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Archive for Sunday, February 20, 2005

The Motley Fool

February 20, 2005

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Last week's question and answer

Born in 1999, I'm already the world's largest online DVD movie rental service, serving more than 30,000 different titles to more than 2 million members. For a fixed monthly fee, they can rent lots of DVDs, with no due dates or late fees and with free shipping included. I employ more than 1,000 people at my California headquarters and my 29 shipping centers. I signed up my first million subscribers faster than AOL did. I own more than 16 million DVDs and ship 17 tons of them per day. I sport more than 300 million movie ratings from customers. Who am I?

(Answer: Netflix)

Kids should invest

Give your young ones a financial head start in life by introducing them to investing. With time on their side, they're positioned to reap great benefits from the magic of compounded growth. You can begin by playing and experimenting together.

  • Build a mock portfolio. Have your kids list companies that interest them. If they look around their home, their classrooms, the mall and on TV, they'll see firms such as Ford, Nike, Microsoft, Coca-Cola, Kraft Foods, Gap, Apple, Wal-Mart, McDonald's, Kellogg, Disney and Wrigley. Have them list 10 to 20 companies on a sheet of paper, with ticker symbols, current stock prices and today's date. Every day or week, have them record the latest prices. Calculate the gains or losses regularly. Such short-term stock price movements aren't terribly meaningful, but they can help a child understand how the market works. If you set up your portfolio online at http://finance .yahoo.com, tracking your holdings will be a snap.

l Follow the companies together. Scan newspapers and magazines for stories about the businesses and note how news affects stock prices. Watch the companies expand internationally, add more stores, announce new products or services, report sales and earnings each quarter, and discuss their strategies. Read through their Web sites and annual reports.

  • Eventually, help your child actually invest money. You can open a custodial brokerage account, with you acting as the overseer. Or informally "sell" some of your own shares to your child. If you own shares of PepsiCo, you can sell a few to your child at its current price. If you're about to buy 100 shares of ExxonMobil and your child wants to buy a share or two herself, you can buy 101 or 102 shares. Once your child turns 18, she can open her own brokerage account.

Help your kids get started. Your teens can learn more at www.brasscu.com and www. Fool.com/teens, or in our book "The Motley Fool Investment Guide for Teens: 8 Steps to Having More Money Than Your Parents Ever Dreamed Of" by David and Tom Gardner with Selena Maranjian (Fireside, $14).

Derivative dirt

What are derivatives? -- G.D., Gary, Ind.

A "derivative" can be any of a range of investments such as options, futures contracts and warrants. Some are very creative financial instruments based on other instruments. While shares of stock represent real ownership stakes in companies, derivatives often represent contracts, not assets. They derive their value from the performance of other assets, such as stocks, bonds or commodities.

Derivatives permit sophisticated investors to hedge their bets, engage in arbitrage (profiting from differences in prices), lock in prices and use leverage. For example, several derivatives may be based on a single bunch of home mortgages, with one representing the interest payments and another representing principal payments. Since they would react differently to interest rate changes, they each will likely appeal to a different kind of investor.

Derivatives are typically used by large institutional investors to boost their overall return or to hedge against risk in their portfolios. They can be very risky, though, and when used aggressively can result in investors losing more than their initial investment. Even some Nobel Prize winners lost big on derivatives, when the massive Long-Term Capital Management hedge fund failed.

I'm new to investing. Can you recommend a good book on financial planning? -- S.C., Albuquerque, N.M.

Try "Ernst & Young's Personal Financial Planning Guide" (Wiley, $20), Stan Hinden's "How to Retire Happy" (McGraw-Hill, $15) or "The Motley Fool Personal Finance Workbook" by David and Tom Gardner (Fireside, $14). Kudos for educating yourself instead of just handing over your money to someone else to manage. Still, it's sometimes valuable to consult a financial adviser as you get your ducks in a row. Learn how to find a good one at www.sec. gov/investor /brokers.htm.

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