Investing Online for Dummies

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Chapter 16 - Taking the Option: Alternative Investing

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In This Chapter
Increasing your stock profits with options
Recognizing the characteristics of calls and puts
Locating online option quotes, news, calculators, and screens
Avoiding mistakes by testing your strategies online
Selecting the best option analysis software
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In this chapter, I explain how purchasing stock options can assist online investors to make money in a bear or bull market. Here, you find the basics of online investing in stock options, as well as discover which Internet sites provide guidance, news, quotes, online tools, and software to help you leverage your investment dollar. You can uncover which exchanges list stock options and also gain an understanding of the online brokerages that specialize in these types of transactions as well as the commissions that they charged.

Trading Stock Options

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Suppose that a well-known novelist decides to let Hollywood make a movie based on one of her books. The novelist receives a payment from a Hollywood producer for the option of deciding within a specified time to make the movie. If the Hollywood producer decides to go ahead and make the movie, the novelist sells him the screen rights. If the Hollywood producer changes his mind, the novelist keeps the option payment and her novel.

Trading stock options is a similar transaction. Options are contracts between a buyer and a seller. These contracts represent the right of the investor to buy or sell shares of the stock that the shares represent, called the underlying stock. Contracts are usually for 100 shares and don’t oblige the investor to purchase or sell shares of the underlying stock.

Types of option contracts
An option is a contract between a buyer and a seller. An option contract that gives the owner (holder) the right, if exercised, to buy or sell a security or index at a specific price, called the strike price, within a specific time period. Option contracts are generally available for one to nine months, although some longer-term options are available on selected securities. Each contract usually equals 100 shares of stock. Calls and puts are two types of options, and I explain them in the following sections.

Why buy stock options? Stock options enable investors to position themselves for a big market move even when they don’t know which way stock prices will move. For example, the cost of the premium (the amount paid for the option contract) is often less than what the investors would lose if they purchased shares that later suffered a steep price decrease.

Stock options enable large and small investors to leverage (the wherewithal to control large amounts of a financial asset with a somewhat small amount of capital.) their investment dollars. For example, a stock might increase by only 25 percent, but the investor receives a 100-percent return on his or her cash investment in the stock option contract. However, if the stock experiences a decrease or remains at the same price, the investor suffers a 100-percent loss of the premium paid for the stock option contract.

Short rallies exist even in a down market. With options, investors can exercise an option during one of these peaks to gain short-term profits. If the rally doesn’t materialize, the only loss the investor suffers is the cost of the premium paid for the options contract.

Some large corporations, such as insurance companies, want to reduce their exposure to the market. They sell their options to offset losses incurred by their current stock holdings. Individual investors can limit the exposure of their personal portfolios (especially in a volatile market) in the same way.

Exercising your stock option
All stock options have exercising dates that are stated upon the option’s introduction to the market. During this time, the same stock option can be bought and sold many times. To exercise the stock option, you can do one of three things:

Buy or sell the underlying shares of stock (exercise the option). Shares purchased can be held for long-term gains. Shares sold realize an immediate capital gain.
Sell the option on the open market. Profits from the sale of your option are automatically credited to your trading account and are taxable.
Let the option expire. If the option expires, it loses all value.

Call options
A call is defined as the right to buy a specific number of shares at a specified price by a fixed date. If the stock is above the agreed-upon price by the fixed date, the investor wins — he bought the stock for less than what it’s worth that day on the market. For example, you believe that IBM is underpriced. You purchase a 3-month call at $100 when the stock is selling at $90. The call options selling price is $3 per share, which is the premium. You purchase ten contracts (of 100 shares). You now control 1,000 shares. The total amount of the premium is $3,000 — that is

$3 (the option selling price) * 10 (contracts) * 100 (shares) = $3,000

One month later, IBM’s shares are selling for $110. You can now either

Exercise your option by purchasing 1,000 shares at $100 and then sell the shares at $110 for a profit of $10,000 less commission (the premium). Before taxes, you would net $7,000.
Sell your call option, which is worth approximately $10,000.

Using call options has two advantages. First, you need less cash to control a large number of shares. As you can see in the preceding example, the purchase of the option was $3,000, and the cost of purchase of the shares is $90,000. Second, if the IBM stock price severely drops, an investor who owns the shares loses more than an investor who owns only the option.

Put options
A put option contract gives the holder the right, but not the obligation, to sell 100 shares of common stock at the strike price on or before the date of expiration. For example, thinking that IBM is way overpriced, you buy 10 IBM February puts at $2 per contract. That is, you buy 10 contracts, and each contract represents 100 shares of stock, so you control 1,000 shares. Here is the game plan:

IBM is the stock.
February is the month when your option expires. Options always expire the third Friday of the month.
$100 is the strike price.
$2 is the price you paid per contract.
Well, actually, $2 is the price per share that you control — so buying 10 of these puts (1,000 shares total) costs you $2,000 plus commission.

As the owner of this put, you have the right (but not the obligation) to sell up to 1,000 shares of IBM at a price of $100 per share anytime between the February day when you buy and the third Friday of February. Most people wouldn’t do this because it’s complicated. Selling the contracts that you’ve bought is easier (just as you would sell stock) and often just as profitable.
Suppose that you pegged IBM correctly, and its price drops sharply. Say the value of your put increases from $2 to $10. You sell at $10 and make a huge profit.

In the event that you’re wrong and IBM keeps going up, your option expires worthless. All you lose, however, is the $2,000 that you initially invested (and any brokerage fees). The appeal of options is that you have unlimited upside potential. You can make five or ten times your initial investment, but you can never lose more than what you initially invested.

Education and Data Sources

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Many helpful Web sites can assist you in getting a grip on buying and selling options. Some of the better sites are sponsored by option brokerages and exchanges. Here are a few examples of what you can find online:

Chicago Board Options Exchange offers many educational resources. The Trading Tools section includes delayed quotes, charts, news, market data, company research from Zacks , and an options calendar.
Optionetics offers help on topics such as understanding basic and advanced option concepts, option strategies, understanding investment proofs, and suggestions for selecting a broker.
Options Industry Council is an industry trade group that supplies access to educational material and free educational seminars across the country. It offers 12 online training courses. The Options Industry Council (OIC) invites you to expand your options knowledge by attending one of its three free educational equity option seminars (LEAPS Seminar, Practical Applications Workshop, and Basic/Intermediate Seminar). Exchange professionals teach the OIC seminars, which take place from 6 to 9 p.m. Check the Web site to find out when a seminar will be held in your area.

Online sources for option quotes
To make intelligent investment decisions about your stock options, you need the latest stock quotes. (It’s the only way to tell whether you’re making money or you’re out of the game.) The following Internet sites provide realtime and delayed option quotes:

INO.com features information on stocks, options, futures, and currency, as well as intraday (delayed) daily and weekly charts.
Chicago Board Options Exchange offers delayed quotes. Just enter the stock or index symbol; for most searches, click List Near Term At-The-Money Options. For volume leaders (the most active options), go to this page .
Philadelphia Stock Exchange offers quick links to New Options Listings and 15-minute-delayed options quotes. Click Marketplace and then Quotes for easy-to-read information.
U.S. Futures & Options offers quotes and charts, news, commentaries, book and software suggestions, and much more.

Online sources for options news and data
Option prices are affected by many variables including time, market expectations, market volatility, stock price, dividend yields, and other factors. The Internet provides many sources of information about these variables, including the following:

Covered Calls offers tools, data, and resources to options traders. Discover how to write a covered call and follow an ongoing case study. Don’t forget to check the list of covered calls that pay 10 percent or more.
OptionSmart shown in Figure 16-1, provides stock quotes, news, broker reports, charges, analysts’ reports, and research based on technical and fundamental analysis. The Web site has free and fee-based content. Several types and levels of subscription services are available with a free ten-day trial.

Figure 16-1

Options Industry Council offers FAQs of the Week, strategy information, and 20-minute-delayed options quotes. Check out the useful glossary, as well as a basic and advanced option-pricing calculator.
PitNews.com provides daily derivative market news and commentary. You find a futures forum, commodity prices, an education center, and information about futures seminars.
SchaeffersResearch.com offers a well organized but somewhat busy Web site loaded with tools, data, and educational features. Type a ticker symbol for detailed quotes. Features include best trades, year-to-date returns, and more. SchaeffersResearch.com offers a variety of fee-based products and services. Two examples are The Option Investor newsletter for $149 per year and online access to Schaeffer’s Gold section that includes commentary, tools, data, and filters for $9.95 per month. The Gold section has a free 30-day trial.

Option Screeners and Calculators

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Just like mutual funds and stocks, options have online screeners and calculators to assist you in valuing and screening investment candidates.

optionsXpress offers the Trade & Margin Calculator, which graphically illustrates the buying power required and potential profit or loss of a trade. In other words, you can easily calculate the investment risk or reward of your potential trading order without losing a dime. To sum it up, the Trade & Margin Calculator lets you test your knowledge and grow your experience on paper.
PowerOptions offer four levels of content and services. Limited access is free with your registration. PowerOptions Essentials, at $9.95 per month, includes limited access to the Web site, 20-minute-delayed quote position reports, full access to the help section, and lots of research. PowerOptions Plus is $59.95 per month for unlimited access to the Web site, 20-minute-delayed searches, and option chains to find high return option positions. Subscribers have access to more than 150 pages of tools and articles. PowerOptions RT is $79.90 per month and includes everything you get in the PowerOptions Plus subscription but with real-time prices, investment opportunity search, calculations, and option chains.
Chicago Board Options Exchange offers both free and fee-based trading tools. The CBOE and IVolatility have partnered to bring you a suite of option analysis and strategy tools. Free services include IV Index, which offers basic end-of-day information. The Option Calculator brings you features that were previously available only to professionals. You can customize all the input parameters (option style, price of the underlying instrument, strike, expiration, implied volatility, interest rate, and dividends data) or use the IVolatility database to populate all those fields for you. Both services are free. Fee-based services include Strategies Scanners & Worksheets, Advanced Volatility Ranker, Advanced Options, and Spread Scanner. Each premium service offers a free trial.
Options Industry Council offers a basic calculator and an advanced calculator. The basic calculator walks novices through the process of setting the variables that affect the price of an option. This calculator provides an explanation of all input variables and the output generated (theoretical prices and risk parameters). The advanced calculator provides those users who are familiar with option trading with a fast interface. The advanced online calculator has an additional feature that allows users to calculator theoretical option prices and risk parameters over a range of strike prices.
SchaeffersResearch.com provides a Portfolio Protection Analyzer. This hedging calculator estimates the value of your portfolio if it declines 5, 10, 15, or 20 percent. Then it suggests the amount of puts that you should purchase to protect your portfolio.

Determining Stock Option Values

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The value of the stock option is derived from an actual stock or equity. The price movement of the underlying stock makes the value of the option increase or decrease. This price movement is the intrinsic value, or fair value, of the stock. (See Chapter 8 for more information on determining the fair value of stocks.)

In addition to their intrinsic values, options also have time values, which reflect what the holder is willing to pay for an option in anticipation of a stock price increase before the expiration date. Most options are for nine months, and the option can be bought or sold many times during this time period. As an option gets closer to the expiration date, the value of the option can decrease, increase, or remain unchanged, depending upon the current value of the underlying stock. Just before the expiration date, the time value becomes zero.

The Chicago Board Options Exchange (CBOE) provides many materials for novices to check out, including an excellent introduction to options, profitable trading strategies, answers to frequently asked questions, a glossary of option terms, and a schedule of educational events and seminars for beginning investors. To access these materials, go to the CBOE home page and click Learning Center.

Investors often use stock options to hedge their bets or to gamble on the future. Investors need to know four things to make a good investment decision:

Name of the underlying stock: The name of the underlying stock or equity. The name could be a company that your analysis shows might soon rapidly increase — a company stock that you want to purchase but can’t afford. You might want to select stock options for a company in which you already own stock to protect your portfolio from a marketdriven decline in price.
Strike or exercise price: The stated price per share for which the underlying security can be purchased (in the case of a call) or sold (in the case of a put) when you exercise the option contract. Option contracts are usually for 100 shares. The higher the exercise price, the lower the value of the call option. (See the section “Types of option contracts” for
more on calls and puts.)
Expiration date: Option contracts are for three, six, or nine months (or remaining fractions thereof) on three calendar cycles. Cycle 1 is January/April/July/October; Cycle 2 is February/May/August/November; and Cycle 3 is March/June/September/December. As the option approaches the expiration date, the value of the option decreases. Options usually expire at midnight EST on the third Friday of the expiration month.
The premium paid for the option, plus the broker’s commission: The price of the option contract is the premium. All things being equal, the longer the time period of the option, the higher the premium. The commission is the amount that you, as the investor, pay the brokerage for executing the transaction of purchasing the option contract.

optionsXpress offers virtual trading, which is a practical method of gaining experience with options trading without risking any of your precious capital. All your trades are tracked on paper only. Virtual trading is useful because you make decisions and experience the results of those decisions in real time. Virtual trading is available to individuals who open an optionsXpress trading account. No minimum amount is required to open a cash account; there is a $2,000 minimum to maintain a margin account.

Taking a closer look at options
Using the business school approved intrinsic value method, a stock option’s value is equal to the difference between the option strike price and the fair market value of the stock. For example, suppose that you’re granted an option to purchase 100 shares of the company’s stock for $10 each. The stock sells for $54. The intrinsic value of the option is $44 because $54 – $10 = $44. The intrinsic value is a positive number, so the option is in-the-money. However, this formula doesn’t consider brokerage fees or interest fees on a margin loan from your broker, which can reduce the actual gain you realize.

Keep in mind that the intrinsic value method also doesn’t consider that option holders have the right to use their options at some time in the future, which can result in a greater profit or loss if the trading price of the underlying stock falls.

myStockOptions.com with your free registration, provides step-by-step instructions that help you to determine exactly how much money you’ll take home (after taxes) if you exercise your stock option today. Use the Quick Take Calculator by entering the number of shares in your stock option grant, the exercise price, and the company’s current stock price and then click Calculate. What makes this calculator unique is that it applies taxes to your transaction. You can even use the myStockOptions modeling tool to perform a what-if analysis. For example, enter a percentage increase or decrease under the What If Company Stock Price to determine an ideal selling price.

Discovering what your options are worth
The first step in understanding what your options are worth is to be able to understand an option premium table. Premiums (prices) for options that are traded on stock exchanges are published daily in newspapers and online. Table 16-1 shows what a typical listing looks like.

Use this guide to help you understand some of the key elements in Table 16-1:

Identification of stock: This is the ticker symbol for the underlying stock.
Stock closing price: This is the closing value of the stock on the New York Stock Exchange.
Option strike price: The strike price is the stated price per share that the underlying stock can be purchased for (called) or sold (for a put) if the option contract is exercised. Option strike prices usually move by increments of $2.50 or $5. In this example, the strike price moves in $5 increments.
Option closing prices: This is the closing value of the option contract.
Option expiration months: This shows the termination date of an option contract. Remember that U.S. listed option contracts expire on the third Friday of the expiration month.

In Table 16-1, XYZ July $115 calls closed at 31⁄2 ($350) per contract. XYZ stock closed at $112bf3/8. Therefore these options were out-of-the-money because the closing price didn’t reach the $115 or greater.

Puts are the opposite of calls. Table 16-1 shows how a put must be greater than $1123⁄8 to be in-the-money. The July $120 puts closed at 83⁄4 ($875) per contract. Therefore, in this example, these puts are in-the-money because $120 is greater than the closing price of $1123

Online brokerages and options
Not all electronic brokerages trade stock options. The sales commissions for option transactions vary from broker to broker. Some online brokerages charge a flat rate plus $1.50 to $2.50 per contract. Others just charge a flat fee. See Table 16-2 for a few examples of online brokerage commissions for options transactions.

Online brokerages that specialize in options trading frequently offer investors unique tools for research and analyses. For example, optionsXpress is an online brokerage that doesn’t require a minimum initial deposit for opening a trading account. The commission fees are $1.50 per contract. The minimum number of contracts you can trade at one time is ten — or if you trade less than ten contracts, you’ll pay $14.95.

The CBOE offers a listing of options brokerages. The brokerages aren’t endorsed by the CBOE and will require your investigation. Many of the listed option brokerages don’t have Web sites, so you’ll have to contact some brokerages by phone.

Optionetics provides useful reviews of top options brokers. You can compare brokers by site design, user friendliness, options usefulness, option trading cost, and so on. You can also find useful information about what you need to know about your broker, such as questions you should ask your broker.

Software Tools for Options Trading

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Option analysis software tools measure the probability of profit and identify profit goals and stop-loss points while often providing prebuilt strategies or allowing simulations of investor strategies. As an investor, you’ll find all this information valuable. Each year, software developers spend hundreds of thousands of dollars developing these software tools and often sell the product for a few dollars.

Investors can frequently get their favorite tools enhanced and upgraded on a regular basis. With all these great programs available, selecting the one that meets an individual investor’s specific needs can be difficult. Table 16-3 lists some of the analysis software that can help you maximize your returns with stock options.

Options software can assist you with

Creating computer-generated strategies
Taking risk measurements
Experimenting with multiple pricing models
Graphing your option analyses
Forecasting or making projections using what-if analysis

If you can’t determine whether investing in options is for you, and you don’t want to spend a lot of money on a software program, I suggest trying one of the demos that I list in Table 16-3. Or you can download one of the more limited software programs at Shareware.com . Just select your operating system — Windows, Mac, Linux, and so on — and enter Stock Options in the search box. Click the Search button. The options software at Shareware.com comes from several third-party sources. The shareware includes freeware (no cost), shareware (try it for free), and company-sponsored no-cost demos.

Checking Out the Latest Strategies

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More experienced options investors are likely to be interested in the latest strategies for different types of markets. Often discovering a new strategy can help you increase the amount of your profits (or decrease the amount of your losses).

Chicago Board of Trade offers many regularly scheduled Webinars, tutorials, and trading strategies that can assist you in becoming an educated options investor. Note: Don’t forget to check out the strategies archive.
optionsXpress offers Strategy Scan, which is a valuable tool that allows you to develop an investment approach based on your option of the market. Through a series of drop-down menus, you enter your bullish or bearish opinion of a stock, your investment time frame, your experience, and investment (risk) amount. After you enter Strategy Scan, it shows you up to three opportunities with potential profit and loss amounts for each action, and a ready-made link to preview each trade. To get started, you need a trading account, but opening an account online takes only about ten minutes, and no minimum initial amounts are required to open an account.
Options Industry Council provides nine preset trading strategies that are explained so that beginners and more sophisticated options traders can easily understand the results of their decision-making. At the home page, enter the Learning Center and choose Strategies. Then click Strategy Index.
SchaeffersResearch.com offers a topnotch primer on basic option strategies, such as straddles, spreads, and hedges. This Web site is designed for beginning and experienced investors who are serious about investing in options. Click the Education tab for an online tutorial.

Chapter 17 - The Internet and Managing Your Portfolio

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In This Chapter
Tracking investment information
Taking the work out of calculating your investment returns
Selecting the portfolio tracking program that works best for you
Keeping up with online news
Using proven strategies for improving your investment performance
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Portfolio management is not busywork: Knowing how much you own in cash, stocks, bonds, and other investments is important. Without portfolio management, how can you determine whether your returns are meeting your financial requirements? Are you missing opportunities by not buying or selling securities at the right time?

In this chapter, I cover three Internet-based approaches to managing your portfolio:

Purchase prebuilt portfolios. This strategy allows you to diversify your portfolio and avoid high brokerage and administration fees.
Use free and fee-based Web portfolio tracking tools. You can customize these tools, which often provide e-mail alerts on price changes and endof-the-day quotes. Over the last two years, these tools have become more sophisticated, and they can now even track all your credit cards, bank accounts, and investments at one Web site.
Take advantage of PC-based tools that are free, offer free trials, or cost only a few dollars. These programs use your Internet connection to automatically update portfolio quotes. (If you already have MS Money or Quicken, you can use the portfolio feature and update price quotes in just a few clicks, as I explain in this chapter.)

Also in this chapter, I describe the difficulties of measuring portfolio performance and risk.

Why Manage Your Investments?

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The gyrations of the market over the last five years have dampened many investors’ hopes of easy riches. According to The New York Times, investing isn’t the popular hobby it once was; personal finance magazine subscriptions are down; and the number of investment clubs has declined from a peak of 37,000 clubs in 1998 to 21,000 as of June 2004. In a recent survey of 1,100 people who own stocks and mutual funds, the National Association of Investors Corporation discovered that investors believe that stocks are worth buying but are uneasy over the volatility of stock ownership. This apprehension is not unfounded. Stocks slumped for most of 2004, falling by as much as 4 percent. However, by the end of October 2004, stocks rebounded, and the S & P 500 completed the year with an increase of 8.99 percent.

Monitoring your portfolio in a volatile market is very important. You can select the best investments, but if you don’t have a way to track your gains and losses, you can lose time and money. Good record keeping is invaluable for calculating your taxes, preparing for retirement, estate planning, and taking advantage of opportunities to increase your personal wealth.

Sources on the Internet can assist you in keeping careful records of every stock, mutual fund, bond, and money market security that you own. Setup time can be as little as ten minutes. You can update and monitor your portfolio once a week or once a month. Your investments can be in one portfolio (for example, your retirement fund) or many (say, your retirement fund, an emergency fund, and your children’s college fund). You can also track investments that you wish you owned or that you’re considering for investment.

The Internet offers programs that automatically update your portfolio with daily price changes and then re-tally your portfolio’s value to reflect those changes. Many portfolio management programs can

Help you determine how much you own in cash, stocks, and bonds
Show you how these investments line up with your asset allocation targets
Indicate what returns (capital gains or losses) you’re receiving
Compare returns with your financial requirements Alert you that securities are at the prices at which you want to buy (or sell)

Tracking the Right Information

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If you own more than one investment, you probably want to compare the performances of your investments. The more investments you have, the harder this task is. Many novice investors find it difficult to determine whether they’re making money, losing money, or just breaking even. To determine how your investments are performing, you need to look at the following data:

52-week high and low: The highest and lowest selling prices in the previous 365 days
Dividend: The annual per-share amount of cash payments made to stockholders of the corporations
Dividend yield percent: The total amount of the dividend paid in the last 12 months divided by the closing price (the price at which the last trade of the day was made)
Growth rate: How much the dividend increases from one fiscal year to the next
P/E ratio: The price/earnings ratio of the closing price to the last 12 months’ earnings per share
Volume: The number of shares traded in one day
High, low, close: Highest selling price of the day, lowest selling price of the day, and closing selling price
Net change: The difference between the day’s closing price and the previous day’s closing price

You can compare these amounts and ratios with the performance of your other investments, the firm’s previous performance, the industry, and the market indexes (for example, the S & P 500).

If you own several securities, how do you keep track of all this data? Once again, the Internet provides an answer. The Internet has hundreds of Weband PC-based portfolio management programs that are just waiting to assist you. Some of them are free, others are fee-based, and some are automatically set up for you by your online broker.

Mobile portfolio management is a reality at CBS MarketWatch for registered users. You can receive price and volume alerts, or news alerts for your Portfolio on your mobile phone, Palm VII, or Pocket PC. At the CBS MarketWatch Web site, you can customize alerts by indicating exactly what you want and when you want it delivered.

Balancing Your Portfolio with Web-Based Asset Allocation Tools

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When building your portfolio, remember that diversification is the key to ensuring that the volatility of the market doesn’t affect your returns. In other words, you want to make certain that your portfolio is not overwhelmed if the price of one asset plummets. When seeking to diversify your portfolio, I suggest that you try one or several of the following approaches:

Invest in different asset types. Asset types include mutual funds, stocks, bonds, CDs, money market funds, and other types of financial instruments.
Invest in diverse sectors and industries. Investing in different stock sectors and industries can protect your portfolio from economic changes, unanticipated technological innovations that can make your investment obsolete, and unfavorable regulatory changes.
Invest in numerous geographic locations. If the value of the U.S. dollar weakens, international investment can be a new source of profitability. Companies located on one geographic area can be devastated because of natural disasters.
Invest in assorted company sizes. It’s often difficult to diversify by investing only in large companies. Investing in medium-size companies can provide consistent returns. Small companies can rapidly expand, but then just as quickly go bankrupt.

Many Web sites can assist you in determining how you should allocate your assets. Some of these Web sites include questionnaires that can help you determine how much risk you can take - and still sleep at night.

Fidelity offers an online worksheet to assist you in diversifying your annuity assets. The Annuity Asset Allocation Worksheet is geared to help you determine what the optimum asset allocation is for you based on your tolerance for risk. The worksheet takes about ten minutes to complete. At the home page, click the Retirement & Guidance tab and then click the Guidance Tools link. Click the Go To Fidelity Portfolio Analysis link and then click Additional Resources. Click the Calculators, Planners, and Worksheets link; then scroll down to the Annuity Asset Allocation Worksheet. Other portfolio tools, such as Portfolio Review, are available only for Fidelity
clients.

NETirement.com offers an online calculator that indicates the asset allocation you should use
based on the level of risk that you can tolerate. The calculator starts a portfolio that has the highest minimum return over 30 years with a 5 percent comfort level. (Ninety-five percent of the time, its average returns will be higher.) Click More Risk or Less Risk to see how different asset allocations affect the amount of your returns. This online calculator is useful for assessing how much risk you’ll have to take to receive a predetermined amount of return.

Using the Internet to Uncover the Risk in Your Portfolio

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Over time and without your intervention, the characteristics of your portfolio will change. Ignoring these changes can be dangerous to your financial health. There are no set guidelines for how often you should review, analyze, and rebalance your portfolio. Some individuals check the risk of their portfolio on a weekly or even a daily basis. I suggest that the more volatile the
market, the more often you should analyze your portfolio’s risk exposure.

As part of your portfolio management, you’ll need to watch for unexpected changes that can affect your portfolio’s long-term objectives and plan for short-term volatility. If your portfolio is not performing to your expectations, don’t panic or ignore the problem. Find out what’s driving your portfolio’s performance. It may be that you’re taking on more risk than you originally
anticipated.

Online portfolio risk analysis measures the risk exposure of your assets to market risk. For individual investors, this analysis is often the first time they can determine whether their investment return is equal or better than their risk exposure. In the past, only financial institution had access to this type of analysis. The following are a few examples of the online financial institutional strength tools that can make certain that you don’t take on more risk than is necessary.

RiskGrades
RiskGrades offers free tools to determine your risk tolerance and to measure the risk of your assets. Assets are assigned a risk score from 0 for cash to 10,000 for highly risky stocks. The My Portfolio screen allows you to view the risk statistics of your portfolio. You can view your results as a table or graph. You can also print your results. RiskGrades provides definitions at the bottom of the page so that you don’t get confused. Click the statistic or story icon within each asset class.

RiskGrades allows you to analyze your investment style against benchmark indices, perform a risk ranking of your portfolio, and create a risk versus return chart to determine whether you’re being fairly compensated for the amount of risk you’re taking.

RiskGrades offers What If analyses so that you can try out different strategies to your portfolio. For example, if you buy or sell assets, what are the tax consequences? RiskGrades offers risk event analyses, price acceptability testing, a helpful risk map of the market, and an asset selector function. You can also find online tutorials about understanding risk and a risk profile quiz.

FinPortfolio
FinPortfolio is the Cadillac of online portfolio analysis tools. You find information about how to plan a portfolio that matches your investment goal and discover how to use online portfolio analyses to optimize your portfolio’s returns and minimize risk. Two levels of service are available for individual investors. Basic service is a set of easy-to-use planning and analysis modules that provide interactive guidance and support through the financial planning and investment decision-making process. You can track up to 50 stocks or funds in one portfolio and perform analysis on up to 5 stocks or funds at no charge. You can import portfolio data from other financial Web sites and screen investment candidates, research assets based on risk and return, and perform risk analysis. The premium service extends the basic service by offering additional online portfolio management related services, including the ability to track up to 100 stocks or funds in up to 5 portfolios, perform analyses of 30 stocks or funds across multiple portfolios, and create up to 5 multiple-goal financial plans. Premium subscriptions are $100 per quarter or $300 per year.

Morningstar
Morningstar has one of the better online portfolio management programs for mutual funds. First, set up the free portfolio at the Web site.

If you want Premium Portfolio X-Rays, you have to become a member. Membership is $12.95 per month (or $115 per year). X-Ray Reports includes information on fees and expenses for each of your mutual funds, indicates how all your assets (cash, stocks, bonds, and others) are allocated in your personal portfolio, and shows the fundamental statistics for each of your holdings (P/E ratio, price-to-book ratio, and earnings growth). With Premium Portfolio X-Rays, you can check for your Stock Stats. This feature of the portfolio management program looks into the equities you own individually and those held by your mutual funds, and then tallies the total percentage that is invested in each company. For example, assume that 10 percent of your portfolio is invested in individual shares of Cisco, and you have two mutual funds that recently invested in Cisco. The total percentage of Cisco holding in your portfolio is now 17 percent. That’s stock overlap. Stock overlap can defeat your attempt at reducing investing risk with diversification. In this situation, you might consider replacing the number of shares you own in Cisco with an equal amount of shares (that meet your investor requirements) in a different industry.

To determine your portfolio’s asset allocations, Premium Portfolio X-Rays looks into the holdings of your mutual funds and then analyzes the total of all your portfolio’s assets. For example, assume that your entire portfolio is invested in equities and mutual funds. Using this X-Ray feature, you might discover that about 4 percent of your portfolio is in bonds held by mutual
fund companies. Overall, Premium Portfolio X-Rays enable you to gain better control of your personal finances.

Keeping the Winners and Selling the Losers: Measuring Performance

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Measuring portfolio performance is often difficult. For example, suppose that you invest $2,000 in a mutual fund that returns 15 percent in the first quarter of the year. In each of the next three quarters, you invest $2,000, but the fund doesn’t provide any returns during those months. Your return on the first $2,000 is 15 percent. Your return on $6,000 for following nine months is zero. The fund reports an annual gain of 15 percent, not counting dividends and gains distributions. However, these percentages don’t mean that you should measure performance on a short-term basis. Market prices vary and returns fluctuate for many reasons. What really counts is the true rate of return, which can’t be measured from quarter to quarter.

Another problem in measuring portfolio performance is risk. Risk is defined as the variability of returns. In other words, the more the returns vary, the greater the risk. One of the disadvantages of using standard deviation (a measurement of the variability of historical returns around the average return) is that it considers good variability. Good variability means that returns are exceeding expectations — an event that increases the stock’s volatility and standard deviation. The stock is now considered more risky because returns are higher than expected. What this shows is that standard deviation isn’t always a good way to judge risk. In other words, standard deviation is just a measurement of volatility. Risk enters the picture only if volatility is below the investor’s return target.

You have many ways to measure the performance of your portfolio. One way to measure performance is to use benchmarks — that is, compare the performance of your various investments with top performances and indices. For example, you can rank them by

P/E ratio: Divide your stocks into capitalization groups (small-cap, midcap, and large-cap) and rank each group by P/E ratio. Compare your investments with top-performing stocks in each capitalization group daily and weekly. (For more information about capitalization groups, see Chapter 7.)
Yield: Divide your fixed-income investments (bonds and Treasury securities) by quality rating and then rank each group by yield. Compare your investments with the top-performing bonds in each asset allocation class.

Your Portfolio Management Options

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Managing the performance of your investment portfolio is as important as selecting the right investments. Market conditions can change at a moment’s notice. Your continuous monitoring of your portfolio can ensure that you reach your investment objectives by staying on track. You can use a variety of tools to assist you in analyzing your portfolio and the market environment. The following is a list of several of the portfolio management options that you can use to evaluate your portfolio:

Online purchasing of prepackaged portfolios: Called portfolio investment programs, these investments allow investors to own basket of securities that are tailored to meet their individual requirements.
Web-based portfolio management programs: Investor super-sites, Internet portals, and large news organizations generally sponsor online portfolio management programs for free (or free with your subscription). These programs usually don’t require any software downloading, and they constantly update your portfolio. However, these programs don’t offer many features, such as customized graphs or charts, fundamental analysis, or tax-planning tools.
PC-based portfolio management programs: These programs present portfolio tracking as a feature of a personal software program, such as Quicken or MS Money. PC-based portfolio management involves tracking with a software program downloaded from the Internet. These programs can be very inexpensive or even free. PC-based portfolio tracking programs usually have more choices and functions than Web-based portfolio management programs. However, you must download the proprietary software, and you might have to import (transfer data from one source to another) stock quotes.
Portfolio management with your online broker: Portfolio management with your online broker is automatic. Your online broker knows what you traded, so the brokerage can automatically update your portfolio. This choice is a terrific way to track distributions from mutual funds and stock splits. Overall, the advantages of using your broker’s portfolio management system are that you don’t have to manually add transactions, and your portfolio always reflects the current value of your investments.

You don’t have to limit your portfolio tracking to just one approach. For example, you might use an online tool to determine your percentage rate of return for the current year and use your PC portfolio software to track your annualized returns. When traveling, you may want to use your online brokerage’s portfolio services to verify the completion of investment transactions, dividend reinvestments, or stock splits.

In the following sections, I offer examples that detail the features and functions of various types of portfolio management programs.

Purchasing Portfolio Investment Programs

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Online do-it-yourselfers can now purchase prepackaged portfolios and baskets of securities that are geared for their unique needs. Both beginning and advanced investors can easily understand the portfolio investment programs, which tend to be a low-cost way for you to own hundreds of stocks. The primary difference between prebuilt portfolios and mutual funds is that with prebuilt portfolios, you know exactly what you own because you’re the manager.

In other words, there’s no lag time between purchasing the shares and receiving the information from the fund managers. If you’re an advanced investor with unique investing needs, prepackaged portfolios can be more desirable to you than a mutual fund because you can custom tailor the prepackaged portfolio to meet your particular requirements. For new investors, a prepackaged portfolio can be a way to control a number of individual shares and avoid errors of investing in just a few individual stocks.

Here are two sites that offer prebuilt portfolios:

FOLIOfn.com offers more than 120 prebuilt portfolios. Each prebuilt portfolio averages 50 securities; 2,500 stocks are available. Additionally, trades are free with some limitations. For example, trades are executed twice a day at the market price. You can rebalance a prebuilt portfolio at no charge, but individual trades cost $14.95. If you’re not sure where to start, use the FOLIO Wizard to identify your investor profile and which Ready-to-Go Folio might be right for you. FOLIOfn.com hasn’t set a minimum investment requirement. There are three folio plans. The 1-Folio Plan includes up to 200 commission-free trades every month, 50 (1 folio of up to 50 securities), one-click diversification, and automatic rebalancing for $19.95 per month or $199 per year. The 2-Folio Plan includes up to 400 commission-free trades every month, 100 (2 folios of up to 50 securities each) one-click diversification, and automatic rebalancing for $29.95 per month or $299 per year. The 3-Folio Plan includes up to 600 commission-free trades every month, 150 (3 folios of up to 50 securities each) one-click diversification, and automatic rebalancing for $39.95 per month or $399 per year. You pay an annual $25 IRA fee. You can also take advantage of a free 30-day trial. FOLIOfn.com has partnered with Reuters to offer members a way to purchase portfolio derived from the Reuters Select screens. After you subscribe to FOLIOfn.com, add the Reuters Select Folio service for an additional $99 per year to get started. You can select eight Reuters Select Folios, including Consensus Choices, Favorite Value Plays, and Growth.
Merrill Lynch HOLDRs — Holding Company Depositary Receipts — are baskets of securities that can be broken into their component stocks. You buy HOLDRS just like a stock. With each HOLDR, you get ownership in 20 or more stocks, but you pay only a single commission. And the annual fees on HOLDRS are inexpensive — only eight cents per HOLDR. Assuming that you bought 100 shares of a HOLDR with a market price of $100, the annual fee on your $10,000 investment would be $8 (or 0.08, expressed as a percentage). And it can get even better: The annual fee is waived to the extent that dividends and cash distributions on the underlying stocks are not enough to cover the fee. To cancel your HOLDRs, just instruct your broker to deliver your HOLDRs to the HOLDRs trustee and pay a cancellation fee of $10 per round-lot of 100 HOLDRs. This converts your HOLDRs to individual stocks. Canceling your HOLDRs isn’t a capital gains event, so you don’t have to pay taxes. Overall, HOLDRs allow you to diversify your investments and give you personal control of your investments. HOLDRs offer you tax benefits, liquidity, and flexibility — and no management fee. However, you do pay a small annual custody fee that’s taken against dividends and distributions when HOLDRs are issued.

Using Web-Based Portfolio Management Programs

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Many Web sites provide online portfolio tracking services. Some of these services are free, and others are fee-based. The aim of Web-based portfolio management tools is to help you make better investment decisions and thus increase your capital gains. Each Web-based portfolio management program offers something different. In the following sections, I describe just a few
examples.

Don’t let the fascination of having your portfolio online tempt you into overtrading (buying or selling) your investments.

Investor compilation or super-sites provide, among other things, free and feebased portfolio tracking. Some investor supersites require your free registration and are supported by advertisers. Other compilation sites provide different levels of services, costing up to $8 to $10 per month.

The benefit of tracking your portfolio at one of these sites is access to the vast repositories of investor information, data, and tools that they offer. If you want to research or analyze something in connection with your portfolio, you don’t have to go to several investor sites to get the job done, which can save you time and money if you need to make a quick investment decision. In the following sections, I profile several of these investor compilation sites.

B4Utrade.com offers (among other things) a real-time streaming portfolio tracker that gives you the ability to view your portfolio in the same way as the professionals. All the quotes are updated live without you having to refresh your screen. You can create up to 10 portfolios of 50 stocks each and either watch the expanded quotes or track your gains and losses, all streaming in real time. Monthly subscriptions are $25 (or $250 per year). There is a free 30-day trial.

MSN Money offers two types of portfolio management programs. The basic program doesn’t require a download to get a quick view of your investments. The MSN Money Deluxe program, however, requires you to download a program that includes customizable portfolio management, instant analyses, charts, stock and fund screens, and more. This flexible portfolio tracker can bring together all your personal accounts on one page under one security key. The MSN Money
Deluxe Portfolio Manager allows you to

Customize your portfolio view. Choose and arrange columns, sorting the information so that the information that is the most important to you is listed first. Your Deluxe Portfolio Manager page provides quotes, information about insider trading, a current valuation of your portfolio, today’s events, portfolio tracker alerts, valuation ratios, analysts’ ratings,
and technical rankings.
Conduct research and analyses. For example, the portfolio and each stock are rated on a scale of Strong Sell to Strong Buy, based on the recommendations of analysts who follow the company. Over- and undervaluation are based on the price/sales ratio, with individual statistics on different fundamental factors.
Access your credit card, bank, and investment accounts. You can view the history of your transactions for up to 90 days. Assign categories to your transactions and then use the MSN Financial Tools to look at how you’re spending your money. If you want, you can even create a budget. In the Investment Accounts section of the program, you find the following: current quotes, dollar and percentage changes on your account values, alerts, and news on your holdings.

The MSN Money Web site also provides a listing of financial institutions that can provide MSN Money with your account balances and other account details. To sign up for this expanded service, go to the My Accounts section of MSN Money and follow the easy-to-understand instructions. The process takes about 10 minutes, requires a Microsoft password account (you can get one while signing up), and the information you use to sign in to your financial institution’s Web site. (In the later section “Personal finance software programs,” you see how you can combine this feature with your MS Money personal finance software program.)

Reuters offers a reliable portfolio tracker and Watchlist tool with your free registration. Enter your portfolio data (ticker symbol, price, number of shares purchased, and commissions). Analyze your portfolio by selecting from the viewpoint of performance, valuation, fundamentals,
and today’s action. The color-coded performance view is an immediate eyeopener about the health of your portfolio. One of the great advantages of the Reuters Portfolio Tracker is the ability to click a stock’s ticker symbol and view the financial institution quality company research, stock information, news, and charts. At the home page, click Investing, then look in the left margin.

StockSelector in my opinion, lets you view your portfolio “every which way for Sunday.” You can look at today’s change, portfolio value, today’s news, today’s discussion, earnings summary, analyst summary, valuation summary, technical summary, fundamentals, and so on. Additionally, you can see how capital gains can impact your profits. The portfolio tracker is free with your online registration.

The Wall Street Journal offers easy access to your portfolio. Click the top-right corner of almost any page of the Interactive Edition to access the portfolio program. You can establish five portfolios with as many as 30 securities in each one. Delayed stock prices constantly update the portfolio, which also shows percentage change and gain/loss information.

The grid displays an issue-by-issue breakdown of your investments. Total value (along with your portfolio’s current gain/loss and percentage of change) is included at the top of the grid, along with the current value of the Dow Jones Industrial Average. You can download investment information to your favorite spreadsheet program.
If news is available for any company in your portfolio, a flag appears next to the company’s name. To access the news, click the flag. Links to detailed quotes and mutual fund snapshots are also available. These links provide additional performance and background information. Annual subscriptions cost $59.

Following Online News with Portfolio Tracking

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With online portfolio tracking tools, investors can see exactly how their investments are prospering. Many large news organizations provide portfoliotracking services that can make your portfolio tracking very convenient if you already use one or more of these news sources. The portfolio tracking functions of online news organizations generally require the security’s ticker symbol, quantity you purchased, purchase price, and date of purchase. In return, your portfolio tracker shows today’s delayed market price, today’s change, market value of your shares, the value of your investment, your gain or loss, and the percentage of the return. The following sections profile a few examples of online news organizations’ portfolio trackers.

Business news
Many online business news organizations provide portfolio tracking. Getting your investment news and tracking your investments at the same site is like one-stop shopping and can be a real timesaver. You can read the news and check on your securities at the same time. Check out the following sites:

CBS MarketWatch offers (with your free registration) a program that enables you to create an unlimited number of portfolios and to track up to 200 ticker symbols for options, mutual funds, and stocks on all the major exchanges in each portfolio. You can also customize price and value views to display the data you want to see first. Prices are automatically updated every five minutes.
FT.com is a handy online portfolio tracker if you’re trading in a variety of currencies. You can track 24 currencies on a number of exchanges. The Financial Times allows you to analyze your allocations, as well as link to financial data and news. A convenient online currency converter tallies up your international gains or losses. The portfolio tracker is free with your registration.
New York Times lets you set up or see the status of your portfolio (with your free registration). Go to the Business Section and click Stock Portfolio. To set up your portfolio, just enter the securities that you own or want to own by inputting the ticker symbol, amount of shares, commission paid, and date of purchase. The portfolio program does the rest. PC Quote provides the quotes, and The New York Times provides the free service.

Portal portfolio management
Portals are Web sites that are designed to be the Internet user’s first window onto the Web — the first page that comes up when the user accesses the Web. Often, you can personalize portals so that you can access news, sports, current portfolio data, or interest rate information before moving on to other sites. In the following sections, I profile two examples of portals with free portfolio tracking.

Yahoo! portfolio management
Yahoo! features a personalized portfolio program. To use the free portfolio, you need to set up an account with My Yahoo!. Click the Log In link that appears on the Portfolio line and then click Create an Account. Click the Edit link that appears and enter a portfolio name. Add the ticker symbols of your investments, separated by commas where indicated. You can also enter indexes like the S & P 500 (SPX) for comparison purposes. You can use the same ticker symbol to record separate purchases. Enter or edit the number of shares or purchase prices by clicking the Enter More Info button at the bottom of the page.

Quotes are delayed by 15 minutes for NASDAQ and 20 minutes for other exchanges. Portfolio management information includes company ticker symbol, price at the last trade, amount of price change at last trade, trading volume, number of shares held, the total value of the issue, dollar and percentage of change between the purchase price and the current value, amount paid per share, dollar capital gain or loss, and percentage of capital gain or loss.

The program provides charts, news, research, SEC (Securities and Exchange Commission) filings data, and related information. Recent headlines that link to news stories about your portfolio investments appear at the bottom of the page. You can get your information by signing in on any computer (and use the sign-out feature to make certain that others can’t pry).

You can select a nontable version of the portfolio’s data, choose to have all portfolio data downloaded to a spreadsheet, and retrieve detailed quotes for each investment. You can customize the portfolio by deciding to sort information alphabetically, use a small font, or display the portfolio by using detailed quote information rather than basic quote data.

Detailed quote information includes last trade (date and time), change (dollars and percent), previous closing price, volume, the day’s price range, 52-week range, and bid, ask, and open prices. Also included are ex-dividend dates, earnings per share, P/E ratio, last dividend per share amount, and yield. Charts of the security’s price for the last three months, year, two years, five years, and maximum number of years are available.

You can view your portfolio in a floating window, which lets you track your portfolio even when you leave My Yahoo!. Just click the stacked pages icon in the top-right corner of the portfolio module. If you get tired of seeing your portfolio, click the X to close the floating window.

Excite
Excite is a portal that lets you customize more than any other portal Web site (after you enter your zip code and e-mail address). You can choose your favorite links, decide how the page looks, pick which news stories will be listed first, set select reminders, and more. You can select stocks to track and create multiple portfolios.

The first portfolio view shows only the ticker symbol, current price, and percentage of change since the last closing price. The portfolio tracker provides alerts, information on the most active stocks, and a market update. The full portfolio screen shows the ticker symbol, current price, today’s change, percentage of change, volume, shares you own, gains or losses, and links to company news and chats. If you need to look up a company’s ticker symbol or find a delayed quote, Excite includes the service.

Portfolio management alerts
Many Web-based portfolio management programs offer registered users free daily updates on their portfolios. Investors can receive news, alerts, and closing prices on all the securities listed in their online portfolios. Investors usually enter their preferred e-mail address and complete a confirmation process. Many programs allow investors to set the criteria for specified alerts. For example, if the price change of a certain security changes by more than 5 percent in a day, an alert is automatically launched to notify the investor of the change. The following are a few examples of portfolio alerts:

Marketocracy believes there is no one solitary path to success in the stock market. The common destination is to learn about the strengths and weaknesses of the market environment. To that end, Marketocacy offers Marketscope Newsletter, stock alerts, weekly insights, and daily stock information. There is a free 30-day trial. The subscription price for this premium level research is $60 for three months or $180 for one year.
MSN Money Deluxe is a free downloadable program that takes a few minutes to download with a 56 Kbps modem. At the Investor home page, click on Portfolio in the header. You can save personalized views of your portfolio, use the MSN Stock List to track symbols, import stock screener results to a watch account in your portfolio, see an analysis of your portfolio and easily add new symbols to your account. Among other things, the MS Money Deluxe launches e-mail alerts delivered to MSN Messenger, Windows Messenger, e-mail, or your mobile device. Alerts can be based on stock or mutual fund ticker symbols to notify you of changes in price, volume, and more.
SmartMoney.com offers intraday stock alerts. Get notified as soon as your stock hits your specified price target, volume target net change, and more. You can add, edit, and remove alerts for immediate use. You can even set up multiple alerts each. For example, you can be notified when your stock goes up or down 10 percent and when it hits a 52-week high. There is a free two-week trial. Subscriptions start at $5.95 per month for delayed quotes ($59.95 per year) and $10.95 per month for real-time quotes ($109.00 per year).
Stock Alerts offers custom alters for a variety of events and periodic reports on stocks and portfolios. Delivery is to desktop e-mail, pagers, cell phones, and any other e-mail capable Short Message Service (SMS) device. Messages are in HTML or plain-text formats. There are three subscription levels. The free subscription is one report or watch, one portfolio, a maximum of ten lots per portfolio, total of two deliveries per day, a total of three destinations for messages per day, and ten messages archived to the Web. The mini-subscription is $29.95 per year and includes five watches or reports, one portfolio, 25 maximum delivers per day, 50 delivers per day, three destinations, and 15 recent messages archived on the Web. The full subscription is $84 per year and includes 20 watches or reports, three portfolios, 50 lots per portfolio, a maximum of 50 deliveries per day, five destinations for messages, and 50 recent messages archived on the Web.

Using PC-Based Portfolio Management Software

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If you want more analysis, including graphs of your investments’ performance, tax data, and price and volume alerts, consider a PC-based portfolio manager (a software program that operates on your PC). For example, you can select MS Money or Quicken (which you perhaps already use for your online banking), shareware, or free Internet programs. In the following sections, I describe a few examples of PC-based portfolio management programs.

Personal finance software programs
Personal finance software programs often offer much more than what you pay for. These programs provide a way to access online banking, organize your personal finances, understand what you have and what you owe, and organize your financial accounts for the tax collector. Additionally, portfolio management programs track and analyze your portfolio’s performance. Most personal finance software programs automatically use your portfolio’s gains and losses for your net-worth calculations. With many personal finance programs, if you’re connected to the Internet, you can automatically update securities prices. In the following sections, I describe the two most popular personal finance software programs: MS Money and Quicken.

The National Association of Investors Corporation (NAIC) portfolio management program and other portfolio management programs enable investors to sort investments by type of industry or company size and then print the reports. In this way, investors can make comparisons within their own portfolios. In other words, it’s a convenient way to sort out the winners and losers. A limitation of some personal finance software programs is that they don’t include this feature. Additionally, personal finance software programs often have trouble with dividend reinvestment plans.

MS Money
MS Money is a personal finance software program that can help you stay organized by tracking activities in your savings and checking accounts, and doing your banking and bill paying online. You can use Money to manage your investments by downloading quotes and brokerage statements from the Internet, plan your retirement, and more. Four types of MS Money products are available, but only two of the products include the full menu of portfolio management tools: MS Money Premium ($79.95) and MS Money Small Business ($89.95).

MS Money tracks your portfolio’s investment positions, updating the price or quantity held without entering all purchase and sales data. You get a detailed analysis of your investments by risk, performance, and asset allocation. The portfolio management program tracks stocks, CDs, and bond capital gains throughout the year. The asset allocation feature analyzes the allocation of the assets in your current portfolio and suggests ways to improve it, based on the historic returns for the investment classes that you hold. Portfolio management features include

Portfolio manager: You can directly download account information from banks and brokerages nationwide. You can access your account information 24/7.
Portfolio tracking: MS Money includes features that many online free portfolio trackers lack. For example, you can track stock splits in the transaction list, as well as in the portfolio and transaction report. Additionally, there is a 401(k) manager and automatic Internal Revenue Service (IRS) Schedule D reporting (of capital gains and losses).
Capital gains estimator and capital gains tracking: The capital gains estimator calculates your capital gains taxes and alerts you of taxes owed if a specific investment is sold. You also discover capital gains tracking and optimization features.
Asset allocation and investing alerts: MS Money provides timely market information, as well as an Investing Advisor FYI module featuring recent alerts. These alerts can give you a quick snapshot of what’s happening with your stocks and can notify you of any significant news so that you can stay on top of your portfolio.

Quicken
Quicken is similar to MS Money in that both personal financial programs offer you the option of downloading your checking, savings, and investment data directly from your bank or rokerages. Additionally, when it comes to managing your portfolio and tracking your investments, both MS Money and Quicken provide high quality, personalized tools. The Quicken Premier ($79.95) personal finance software program

Can help you track tricky financial transactions, such as stock splits and corporate takeovers
Offers a portfolio analyzer, a capital gains estimator, and the ability to customize your portfolio data
Lets you download up to five years of stock quotes for trend analysis and recordkeeping

Quicken offers tax-preparation and planning tools. Quicken can help you calculate your capital gains taxes (not an easy task with today’s tax laws), and it easily integrates with Intuit’s TurboTax software programs, a feature that users truly appreciate at tax time. Quicken also features Online Investment Tracking, which connects individuals to financial institutions for online banking, online bill paying, and online investment tracking.

Portfolio management software programs
Several hundred portfolio management programs are available for your investment tracking. The programs vary in price from free to $800. Many of the freeware and shareware portfolio management programs include an amazing amount of features, but are somewhat cumbersome to use.

Some brokers give free portfolio management programs to customers who open an account. Financial data providers frequently give free portfolio management programs with a ubscription to their services. Other portfolio management programs are components of larger investment analysis applications.

To discover what works for you, try some of the free demonstrations or trials that vendors offer. They require no obligations, and after sampling several programs, you can get a good idea of which features you need. Here are some examples of PC-based portfolio management programs:

Portfolio Systems Inc. comes in three flavors:
• Portfolio Gains ($145) is geared for individual investors and allows data export to TurboTax, provides unlimited quotes and portfolio updates, has complete privacy, allows an unlimited number of accounts, tracks stock and options trades, and provides an account summary view.
• Option Money ($345) is designed for active stock and option traders. Investors can track their option strategies, check out account statistics, and view their option and stock positions. Additionally, Option Money supports an interface between investors and their brokerages.
• Portfolio Director ($795) includes all the previous features and consolidates reports, easily manages multiple accounts, and offers an aggregate portfolio view. A free 30-day trial period is available. To use real-time quotes with Option Money or Portfolio Director, you have to subscribe to either the Chicago Board Options Exchange for $19.95 per month for unlimited quotes plus exchange fees, or PCQuote.com for $19.95 per month for unlimited real-time equity and option quotes plus exchange fees.
Captool Individual Investor for Windows includes a portfolio management tool for all types
of securities and transactions. One of the benefits of this portfolio program is that it accounts for reinvestments, short sales, splits, mergers, and return on capital. The program contains over 70 transaction codes to facilitate modeling all situations and calculates returns on investments (ROIs), estimates your tax liabilities, and performs batch valuations (for multiple portfolios). Captool Individual Investor automatically updates security prices with your Internet access. You can also make manual entries as well as customized reports and graphical reports to include valuation versus time, ROI versus time, and portfolio growth versus indices. The program runs under Windows 95/98/NT/2000/Me/XP, and it costs $249 plus shipping and handling.
Fund Manager Version 7.1 is a top-rated portfolio management program for stocks and mutual funds for the average individual investor. You might experience a learning curve, but samples will help you get the hang of it. Fund Manager provides many easy-to-read graphs, charts, and reports that you can print. Update prices by clicking Internet. Retrieve the latest quotes from AOL, CompuServe, or many international Internet sites. Fund Manager imports from Prodigy, MSN, Quicken, and other sources, tracking your investment performance quickly and easily. The program runs under Windows 95/98/NT/2000/Me/XP. There are three versions of the program. You can try all three for free. The Personal version is $59, the Professional version is $195, and the Advisor version is $395.
NAIC Personal Record Keeper 3.0 is the official software offered by the National Association of Investors Corporation for personal portfolio management. The program tracks investment transactions (buy, sell, income, and reinvestment) for a variety of investments. It also automatically updates prices from online services. You can print reports that record the full history of your portfolio or for a specified time period, including industry and company size breakdowns and return calculations. The program generates more than 35 reports and graphs, keeps tax records, indicates diversification, compares portfolio performance to the market, and automatically notifies you if a price alert has been reached. The program runs on PCs with Windows 95/98/2000/Me/XP. A free 30-day demo is available for download. The program costs $89.
Personal StockMonitor shown in Figure 17-1, is an investment tool that uses the Internet to assist you in making better financial decisions by providing continuously updated quotes and charts on your desktop computer for free. Personal Stock Monitor collects quotes from 15 markets worldwide and includes a portfolio manager that works in the background, recalculating the value of configurable intraday, end of day, and asset allocation charts, as well as import and export capabilities from Quicken, MS Money, MetaStock and similar software programs, giving you a consolidated view of your accounts. In other words, Personal StockMonitor retrieves raw data from the Internet and organizes it according to your preferences. Your portfolio information is stored on your hard drive instead of the Internet. Overall, Personal StockMonitor combines online finance Web sites with the convenience, automation, and privacy of a desktop application. The program runs on PC Windows 95/98/2000/Me/XP. Personal StockMonitor Gold is $49.95, and Personal StockMonitor is $29.95. A free 30-day trial is available.

Figure 17-1

Part IV

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The Part of Tens

In this part . . .
In The Part of Tens, I offer some timely advice about
how you can tell a good deal from a scam, some guidelines
about determining the time to sell, and information
on how to spot the green flags for buying.

Chapter 18 - Ten Warnings About Cyberfraud

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In This Chapter
Recognizing potential online investment scams
Requiring real financial disclosures
Unmasking dishonest brokers by asking the right questions
Knowing where to complain online if you receive an unscrupulous investment offer
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The Securities and Exchange Commission receives hundreds of complaints of online investment fraud every day despite many consumer warnings and a federal crackdown. Don’t get taken for a ride on the Information Superhighway. In the past, swindlers used the U.S. mail and telemarketing boiler rooms to exploit unsuspecting investors. Cyber scam artists have now taken online investor fraud to a more sophisticated level with look-alike portals of legitimate brokerages complete with hyperlinks to fabricated press releases and fake news stories that look almost like the real thing.

Investigating investments is difficult. The terms of the deal might be hard to understand, and the investment literature and salespeople might omit key facts. However, you can observe warning signs of potential scams, schemes, and deceptions. Doing so involves a little effort, homework, and investigating, but isn’t that what investing is all about?

In this chapter, I provide ten warnings (and then some) about online investment information and offers that may be too good to be true. I provide guidelines for checking out brokers and investments, as well as tips for identifying a pyramid scheme. I show you how to read financial disclosures to get the facts, and I explain how to complain online.

Don’t Believe Everything You Read

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Every investor dreams of being an early stockowner in a Microsoft or Intel Corp. Dishonest brokers and stock promoters prey upon this greed and offer unsuspecting investors low-priced stocks in companies with new products or technologies (like the self-chilling soda can). Many fraudulent Internet messages are about general stock-picking advice or mention other investment possibilities. However, some messages tout specific stocks, moneymaking ventures, and service providers. Just remember one simple rule: Don’t believe anything you read until you’ve done some of your own research first.

The following are ten examples of online investment scams that you should be wary of.

Multilevel marketing plans and pyramid schemes
Pyramid schemes, sometimes called multilevel marketing plans, are sure ways to lose money. Individuals are often contacted via e-mail messages and encouraged to recruit six friends; those six people recruit six more friends — and so on, in a relentless search for new recruits. New recruits are expected to purchase a minimum amount of the pyramid’s products. If everyone cooperates, then by level 15, the scheme needs 7.6 billion participants — more than the Earth’s population.

Profits from these schemes don’t come from selling products or distributorships but from recruiting new participants. The endless recruiting of more participants eventually leads to an oversupply of sellers. Investors are left with garages full of products and the loss of their investment.

Three elements characterize pyramid schemes:

A reliance on funds from new investors (recruits) to pay returns, commissions, or bonuses to old investors.
The need for an inexhaustible supply of new recruits.
The promise of earning profits without providing goods or services.

A good example of a pyramid scheme is located in the United Kingdom and online. The enterprise is called a “gifting scheme” and was still available online as of February 2005. Unfortunately, because it doesn’t’ appear to breach any current U.K. legislation on pyramid schemes or multilevel marketing and doesn’t involve any trading of products for services, it has wriggled through a legal loophole and (at this time) can’t be shut down by U.K. authorities.

Here’s how the scam specifically works: If eight individuals invest £3,000 and then progress through the levels of the network, they can each expect to receive £24,000 when they reach the top level. However, to reach that top level, 64 people have to each invest £3,000. Each of those 64 investors also expects to collect her £24,000. However, that means that another 512 investors need to participate. The next level requires 4,096 participants, then 32,768 participants, and then 262,144 participants.

To sum it up, each investor needs eight investors in the scheme in order to get her money back and to make a return. In most cases, the supply of potential investors dries up, leaving the majority of investors with nothing to show for their investment.

Financial chain letters and Ponzi schemes
Financial chain letters can sneak around your spam-blocking software because they’re usually sent by people you know. Generally, the e-mail message states that you’re missing out on a big investment opportunity. If you forward the message to a dozen of your friends, you’ll be allowed to see the details of this once-in-a-lifetime investment opportunity and reap big returns.

Most financial chain letter promoters claim that if you participate, your name will eventually be at the top of millions of lists and you’ll receive millions of dollars. You may be asked to send ten dollars to each of the first ten people whose names are at the top of the list. Next you’re instructed to delete the name at the top of the list and add your name to the bottom of the list. Money is made solely by getting other new recruits to join the chain. Most people receive nothing for their “investment.” Anyone can break the chain and deprive you of your possible “gains.” Even if the financial chain isn’t broken, about 95 percent of financial chain letter participants don’t ever receive anything in return for their “investment.”

According to the U.S. Postal Service, financial chain letters are a form of Ponzi scheme and are illegal. Ponzi schemes are named after a 19th-century clerk, Charles Ponzi, who conned investors out of $10 million by promising returns as high as 40 percent. Ponzi schemes are a close cousin to pyramid schemes because they rely on new recruits. What makes the two approaches different is that with a Ponzi scheme, any profits go to one person. In contrast, in a pyramid scheme, any profits go to early investors that have reached a certain level.

If you’ve been targeted to receive a financial chain letter or if you believe you have been solicited for a Ponzi scheme, notify your Internet service provider or the Federal Trade Commission at spam@uce.gov.

Cons based on bogus research reports and newsletters
The Wall Street Journal has a circulation of 1.8 million, and USA TODAY has a circulation of 1.6 million. In contrast, more than 70 million adults log on to the Internet each day. By using mass e-mailing programs, fraudsters can quickly and inexpensively reach more people than these publications can. In other words, with one keystroke, fraudsters can reach thousands, even millions, of potential online investors. This type of e-mailing strategy is called spam. Spam is junk e-mail, and creating it is easy. Often, you may receive unsolicited e-mail newsletters that tout stocks expected to double or triple in value over a very short time. If you look closely enough, you might find a disclaimer, usually included in the very small print at the bottom of the newsletter. The following are several examples of potential disclaimers:

The publisher of the report isn’t a registered investment advisor or broker dealer. The report isn’t an offer to buy or sell securities.
The owners of the report may already own shares of the stock described in the publication and may immediately sell all or a portion of these shares into the open market at or about the time that the report is published.
Investing in the profiled company is high-risk and use of the report is for reading purposes only. If the reader decides to act as an investor, it’s at that investor’s sole risk.
Statements in the report are forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. These terms may include such words as expect, believe, may, will, intend, or similar terms.

Some so-called research reports are nothing more than paid advertisements for certain stocks. The authors of these supposedly legitimate newsletters don’t disclose conflicts of interest or biases in their reporting. For example, in December 2000, a stock guru misled prospective investors in companies highlighted on his Web site by failing to disclose that the companies had paid his firm a fee to publish favorable research analyses of their firms.

In October 1999, the SEC conducted their first nationwide sweep against these so-called research reports that touted stocks on the Internet but didn’t disclose that they were being paid to make the promotions. The SEC filed fraud charges against 44 people and firms, following up in February 2000 with charges against another nine people and four companies.

Spammers can purchase your e-mail address from a variety of sources. Sometimes, you may unwittingly provide the information yourself. For example, when you complete a free registration form at a Web site, you may overlook a little box that states Uncheck This Box if You DO NOT Want a Newsletter. Unwanted e-mail newsletters are often marked Urgent or Recommended Strong Buy. You should ignore e-mail messages like this and delete them immediately. Unsubscribe as soon as possible because this type of junk mail is a waste of your precious time. For more on how to protect yourself from unwanted e-mail of this nature, check out Fighting Spam For Dummies by John R. Levine, Margaret Levine Young, and Ray Everett-Church (Wiley).

Phishing for your personal information.

Phishing (pronounced “fishing”) is a type of brand spoofing. That is, the Web page of a legitimate Web site — such as your bank, PayPal, Best Buy, and so on — is recreated by a fraudster. An e-mail message is sent to you in an attempt to fool you into revealing your personal financial information or password data. Sometimes, to gain your personal financial information, “Phishers” will use

Social engineering: Phishing sometimes uses social engineering to gain your confidence. Social engineering is when unscrupulous individuals exploit the weaknesses in people to gain confidential information, such as passwords that will compromise information system security. Social engineering is as a low-tech way that Internet users can have their identities stolen.
High-tech lures: The term phishing is used to describe how fraudsters use sophisticated lures to deceive everyday Internet users. Experts note that about 5 percent of all recipients respond to phishing exploits.

Industry experts state that about 95 percent of all phishing exploits originate from a spoofed (forged) Internet address. About five new phishing exploits are reported each month. This is how it works:

The bait: You receive an e-mail message from your bank stating that, due to a security break-in, they need to verify your password and ID number.
The hook: You follow the link to the phisher’s Web page. The spoofed Web page has a similar URL and looks just like the page you usually use.
Reeling you in: A pop-up appears, requesting that you sign on using your personal password and user ID.

The pop-up is often a dead giveaway that something is wrong. It’s important to report suspicious activity to the FTC. Another way to check whether something is wrong, in case a pop-up doesn’t appear, is to compare the current URL to the URL you usually use. If the URLs are different, you’re being scammed. If you get spam that is phishing for information and you want to help stop this type of activity, forward it to spam@uce.gov.

Nigerian e-mail letter investment scam
Over the last 18 months, I have received 147 variations (that’s almost three e-mail messages a month) of the Nigerian investment scam. I call these e-mail messages Nigerian, but recently many of these bogus business opportunities or advanced fee scams have originated from Iraq, Zimbabwe, London, Hong Kong, and South Africa. Often, these e-mail messages promise that I’ll receive millions in return for helping a VIP collect money trapped in a Central Bank. The plea for help assures me that the investment is 100-percent safe. Each version of the e-mail appeal is slightly different, but the scam remains the same: I’m guaranteed 20 percent of all recovered funds. In some instances, the fraudster will ask for enormous amounts of money for fees, taxes, traveling expenses, and so on. I’m then asked to provide the name, address, and account number of my bank. For those investors who fall for the scam, the con artist uses this information to rob the investors’ accounts. See the Federal Trade Commission’s Consumer Web site, which offers a short history and details about this scam.

If you’re interested in more information about these scams, including copies of some of the initial letters and the extensive official documents that are sent to victims, download the Nigerian Advance Fee Fraud report from the U.S. State Department. You need to download Acrobat Reader to view the PDF file (if you haven’t already downloaded and installed the free program).

Investment hoaxes designed to get your cash
Many individuals have used the Internet as a medium for investment hoaxes. The following are two real-life examples of how a bogus press release allowed unscrupulous individuals to make thousands of dollars in illegal profits:

A bogus press release stated that Uniprime Capital claimed to have documentation from the government of Spain indicating that the Plasma Plus was a breakthrough treatment for the virus that causes AIDS. The stock was touted online in several investment chat rooms as undervalued. In a few days, more than 5 million shares were traded, and the stock skyrocketed by 800 percent. The investment hoax cost investors about $20 million.
In a similar story, an individual issued a negative press release about Emulex, a fiber-optic company. In the press release, the fraudster claimed that the CEO had quit and that the company was restating its quarterly earnings. In an effort to cover his tracks, the fraudster — who lived in El Segundo, California — went to a hotel room in Las Vegas to make his
online stock trades on the day of the hoax. The stock dropped by 62 percent, and the con artist made $241,000 by short-selling the stock.

Bogus IRA-approved investment schemes
Many Americans are seeking ways to profitably invest their retirement nest eggs. Fraudsters are aware of this demand and have devised online schemes that may scramble the dreams of many investors with so-called IRAapproved or otherwise endorsed Internal Revenue Service (IRS) investments. Fraudsters frequently contact investors through bogus e-mail newsletters or Web sites to offer huge returns that will ensure investors an easy retirement. Investments include high tech (including wireless cable television and specialized mobile radio) to exotic livestock (ostrich farming, anyone?) to real estate investment pools.

Con artists use the “IRS approved” statement to evade the consumer protection requirements of state and federal securities laws by claiming the investments are unregulated general partnerships and limited liability companies. Keep in mind, there is no such thing as an “IRA-approved” or “IRA-sanctioned” investment. These investments are designed to fly below the regulatory agencies’ radars and are a guaranteed way to lose most or all of the money that you invest.

Guaranteed high returns frauds
Many fraudsters provide online ads that guarantee “the potential to make a six- or seven-figure annual income.” The Securities and Exchange Commission has started a campaign to warn online investors about this type of stock market scam by creating a sting Web site — that is, a Web site that’s designed to shock online investors into being more cautious with their hardearned cash. In the first two days, the SEC’s sting Web site drew 125,000 hits by advertising fake offers, drawing interest in March 2002 with a press release that praises the biological defense firm McWhortle Enterprises. The site features bogus testimonials and analysis reports regarding McWhortle. Clicking an Invest Now tab transports potential victims to a Web page, which states, “If you responded to an investment idea like this . . . You could get scammed!” The text goes on to explain how the Web site incorporates the telltale signs of online investment fraud, including information about how to tell that the corporation is a fake. Look for these signs:

Promises little or no risk with the reward of fast, high profits: Believing extravagant claims of quick wealth is a dangerous practice. Often, returns are based on pro formas (the hypothetical performance) of the company — not on actual returns.
Doesn’t offer any track record and has no legitimate products (being a fictitious company, it has neither): Before you consider spending any money, do some homework. For example, you can — and should — ensure that a company is a registered corporation and find its location and the names of its corporate officers.
Offers a lucky few investors an opportunity to get in on the ground floor of “pre-IPO investing”: Pre-IPO investing is the investment stage that carries the most risk for any venture. Consequently, this investment cannot be risk-free.
Requests that each investor supplies a credit-card number and a Social Security number online for identification purposes: With these two numbers, the fraudsters can steal a potential investor’s identity and ruin his or her credit rating.

Get rich quick with investment seminars
One of the newer online scams is the fake investment seminar. Investors are encouraged via e-mail messages to enroll in expensive seminars to become day traders or to learn how to trade options, commodities, or futures. Often, unlicensed practitioners teach the seminars. These unlicensed practitioners are unlikely to disclose conflicts of interest. For example, attendees may be required to open a trading account at a specific brokerage (usually a firm that isn’t as inexpensive or reliable as a top-rated brokerage). Attendees must also pay hidden costs, such as buying a particular brand of software from the investment seminar company and using an expensive interface for real-time data. (Software for these courses can be in the thousands of dollars.) Unfortunately, naive investors often believe that if they follow the recommendations they learn in the course, they can earn 250 percent (or more) back on the money they spent for the course. Seminar leaders foster this belief by touting false testimonials about how past attendees are now using the fail-safe trading system and making hundreds of dollars per day.

Pump-and-dump schemes
Pump-and-dump schemes are swindles in which greedy people manipulate the stock prices so that they can make illegal gains. Frequently, pump-and-dump schemes target elderly investors. For example, fraudsters purchase shares in small companies with low stock prices and then use high-pressure telemarketers to hype the stock to unsuspecting would-be investors. The fraudsters pocket the money as the stock’s price rises, leaving investors with virtually worthless shares.

Fraudsters are using the Internet to perpetuate pump-and-dump schemes. Pairgain, a California company, was touted by scam artists on Internet message boards as being poised for a takeover by an Israeli company. The “takeover” announcement was hyperlinked to a bogus news release made to look like a legitimate financial reporting service had written it. This scenario is a classic pump-and-dump scam; fraudsters artificially drive up the stock price and unload it on unsuspecting investors who believe the stock is on the rise.

Cyber smears are also common. For example, a fraudster borrows 100 shares of a certain company’s stock from a broker and immediately sells them at $10 a share. Then the fraudster starts an illegal negative message board campaign with fabricated news stories. The stock price drops to $8 a share. The fraudster purchases 100 shares at $8 a share and returns them to the broker. He then pockets the $2 a share difference, less interest. The Investing Simulator Center, offers an interactive “Don’t Get Burned” simulator to assist you in test-driving what can happen when you take phony research reports seriously.

If you believe you’ve been scammed, file your complaint at www.ftc.gov and then visit the FTC’s Identity Theft Web site to learn how to minimize your risk of damage from ID theft. Visit www.ftc.gov/spam to learn other ways to avoid e-mail scams and deal with deceptive spam.

If an Offer Seems Too Good to Be True, It Usually Is

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As the popularity of the Internet grows, millions of people flock to the new Global Village. Inevitably, individuals with criminal intent follow the crowd.

Online investor fraud often starts when you receive an e-mail message describing an appealing offer. Remember that offers that seem too good to be true usually are. Here are a few of the warning signs to help you identify potential scams:

Exceptional profits: Usually, the profits are large enough to get your interest but not large enough to make you suspicious.
Low risk, high return: All investments involve some risk. If a fraudster advertises a no-risk investment, a red flag should immediately go up that something is wrong. Don’t invest if you don’t know exactly what the risks are. (Remember, fraudsters don’t honor money-back guarantees.)
Urgency: Fraudsters usually offer a reason why you must invest as quickly as possible. They may tell you that delays mean losses of big profits or that they’re limiting the offer to just a few individuals. Fraudsters often play on new technological advances that create a brief market that you must get into right away. However, if you feel that the posting is valid, wait before you respond. Others won’t be shy about posting their opinions.
High-pressure tactics: Fraudsters often act like they’re doing you a favor by letting you get in on the investment opportunity. Don’t be afraid to ask questions publicly. Post a follow-up message. If the original post is valid, the person who sent it will be happy to post a public response.

Although you can find plenty of helpful investment-related postings online (after all, that’s what this book is all about), the Internet, like other places, has its share of fraudsters. At the home page of The National Association of Securities Dealers Web site click Investor Alerts on the left side of the page. Next you find alerts that can give you the timely information you need to protect your money and to avoid scams and investment problems.

Checking It Out Before You Put Your Money Down

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If you’re an online investment victim, the chances of getting your money back are slim. Even in cases in which government agencies recover money, the consumer usually gets back less than 10 cents on the dollar. The best defense is to thoroughly investigate an online investment before you put your money down.

The Federal Trade Commission (FTC) inspects investment swindles and provides summaries that document recent allegations of corporate fraud and misconduct in relation to securities investors. Here are some suggestions about how to investigate that “once-in-a-lifetime offer”:

Check with your city or state consumer protection agency for information about a firm you’re considering for investment: Additionally, a consumer protection agency can direct you to other organizations that might have information about the investment.
Contact regulators: Regulatory organizations include the Federal Trade Commission, the Securities and Exchange Commission, and the National Association of Securities Dealers. For the name and contact information of your securities regulator, go to the North American Securities Administrators Association (NASAA) Web site .
Write or telephone law enforcement agencies: Fraud is illegal in all 50 states. You can contact your local public prosecutor, your state’s attorney general, or your state’s securities administrator (or all three).

The Better Business Bureau Web site provides helpful reliability reports on firms. You need to read reliability reports before you purchase the firm’s securities. Each report indicates how long the firm has been in business, how long the Better Business Bureau has known about the company, complaint patterns (if any), and whether any government agencies — for example, the FTC or the state attorney general — have taken any enforcement actions against the company in the last three years.

Understanding What Real Financial Disclosures Include

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If you’re considering investing in a company, you may want to download and print a copy of the investment offer. If the sales literature doesn’t include a prospectus with financial statements, ask for one. If you’re told that the company doesn’t have a prospectus, request a written financial disclosure about the company. All in all, you should have the following information:

Offering circular: Sales literature that presents the investment.
Prospectus: A formal written statement that discloses the terms of a public offering of a security or a mutual fund. The prospectus is required to divulge both positive and negative information to investors about the proposed offering.
Annual report: A written report that includes a statement by the chief executive officer, a narrative about last year’s performance, and a forecast for next year’s performance. Financial statements include a balance sheet, income statement, a statement of cash flows, and retained earnings.
Audited financial statements: Financial statements audited by a certified public accounting firm.

The SEC, doesn’t require companies seeking less than $1 million to be registered, but it does require these firms to file a Form D. Form D doesn’t include an audited financial statement, but it does state the names and addresses of the owners and promoters of the firm. Other information is limited. If a Form D isn’t available, the SEC suggests that you call its Investor Education and Assistance Department at 202-942-7040.

Telltale Signs of Dishonest Brokers

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Dishonest brokers often ask their victims a steady stream of questions designed to derail honest investors from asking the right questions. In contrast, honest brokers encourage you to ask questions, provide you with additional educational materials, and make certain that you understand the risks involved in your investment decision. And if you decide not to spend your money, they’re untroubled by your investment decision.

The National Futures Association has collected 16 questions that are turn-offs for dishonest brokers . In the following list, I’ve tailored those questions to meet the needs of online investors:

Where did you get my name? The dishonest broker may answer, “from a select list of investors,” but your name was probably obtained from a Usenet newsgroup question that you asked, from a bulk e-mail response, or from a mailing list subscription.
What risks are involved in the investment? All investments except U.S. Treasury securities have some default risk. (U.S. Treasury securities are considered risk-free. The Federal government backs these securities just as it does the legal tender — that is, the money in your pocket. The government isn’t likely to fail, so the securities — and your money — are risk-free.) Some investments have more risk than others do. A salesperson
who really has a sure thing won’t be on the telephone talking with you.
Can you send me a written explanation of the investment, so I can consider it at my leisure? This question provides two turn-offs to dishonest brokers. First, swindlers are reluctant to put in writing anything that may become evidence in a fraud trial. Second, swindlers are impatient; they want your money right now.
Would you explain your investment proposal to my attorney, financial planner, investment advisor, or banker? You know the investment is a scam if the salesperson says something like, “Normally, I would be glad to, but . . .” or “Unfortunately, we don’t have enough time,” or “Can’t you make your own decisions?”
Can you give me references and the names of your principal investors and officers? Swindlers often change their names so that you can’t check their histories. Make certain that the reference list contains the names of well-known banks and reputable brokerage firms that you can easily contact. The Investor Protection Trust page includes links to various resources that you can use to check out a broker or other financial professional.
Which exchanges are the securities traded on? Can I have copies of the prospectus, the risk disclosure statement, or the audited financial statements? For legitimate, registered investments, these documents are normal. A legitimate investment may or may not be traded on an exchange. However, fraudulent investments never are.
What regulatory agency is the investment subject to? Tell the broker that you want to check the investment’s good standing with its regulatory agency before going forward. The possibility of having to talk to a representative of a regulatory agency is a real turn-off to a swindler.
How long has your company been in business, and what is your track record? Can I meet another representative of your firm? If the broker or the investment doesn’t seem to have a past, the deal may be a scam. Many swindlers have been running scams for years and aren’t anxious to talk about it.
When and where can I meet you to further discuss this investment? As you might imagine, dishonest brokers often won’t take the time to meet with you, and they don’t want you in their places of business. Legitimate registered brokers are happy to sit down and discuss your financial goals.
Where will my money be? What type of accounting can I expect? Often, funds for certain investments are required to stay in separate accounts at all times. Find out which accounting firm does the firm’s auditing and what type of external audits the firm is subject to. (Make certain that the well-known accounting firm is actually the auditor.)
How much of my money will go to management fees, commissions, and similar expenses? Legitimate investments often have restrictions on the amount of management fees the firm can charge. Getting what the firm charges in writing is important. Compare the firm’s fees with charges for similar investments.
How can I get my money if I want to liquidate my investment? You might discover that your potential investment can’t be sold or that selling your investment involves substantial costs. If you’re unable to get a solid answer in writing, the investment might be a scam.
If a dispute arises, how will it be resolved? No one wants to go to court and sue. The investment should be subject to a regulatory agency’s guidelines so that disputes are resolved inexpensively through arbitration, mediation, or a reparation procedure.

Is your broker dishonest or just incompetent? The state of Massachusetts provides a list of investment watchdog agencies . You can also find the names, telephone numbers, and, when possible, the Web link to each state’s securities commission.

Where to Complain Online

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The Internet provides many ways to complain about online investor fraud. Here are four good resources:

Better Business Bureau has an online complaint form and promises to follow up within two weeks of your complaint.
Federal Trade Commission provides an easy-to-use complaint form. Click File A Complaint Online at the home page.
Securities and Exchange Commission has an excellent online complaint process.
National Fraud Information Center forwards your complaint to the appropriate organizations and includes it in the center’s Internet fraud statistics (which might not help you get your money back but might be helpful to other online investors).

Chapter 19 - Ten Important Selling Points

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In This Chapter
Getting a grip on selling principles
Setting profit goals and maintaining them
Facing your disappointments
Moving out mediocre performers
Keeping an eye on the right economic indicators
Watching what the insiders are doing
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Knowing which stocks to sell and when to sell them is the hallmark of a savvy investor. Selling decisions are difficult because no single solution fits all investors. In this chapter, I present some general rules and insights. You discover that individual investors routinely sell winners too early and ride losers too long. From the time that you purchase a stock, you want to start considering the right time to sell and reap your rewards. If you’re pondering a sale, don’t focus on only the sales price. Take the time to ask several questions and to research the Internet for answers about the security’s future. Use this chapter to develop your personal selling system checklist. Compare your selling candidates with your personal selling system checklist. If your investment choice is a loser, face up to your disappointment and take your losses. If your investment is a winner, you can laugh all the way from cyberspace to the bank.

Determining Your Personal Selling Rules

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When you purchase a security, you anticipate a certain rate of return. To examine your investment selection’s performance, calculate what you have gained by holding the security:

For bonds, measure the current yield by taking the annual interest payment and dividing it by the current price of the bond. (For details, see Chapter 13.)
For stocks and mutual funds, calculate the investment’s total return (ending value less beginning value plus income divided by beginning value). See Chapter 3 for more information.

Visit the several credit-quality Web sites to check the quality rating of all bonds. Read the appropriate annual reports and fund statements for your stocks and mutual funds. Remember that no scientific formulas exist to guide you in your selling decisions. Knowing some wide-ranging rules and the kinds of questions to ask, however, can help you become a more successful investor. I describe some general examples of selling rules that beginning investors might find valuable. Veteran investors can have the same selling rules or quite different ones. Regardless of which category you fall into, both new and experienced investors need to choose a personal system and stick to it.

When it’s time to sell, consider using a stop-loss order — also called a stop market order (see Chapter 5). You can place a stop-loss order to sell when a certain price is reached. Its purpose is to limit your loss on a particular security. For example, you can set a stop-loss order for 10 percent below what you bought the stock for to limit your loss to 10 percent. For investors who are unable to watch their portfolios for an extended period of time because of holidays, vacations, and so on, this order can be a tremendously useful tool.

A sure way to lose big money is to hang on to an investment that’s losing money. Try not to involve yourself emotionally with your investment selections. One way to lower the likelihood of holding on to an investment for too long is to develop a few personal selling rules. Write your personal selling rules in your investment plan and store the plan on your computer’s hard drive. If you’re thinking about selling an investment, use these rules to compare your current state of mind with what has worked for you in the past. Your personal selling rules may state, for example, that you should sell the stock if any of the conditions in the following sections occur.

The stock drops below your predetermined trading range
This selling technique is called scaling out. In other words, it is a structured selling method based on your predetermined trading range. For example, you can sell stock at predetermined levels as it goes up, say 20 to 25 percent of your investment at a time, securing profits along the way. Each time you sell 20 to 25 percent, the average cost of the stock remaining decreases, protecting you from the effects of a sudden possible decrease in the price of the stock. Some industry experts suggest selling any stock that increases by 30 percent above the original purchase price. In contrast, sell the stock if it drops below 10 percent of the purchase price.

Before you sell it, however, remember why you purchased the stock in the first place; then find out what changed and how it affects your portfolio. In the past, maybe the company was a market leader or the company had a new technology. Perform a post-sale analysis of the stocks that plan you sell. Determine the best time for selling by examining the tax consequences of
your actions. For more about how you can avoid profit wipes-outs due to capital gains taxes, see the last section of this chapter.

You discover that the company’s relative strength is flat or trending downward

Relative strength is how the company compares with the market or operates in the current market environment. (When researching, you often discover the relative strength number calculated for you.) Check out the relative strength of the stock’s performance over the latest 12-month period. Compare this number with other stocks’ numbers to determine whether your stock is a loser. Low relative strength ratings are often the first red flags for sell candidates. The rating scale is between 1 (lowest) and 99 (highest). Stocks rating 70 or lower may be laggards and potential sell candidates.

You recognize that the industry is in a serious downturn
To recognize a downturn, you must watch the company, the industry, and the sector rather than just the stock price. Management changes can also adversely affect stock prices. Sell the stock if the company shows signs that it may not produce the earnings or sales growth you originally expected when you purchased the stock.

You determine that the company is in decline
Even great companies are cyclical — that is, they have up periods and down periods. Sometimes you can purchase shares at bargain prices, and other times you buy shares that are overpriced. In general, all companies are affected by the economy and have selling cycles. Some stocks trade with a low P/E ratio even if the company is earning money. These low P/E ratios indicate that investors fear the company’s earnings will decline. These fears, which may be based on new competition in the marketplace, can also adversely affect earnings growth and long-term prosperity. For example, does the company rely on one single product whose life cycle or patent may be running out? If so, consider selling this stock and replacing it with a similar stock that has more promise.

You discover that the company’s profitability or financial health is in trouble
If profit margins and the financial structure of the company seem to be weakening, you should consider selling. That is, sell if the stock shows belowaverage profitability compared with the industry standard or other selling standards based on the firm’s financial statement. For example, determine whether the stock has three years of earnings that are up 25 percent or more and a return on equity ratio (ROE) of 17 percent or more. Use a selling standard that meets your required rate of return. If the stock doesn’t meet your standards, sell it.

Market experts call the company “steady” or dividend increases are behind the general market
Some investors seek earnings growth (net income for a company during a specific period, usually after-tax income) of at least 10 percent per year. Determine the amount of returns you can expect over the next five-year period. Make your best estimate of earnings and discount them heavily if you expect the market to be depressed. (See Chapter 8 for details.) Keep in mind that, because of market volatility, your estimates may be subject to big errors. Compare your results with your own required rate of return (which is different for each investor). Is the stock worth holding if that’s your potential gain? If not, it’s time to sell.

Company insiders are selling in the public marketplace
Insiders are individuals who own 10 percent or more of the company and are required to report all their company stock trades. If insiders are selling their shares in the company or if the company is purchasing its own shares — both activities that may indicate future financial problems — you might want to sell.

Rebalancing Your Portfolio: Which Winners Should You Sell?

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Over time, your portfolio will go out of alignment if it’s not actively managed. Rebalancing and allocating your assets can assist you in reaching your financial goals. Selling securities to rebalance your portfolio can be difficult because you have to “prune” some of your winners. In other words, to keep your portfolio in balance, you might have to replace some of the investments you have grown to count on. You can use online portfolio trackers to unemotionally
determine which investments need to be pruned. Most online brokerages include portfolio tracking; however, what’s offered by your brokerage may not meet your specific needs. Here are a few examples of what you can find online:

GainsKeeper provides accurate cost basis, capital gains tax data, and trade decision tools that can maximize aftertax returns. GainsKeeper allows you to import your portfolio from your broker, MS Money, Quicken, or Excel files. You can export results to Excel files, TurboTax, TaxCut, and other tax software programs. Expect to pay $49 to track 100 stocks and $140 to track 1,000 stocks.
Morningstar.com offers Premium Membership, which includes analyzers that can help you understand the tax and cost consequences of replacing a security within your portfolio. Additionally, you can discover a plethora of online asset allocation tools that can help balance your holdings, determine your optimum asset allocation, and uncover the risk in your portfolio. A free 14-day trial is available, and subscriptions are $12.95 per month, $115 per year, or $199 for two years.
Reuters requires your free registration to take advantage of the portfolio tracker. The Reuters portfolio tracker is easy to use and allows you to set up multiple portfolios with on-demand research for domestic and international stocks, U.S. funds, and cash. You can edit your portfolios by adding or deleting companies and changing investment amounts or shares. You can view your portfolios by performance (How is the portfolio doing?), fundamentals (How do my investments compare?), valuation (Am I making any gains or losses?), and daily action (Do I need to make a trade?). Help icons provide additional information about portfolio functionality.
Risk Grades is based on a complicated scientific formula for calculating the risk of your investments. With your free registration, you receive five portfolios, graphing features, risk versus return analyses, risk alerts, “what-if” analyses, and historical event simulations. Using these tools, you can determine which investments are beyond your risk-tolerance level. Additionally, you can determine whether you’re beingproperly compensated for the investment risk you’re taking.

Setting Profit-Taking Goals

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Realizing your profit is what investing is all about. Paper profits may look good, but money in the bank is what pays for your child’s education or enables you to retire early. If your stock is selling for a high price and is now a large part of your portfolio, you might want to sell.

What’s more, if you’re contemplating selling the stock, you don’t want to sell before the stock reaches its peak. In other words, you want to sell at the best price, before the stock starts to decline. What should you do? The following list gives you some ideas:

Suppose that you purchased your shares in 1996 and, despite market downturns, your stock is currently selling for 50 percent more than your purchase price. If the stock isn’t likely to go any higher, you may want to take the money and run.
Set a target price that might not be your sell price but will be a benchmark. If your stock reaches the benchmark price, reevaluate your investment plan. Make certain that you check similar companies to see whether they’re selling at the same level or higher. If so, you might want to raise your target price.
If a winner now represents more than 10 percent of your portfolio, you might want to sell part of your holdings. That way, you lock in part of the profit and still benefit if the stock keeps rising.
Don’t try to sell at the stock’s top price. You didn’t buy at the bottom, so don’t expect to sell at the very top. Even after all your analyses, you still need to rely on your gut feelings about the right time to sell.

You Can’t Be Right All the Time

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Selling a loser is often harder than selling a winner. If you purchase a stock with a certain expectation, but the company never lives up to your expectations, you should sell. The following list provides a few examples of such situations:

You may want to consider selling a stock if it declines 20 percent in a down market and 10 percent in an up market. If a stock drops 15 percent in a flat market, reevaluate.
The company’s growth rate and earnings trends peak and then fall.
The company cuts its dividend or stops dividend payments entirely.

If you sell a loser, note exactly why it didn’t turn out as expected and include these notes in your investment plan. Such documentation helps you avoid making similar mistakes in the future.

Everyone expects strong performers to keep up the pace. Past performance, however, doesn’t guarantee future performance. For more information, see the article “Do Past Winners Repeat?” at the Investor Home Web site.

If the Stock Is Going Nowhere, Get Going

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If the stock or fund in which you invested is a mediocre performer, you need to replace it. You may not want to rush to judgment, however. Give the company about a year to make any needed changes to bring its performance up to speed. If you don’t see any improvement at all, sell it.

You can tell whether you have a nowhere stock by comparing it with the appropriate index; see Chapter 8. If the index consistently matches your nowhere stock, consider selling. Doing so frees up funds for you to purchase better performers. If you don’t have any great investment candidates, think about spreading the proceeds among your portfolio’s best existing ideas. Or,
better yet, just hang in there — a good investment opportunity is likely to appear sooner or later.

To beat the crowd, get some help from The Online Investor.

Don’t Be Fooled by P/E Spurts

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Be suspicious of sudden jumps in the P/E (price/earnings) ratio, which may indicate that the stock is headed for a fall. Soaring P/E ratios and depressed dividend yields can be signs that market prices are unstable. Consider selling if the P/E ratio rises more than 30 percent higher than its annual average for the last ten years. Suppose that the P/E ratio for the last ten years is 20, for example, and then it suddenly climbs to 26. Consider selling the stock. (On the other hand, don’t sell stocks that are in a temporary sinking spell.)

Watch Interest Rates

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Bond investors must anticipate the turns and directions of interest rates. If interest rates increase, bonds and bond fund prices decrease because buyers are less willing to purchase investments with lower rates than those stated on new bond issues.

Bonds with longer maturity terms lose more value if interest rates continue to climb. Bonds are subject to inflationary expectations, monetary demand, and changes in short-term interest rate expectations. Thirtyyear bonds purchased in the ’70s, for example, lost approximately 45 percent of their value after interest rates increased in the ’80s; for details, see Chapter 13. Keep in mind the following principles for a personal selling system:

Rising interest rates tend to divert money from the stock market and depress stock prices.
Low interest rates usually indicate a good time to own stocks because the economy grows as a result, and stock prices are sure to increase.
Declining interest rates indicate less fear of inflation.
Income stocks are often more sensitive to changes in interest rates than are other types of stocks.

Keep an Eye on Economic Indicators

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From December 31, 1948 to December 31, 1998, U.S. inflation has averaged 3.9 percent a year. Investments such as certificates of deposit (CDs), Treasury securities, agency bonds, and corporate bonds are fixed-income investments; their yields don’t vary regardless of the inflation rate. Over the long term, therefore, low-yielding fixed-income securities can lose out to inflation.

Stock market declines often precede economic recessions. Indications of an economic slump may suggest to you that you want to get out of the market. Stock prices often rebound at the end of a recession, however, which argues against selling during a recession.

For more information about what to look for in economic data, see the CBS
MarketWatch Web site .

Sell When the Insiders Sell

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Do you want an inside tip? Watch what insiders do with the stocks for their own companies. The SEC requires that officers, directors, and shareholders owning 10 percent or more of the company’s stock report their trades. These reports are readily accessible on the Internet.

Insiders trade shares so that they can purchase shares by using the options that they receive as part of their employment contracts. Additionally, if the stock’s value is significantly different from its selling price (either higher or lower), you see lots of insider trading activity. High sales activity by insiders may foreshadow a financial debacle. Consider selling your own shares if such
trading occurs (especially if the sale price is decreasing).

For a daily report of insider trading, see Yahoo! Finance. Look up a quote for the company you’re researching and click Insider Transaction in the left margin for a list of the most recent insider trades. Keep in mind that some of this data may be delayed.

Get Out if the Company or Fund Changes

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The company in which you own stock may have changed its core business since your purchase, or the fund may have changed its objectives or increased fees. You need to think about the original reasons you purchased a company’s stock or a mutual fund. If the investments no longer meet these criteria, your best bet is to move on.

Similarly, if your own financial situation changes, you might want to sell some or all of your investments. A good reason to do so is if your risk-tolerance level changes; for example, you’re getting close to retirement or your child is
about to start college.

Have you witnessed a material change in the company? For the latest news,
see MSNBC or Yahoo! Finance .

A Final Word about Stopping Profit Wipe-Outs

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Selling your investments at the wrong time can result in Uncle Sam receiving a big chunk of your gains. When deciding which investments to sell, you should take into consideration the tax consequences of your decisionmaking. However, don’t forget the elements listed earlier in this chapter. After all, the best strategy is to make good investments, hold on to them,
and maximize your returns.

In December of each year, look at your portfolio and determine whether it still fits your long-term financial objectives. Over the last year, some of your investments may have shifted. The shifting of these investments and your long-term financial objectives can result in a mismatch. Calculating the tax consequences of selling these particular securities might help you decide
whether now is the right time to sell or to hold.

Capital assets are defined as any property you can buy and sell. A capital gain occurs when you sell an asset for more than what you paid for it. Conversely, a capital loss happens when you sell an asset for less than what you paid for it. Table 19-1 shows a simplified view of how you calculate the basis for your capital gains. The first row gives the sales price of the securities. The second row shows how the original cost of the asset is deducted from the sales price. The third row lists the brokerage fees for buying and selling the securities that was deducted from the proceeds. The fourth row shows the net gain.

You can hold your capital assets until the cows come home and not have to pay any taxes. However, the minute you sell, all your deferred capital gains (or losses) are taxed at your personal capital gains rate. There are two types of capital gains rates:

Short-term capital gains: Capital assets owned for less than a year and sold for a capital gain (that is, more than their purchase price) result in a short-term capital gain. Short-term capital gains are taxed as ordinary income (at your regular tax rate).

Long-term capital gains: Capital assets held for more than a year and sold for a capital gain are taxed at a maximum rate of 15 percent (if your marginal tax rate is 25 percent or higher). If your marginal tax rate is 10 or 15 percent, your long-term capital gains are taxed at 5 percent. (Note: These capital gains rates are scheduled to remain in effect until 2009).

Table 19-2 shows the impact of the capital gains tax on an investor in the 35-percent tax bracket. Table 19-2 illustrates how the investor sells $30,000 worth of securities. The investor’s personal tax rate is 35 percent. The next row shows how the securities are taxed at the appropriate capital gains tax rate. The last row illustrates the tax liability for the sale of the securities. To sum it up, Table 19-2 shows how the investor saves $6,000 if he has a longterm gain.

For more information about the tax consequences of selling your securities, see these Web sites:

InvestorGuide offers a quick tutorial about taxes and your investments. Discover the ins and outs of how to calculate the cost basis of your securities.
IRS Tax Tips for Capital Gains and Losses offers a brief account of how exemptions from capital gains are calculated and when you should pay taxes on capital gains. Additionally, find links to in-depth coverage of the capital gains rules for mutual fund distributions, investment income and expenses, and the sale of investments.
SmartMoney.com, as part of its Personal Finance section, offers a guide to assist you in estimating your capital gains liability. The guide also includes a Capital Gains Tax Estimator. Just plug in your gains and losses for the investments you sold last year to figure out the taxes you owe.

Chapter 20 - Ten Green Flags for Buying

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______________________________________________________
In This Chapter
Buying low so that you can sell high
Checking out earnings forecasts
Watching for bargain stocks that are trading under book value
Selecting a P/E ratio strategy that works for you
______________________________________________________
More Americans own equities than ever before. According to the Securities Industry Association a total of 84.3 million individuals owned equities (stocks) in early 2002 — about 49.5 percent of all American households, a total of 52.7 million households. This number is a big change from 1983, when only 42.4 million individuals owned equities. Despite all this popularity, equities have a serious drawback: They don’t offer the security of interest-bearing investments (market funds, CDs, and fixed-income securities).

Interest-bearing securities offer consistent returns. In contrast, stock price fluctuations just “happen.” Every stock investor can count on market increases and decreases. These fluctuations aren’t company-specific, but that fact doesn’t offer much comfort. Over time, stock investments tend to reward patient investors with good, inflation-beating returns that are greater than those of any other type of investment. For many individuals, investing is the only way to reach their financial goals.

Over the years, avid investors have developed many methods to help others decide which stocks to buy and when to purchase them. No hard-and-fast rules exist. The approach that’s best is the one that works for you. The following sections offer a collection of investor wisdom that can assist you in maximizing your personal wealth.

Digging Out of a Recession with Dollar-Cost Averaging

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Many investors have learned that markets can decline as fast as they can increase. Frequently, a recession causes these market turnarounds. The National Bureau of Economic Research (NBER), located at www.nber.org, defines a recession as two or more quarters of negative gross domestic product (GDP) growth. The NBER documents the beginning and ending of recessions. Many companies (such as automobile manufacturers) have business cycles that are closely related to the GDP. For companies that are linked to the GDP, a recession means a reduction in sales and earnings, which in turn affects the profits of individuals who have invested in these companies.

Understanding that the economy may be affecting the future performance of an investment candidate and factoring this information into your buying decision can be difficult. Ideally, you want to buy low and sell high. Some economic reports can assist you in predicting upturns. In other words, referring to these reports can help you get ready to buy. For example, if the consumer confidence survey (www.conference-board.org) shows an increase, the market may be improving; employment increases for two consecutive months (www.bls.gov/home.htm) may indicate an upturn; and the Census Bureau (www.census.gov/ftp/pub/indicator/www/m3/index.htm) showing a consistent rise in capital-goods orders may be a predictor of a stronger market.

What if there are no clear indicators of the market moving upward or downward? In this situation, the dollar-cost averaging approach is the best way to get back into the game. The dollar-cost averaging approach is used when you regularly invest a fixed sum. When stocks are down, you buy more. When stocks are up, you buy less. Use your online broker, a direct purchase plan, a low-fee direct purchase plan (such as ShareBuilder), or buy no-load mutual funds (for example, from Charles Schwab), which may let you invest as little as $50 per month.

For a $4 monthly brokerage fee, ShareBuilder (www.sharebuilder.com) allows you to purchase the stocks you want and to automatically deduct
the amount you select (it can be as little as $25) from your checking account.
For the more affluent, Charles Schwab (www.schwab.com) has a similar plan; if you invest $500 per month in a no-load mutual fund, you pay no quarterly maintenance fees. Maintenance fees are $45 for accounts under $5,000 and $30 for accounts under $50,000.

Buy If the Stock Is at Its Lowest Price

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“Buy low” is easier said than done. Excellent investment candidates are stocks that are selling at their lowest price in three to five years (assuming that the company’s financial position hasn’t deteriorated). Wait for the price to stop declining and the company to show some strength, however, before you put your money down. You must condition yourself to work against the crowd. For free, delayed quotes and online company reports, see Reuters at www.reuters.com. At the home page, click Investing and then click the appropriate link in the left
margin for the data you seek.

Invest in Companies with Beautiful Balance Sheets

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Carefully analyze a firm’s financial statements before investing. The only way to determine a company’s true financial situation and to evaluate the potential risk of investing in the firm is to do your homework and look behind the numbers:

The statement of cash flows: Does the company generate more cash than necessary to sustain the business? Does it look like this situation will not change for several years? If so, you may have found a winner.

A change of auditors: Some firms use aggressive accounting standards that may require them to restate their earnings. If a firm has to restate earnings, the value of the stock usually decreases.

The financial statement: If you don’t understand the financial reports, don’t buy the stock.

-To find the latest financial news on publicly traded companies, see the following:

The Wall Street Journal (www.wsj.com): An annual subscription costs $79 for the online edition, with two weeks free.
CNN/Money (money.cnn.com): Gives free information.
CBS MarketWatch (cbs.marketwatch.com): This site requires your free registration for more in-depth content.
Investor’s Business Daily (www.investors.com): This site requires your free registration for most of its content.

Check Out the Earnings Forecast

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People use earnings forecasts in fundamental analyses to determine the fair value of a stock. If this fair value is less than the stock’s current price, the stock is overpriced. If the fair value is more than the current price, the stock might be underpriced and therefore a bargain.

Financial software developers and most brokerages have analysts that develop earnings forecast for companies. Prices for these reports vary from free to several hundred dollars. The Internet provides many sources for earnings forecast reports:

123Jump (Investing Newsletters) provides free earnings upgrade and downgrade information in addition to other related information.
MSN Money provides earnings reports, earnings forecasts, and earnings surprises of publicly traded companies.
Stock Wiz Links provides a links page for company information. Just enter the ticker symbol of the company you’re researching, and you have your choice of hyperlinks to quotes, news, broker recommendations, research analysts’ earnings estimates (and actuals), company profiles and fundamentals, SEC filings, and intraday charts.

Watch for Stocks That Are Trading under Book Value

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Book value is the company’s net asset value — that is, assets minus liabilities divided by the number of outstanding shares. This amount appears in the company’s annual report. See the Reuters and use its high-powered stock screen to find companies that are trading below book value. Then go to the Securities and Exchange Commission and read the annual reports of likely investment candidates. Companies that sell below book value (if they don’t have serious problems) are often bargains.

Look for Strong Dividend Pay-Out Records

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Income stocks tend to hold their value in volatile markets because investors are confident that they’re going to continue to receive sizable dividends.

To find companies that investors categorize as income stocks, see Reuters Ideas & Screening . Reuters has developed a screen for income stocks. The screen seeks yield and companies that have realistic expectations of how much they can grow, how much capital they can productively reinvest into the company, and how much they can pay out to shareholders. Scroll down to the bottom and click the Daily Results of This Screen link to see the daily results. The 50 income stock candidates can be downloaded to your Excel application program for further research, or you can use the results for additional sorts using Reuters Power Screener.

Seek Out Firms with Low Debt Ratios

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Usually, the lower the debt ratio, the safer the company. Compare the company you’re researching to similar firms. Get an industry report from BigCharts and discover the average debt ratio for the industry. Compare this average to the debt ratio of the firm you’re researching. To discover which firms have low debt ratios, use the online stock screens at MSN Money . Use the Basic or Deluxe stock screeners to find companies with low debt equity ratios. Remember that companies that have paid down their debt over the last two or three years may be up-and-comers — and well worth your serious consideration.

Invest in Industry Leaders

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If you investigate a company in a specific industry, determine which companies are growing the fastest in that industry and which ones are the industry leaders. By focusing on just these two elements, you’re likely to reduce the number of investment candidates for your consideration in this industry by 80 percent. You also discover that

Many companies in the industry have no growth or display lackluster growth.
Older companies have slower growth rates than do younger companies.

Remember that investing in industry laggards seldom pays, even if they’re amazingly cheap. Look for the market leader and make certain that you have a good reason to invest in the industry in the first place. Additionally, be aware that all industries have cycles of growth; you want to invest in an industry that’s in an upswing. For industry surveys and reports, see Value
Line Investment Surveys .

Buy Good Performers

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Try to buy for value and not for price. Select companies that regularly outperformed their competition in the last three to five years and that have consistent rather than flashy returns. Also consider the following guidelines:

Check the company’s stability and examine its five-year earnings record.
Keep in mind that an annual percentage increase is desirable, but so is stability and consistency over the past five years’ earnings.
You may want to consider not including a company’s one-time extraordinary gains in your calculations.
Determine whether the company’s annual growth rate is between 25 percent and 50 percent for the last four or five years. If so, it may be a winner.

Don’t try to chase after last year’s high performer; it could be this year’s loser. Double-check what you want. For company reports, see CAROL , which provides Company Annual Reports On-Line from companies in the United States, Asia, and Europe. Your free registration is required.

Select Your P/E Ratio Strategy

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Any analysis of investment candidates includes P/E (price/earnings) ratios. The importance of these ratios varies from analyst to analyst. The following sections describe two strategies that are worthwhile to consider. Select the one that works best for you. (See Chapters 8 and 9 for additional information about P/E ratios.)

Low P/E and high dividend approach
Long-term investors often employ the 7 and 7 approach — that is, they purchase stock in companies with a P/E ratio of 7 or less and a dividend yield greater than 7. Additionally, if the company’s P/E ratio is lower than 10, and the earnings are rising, you may have found a winner. Make certain by investigating the security, however, that no major long-term problems exist that can drive the P/E to 4 or lower. (See Chapters 8 and 9 for details.)

High P/E ratios are worth the price
You often get what you pay for; consider the following example: From 1953 to 1985, the average P/E ratio for the best-performing emerging stocks was 20. The Dow Jones Industrial’s P/E at the same time averaged 15. If you weren’t willing to pay for the stocks that were trading over the average, you eliminated most of the best investments available. In other words, sometimes it doesn’t pay to be frugal. Investors who bit the bullet and bought the bestperforming emerging stocks were overwhelmingly rewarded for it in the next several years for their timely purchases.
For more information about how to use P/E ratios in your stock buying analyses, visit the Investorguide Web site .

2008-09-25T03:40:00.000-07:00

The stock market has always been a centerpiece of the American financial scene. With a balanced portfolio that includes stocks you can make a relatively quick profit or save for retirement—if you know what you’re doing.
Whether you’re a beginner that wants to take a crash course on stock investing or you’re already a stock investor who would like to review your current situation, Stock Investing For Dummies has valuable lessons to offer.
Stock Investing For Dummies will give you a realistic approach to making money in stocks. It offers the essence of sound, practical stock investing strategies and insights that have been market tested and proven from nearly a hundred years of stock market history. This book will help you succeed not only in up markets, but also in down markets.