As is always the case with Ponzi schemes, the victims lost everything.  Madoff’s personal wealth, as great as it looked, could hardly cover even a small piece of their losses, and many of his victims lost much of their wealth.  Madoff went to jail.  The authorities moved on — as if they had done their job.

Protecting Yourself

The only defense is to always remember the old Wall Street saw: “If something looks too good to be true, it is.”  No one, not even the most gifted investor, can produce superior investment performance year after year without pause, as Madoff and other Ponzi schemers claim, or can make money in every down market.  If you keep that in mind, you can avoid being taken in, no matter how many of your friends, colleagues, and prominent fools claim the thief’s brilliance, no matter how tempting it is to secure the gains the Ponzi schemer promises which, in the end, he or she can never deliver.


First Steps for a New Investor

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For many, investing seems to happen in a foreign place where the inhabitants speak a strange language.  Most don’t know where to begin, and it’s easy to understand why:  They don’t teach this stuff in school.  One thing, however, is clear.  Unless you entered life with a trust fund, investing starts with small savings and the cultivation of the savings habit.  So let’s start at the beginning, with techniques for saving and how to plan your investment scheme.

Developing the Saving Habit

Too many of us procrastinate.  It’s easy to convince yourself that setting aside only a few dollars will make little difference compared to some “urgent” household or personal need. While sometimes these needs can be genuinely important, most are usually an excuse to put off saving and seek immediate gratification instead.  It might help you resist temptation to realize that every dollar you save each week or even each month will start growing beyond what you are depositing, what I call building on itself.  And soon the increased savings will offer their own gratifications.  The effort will also help you strengthen your saving habit, which, in most cases, is more than half the battle.

Here are seven tips to get in the habit of saving:

  1. Put aside all your loose change in a jar at the end of the day.  Better yet, add a dollar or five dollars into the jar each evening.  Such small amounts can quickly become a significant contribution to your savings. And most of the time it’s money that you won’t miss.
  2. Leave your credit cards at home.  Paying with cash will put a cap on how much you spend at a given time.  And if you have to run home to get the card, it might give you time to rethink an unnecessary expenditure.
  3. Contribute to stock purchase plans and reinvest the dividends.  Many companies allow employees to use part of their paychecks to buy the firm’s stock through automatic deductions.  This is money you might otherwise spend.  If you are in such a program, reinvest the dividends instead of taking them in cash.  This is a good rule to follow with any stock you own.
  4. Consider savings as you would any regular expense — like bills from the electric company or mortgage payments.  Set a dollar amount, say 1 percent of your take-home pay, or better yet 5 percent if you can, and “pay” that into your savings account each paycheck.
  5. Use automatic savings plans.  Some employers offer plans that take a designated amount of your paycheck to buy you U.S. government savings bonds (more on these in later posts).  Ask your bank if it can automatically transfer a designated amount each month from your checking to your savings account.
  6. Keep putting money aside even after you have paid off a loan or a mortgage.  Continue to write a check every month for the same amount, or at least a good portion of it, and put it into your savings.  This is money that you have long learned to live without, so you can increase your wealth painlessly.
  7. Occasionally give yourself a reward.  Saving is hard, and its payoff is often years in the future.  So once or twice a year, designate one month’s set aside for a little extra spending. Take the family out to dinner or buy something special for yourself or someone you love. It will give you something to look forward to that is nearer in time than the ultimate use of your savings.

Make a Plan 

Though saving and investment plans vary as much as individual desires and goals, one element should appear in every plan: an emergency fund, a pool of cash for unforeseen events, like sudden medical problems, appliance repairs, or possible unemployment. Ideally, set aside 3 to 6 months income to cover such needs. The money should go into what financial people call a “liquid vehicle,” one that you can access immediately such as a bank savings account or other easily accessible vehicles that I will describe in subsequent posts.  Once in place, this saved money will work for you: by building on itself through bank interest and by protecting you and your loved ones from harm.  Importantly, it will also give you confidence to take the next steps.

Once you have established this basic source of security, and the habit of saving, you can begin focusing on personal wants and needs. There is no right answer here. Much depends on your age, income, family circumstances, and interests. The money should serve your desires as well as your needs.  Some goals are very long term, like a young person saving for retirement.  Others are not quite that far off, like college for a newborn or buying a home, or starting a new business.  Still others may be more immediate, like buying a new car or kitchen.  All are legitimate, but each requires a different investment strategy.

To organize your thinking, create a small chart like the one at the end of this section.  It can link each need to an investment goal.  List your savings goals on the left.  I offer a few examples.  Yours will be different.  Next, fill in the likely cost.  You can research this on the Internet but in the case of housing for example, you may also want to do a bit more research about what it will cost when you are ready to buy.  Next, determine when you expect to need the money.  Count the months to that date and divide the cost by the number of months to see how much you’ll have to put aside each month.

The “months to go” will reflect where you are in your financial life.  A parent starting a college fund for a newborn, will be looking at an 18-year time horizon (216 months) before he or she needs the money.  Other goals will reflect more personal preferences.  If you think your car will last only another year, you’ll have to save for the replacement in only twelve months.  Plans to marry in two years will give you 24 months to accumulate the desired funds.  If planning reveals that your goal requires more savings a month than you can support, you might have to adjust your lifestyle, delay the target date, or even abandon this particular goal.  Harsh as these tradeoffs may seem, they are simply facts of life that no one can ignore.

                                                               Planning Guide                   

Goal Cost Date Months to Go Set Aside Each Month
Car Purchase:
Purchase of Home Entertainment System:
Money for a Good Vacation:
Funds to Buy a New Kitchen:
Purchase of a Home:
Money for a Retirement Nest Egg:  



Executing the Plan — Time is on Your Side

The further in the future your target date is, the less harsh the tradeoffs.  Remember that everything you save earns interest or dividends that over time will build the fund alongside your monthly savings contributions.  Because you are paid this interest not only on your contributions but also on the interest previously accumulated, what financial people call compounding, the longer you can wait before using the money, the more your savings or investment plan will help you accumulate.  These earnings will defray the burden of the monthly set aside.  Two examples:

One:  You need $20,000 for a car and a year to get the money.  Here, returns from investments will contribute only a small part of the total. In this example, it will require a set aside of about $1,629 a month.  Even if the savings account pays 5 percent, it would earn only about $88 over the course of the year. So most of the money would have to come from your monthly savings contributions.

Two:  With longer-term projects, however, earnings from savings and investments can contribute considerably more.  Say you are one of a newly married couple that wants to buy a $250,000 home in 15 years. To meet your goal entirely from setting money aside, you would have to save $1,389 a month.  But after five years of saving at that rate, your accumulated investment account would amount to $83,333.  At 5 percent interest, it would earn $4,723 a year from then on and more each successive year from the accumulated interest as well as your contributions.  That income alone would effectively substitute for over three months of future savings every year.  After ten years, you would have accumulated $166,666.  At a 5 percent interest return, it would earn $10,784 a year, enough to pay over seven months’ required savings.  These would amount to a major contribution toward your goal of home ownership. This is why time is on your side. The table at the end of this post lays out the accumulations of savings and interest year by year.

With even longer time horizons — say retirement savings — the contribution from investment income becomes even more significant. Over 30 years, in fact, the accumulated earnings from the investments would actually exceed the total of monthly set-asides.  In the example of the home purchase, the annual earnings from accumulated savings already by the fifteenth year would have come close to surpassing the annual savings need originally calculated.


                                    Interest Earnings Help Savings Accumulate

Years Yearly Savings Set Aside[1] Earnings on Savings[2] Total Available[3]
1 $16,667 $16,667
2 $16,667 $833 $34,167
3 $16,667 $1,708 $52,542
4 $16,667 $2,627 $71,835
5 $16,667 $3,592 $92,094
6 $16,667 $4,605 $113,365
7 $16,667 $5,668 $135,700
8 $16,667 $6,785 $159,152
9 $16,667 $7,958 $183,776
10 $16,667 $9,189 $209,632
11 $16,667 $10,482 $236,780
12 $16,667 $11,840 $265,285
13 $16,667 $13,264 $295,216
14 $16,667 $14,762 $326,644
15 $16,667 $16,332 $359,643


[1]$1,389 a month for 12 months = $16,667.

[2]Five percent on the account amount of the previous year.

[3]Savings set aside plus the earnings on the accumulated savings.


Shams, Scams, and Frauds: Pump and Dump

man in black shirt and gray denim pants sitting on gray padded bench

Photo by Inzmam Khan on

The best protection against any investment scam is to remember that if an investment looks too good to be true, it almost certainly is.  Most investment frauds lure their victims by promising returns that are simply unbelievable. A good investment track record is attractive.  A fabulous one is suspect.  When offered something that seems extremely desirable, always ask yourself:

  1. Why would someone who can secure such returns want to share them?
  2. Why would that person want to share them with me in particular?

An effective shyster will have plausible answers to these questions and others, but a little thought should revel the danger in what the scammer is proposing.

It is simply impossible to itemize all the scams set to trap the unwary.  They are as broad and varied as human imagination.  Here I outline one of the most common and so most destructive:

How Pump and Dump Works 

This is an old game.  The swindler is frequently a broker who begins by buying a thinly traded stock with the firm’s own funds.  Because the stock is thinly traded, his or her buying pushes the price up smartly.  At the same time, the broker’s sales force promotes the stock as a great buy. Frequently, the con involves glowing reports placed on the broker’s website.  The unsuspecting — day traders and others — read the glowing reports or hear the sales pitch over the phone, see how the price is rising, and put in their orders.  This additional buying pushes the price up even faster, giving the promoter an ample profit on his or her earlier buying, at which time the con artist sells and ends the sales promotion.  Those sales and the sudden end to the hype reverses the upward momentum of the stock, and the price falls, leaving the people who succumbed to the con with losses.

Hollywood has produced several films about pump and dump artists. They typically glamorize what is in reality a grubby business, but behind the slick veneer Hollywood does show the fundamental nature of the abuses, the deceit, and the complete disregard of others and for common decency.  These films also show more sex and better-looking people than exists in the real world, especially in such ugly operations.

Targeting the Most Vulnerable

The saddest part of these swindles is how they target those least able to cope with the losses — financially unsophisticated people, especially the elderly who may have substantial savings but not much financial experience or expertise.  Court cases show the lengths to which some of these con artists go to target their promotions:

  • They will read obituaries to identify surviving spouses who might have received a large insurance check and at the same time face emotional strains that make the person easier to confuse. (See an earlier blog on coming into money.)
  • These swindlers are well aware that retirees often get substantial sums from retirement plans or from the sale of a family home, larger amounts than these people have ever handled. (See an earlier blog on coming into money.)
  • The con artists are also well aware that the elderly often live alone and have no one to help them think twice about an impulse planted by an Internet notice or an enthusiastic phone call.

How to Protect Yourself

Whether dealing with this particular game or one of hundreds of other scams, people can protect themselves.  Here are half a dozen tips:

  1. Remember again that any investment that looks too good to be true almost surely is.
  2. Collect names and addresses. Visit the promoter’s office. If the person on the other end of the phone refuses or makes excuses, take that as a bad sign.
  3. Insist on getting details in writing. Ignore claims about too much urgency for such things.
  4. Never give information about yourself, your bank account or your finances to anyone who has solicited you whether on the phone, via email, or any other way.
  5. Check on the firm soliciting you. The Internet makes this easier than it once was.
  6. Check with the authorities:  
    • See if the broker soliciting your is registered in the state where you live.  The North American Securities Administrators Association can help with this.
    • The SEC requires securities firms to register.  It’s website can provide information.
    • The SEC also provides information on brokers that have run into trouble with the authorities in the past. You can check this out at
    • The SEC also offers guides on what questions to ask and how to file a complaint.
    • If you think you have been swindled, the Consumer’s Action Handbook from the Federal Citizen Information Center can guide you through the steps to take at


How You Should Choose a Bank

Choosing a Bank

For this post, I thought it would help to go back almost to the beginning.  Your first step, after you have saved a bit (techniques for that in another post) is to put that money to work for you where it can earn something.  A savings account at a bank is the obvious, though not the only place.  Even among banks, not all are the same.  Here is some guidance for making your choice:


It would be foolish to choose a bank simply because it is near your home, but it is a consideration nonetheless.  While factoring in this convenience, also consider if that bank has branches near where you work.   That may be more important, since you are more likely to be there when the bank is open than at home.  Find out if the bank has branches in other cities, especially those that you visit often.

What They Pay

These days, banks offer little interest on savings accounts, less than 1 percent, in fact, and in some cases considerably less.  That will change. In time, interest rates will rise. The Federal Reserve, or Fed, as it is called in financial circles, has plans to raise them, perhaps to 3.0 percent or higher.  Small savers will benefit as that occurs, because the banks will respond by raising what they pay on their accounts.  But that will take time. Savers for now have no choice but to accept low rates. Still, there is more to choosing a bank for your savings than just the rate paid or the convenience of a branch.

Fees and Services

To make your decision, you should check out the banks in your area with a personal visit.  Talk to the person in charge of new accounts.  Describe your financial needs and listen carefully to his or her responses.  Among the issues the bank’s representative will describe, or should, are the conditions attached to newer accounts and what other services the bank offers.  Take notes and gather all written material available at the bank and on the Internet.  Study these and make comparisons of each bank to the others.  Here are matters on which you should focus:

  • Minimum deposit requirements.  The bank might pay different interest rates on different accounts, usually higher for those that require higher minimums.
  • Online services.  Almost all financial institutions these days have online services, but not all reach the same standard.  See if the bank allows you to deposit checks online, arrange bill paying, and other services.  If it does, this could save you a lot of time.
  • Help desk.  Find out if you must visit the bank in person if you have a question or whether it has Internet or telephone service. Usually, the level of service rises with the size of the account.
  • Penalties.  Banks often charge fees or reduce your interest if your balance falls below a certain amount.  This has become especially important in these times of low interest rates.  Identify how large these penalties are and when the bank would levy them.  This will not only prepare you, but it will help you plan to avoid such expenses. Penalties might also occur if you fail to make deposits or withdrawals for a long time, or if you make a lot of small withdrawals.  Find out and plan accordingly.
  • Yield.  Banks typically advertise two interest rates paid on deposits: the “annual rate”and the “effective rate.”  The difference reflects how often interest is calculated and credited to your account.  The effective rate includes a consideration of how frequently the bank credits your account with the interest.  The more often it does so, the more each calculation will earn interest on the interest already paid.  Find out.
  • Automatic savings.  Some banks will transfer a specific amount from your checking account to your savings account automatically each month. Find out if the bank offers such a service and if it involves a fee.
  • Favorable loan, credit card, and mortgage rates.  Some banks offer depositors favorable terms and rates on loans or mortgages.  Find out if you have access to such an arrangement. It might involve a larger minimum deposit.
  • Currency exchange.  The most cost effective way to get foreign currency is through an ATM in the country you are visiting.  Not all banks charge the same rates and conversion fees on such transactions.  Especially if you expect to spend significant time abroad, find out what each bank charges.
  • Overdraft charges.  Most banks will enroll accounts in their overdraft program.  It automatically advances you funds to cover checks you accidentally write in excess of your balance.  Without such an advance, your checks might “bounce” or, even if the check is honored, face a hefty fee. An overdraft program can protect you.  Find out how it works.  The program itself very likely has charges.  Find out what they are, under what circumstances the bank might charge you, and how quickly the bank will notify you so that you can take action to minimize any costs.  The best protection, of course, is to keep your checking account balanced and avoid overdrafts altogether.
  • Fees on automatic teller machines.  These have largely disappeared, but check to make sure.  Also, find out what fee the bank charges to use the ATMs of other banks or to use a credit card at the ATM machine.  Here are three additional tips on the use of ATMs:
    1. Each bank will set a limit or how much cash you can withdraw from an ATM at any one time. You should know this to calculate how many trips to the ATM it will take for you to amass larger amounts should you need them.
    2. Since most banks post interest at 3:00 pm each business day, try to make your withdrawal later in the afternoon so that your interest calculation for that day will occur on as much money as possible.
    3. All ATMs ask you to create a personal identification number, or PIN, that you must key into the machine to do the transaction.  Never give your PIN to anyone. Nor should you keep it anywhere on your person.  It should be easy to remember.  Do not use your birthday.  Hackers are onto this practice.


Make sure any bank you consider is federally insured. The Federal Deposit Insurance Corporation (FDIC) insures deposits up to $250,000 per depositor, no matter how many accounts you have with that bank.  For more information, visit the FDIC website,  The FDIC also provides information on banks’ relative financial strengths.  The Federal Reserve, which is the country’s primary bank regulator, runs a series of what it calls “stress tests” on how each bank would cope in a difficult financial environment.  Its website,, and financial media cover the results of these tests thoroughly.  Credit rating agencies, Moody’s, Standard and Poor’s, and Fitch, will, for a fee, provide information on bank finances.  Visit their websites:, and The private firm, Veribanc, also reports on bank safety ratings,

Which to Pay First

Which to Pay First

In response to my last post about what to do with surplus cash, an insightful reader asked whether it is best to pay off credit cards first or student loans.  Definitely, pay the cards first.  The most onerous student loan debt carries a lower interest rate than the least burdensome credit card.  Pay the cards off first, starting with those that charge the highest rates.  Only then should you turn to the student loans.

Student loans, burdensome as they are, often carry attractive terms.  In such cases you might consider investing the surplus cash and using the income from those investments to meet the regular student loan payments.  This way, the student loan payments cease to burden your everyday income, presumably from your job, and possibly even earn a little extra.  If you pay off the student debt, you do, of course, get relief, but no chance of that little extra from your investments.  With credit cards, the cost of borrowing is so high that there is no chance investing what would pay them off can earn more or even enough to cover the cost.  Best to use the surplus cash to pay off the cards as completely as you possibly can.

This was a good question, I look forward to others from other readers.