They say love can do crazy things to a person. It can help some people overcome seemingly insurmountable odds. It brings joy and happiness to a person’s life. And for others, it just helps them get through the day. What did it do for me? It taught me how to become a super investor capable of turning an investment large enough to feed a goat for the day into enough to build a nuclear power plant the size of Nicaragua. 

And how is this even possible? Let’s start by recounting my personal experience over the last while. Then we’ll tie it together to what it has to do with investing.

The experience

I recently got me one of them fancy corporate jobs with a fancy office, a fancier car and a set of fancy little slaves who carry me around from my office chair to the fax machine and back. My diamond-encrusted whip is still in the mail.

So, what can possibly be wrong with this here fancy situation? The stress. I was under so much stress that I could barely breathe. All I could think about was getting through the next minute, let alone the next hour. I would go to sleep stressed and would wake up scrunched in a ball and trying to think of an effective way to get myself fired.  It wasn’t the most ideal situation.

Fast forward to a month later, where I was sleeping when I wanted, where I wanted. I would do what I want go where I want. Every time I would enter the building I would be greeted with a fanfare of trumpets and scantily clad women seeing to my every whim. It was bliss.

So, what fundamental change occurred during this one month interval? I fell in love.

You see, in the pre-love phase, this job was all I had. Every time my boss would throw a stapler at me for making a mistake, I would get stressed out. Every time a client would attack me with a shovel for accidentally selling their family dog, I would get stressed out. Every time the phone would ring, my heart would sink, imagining it’s my boss, an angry client, or whoever calling me to tell me what I did wrong. Why was I so stressed out? Because this job was all I had. I couldn’t afford to lose it.

Then I met her. Then I asked her out. Then we went out. Then I kissed her. And she kissed me back. Then we did some things that would get me arrested if I were to share them online. Then we fell in love.

Suddenly, my work life began to drastically improve. Every time my manager would yell at me, I would sit there with a smile on my face. Every time a client firebombed my office, I would sweep away the ashes while whistling a tune. I just didn’t care. So what if I lost the job? I still had her.

The lesson

So, what does all this have to do with investing? How can love possibly teach somebody to be a better investor? Well, let’s see…

Pre-love

Take a look at my life before I fell in love. My work was the most important thing in my life. Every little marginal fluctuation in that situation would cause a flood of irrational emotions to run through me. Too much of my life was invested in this job. All my eggs were in one basket.

The exact same thing applies to when you have all your money invested in one stock or investment. If the stock suddenly drops 10%, that means you’ve just lost 10% of all your money. If the stock drops 50%, you’ve just lost half of all your money. How can you possibly expect to make any rational decisions if you’ve got all your money invested in one place?

Of course you’re going to freak out if the stock drops a couple points that day! Of course you’re going to cheer and drench yourself in a concoction of champagne and confetti if the stock rises a few percentage points that day! Your whole livelihood depends on it!

Post-love

Now look at my life post-love. I had a healthy work/life balance. Suddenly I could make rational decisions without worrying that my life was going to come to a grinding halt if I were to make a mistake. And even if I did lose the job, I still had someone to come home to at the end of the day. All my eggs were no longer in one basket. The values in my life were now diversified.

Compare that to owning two stocks, as opposed to just one. Suddenly, it isn’t nearly as big of a deal if one stock falls in price. Every fluctuation’s impact is now cut in half. One of your stocks just fell 50%? Sure, you took a hit, but you didn’t lose half your money – you lost half of half your money. Hell, the other stock can explode in price and make up for the crappiness of the other one.

Sure, both stocks can depreciate in price. Sure, I can lose my job and my love. And that would really, really suck. But both of these events happening at once is significantly less likely than having either of these events occurring.

Post-Post Love

As life goes on I’ll get married, I’ll have kids, I’ll have mistresses, I’ll have new jobs, probably a helicopter, hopefully a yacht, new ventures, new experiences and pretty much new everything. And so will you.

When I get married, my girlfriend suddenly won’t seem so important to me. When I get a voluptuous new mistress, suddenly my wife won’t seem so important to me. When I have kids, suddenly my mistress won’t seem so important to me. When I get a new car, suddenly my kids won’t seem all that important to me. New things change the way you see old things; they further diversify the values in your life.

Every time you buy a new stock, the fluctuations of the other ones won’t seem as hefty to you as before. That’s what diversification does. It reduces risk. It let’s you think rationally. It let’s you move forward (and back). It’s a pretty great thing. You should use it.

Just don’t diversify too much – your life or your investments. Or you’ll lose track of the things that matter, and will pay too much attention to the things that don’t. Balance is key. At least, that’s what I think.

This post has been written by Mr. Moneybags from MeanStock.com, a site that proves that investing shouldn’t have to make you want to douse yourself in gasoline and run into a forest fire. Don’t forget to download his new book!

Since I was blessed to be around strong doses of equal parts wisdom and healthy skepticism growing up, I look at things much differently than most people in my age bracket. Some may call it pessimism. I get that. In fact, I have to be careful not to take a glass is half empty approach to all of life, for I have much to be happy about and I remind myself of that frequently.

However, I’ve also learned that in many areas of life it pays to put an ear to the ground, listen for the sound of the thundering herd coming, and run in the opposite direction. The “herd” is comprised of those that often blindly follow conventional wisdom.

The Financial “Herd”

In financial terms, you may remember members of the herd buying into tech stocks in the late 90s after months of ridiculous gains. They were late to the party, but wanted to join in and got creamed. More recently, the herd turned to housing, and before 2008, housing prices were sky-rocketing, and people were feeling good again a decade after the tech bubble.

Then the fall of 2008 came and went, and in its wake left many folks in underwater mortgages. Some managed to hang on, others (very few) benefited from a loan modification program, and a large majority simply had to foreclose because they couldn’t keep up the high payments, and couldn’t sell for what they owed.

My Years in the Herd

In my early 20s I followed the herd. I borrowed money when I was 20 to invest in a Roth IRA because I heard on the radio it was simply too good an investment opportunity to pass up, even if you had to borrow money to do it. Well, it is a good investment vehicle, but in my opinion, not so good that is worth borrowing the money to invest.

Around this time I also opened several credit cards in college because the herd was doing it, en masse, at football games, and other campus events. We traded in fiscal discipline for a free t-shirt, or a pizza. Bribery works with college kids, and credit card companies know it (and so do the colleges that allow them on the campus).

How I Finally Broke Free

Fortunately, I returned to my senses, and my old frugal ways before digging a hole so deep I could never climb out. We did eventually climb out, after years of scratching, clawing and fighting to pay for past financial sins. It was not a fun time, and our family adopted a saying, “Never again.”

After turning 30 I realized an entire decade had raced past me with little to show for it, financially. I was blessed to have a wife and two children, and a secure career, but I spent much of the decade treading water. That’s not really true. I was underwater, but able to come up for air just often enough to keep from drowning.

It was time to get back to the basics – old school personal finance with a paper household ledger, an envelope system for budgeting and living on cash. Gone were the credit cards, the student loans, the personal loans I foolishly used to invest, and all other “fancy” financial tools.

I recognized that for too long I had followed the herd. I thought car payments and credit cards were normal. I figured everyone borrowed money on their home, paid a little down, and then borrowed more money for a bigger home. I figured most of my friends, also in their 20s, weren’t concerned with retirement savings and emergency funds. In short, I lived it up.

To turn things around, I started living by the following what you might call “contrarian” principles, and over the last few years, it has paid off (or at least kept me relatively safe through the biggest financial storm in my lifetime…so far). I started observing conventional wisdom in a new way. I became skeptical of those pitching the next hot stock, flipping houses, and encouraging people to borrow their way to wealth.

I started paying more attention to our nation’s fiscal health, and considering the trends being repeated from the past. I don’t claim to possess some prescient skill to see into the future (else I’d be a very rich man), but there were some trends that just seemed large to ignore.

It was around this time (Christmas 2007) that I started this blog, primarily as a way to keep myself accountable. I knew what I was writing wouldn’t be popular, but I thought if things hit the fan, it just might be one day. Heck, I even remember bashing those stimulus rebate checks the government was handing out early in 2008 – remember those? Yeah, that was a popular stance at the time.

Besides managing to tick off a few people along the way with my blog ramblings, I did learn some real lessons throughout the journey and continue to apply them today.

Pay Off Debt When Everyone Else is Borrowing

This was especially popular in 2005 up to the recession. At the time we were leasing a house, and still had debt. I couldn’t begin to count the number of people who told us we were stupid for “throwing money away on rent.”

We didn’t buy our home until March 2009, when we were on solid financial ground, and after prices had already depressed significantly. My only regret – if I had waited a little longer we could have got a sub 5% mortgage, but you know what they say about hindsight.

Pay Off Debts When Consumer Spending and Borrowing is Increasing

When we started our debt-free journey after Christmas in 2007, things were still pretty rosy, economically. The herd was at the malls shopping and borrowing there way into oblivion, and refusing to save a nickel of their income.

When the first hint of economic slowdown appeared the government sent out stimulus checks, and encouraged people to “get out there and spend!” Most people followed orders. We put half of ours in the bank and the other half on credit card debt.

Pay Down Your Mortgage and Stay Put When Everyone Else is Trading Up

A few years ago, it was a popular move to fully leverage your home via maxed out home equity lines, thanks to unnaturally high home values and falling interest rates. Others who didn’t tap equity just traded up to a bigger mortgage – after all, rates were on the way down and times were good.

Unfortunately, many of those same people are struggling to make a mortgage payment after losing half their household income, and seeing their investments wiped out (but more recently re-inflated).

Work a Year or Two and Save Up Money to Attend School While Others Borrow Thousands in Student Loans

This one is always popular. I believe one of the biggest economic threats to the next generation is student loan debt.

New graduates face a crushing debt that will be with most of them for the first decade out of school, limiting their ability to enjoy solid financial footing until well into their 30s.

It isn’t all the students’ fault, either. Colleges and tuition boards have increased rates at a ridiculous pace because, well frankly, because they can. The student loan industry has been nationalized and colleges know they can charge ungodly tuition because students can borrow the money from the government.

If there were less easy money to be borrowed, colleges would have to once again compete for a family’s dollar, and tuition would likely come down. Not going to happen, so make plans now for your kids (or yourself) to find a way to get educated without going thousands into debt.

Buy What Everyone Else is Selling (and Vice Versa)

This is where my personal investment strategy has really changed over the years. I used to stay glued to CNBC and investment newsletters to try to get a scoop on the next big market. Then it occurred to me that by the time I read about it, or heard about it, those with big money had, too.

This is when I became sort of a contrarian investor, if there really is such a thing. Wikipedia sums up a contrarian investor’s philosophy quite well.

In finance, a contrarian is one who attempts to profit by investing in a manner that differs from the conventional wisdom, when the consensus opinion appears to be wrong.

So, I adopted my own two-pronged investment strategy. I would become a dividend investor – buying stock in strong, dividend-paying growth companies in industries that did well in both good times and bad. I would reinvest those dividends to build my positions in these companies, and one day, we just might be able to live off the dividend income alone.

I would also invest a smaller percentage of money (because there is more inherent risk with this approach), in stocks with strong fundamentals, but that had been beaten down thank to negative publicity, natural disaster, or were just oversold as part of the Great Recession. This led me to sectors like:

• Regional Banks. Many regional banks did not accept TARP money, maintained healthy balance sheets and avoided toxic mortgage markets in smaller locations. But, they still got beat up in the financial sector meltdown.

• Housing market. The housing market touches so many secondary markets besides the home builders themselves, who have been largely decimated the last couple years. Home improvement stores took a hit, too, and I thought rather unfairly, considering more people would be staying put and investing in home remodels, etc. when the worst was behind us. I joke with my wife that you can get a pretty good read on the local economy by visiting a Lowes (I used to work at one, part time) or Home Depot early on a Saturday morning.

• Nuclear Power. In the wake of the Japanese earthquake and nuclear disaster, nuclear power stocks took quite a hit, and one could easily understand why. During the threat of a full reactor meltdown, who wants to bet money on the future of nuclear power. Same thing happens after coal mining disasters, oil spills, etc. The fact is, we need some of all three types of energy to meet demand. I certainly don’t sit around hoping to profit from a disaster, but you have to be willing to buy when everyone else is selling, if (1) you can afford to lose money on paper in the short term, and (2) you know enough about a company’s fundamentals to believe the stock really is cheap.

This whole contrarian approach to finance won’t make you very popular at dinner parties, but it just might help you avoid debt and build wealth. For that, I don’t mind occasionally being called a “party pooper.”

Over the last few months, I’ve changed my investment strategy for the little bit of after-tax money I have available to invest outside of retirement plans. It’s worth noting before going any further that it almost always makes more sense to put available money in tax-deferred or tax-free retirement savings vehicles, such as the Roth IRA, before investing outside of these plans.

I take sort of a dual approach, recognizing that I may in fact need access to some of my savings and investments before I reach 59 1/2. Roth IRA contributions are available to withdraw any time since they represent investment dollars that have already been taxed. However, I’d like to let the Roth IRA grow as long as possible without removing contributions.

Investing Money in Taxable Accounts: The Options

When it comes to investing money in taxable accounts, the options are endless. Here’s a short list:

• Mutual funds
• Individual stocks
• Bonds/Treasuries
• CDs
• Money Markets
• Cash
• Metals

Each of these vehicles offer different degrees of risk and potential investment reward. Obviously, in a low-rate environment like the one we are in today, cash-based investments don’t offer much in the way of return. Most money markets are hovering around 1.5% APY, and regular savings accounts and short-term CDs are even worse.

I’m generally a fan of mutual funds, and have most of my retirement in Vanguard funds. However, after dabbling in mutual fund investing for our taxable accounts, I’ve found they don’t offer the element of control I like to have over that money (deciding when things are sold to take the tax hit, etc.).

Individual stocks can also be promising, but on the risk scale these are near the top. I’m won some and I’ve lost some, and in all honesty, I’ve done well just to break even on most of my trades over the last few months. Any small gains I earned were eaten up by broker fees, the rest in capital gains taxes. Seemed like a lot of work for a relatively small reward (in most cases).

Dividend Reinvestment Plans

I still like the idea of investing in particular companies that I believe will do well over the long term. Companies that have been around for a few decades, cranking out profits and returning some of them to shareholders.

These large, blue-chip growth companies can typically withstand a market meltdown, and often experience modest gains in bull markets as well. But their real beauty lies in their dividend. It is that dividend that spins off consistent income to investors quarter after quarter that makes them so attractive.

Many of these companies offer a direct purchase dividend reinvestment plan, meaning you can buy stocks directly from a plan administrator, often for much lower commissions than you would find at brokerage.

After an initial purchase you can set up an automatic withdrawal from your checking or savings account to purchase shares (even fractional shares) of the company. Dividends earned may be reinvested to purchase more shares, providing a compounding effect that can quickly grow the number of shares owned.

Many years down the road, once we’ve accumulated a large number of shares in a particular company, we may opt to start receiving dividend payouts in cash. Most transfer agents allow a direct deposit to your checking account.

A Working Example

Imagine you are 55 years old, and 30 years ago you dropped a couple thousand dollars into a stock like Procter and Gamble (PG). That single investment would be worth more than $123,247 today. You would have started with 27 shares, but by reinvesting dividends, you now would have over 1,980 shares. *I found that example on the Fool.com website, a great source for dividend investing info.

Proctor and Gamble currently pays shareholders an annual dividend of $1.93 per share, or roughly $0.48 per share each quarter. That means every three months you would be receiving a check for $950. Doesn’t sound like much?

What if you had invested a couple thousand back in 1980, and then decided to add $100 a month to your holdings all along. The math is a little tricky, so we’ll just use some very rough estimates. Let’s assume that continuing monthly investment allowed you to add another 3,000 shares, so you now own 5,000 shares of Procter and Gamble. Each quarter, you would receive a dividend payment of $2,412.

Now imagine you took the same dividend investing approach with a couple other favorite holdings…maybe something like Coca Cola and Exxon Mobile. You can see how a sustained investment in a handful of high-yield dividend stocks could spin off a comfortable income down the line.

What are the Risks?

I certainly don’t mean to present this as a zero-risk investment, because there are risks. One of these companies could go bankrupt and you could lose your investment. The company could cancel its dividend, as many bank stocks did during the recent recession, or BP did after the Gulf oil spill.

If one of these stocks abruptly cancels its dividend, and you are counting on it for income, you may be forced to sell all of your shares and move them to another investment, which could result in a realized loss or a sizable tax event.

There is also a political risk in the form of higher taxes. Qualified dividends are currently taxed at the long-term capital gains rate, but there is a move to count these earnings as ordinary income, which could significantly increase the tax liability – hitting those relying on dividend income the hardest.

For these reasons, it makes sense to make this only a part of your overall investment strategy. I would still invest in well-diversified mutual funds, bonds or bond funds and consider owning some assets outside of the market (real estate, farmland, silver, etc.).

How to Pick a Dividend Stock

In terms of stock picking, I recommend checking out listings such as the Dividend Aristocrats, a collection of S&P 500 companies that meet strict criteria to be included on this list, such as:

• Companies must be a member of the S&P 500.
• Companies must have increased dividends every year for at least 25 consecutive years.
• Companies must have a float adjusted market capitalization of at least US $3 billion as of the rebalancing reference date.
• Companies must have an average trading volume of at least US$ 5 million for the six-months prior to the rebalancing reference date.

Source: S&P 500 Dividend Aristocrats factsheet

You may have additional screening criteria to add, but this is a good starting point. The members of this list represent large, stable blue-chip companies, often with world-wide operations and a solid history of producing profits. Many of them are somewhat recession-resistant (think of Proctor and Gamble’s product line – people still buy detergent and cleaners and batteries and paper products in a recession).

Where to Get Started

Most company websites have an “Investor Relations” area with information on shareholder services such a dividend reinvestment programs, direct purchase plans, etc. Most DRIPs are handled through an administrator, such as BNY Mellon Shareowner Services or ComputerShare.com.

If the company you are interested in investing does not offer a DRIP or direct investment plan, there are other cheap ways to buy dividend stocks. You can always use a discount broker such as TradeKing, Scottrade or Sharebuilder. Sharebuilder even allows fractional share investing so you can purchase a specific dollar amount of a particular security, rather than being forced to buy whole shares (which can be costly for many of these larger companies with high stock prices).

Be sure to consider the various fees charged by a broker versus direct investment plans (a few of these can be costly as well, so don’t just assume a DRIP is cheaper).

If you don’t have thousands to invest, or even if you do, consider starting a DRIP and adding any extra dollars you can squeeze from your budget towards and income-replacer later on. If twenty years from now you could live a frugal lifestyle on passive dividends you’ll be glad you started.

Disclaimer: At the time of this writing, I do not own the individual stocks (PG, KO, XOM, BP) mentioned in this article

An easy way to increase your investment returns is to pay more attention to the expenses you are incurring. Even seemingly small savings can result in a notable increase in your long-term profits. More importantly, every dollar you save in expenses is a dollar increase in your net worth.

Keep in mind, however, that investing involves finding a balance between the potential for making money and the potential for losing money, and expenses are no different. This is why you should always compare the costs you incur against the value you are receiving.

In some circumstances, higher expenses may be warranted. In others, they are an unnecessary transfer of wealth out of your portfolio.

I recommend reviewing all of your investing expenses on an annual basis. There are five primary areas to look at: brokerage commissions, taxes, trading costs, fund fees and advisory/custodial fees.

Brokerage commissions – These are the fees you pay to buy or sell a security. In general, lower fees are better, though you should consider the other services provided by the brokerage firm. For example, it might be worth paying a few extra dollars per trade if the brokerage firm provides good research, access to useful online tools, or offers certain conveniences that you find to be of value.

Taxes – Capital gains and dividend taxes reduce the actual profit you realize. Though the new tax law extends low rates, taxes still lower your true return. Short-term capital gains are even more expensive. Whenever possible, hold your least tax efficient investments (e.g. dividend-paying stocks) in your IRA and your most tax efficient investments (e.g. municipal bonds) in your regular brokerage account.

Trading Costs – Also referred to as transaction costs, these are expenses incurred when a buy or sell order causes a security’s price to move. Trading costs are extremely low for an actively traded stock such as General Electric (GE) and are higher for a stock or bond that is not actively traded. In all cases, you should consider the average daily dollar volume (total number of shares times price per share) and how much money you are looking to invest.

It may be more profitable to place several small orders rather than one large order. You should also use limit orders to ensure your transaction is executed within the bid-ask spread (the price buyers are willing to pay and the price sellers are looking to receive).

Fund Fees – Both mutual funds and exchange-traded funds (ETFs) charge annual management fees. Mutual funds may also charge fees for buying (front load) or selling (back-end load) shares, as well as fees for marketing expenses. Since most mutual fund managers do not beat their benchmarks (e.g., the S&P 500), lower fees are preferable.

As far as ETFs are concerned, the free trading commissions offered by brokerage firms may not be justified if the annual expense is higher than a similar ETF that does not qualify for the waived commissions. Be sure to consider both the risk-adjusted performance and the diversification benefits a fund offers; a higher fee may be justified if a fund provides less volatility or allows you to invest in an asset class you are not already invested in.

Advisory/Custodial Fees – Some firms charge advisory, custodial or account maintenance fees. You may also pay separate expenses to consult with a financial advisor. These expenses can be justified if you are receiving quality advice, lower commissions, or provided access to other financial services. The more complicated your financial or tax situation is, the more you will need to spend on advisory fees. Furthermore, a good advisor is worth the expense if he can keep you on track to achieve your financial goals.

As stated above, you should review your investment expenses annually to determine whether you are receiving adequate value for them. In my book, Better Good than Lucky, I recommend keeping a trading journal that lists the reasons you bought and would consider selling the stocks, bonds and funds you hold in your portfolio. It is also a good idea to include a list of your investment fees and the reasons you think they are valid. Doing so will provide a checklist that can assist with your annual review. It’s simple, but very effective.

Luckily, if you have a spare $1,000 to invest, here are ten ways to make a strong return without putting a dime in the stock market.

1. Win the Grocery Game

As of fall 2010, financial experts are extremely concerned about significant inflation. While you can easily cut back on incidental expenses, you still have to eat. Putting your $1,000 into long-term food storage could be one smart move if things keep going downhill. Focus on big ticket staples like butter, milk, meat, canned goods and dry goods. Buying a side of beef and a freezer big enough to hold it will easily pay off if food prices go through the roof.

2. Give Social Lending a Try

My small, but growing, portfolio of hand-picked investments at Lending Club is currently averaging a 10.92% net annualized return. Not too shabby, considering “high-yield” cash accounts are averaging about 1.30%, and even 30-year treasuries are only offering 4.25%. Be sure to check out my recent Lending Club review for a few secrets to success.

3. Seal the Holes

After food, housing and utilities are going to eat up a huge chunk of your monthly budget. If you need creative ways to spend $1,000, plug the leaky gaps around windows and doors, which is one of several ways to prepare your home for winter. Upgrading windows and doors should be your first step if you don’t already have double-pane energy efficient models already in your home.

4. Beat the Bad Job Market

Nobody is secure in their employment these day, it would seem. However, you’ll have a much tighter handle on your cash flow if you are in the driver’s seat. Start a side hustle with low overhead and invest that $1,000 to get it off the ground. Having a second income is great for supplementing your income, and a nice hedge against periods of unemployment.

5. Solar Solutions

You won’t be able to change our your whole house’s electrical system and live off the grid with $1, 000 . However, you can add some solar components that will give you lighting absolutely free. Start with your outdoor lighting, as that’s the easiest to upgrade to solar. You can also add components like a solar attic vent.

6. Get Self Sufficient

When times are tight, those who can rely on themselves will have dozens more options. Investing in self sufficiency is a smart move. Buy chickens and build a coop with your $1,000 and you’ll benefit from almost free eggs and meat. Start a square foot garden; dig a well; install a root cellar; buy a milk cow.

7. Educate Yourself

It’s not rocket science that people with degrees make more on average than those who don’t have credentials. These discrepancies are going to get even more obvious. Spend your $1,000 on some classes that can give you the leg up on the competition.

8. Appliance Appeal

Swapping older appliances for newer models can be a great way to invest that $1,000 . New appliances can cost as much as 40-50% less to run than models that were sold just seven to ten years ago. If you swap out several appliances, the savings can really add up over time.

9. Maid to Order

Spending cash for household help might seem a bit over-the-top. However, if you use the time savings to focus on other money-making goals, it can really pay off. A few hours that you don’t have to spend scrubbing floors can be turned into a part-time venture or money-making hobby that yields way more than the maid’s wage.

10. Invest in Their Future

Charitable ventures aren’t necessarily direct money-makers, but who’s to say what priorities your money should be spent on? Choose charities that truly provide a leg up. Buying a goat for a poor African family can give them a long-term way to get ahead.

You also might to consider investing in a micro-lending program such as Kiva.org that gives loans to overseas small business owners; the default rate for this truly leg-up investment is astronomically low, and imagine the lives you could change.

ETF’s (Exchange Traded Funds) are pretty darn popular these days.  The total dollars invested in these buggers grew 45% last year to $242 billion.

You probably read about ETF’s where ever you go and you might feel like a relic for not owning any.  I’d like to explain what they are, how they can be used and why you might be just fine not worrying about them at all.

First, what are ETF’s?

Think of these as mutual funds.  They both have a lot in common.  Like funds, an ETF owns a basket of stocks. When you buy into an ETF you own a small portion of each stock – just like you do when you buy a fund.

So how are they different?

Well…the ETF usually holds on to the shares they buy.  There is very little buying and selling.  They simply buy the stocks that are held in an index and they only buy or sell when the people who run the index replace one company with another. A mutual fund on the other hand buys and sells shares much more often.  This is the core issue that separates ETF’s and funds.

Because ETF’s have little trading activity, they offer much lower costs and fewer tax problems.

You see, if a fund trades shares, they need someone to do the trading and other people to make the decisions.  These people are usually very highly paid and that’s one of the reasons why funds have higher expenses.

Are the high costs of trading and fancy managers worth it?  Do funds have a higher return than ETF’s?

Usually not.

Depending on the year, 70% to 80% of the actively managed funds fail to outperform the indexes – and ETF’s are just index funds.

So, should a reasonable person conclude that it’s silly to buy mutual funds.

Well….yes and no.

“”Yes – stick with ETF’s “ if you are a buy and hold investor.  ETF’s are less expensive and that’s the reason why they outperform 70% to 80% of the actively managed mutual funds.  That being the case, if you buy and hold your funds, get some broadly based ETF’s and hold on to them.

But that’s not the end of the conversation.

Let’s say you don’t believe in “buy and hold”.  Let’s say you use a strategy that reviews market strength and you update your portfolio often.

In that case, you shouldn’t restrict your investments to only ETF’s.

You should buy the fund (or ETF) that is performing best according to the strategy you use and the criteria you select.

That’s right.  Not everyone is a “buy and hold” investor and not everyone should be.

Some people try to reduce risk by using approaches like these and it’s not something you should dismiss out of hand.

Some investors try to buy funds in stronger areas of the market, stay away from areas that are weak, and possibly get out of the market all together when they see storm clouds ahead.

Do these people make more money than buy and hold investors?  Sometimes they do.  Sometimes they don’t.   Keep in mind that people who use strategies like these don’t always do so because they want to make more money.  They often use these types of approaches because they don’t want to suffer catastrophic losses.

Of course, no matter what approach you use or what investments you use, ETF’s or actively managed funds, you can still lose money.  No matter how you approach investing, there will be periods where you won’t do well. That sucks but it goes with the territory.

The bottom line is that, in reality, the debate between ETF’s and actively managed funds is all marketing and doesn’t mean squat to you.  Well…wait…I take it back….it might mean that you lose focus on the really important issues when it comes to investing and as a result you lose your shirt. So besides ETF’s, are there no other investment strategies that work?

So, should a reasonable person conclude that it’s silly to buy mutual funds?

Well….yes and no.

So what are the really important issues?

Your financial goals.  Your financial timeframe.  Your investment approach.  Your clarity on the first two and your willingness to stick to the third concept no matter what.

Do you only invest in ETF’s?  If so, why?

Photo by kevindooley

On Monday Jason wrote a great overview about dividend investing . Since you now know what dividends are all about, I figured it would be a good opportunity to do a guest post on the subject. I write about the stock market and personal finance at my blog Stock investing 101.

Photo by gfpeck

Dividend investing is the best way to generate passive income and become wealthy, period. It is the perfect example of making your money work for you.

AT&T pays out a 6.7% dividend yield. This means for every 100 dollars of the stock you own you will be given $6.70 a year from the company as a bonus for just being a shareholder of the company. Compare 6.7% to the interest you could get from a standard checking account or a CD. You are getting at least 3 times the return from owning AT&T versus investing in a CD, and that is not factoring in any potential increase in AT&T’s share price.

Most dividend paying companies also offer a DRIP program, DRIP stands for Dividend reinvestment program. If you opt for the DRIP program the money you receive each quarter from owning stock will be used to buy more of the stock instead of being given to you in cash. This is a great way to take advantage of compound interest.

Jason mentioned he purchased 80 shares of AT&T. If he opted for the dividend reinvestment plan those 80 shares would grow to 85.4 shares after just one year. After 5 years his purchase of 80 shares of the company would now have ballooned to almost 110 shares of the company. After those 5 years, assuming AT&T kept its dividend rate steady [which is very conservative when you consider that AT&T has a long track record of consistently raising its dividend] Jason would then be actually getting a 9.3% yield on his original investment. 110 X 1.68= 184.8/ [25.25[share price]X 80= 2020].

The numbers only get more and more impressive and mind boggling over time. In ten years AT&T could go from paying his Netflix membership to making his car payments, in thirty years AT&T could pay his mortgage.

The best thing about this is that there is almost no work involved. After you make your initial investment everything is on autopilot.

Here is a short overview of 5 different dividend paying companies in 3 different sectors to get you started. Remember that this list is not comprehensive in the least bit and it is far from fool proof:

• AT&T: Jason and I have mentioned this company countless times for a reason. It pays out a whopping 6.7% yield, it is in a stable sector that all of us understand, and I don’t see people getting rid of their cell phones or their Internet connection anytime soon.

• Coke: Coke is another great dividend paying company. Its yield of 3.2% is not as impressive as AT&T’s but it is still a great value. Coke raises its dividend religiously so I expect even more from it in the future.

• Pfizer: Pfizer is a huge health care conglomerate. It pays out a very impressive 4.1% dividend yield at the moment and it is a very solid company. It presents a great value to investors.

You will not get 30% yearly returns from investing in dividend paying companies but you will get the best possible return in the long run along with the most stable investment with the least amount of work involved.

If you are interested in learning more about dividend investing, I highly recommend the book The Ultimate Dividend Playbook from Morningstar (written by Josh Peters).

Note from Frugal Dad: After giving it some thought, and investigating the plan with my online brokerage, I have decided to sign up for their dividend reinvestment program. Dividends will be reinvested in eligible securities held in our portfolio, allowing us to build our positions more quickly without an added fee.

A Quick Introduction to Dividends

If you are not a stock investor, or regularly dig into your mutual fund statements, you are probably like me and are unfamiliar with the concept of dividends. Basically, a dividend is a cash payout by a company to its to stockholders. Companies that raise a lot of cash, and are fairly stable (meaning not growing rapidly or in financial trouble), reward stockholders by returning a sum of cash to them on a per share basis, usually in quarterly payments.

Most companies raise or lower their dividend after quarterly earnings results are released. A handful of companies have long histories of increasing dividends over time, and now offer a healthy dividend yield.

Where to Find the Best Dividend Stocks

AT&T often appears on lists of best stocks to own for dividend investors. They have a long track record of paying dividends. In fact, they have increased their quarterly dividend for 26 consecutive years. While there is no such thing as a sure thing, this kind of long track record is what I’ll look for when selecting single stocks for our dividend portfolio.

How to Calculate a Stock’s Dividend Yield

AT&T (T) last declared a quarterly dividend of $0.42 per share, or $1.68 annually, in December 2009.  At the time of this writing, their stock price is 24.86 per share. Dividing the annual dividend dollar amount by the current share price provides the annual dividend yield of 6.75%. Not too shabby, considering most online savings accounts are yielding around 1.30%.

AT&T Pays for My Netflix Membership

That sounds a little strange, so let me explain how this all works. AT&T doesn’t really pay for my Netflix membership, but the dividends I receive from AT&T stock alone cover that expense. That’s the way I look at dividend investing. Each time I add to my portfolio, and increase the amount I receive in dividends, it covers another expense. One day, it is not unthinkable that dividends alone could cover all of our basic living expenses.

I recently signed up for an online brokerage account and purchased 80 shares of AT&T to begin my dividend portfolio. Every three months, AT&T will return a dividend of $33.60 ($0.42 per share dividend x 80 shares). That works out to about $11.20 a month. After taxes, that is just enough to cover my $9.62 monthly Netflix bill. As long as AT&T continues to pay the dividend (and Netflix keeps its price steady) I’ll have our movies-at-home budget category covered.

Dividend Investing for Early Retirement

Last year, I wrote about the concept of an early retirement freedom chart to track passive income, active income and monthly expenses. It was an idea I got from my favorite personal finance book, Your Money or Your Life. In the book, the authors advocate creating a wall chart to track monthly expenses, actively earned income (from an employer, for example), and passive income (interest accumulation, dividends, etc.). I’ll actually track this in Excel, where I do most of my budgeting. I’ll plot our income, expenses and passive income each month.

As our income increases and we can invest more money, our passive income will rise. If we reduce expenses, or keep them flat, eventually the passive income line and monthly expenses line will intersect at a cross-over point. It is at this point where our living expenses are covered without the requirement to earn more active income. Hello financial independence!

The book’s author achieved this point by investing in Treasuries, but this was back in the early to mid 1990s when they were yielding an attractive six to seven percent. These days, that rate is much harder to find.

We plan to use a mix of cash-based accounts and dividend stocks to get to our cross-over point. We’ll diversify into 10-15 stocks across a range of sectors from utilities to telecom to consumer goods, and try to add a little to our positions each pay day. Slow and steadily, we will be building a portfolio of dividend stocks with the potential for lifestyle-sustaining income for the years ahead. That’s an exciting prospect!

If you are interested in learning more about dividend investing, I highly recommend the book The Ultimate Dividend Playbook from Morningstar (written by Josh Peters).

Disclaimer: Please do not buy any stock mentioned here at Frugal Dad just because I mentioned it. Do your own research and buy positions that match your risk tolerance and income needs. One more note, single stock investing is risky, so aim to keep single stocks a relatively small percentage of our overall portfolio. We have 100% of our retirement funds in mutual funds, but I’ll dabble in single stocks for dividend investing.

Now that it is 2010 I am psyched to make even more contributions to our Roth, but wondered if I should wait until the end of the tax year, make monthly contributions, or try to plunk down all the money up front. Turns out this is a costly decision.

Putting aside thoughts on market timing, and market predictions for 2010, it seemed like socking away the maximum contribution early in the year was the way to go. Of course, this meant trying to come up with $5,000 after already depleting some savings to fund last year’s Roth.

Just as I was feeling nervous about moving another $5,000 from my cash reserves, I was reminded of my own advice:  max out because Roth IRA withdrawal rules allow for withdrawal of contributions at any time without penalty. That’s right! Assuming I had not lost my entire investment in the Roth account, I could simply withdraw a portion of the $5,000 contribution later in the year in an emergency.

The Impact of Delaying Roth IRA Contributions One Year

So what’s the advantage of tying up my savings so early in the year? Using the financial calculators at Dinkytown.net, I ran a couple calculations with the following assumptions:

Let’s assume I turn 30 years-old On January 1, 2010, and according to the 2010 Roth IRA income limits I can invest the full $5,000 in a Roth IRA earning an 8% return. I continue to invest $5,000 on my birthday (January 1st) for the next 35 years. My original $175,000 in Roth IRA contributions would grow to $930,511.

If I delayed that first contribution until my 31st birthday, I’d only have $856,584. This is essentially the same result you’d get by waiting to contribute until the end of the year. And while it is nothing to sneeze at, you would lose about $74,000 in compounding growth by waiting a year to get started.

This certainly underscores the important of starting early. It also reinforces my plan to encourage our kids to open Roth IRAs as teenagers when they begin earning an income – even if we have to help them fund the account up to their income. Imagine what the numbers would look like if you started saving at 17 years old!

If you are concerned about earning too much money, contribute now and adjust later. It is possible to avoid penalties if you take corrective action by the due date for making Roth IRA contributions for that particular tax year (typically April 15th or the day you file your return, whichever occurs earlier, but not counting extensions, etc.).

I Have No Savings – Should I Borrow To Make Roth Contributions?

After being in debt for so long, I am very reluctant to borrow again. However, borrowing $5,000 at a very low interest rate (or even free if you can catch a zero-percent balance transfer) might make sense considering the amount of compounding growth you give up over an investing lifetime. Personally, I would not borrow the money, and look for another way to fund the contribution – a side hustle, selling something valuable, but not sentimental, etc.

Whatever you decide to do, do it quickly, as hundreds of dollars are sliding by for every day you put off funding a Roth IRA.

This question is especially important if you are considering retiring soon or if you have been offered an early retirement package.

If you’re like me, when you try to imagine what lies ahead, you think about your most recent experiences and extrapolate going forward.

Investors do this more than anyone – at least as far as I’ve seen. While I can see why folks do this, it’s really not a very good exercise and I’ll show you why.

If you think back over the last 10 years, you’ll agree that it hasn’t been a picnic for investors. Depending on when you calculate the 10-year average, you could get a slightly negative return or a slightly positive return for that period. But either way, it’s a lousy return.

Based on that, investors might forecast a crumby 10-year return going forward.

Even though we’ve heard that old expression that the past is no guarantee of the future when it comes to investing, what else do we have to base our decisions on other than the past?

Well…I do want you to consider the past when you think about the future.  Just think about it a little differently.

Let’s look at an example to help explain this idea.

If you review the chart below, you can see that the 10-year trailing return in 1974 was an ugly -3.8%. That means had you invested in 1965 and held on to your investments through the end of 1974, your annualized return was -3.8%.

[TABLE=2]

[TABLE=3]

But what happened over the next 10-year period? The market had an annualized 6.9% return. In fact, after each of the last 5 decade-long market meltdowns, the market did pretty well.

Is that a guarantee that the next 10 years will be years of wine and roses for all?  Not by a long-shot. But it does indicate that history is on our side. It shows the importance of not falling into the trap of thinking our most recent experience is going to be repeated in the future.

Exactly one year ago, did you predict that the market would do so well by the end of the year?  I sure didn’t.

While we face real challenges ahead as a nation and as investors, it would fly in the face of all the facts to become pessimistic right now.

What do you think we’re in store for over the next 10 years?