How to never pay overdraft fees on your ATM or debit card again

It can be hard to track how much (or little) money you have in a savings or checking account, especially when you make frequent cash withdrawals or debit card purchases.  For this reason, evil banks (which is all of them) institute outrageous fees, often charging you $25-$35 per overdraft transaction.  I’ve heard horror stories where banks have arranged the order in which a day’s worth of transactions occurred to maximize fees.  You could charge $5, $15 and then $40 in one day with a beginning balance of $35, and the bank would structure it so that instead of paying one fee (the $40 when you have $20 left after the first two transactions), FIRST they count the $40, triggering an overdraft fee, then two more fees for the $5 and $15 transactions!  Pure.  Evil.

While you can (and should) always call to reverse these charges, wouldn’t it be better to have them never occur in the first place?

Fortunately, there’s a very simple and painless way to accomplish this.  Just pick up the phone and call your bank’s customer service number on the back of your ATM/debit card (have your account number(s) handy.)  Ask them to make it so that your accounts can never be overdrawn when you use your ATM/Debit/Check card (writing checks will still allow others to overdraw your account, which is good because you don’t want checks to bounce!) Checks will bounce if they overdraw your account, and they are potentially a few other issues (see my confirmation letter below from my bank for details.)  They’ll fill out a form and send it in on your behalf.  Once that goes into effect, you will be unable to overdraw your account.  I recommend also asking them 1) how long it will take to go into effect and 2) to notify you with a confirmation letter or email when it does.

This will make it so that if you don’t have the money, your ATM or debit transaction will be denied until you put more cash into your account.  This is the simplest and best way that I know of to protect yourself from these obnoxious fees.  I called Bank of America to have them do this for me and it took about 10 minutes, so make the call as soon as possible and never worry about overdraft penalties again.

[For those of you trying to eliminate credit card debt by switching to cash/debit card-only shopping, this is a vital step in helping you succeed by forcing you within certain cash limits while avoiding pesky fees.  (Scroll down to page 40 of Ramit Sethi’s book here for more on how to get rid of your credit card debt.)]

UPDATE: Here’s a copy of the confirmation letter that Bank of America sent me when I eliminated my overdraft fees.  They lied to me (likely out of incompetence, not malice) and told me my checks would still go through instead of bounce.  This is apparenlty NOT true.  Thus, I recommend keeping your ATM/debit card account separate from your checking account.  (Or switch all your payments to electronic or cash like I do.)

Posted in Banking. 1 Comment »

Guide to buying and owning a car

I'm lovin' it

Consider total costs of ownership

Make sure that when you shop for a car you consider not only the price (negotiated as low as possible, using this recommended service),  but also financing (loan interest), maintenance, gas mileage, how long the car will last, what it will cost you to insure it and headaches (i.e.: things that will annoy you about your vehicle because it breaks down, doesn’t attract enough chicks, etc.)

Buy a used car (and try to pay cash for it if you can)

A new car loses about 15% of its value the minute you drive it off the lot, and much more after the next couple years.  Since that’s the case, it makes better financial sense to buy a used car, even if it’s relatively new (say, 2-3 years old.)  I also recommend saving up and paying cash for your car.  This forces you to care more about the price, since it’s painful to pay that much money at once.  In addition, you save a bunch by eliminating the costs of financing.  For example, a 10 year loan for $10,000 at 7% would cost you about $4,000 in interest over the life of the loan.  That’s 40% tacked on to the price of the car!

For new or used car buying info, check out the Motley Fool’s guide, and also prices on Edmunds or Kelley’s Blue Book (although I find that the blue book values tend to run a little high.)  If buying used just isn’t for you (Ramit Sethi makes a good case for new cars here), at least follow the next rule:

Drive your car until it has at least 200,000 miles on it before getting another one.

Consumer Reports estimates that you’ll save the price of a new car by driving your car into the ground.  Implicit in this rule is that you must have a reliable car that will last you this long.  Toyota and Honda* both make moderately-price vehicles known to reliably last this long (although the American companies have narrowed the gap in the last 10 years or so.)

Read the owner’s manual and keep up with maintenance to keep your vehicle running well.  (Washing & waxing your car, plus keeping the inside clean, will make it look nicer too. This may encourage you to avoid ditching it just to have the latest model.)

* From Consumer Reports:

Consumer Reports’ “Good bets” for making 200,000 miles: Honda Civic, Honda CR-V, Honda Element, Lexus ES, Lexus LS, Toyota 4Runner, Toyota Highlander, Toyota Land Cruiser, Toyota Prius, Toyota RAV4

Consumer Reports’ “Bad bets” for making 200,000 miles: BMW 7-series, Infiniti QX56, Jaguar X-type, V8-powered Mercedes-Benz M-class, Mercedes-Benz SL, Nissan Armada, Nissan Titan, Volkswagen Touareg, V6-powered Volvo XC90.

URGENT: Haiti needs your help – Take action by donating right now online

[UPDATE: We’ve collectively donated $1415 to date, $585 more to hit the goal of $2000! Please donate and then answer the poll with however much you can spare.]

You are probably aware of the massive humanitarian disaster in Haiti as a result of a 7.0 magnitude earthquake.  An estimated 50,000 people are dead with 2.5 – 3 million people affected by the disaster.  Probably the easiest way to help immediately is by sending money to a relief organization to help out.

It’s important to me to ‘give smart’ and make sure charity dollars go to organizations that make the most of them.  For this, has created a list of charities providing help to Haiti with ‘grades’ of each charity.  Find one that you like and donate whatever you can to help the relief effort (and replenish funding for the next big disaster, whatever that ends up being.)

The internet has become a powerful source of fundraising.  Take advantage of this opportunity and help out the decimated population of Haiti by donating to one of the links below, all of which received ‘A’ ratings from and are providing direct relief to Haiti.  Remember, ANYTHING you can spare helps (the more the better, of course, but the key thing is just to donate SOMETHING):

International Medical Core (Disclosure: my wife and I donated to them) (A+ from

Doctors without borders (A from

As a way of measuring the positive impact of readers like yourself, I’ve put a poll at the bottom of this post.  Please update it with whatever amount you’ve donated (it’s all anonymous.)  I’ll add it up and post the results periodically (if anyone knows of a free polling/survey utility that will add up responder’s numbers and display them, please let me know!)  Let’s try to hit $2,000 at least; that’s $20 from 100 people, $50 from 40, or $100 from 20.  Please join me and the rest of the ‘Words of Ward’ community in doing your part to help those in desperate need.

Transfer money to someone internationally for 0.5% on PayPal

If you have friends, family or business associates living abroad, you may have found it difficult or expensive to transfer money.  PayPal seems to offer a cheap solution HERE.  If you transfer the money using funds in either your PayPal account or bank account (linked to PayPal), the cost is 0.5% of the transaction (at least for denominations of a few hundred dollars.)

I haven’t completed a transaction yet, but apparently you’re shown the exchange rate when you choose to send the money internationally.  My only other question would be how good of a rate you get, but I would assume it’s pretty close to the rate banks and credit cards receive (which I believe is the best you can get.)

If anyone has used PayPal to send money internationally, please comment with your experience and/or the exchange rate you received!

Intro to Investing (asset allocation, stocks, bonds and more!)

After understanding where you should put your money, you need to know WHAT to put it in.  The ‘what’ question is first one of ‘asset allocation’, which is just a fancy way of saying what kinds of things you should buy as investments.  These categories, or ‘asset classes’, are broadly defined as either financial instruments (stocks, bonds, cash) or property (real estate, gold coins, mint-condition Amazing Spider Man comics.)

Spidey notwithstanding, the only categories you really need to consider* are stocks, bonds, and cash instruments (savings accounts/CDs/money market funds.)  These 3 asset classes span the gamut of risk-reward such that you can use a combination of them to plan for ALL of your financial needs.  In general, the more ‘risk’ (how much the value of your investment goes up and down over time) in an asset class, the higher the expected return.  Therefore, one would expect stocks, the most volatile investment, to have the highest rates of return, and safer things like bonds or cash to have the lowest.

If you look at the graph below, taken from finance professor Jeremy Siegel’s excellent book Stocks for the Long Run, that’s exactly what you’ll see.  The graph shows the total real returns for stocks, bonds, treasury bills (approximating money market funds or CDs), gold and cash (= money earning 0% interest, like your checking account.)  ‘Real’ means that these returns are adjusted for inflation, a force which eats away at the spending power of your money.  This is an important adjustment because what you really care about as an investor is how much stuff you can buy with your dollars, not simply how many bills you have.

From this we can see that ultra-safe treasury bills would’ve increased your savings by 300 times, with pretty-safe bonds increasing them over 1000 times.  This sounds pretty good until you look at stocks, which increased the purchasing power of $1 by over 755,000 times, or 755 times that of bonds.  This incredible result demonstrates the power of stocks as a long term investment vehicle.

For this reason, I recommend that any savings you don’t need in the next 5 years be placed in stocks.

You might be a little more conservative with this rule if you were approaching retirement and all of your wealth was tied up with investments.  In that situation you might then extend the time frame rule of thumb to money you don’t need in the next 5-10 years.  Keep in mind though that if you can afford to take a little more risk (like if your house is paid off and/or you have some fixed income in the form of a pension or a healthy amount of social security), on average it pays to weight your portfolio more towards stocks.

There are some important conclusions from this rule: if you’re still 5-10 years from retirement, ALL your retirement funds should be in stocks.  When you’re young, and even middle-aged, you need to be aggressive in your asset allocation by putting your wealth into stocks.  Yes, stocks go up and down a lot in the short run, but in the long run, they clearly outperform everything else.

Say you’re 30 years old and plan on retiring at 65.  If you have a portfolio that represents the entire stock market and the market gets cut in half tomorrow, should you lose any sleep?  Absolutely not!

What does it matter to you what happens to the stock market in the next 30 years as long as you insure yourself against permanent loss by having a well-diversified stock portfolio? (We’ll talk about the best way to diversify in the next article.)  All you care about is what the value of your investment is at age 65.  Anything that happens in between shouldn’t bother you one bit.  There’s an easy way to avoid this stress; don’t check your retirement balance more than once every year until you get close to retirement.  Instead, focus on what you can control and pump as much money as you can into your 401k/IRA.  (Calculate how much you’ll need to save here.)

As another ‘Stocks for the Long Run
‘ table shows below, real stock market returns have been an incredibly robust ~7% per year through periods of war, depression, oil shortages, double-digit inflation, terrorist attacks, and industry bubbles.

Hopefully by now I’ve convinced you of the absolute necessity for your long-term money to be in stocks.  That still leaves the question of short- and medium-term (< 5 year) savings.  For these savings, you want a stable investment so that you’ll know how much money you’re going to have by the time you need to use it.  As you can see below, stocks almost always outperform bonds over long time periods, but not as much over short ones.

Short-term savings (< 1-2 years): Use an online high-interest savings account like this one from INGDirect (or find one on  High-interest savings accounts typically return about 5 times the interest of a brick and mortar savings account.  Plus, ING allows you to create multiple accounts to track each of your short-term savings goals (travel fund, plasma TV, emergency money, etc.)  You can setup automatic deductions from a checking account to fund these savings goals on a regular basis.  Say you want to save $4000 for a trip to Europe one year from now.  Divide the amount of money you need by the months until you need it.  In this case, that would be $4000/12 months = $333 per month.  That’s how much you need to save each month to hit your goal.

Medium-term savings (1-5 year): If you really want to optimize your savings, use a bond index fund like Vanguard’s VBMFX for medium-range goals.  The reason for adding this complication is because bond funds typically earn a couple of percentage points more than high-interest savings accounts, in exchange for a small amount of volatility over time.

If it sounds overly complicated to have separate types of funds for short- and medium-term savings, make life easy for yourself and just use a high-interest savings account for medium-term savings goals as well.  These might include your future wedding expenses or a house downpayment.  Use the same calculation for medium-term goals as I demonstrated above for short-term ones.  These are really important (and simple) calculations to do; they often show you that you need to start saving more money each month than you already are.  (Start here to get 30 excellent tips that can save you big bucks.)


Now that you know how to allocate your assets, you need to know exactly what to invest in.  I answered that in this post for short- & medium-term investments (< 5 years.)  I showed you that for long-term investments, stocks are clearly the way to go, but the question remains, how should you go about investing in stocks?  Should you buy that hot mutual fund you read about, or maybe individual stocks like Google or Walmart; what about investing in foreign companies versus US-based ones?

Read the next article for what may be the only long-term investment choice you’ll ever need.

* Many people might clamor for real estate to be added to this list.  Contrary to popular opinion, real estate has been a terrible investment over long periods of time, appreciating roughly with inflation (ZERO real return.)  From 1975 – 2008, real estate appreciated at real return of 1% per year, versus 2% for risk-free treasury bills and 8% for stocks.  Owning property means paying many expenses like property tax, homeowner’s insurance, maintenance and large transaction fees (like closing costs of ~6% when selling your home.)  Also, real estate is very illiquid, meaning it is hard to turn it into cash; the only way to do so is to sell it.

If you needed money in a hurry you can sell your stocks anytime the market is open instantly for about $10 per trade, whereas your house could sit on the market for months and not sell.  You should treat a potential home purchase as a place to live, NOT as an investment.  Even if you plan on buying property to rent it out, you still have to play landlord, or pay someone else to do it.  Buying a stock index fund, on the other hand, allows you to sit back and do next to no work while your money grows exponentially. [Back to where you left off]

The single best investment choice – Intro to Index Funds

In my last post I showed you why your long-term investments should be in stocks.  In this post I’ll tell you about what might be the only investment choice you’ll ever need.  Before we get into that, let’s go over the various options an individual investor has for participating in the wealth-creating machine that is the stock market.

Individual stocks

Picking individual stocks can be fun, exciting, and, for those of you who love to crunch numbers, very interesting.  Unfortunately, most individuals do very poorly at picking their own stocks.  We tend to buy when everybody is saying good things about the market, when prices are high, and tend to sell when everybody is pessimistic about the market, when prices are low.  Of course, this is completely contrary to the hard-to-follow stock market aphorism ‘buy low and sell high.’  To make matters worse, you’ll be competing against highly educated professionals with loads of experience and resources.  These guys do this all day and get paid very well for it.  Chances are, they know a lot more than you.

Even if you want to try and gain competency on your own, there’s a lot of work involved.  After coming up to speed by reading a TON of material on your own, you must keep up on your stock picks at least quarterly.  You should listen in on earnings calls, read the quarterly financials as they come out, and follow important news about the company’s business prospects and any major changes in its corporate management.

For those who still want to delve into the world of individual stock picking, read my primer here.

Mutual Funds

You might decide that you don’t have the knowledge, time or interest to pick your own stocks, so you might consider paying someone else to do it.  Actively-managed mutual funds are run by professional investors who try to beat the market by picking stocks.  In return, you have to pay them via an ‘expense ratio’, which is charged as a percentage of your invested assets, generally ranging from 1-2% per year.  This means that every year 1-2% of your money goes straight into the fund company’s pockets.  In addition to fees for managing the fund, some mutual funds charge ‘loads’, which are effectively sales commissions that occur when you first buy the fund (a ‘front load’) or when you sell it (a ‘back load’.)  These are often 3-5% of assets; quite a large chunk.  If you see a 12b-1 component of a fund’s expense ratio, that means they’re passing on to you the costs of promoting and advertising their fund to other potential customers.

If all those fees sound expensive, you’re darn right!  Of course, if these highly-paid managers actually beat the market (after taking all fees into account), it would be worth it.  Unfortunately, in any given year 60 – 80% of actively managed mutual funds fail to do just that.  You might then think ‘I’ll just look for the managers that do beat the market and pick their funds’.  The problem with this is that you can only look at past performance, which is often NOT a good indicator of future performance for a variety of reasons:

1) Luck – If you take 100 mutual funds, roughly half of them will underperform the market and roughly half will overperform due to sheer random chance.  (Actually, less than half will beat the market on average due to the fees we talked about above.)  Statistically, you would even expect several funds to beat the market for a few consecutive years, again, simply due to chance.

2) ‘Survivorship bias’ – Mutual fund companies know that investors (and rating companies like Morningstar) look to past performance for an indication of future returns.  Because of this, they close down funds which show poor performance, leaving only the out performers.  When you combine this with the luck factor, you realize that these ‘survivor’ funds are no more likely than the closed, underperforming funds to outperform in the future.

To take an example, pretend you were a mutual fund company that started with 24 funds.  After year 1, 12 are up, 12 are down.  You close the down ones (replacing them with new funds) and wait another year.  After year 2, 6 of the original 12 are up, 6 are down.  Close the down 6 and wait one more year.  After year 3, three funds have outperformed the market an amazing 3 years straight!  Now you heavily tout them in every investment publication you can find, inviting many investors to buy in only to see mediocre results afterwards.

3) Fund manager turnover and ‘style drift’ – Even if you were lucky enough to find a fund manager like Peter Lynch, he might leave a fund, leaving you no better off than you were before.  Similarly, a fund manager who was successfully using ‘value’ techniques might change his investing style to something that doesn’t work for him.  Many managers during the dot com bubble couldn’t resist the allure of high-growth tech companies like Cisco and Amazon.  They bought into stocks completely outside the realm of their expertise, and as a result, their investors lost a ton of money.  This switching of investing styles is known as ‘style drift’, and can make the most conservative fund more risky if your fund manager decides to ditch blue chips in favor of Russian gold mining or that new cold-fusion-developing penny stock company.

4) The market for mutual funds is pretty efficient – Let’s say you do find a superstar fund manager, the fees he commands don’t make his fund underperform, he sticks around, AND he stays on his game for profitable investing.  Now you have a sure winner, right?  Sorry, wrong again.  Good funds quickly become well known, and as a result, their prices get bid up by all the other investors clamoring to give them money.  In an efficient market, the price of the mutual fund will get bid up to the point where its returns should be on par with the general market going forward.  In fact, studies have shown that because of this overbidding of mutual fund prices, many funds with great past performances actually underperform the market going forward because investors have overestimated the fund’s worth.

This adds the following complication to successful mutual fund picking: you have to know something the majority of the market doesn’t in order to get into a good mutual fund and expect to outperform the market.

Given all these problems, it’s easy to see why actively-mangaged mutual funds underperform the market.  Jeremy Siegel, in ‘Stocks for the Long Run‘, has shown by how much these funds fall short of market benchmarks:

If we take out the ‘survivorship bias’ discussed above, we see that over a recent 26 year period, actively managed mutual funds have underperformed the market by over 1% per year.  That might not sounds like a lot, but if you invested $10,000 in 1971 at the market’s 11.55% you’d have $171.5 K by the end of 2006.  If instead you bought a typical mutual fund, you’d have $133.8 K, nearly $38,000 (22%) less!

Not only that, but if you take taxes into account, index funds perform even better.  The reason for this is that active managers are busy buying and selling stocks which generates capital gains (short and long-term) which creates taxes for you.  These taxes, not reflected in Siegel’s chart above, further depress your returns, unless your fund is in a tax-advantaged retirement account.

Now that we’ve shown that high fees from actively-managed mutual funds result in lower returns than the market, wouldn’t it be great if you could just buy the market at a low cost?

Index Funds

John Bogle of the Vanguard company set out to make it possible for investors to do just that.  While Vanguard is still the leader in low-cost index funds, many other major fund houses like Fidelity and T.Rowe Price have followed suit, giving investors myriad index choices.

Looking at recent history, from 2002 – 2007 the S&P 500 index outperformed 71% of actively-managed large-cap funds.  The S&P SmallCap 600 and S&P MidCap 400 outperformed 64% and 80% of actively managed small- and mid-cap funds, respectively, over the same time period.

There are numerous advantages to index funds:

Low fees – Since many index funds are comparable in terms of what they invest in, you need to look at expense ratios first.  A good index fund should have an expense ratio under 0.5%, the lower the better.  Vanguard’s major stock funds are currently at 0.18%, a fraction of the typical 1-2% fee charged by active  mutual funds.

Instant diversification – In addition to low costs, broad market index funds give you instant diversification.  An S&P 500 fund, for example, allows you to purchase 500 of the largest and most recognizable firms in the United States including Google, Microsoft, Wal-mart, McDonald’s, Nike and Disney.  If that’s not diversified enough for you, try a total stock market fund like Vanguard’s VTSMX which invests in over 3,000 US companies both large and small.

In addition to broad, US stock market indexes, individual investors can buy foreign index funds, sector funds, bond funds, etc.  Even though global markets have become more and more dependent on each other, experts still recommend diversifying your stocks across countries as well.  Jeremy Siegel recommends putting at least 30% of your assets into a foreign fund.  Since indexes are ‘capitalization weighted’, which means that the bigger a company is, the more the index owns of it, some investors also like to add small cap funds to their portfolio.  If you like, you can add 10-20% of a small cap index as well.

Here’s a couple of sample asset allocation schemes you could use (with Vanguard funds as examples; here’s a more general list of popular indexes), in order of simplicity:

1) Domestic market only – Total US stock market fund: VTSMX – 100%

2) Add foreign exposure – Total US stock market fund: VTSMX – 70%; Foreign stock market fund: VGTSX (= 50% European, 25% Pacific, 25% Emerging Market)- 30%

3) Add small caps – Total US stock market fund: VTSMX – 55%; Foreign stock market fund: VGTSX (= 50% European, 25% Pacific, 25% Emerging Market) – 30%; Small Cap fund: NAESX – 15%

Simplicity – It’s a piece of cake to use index funds to build a low-fee, diversified portfolio.  Best of all, you hardly ever need to check up on it (you should within 10 years of retirement at the very least.)  Just invest regular amounts in whatever asset allocation scheme you like (see above), repeat, and retire wealthy.  In addition to stocks, you can buy a bond fund for your medium-term savings (or just go with a high-interest savings account.)


Due to the underperformance on both individual stock pickers and mutual funds, index funds are the way to go for the vast majority of investors.  Even those who are very knowledgeable about financial markets do well to ignore the Jim Cramer’s of the world and focus on consistently building long-term wealth through a diversified portfolio of stock index funds.

“Over the [past] 35 years, American business has delivered terrific results. It should therefore have been easy for investors to earn juicy returns: All they had to do was piggyback Corporate America in a diversified, low-expense way. An index fund that they never touched would have done the job. Instead many investors have had experiences ranging from mediocre to disastrous.”

Warren Buffett [courtesy of]

[Check back later for an article on Exchange-Traded Funds (ETFs), which are another way to buy indexes, and a calculator to decide whether to buy the index fund or the equivalent ETF.]

A brief introduction on how to pick stocks

So even after reading my warning, and despite all the ease, simplicity, lower risks and very good returns of index funds, you still want to pick your own stocks, huh?  Read this first to see if you have the traits of a successful money manager.

I recommend keeping at least 75-90% of your portfolio in index funds (which I’ll describe below), and only allowing yourself to pick stocks for the other 10-25%.  That way, if you lose your shirt, you’ll still have plenty of assets to fall back on.  Alternatively, you could designate your retirement funds as index-only, and stick to taxable accounts for any stock picks.  (I do this, since I don’t want to screw up my age 60 retirement accounts (401k & Roth IRA), but am willing to take a little more risk on my ‘early retirement’ accounts.)

Also, diversification (owning different stocks in different industries) helps you lower your portfolio’s risk.  The right index funds give you that diversification so that you don’t have to worry about it as much when you’re picking individual stocks.

1) Educate yourself

Peruse investing education websites like the Motley Fool (which has been going downhill for the last few years; but you can still find some good stuff on investing like this, or this.)  MoneyChimp is a great site too, with many investing (and general personal finance) calculators available.

Read superinvestor Warren Buffett’s ‘Letters to Berkshire Hathaway shareholders’ for free online (or consolidated in a much easier format in this book.)  The best book I’ve read to get a feel for the correct general investing philosophy is Roger Lowenstein’s Buffett biography.  I recommend this as a must-read for any would-be investor to learn the correct investing temperment, which is just as important (if not more so) as learning how to value stocks.

Finally, read Benjamin Graham’s classic ‘The Intelligent Investor’.  Graham was Buffett’s teacher and, together with David Dodd, pioneered value investing with ‘Security Analysis’.

(One word of caution: if you ever come across someone touting ‘technical analysis’, otherwise known as ‘charting’, run the other way as fast as you can!  Technical Analysis is a stock picking method akin to voodoo (and just as scientific.)  It involves looking at the past patterns in past price data (random movements in the market) for a given stock.  Supposedly, patterns like ‘head and shoulders‘ (I’m not making this up) are ‘buy’ indicators, whereas the ‘rounding top‘ pattern is something to fear.  If you think trying to divine future stock movements from random patterns in past price data sounds crazy, you’re right; don’t give this garbage any space in your brain.)

2) Do your homework

Once you find a company you’re interested in, start looking at their financial data and business model.  Order by mail or download their annual reports (10-K’s) and quarterly reports (10-Q’s) from the Investor Relations section of their website.  Do whatever valuation techniques you like, but at a minimum compute some ratios (PE, PEG, Current, Quick, etc) and do a Discounted Cash Flow (DCF) analysis on a company’s Free Cash Flow (FCF.)   Valuation matters!

3) Plan to buy and hold a company… forever!

Warren Buffett is often quoted as saying his favorite holding period is forever.  What he means is that if you do a thorough job in steps 1 and 2 above, you should have found a company worth holding for a very long time.  Ideally, that great business would continue to be a profitable investment for years to come, so why wouldn’t you keep the stock?  There are some legitimate reasons to sell, maybe the business has changed, or maybe you overlooked some glaring issue at the time you purchased.  Maybe the all-star CEO has left and you’re not comfortable with her replacement.  Or, maybe you finally need the money.

Other than these reasons, plan on holding for a very long time.   Buy and hold investing forces you to do your research up front.  It also keeps you from trading too much, which incurs large costs and lowers returns dramatically.  Not only that, but the IRS tax code favors investors who hold their investment gains as long as possible (this last consideration doesn’t matter for retirement accounts that are tax-advantaged, like 401ks or IRAs.)

4) Track your portfolio’s performance against an appropriate benchmark index

This is absolutely critical to knowing whether you’re profitable as an investor or not (which is the whole point of putting in all the effort of picking your own stocks: beating the market!)  I recommend keeping your brokerage account that you use for individual stocks separate from the rest of your investments (like index funds, bonds or money market funds.)

After you calculate your total return, calculate what your total return would’ve been if you’d made the same investments (amount and date of investment) in an index fund like the S&P 500.  Ideally you would like as long a time period as possible, as random fluctuations in your portfolio can make you lucky (or unlucky) in the short term.  Check your portfolio’s return against a benchmark at least every 6 months to a year.  If you can outperform the market for 3 years or more by a 1-2% each year, you’re doing well.


It’s very difficult to gain the knowledge, emotional attitude and discipline to be a successful stock picker.  By using the resources about you’ll have a better chance than most, which still may not be enough.  Stock picking can be fun, but make sure you’re giving yourself constant reality checks by measuring your entire portfolio’s performance against a major stock market index fund like the S&P 500.  Use a buy and hold strategy with a long-term (5+ years) holding period.  Thoroughly investigate the pros and cons of every investment before you buy.  Good luck!

Final word of caution and advice

Be brutally honest with yourself: if this all sounds like too much work, or if you know that your initial excitement to do the work will lose steam in a few months, just buy broad low-fee index funds.  Even ‘buying the market’ will result in huge compound returns over time, and beats the vast majority of professional money managers, not to mention all your friends trying vainly to beat the market but failing.  Not only that, but index funds offer practically ZERO work and maintenance, allowing you to ‘set it and forget it’ and get on with the rest of your life.

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