Archive for Sunday, May 6, 2001

Motley Fool

May 6, 2001

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Q: Do you recommend investors keep a third of their investments in stock, a third in bonds and a third in cash? -- T.R., Kailua, Hawaii

A: We have a simple allocation model. For money that we don't expect to need for five years or more (and ideally longer), we remain entirely in stocks. Stocks can be volatile in the short term, but tend to perform well in the long term. Any funds that you'll need to use in the near future should be in something more stable, such as CDs, money market funds or perhaps bonds.

We roll our eyes when financial experts announce they're changing their recommended portfolio mix from something like 47 percent stocks to 49 percent stocks. Such unnecessary tweaking can rack up commission charges and generate capital gains.

Q: Is there any compilation of these questions and answers that you run in the newspaper? -- E.C., St. Louis

A: Until recently, the answer to this frequently asked question has been "no." But we've just published "The Motley Fool Money Guide: Answers to Your Questions About Saving, Spending and Investing" by Selena Maranjian (The Motley Fool, $15). The book contains 500 questions and answers on personal finance and investing topics, and roughly half of them originated in our newspaper feature. The other half are brand-new.

Topics addressed include credit card debt, insurance, buying a house, paying for college, estate planning, Wall Street's ways, understanding stocks, evaluating companies, mutual funds, managing your portfolio and how businesses and the economy work. Many definitions are included, for P/E ratios, preferred stocks, dollar-cost averaging, return on equity, income statement, market capitalization and much more. If you're interested, check it out at your local library or bookstore.

THE FOOL SCHOOL

Commission Costs

You may not realize this, but even if you're paying just $8 or $12 commissions to your brokerage per trade, you might be paying too much.

Pay attention to what percentage of your investment your commission cost represents. As an example, imagine that you invest $150 in shares of Oxygen Bars International (ticker: HOTAIR), and you pay a $12 commission. Divide $12 by $150 and you'll get 0.08, or 8 percent. That means you've invested $150, but at the same time you forfeited nearly a tenth of that value in commissions. If the shares rose 8 percent in the first year, you'd just be breaking even, really, instead of realizing a significant gain.

The situation gets worse if you're more of a speculator than an investor, frequently buying and selling. In that case, you might invest the $150, pay $12, and then pay $12 again soon after, when you sell the shares. You'd have forked over $24 on a $150 investment, paying 16 percent of its value. Yikes!

Aim to keep your commission costs at 2 percent or less per trade. If your brokerage charges $12 per trade, then you'd want to invest at least $600 each time you buy stock ($12 divided by 0.02 equals $600). If your brokerage charges $20 per trade, your minimum would be $1,000. Instead of plunking $150 into the market at a time, you could save up that money until you have a bigger sum to invest.

If you're like many people, though, the idea of waiting until you've gathered $1,000 is discouraging. Fear not -- you have options:

l You can switch to a discount brokerage that charges less per trade. Check out www.gomez.com or www.broker.Fool.com.

l You can look into a new breed of financial company that charges just $2 or $3 or less per trade (for example, www.buyandhold.com and www.sharebuilder.com).

l You can invest small sums regularly using the above services or investing via direct investing plans (often called "DRIPs"), which permit investors to buy stock directly through companies, bypassing brokerages altogether. Learn more about direct investing at www.netstockdirect.com and www.moneypaper.com.

MY DUMBEST INVESTMENT

Downhill Train

One of the first bits of investment advice I ever received was, "Find a product you really like and invest in the company that makes that product." My dad gave me a set of Lionel electric trains when I was young. When I started investing, I found that Lionel was listed on the New York Stock Exchange. Following that early advice, I bought shares. Lionel made great trains, but when it moved from its primary product and bought toy stores, it faltered. Soon my shares had lost most of their value, and I sold. One upside is that the experience and knowledge I gained with the trains provided the basis for a 40-year career in electricity and electronics. -- Jim Hackenberger, San Marcos, Calif.

The Fool Responds: It's usually not enough for you to love a company's product. After all, if not many others share your conviction, the company won't prosper (unless you buy a LOT). It's also smart to be wary of companies shifting their focus outside their circle of competence. Some firms can pull it off, but many flounder.

Foolish Trivia

I was formed roughly a year ago, by the merger of two big telecommunications companies. I'm now America's largest provider of wireline and wireless communications, the biggest local-telephone company in the United States, and the world's largest provider of print and online directory information. I rake in more than $60 billion annually and employ about a quarter of a million people. I offer everything from Internet access to pay phones, and I'm building a global telecommunications network. My name mixes the Latin word for truth with the word for where Earth meets sky. Who am I?

Last Week's Trivia Answer: I'm the world's third-biggest media maven, raking in more than $20 billion per year. My brands include CBS, MTV, Nickelodeon, VH1, BET, Paramount Pictures, UPN, Showtime, The Movie Channel and Simon & Schuster. MTV alone reaches 330 million households. My syndication unit, King World Productions Inc., offers "Wheel of Fortune," "Jeopardy!" and "The Oprah Winfrey Show." My subsidiary Blockbuster, the world's largest video renter, encompasses 7,700 stores. Who am I? (Answer: Viacom)

The Fool Take

Capital Charge

Don't let the downside of credit card excess deter you from considering some of the credit card industry's best players as possible investments. The top five credit card companies, including Capital One Financial (NYSE: COF), each crank out a return on equity above 22 percent. They're putting shareholders' capital to good use, generating returns well above the market's average.

Capital One's key competitive advantage is its information-based strategy. This allows it to target the most reliable customers, not only in traditional credit card segments, but also among riskier customer groups. Demand is high in that niche, and smart companies are able to identify customers who'll pay their bills.

Capital One pioneered the balance transfer program and the teaser rate. It also helped legitimize the secured credit card business. From 1995 to 2000, it increased revenues at a compound annual rate of 41 percent, upped its number of accounts (customers) by 38 percent annually, and grew its earnings 26 percent annually.

There are risks with credit card companies: consumer bankruptcies, rising interest rates and the overall health of the economy. An additional downside for potential Capital One investors is its soaring stock price. Still, the company has a seemingly sustainable advantage and is growing much faster than its industry. It's worth keeping on your radar screen.

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