Investing: Properly Defining Risk

Many in the financial world define risk using some sort of variance measure, like beta. This, in my mind, is a foolish attempt to quantify something that can only loosely be quantified. Finance is not a hard science.

Warren Buffett often points out the absurdity of using beta as a measure of risk with the following example: if KO were to decrease in value by 50% tomorrow, is it a better buy or a worse buy? It is a better buy, of course...you are buying the same thing for less. However, a 50% decrease in value in one day would lead to a high beta for the stock.

A much better definition of risk is one articulated by Ron Muhlenkamp in his book Harvesting Profits on Wall Street. Ron defines risk as the possibility of a long-term, permanent reduction of purchasing power due to 1) taxes, 2) inflation, and/or 3) capital loss. Individual investors can outpace taxes and inflation buy making sure they invest in equities instead of bonds, providing of course they have a long enough investment time horizon that they can ride out the volatility. Minimizing capital loss, then, simply means buying stocks trading with sufficient margins of safety. No regard for beta is necessary.

Global Trading at ETrade

E-Trade is rolling out a platform whereby American investors can exchange currencies and invest directly on foreign stock exchanges: Canada, UK, Germany, France, Japan, and Hong Kong.

Time will tell if this will actually be a profitable activity for investors given the fees likely involved in exchanging currency and actually trading, but it's a great step in the right direction.

E*trade Global Trading

BofA $50 Statement Credit Amex Card

The offer:

Bank of America currently has a promotion for its Worldpoints cards providing $50 cash-back (via a $50 credit to your credit card) 8-12 weeks after your first purchase.

The fine print:

§§§ To qualify for this offer, your new account must be used to make any purchase or cash advance transactions (including balance transfers; which may include transaction fees within 45 days of the account open date). Limit one (1) item per new account. The Bank of America WorldPoints™ Platinum Plus™ MasterCard® Credit Card offer is subject to application approval by FIA Card Services, N.A.. Upon qualifying, a $50 credit will appear on your Bank of America WorldPoints™ Platinum Plus™ MasterCard® Credit Card statement. Allow 8-12 weeks from qualifying to receive the promotional credit.

The link:

http://www.bankofamerica.com/creditcards/

BofA $0 Equity Trades Not Free!

Bank of America has been heavily marketing it's new $0 trades, but it's important to pay attention to the fine print.

In order to qualify for the free trades you need to have $25,000 in combined accounts with Bank of America. This $25,000 could be yielding ~5% in an internet savings bank like Emigrant Direct for you today. At Bank of America it will be yielding substantially less.

If we optimistically assume that your money will be earning 1% at Bank of America (based on some mix of checking/savings/cd deposits), you will be foregoing 4% of interest income every year, or $1,000 pretax. That is a lot more than free!

$25 Free, American Express ONE Card

How to get $25 free: sign up for an American Express ONE card and they will open a high yield savings account for you with a $25 complimentary deposit. The money is deposited 8-12 weeks after your first purchase.

The card isn't the best deal because after a year they start charging you a $35 annual fee (!) and all you really get from the card is 1% back. And that 1% goes into an account that yield way less than EmigrantDirect does. But, so sign up for the card and cancel after 10 months! $25 free baby, and no cost to you. Here is the link:

View card terms & apply here

$75 bonus with a $1000 NetBank Money Market Account

http://www.netbank.com/pro348.htm

Open a NetBank MMA and get $75 if you have an average balance of at least $1000 for 30 days. Fees to note:

+ $5/mo fee if account balance goes below $500
+ $25 fee if you close account before 6mos
+ $7.50 fee for closing account after 6mos (you still come out way ahead if you deposit $1000, get the $75, and earn a 3.52% APY)

$50 Bonus Offer for New E-Trade Money Market Accounts

Click here for the offer.

To avoid fees:
Maintain $1,000 in Money Market Account, or $5,000 in total E*TRADE Bank deposits, or $50,000 or more in linked E*TRADE Securities and E*TRADE Bank accounts or execute at least 30 stock or options trades during a calendar quarter.

A $10 early closeout fee will be assessed if account is closed within 120 days of opening.

$50 plus a 3.6% APY for three months is not a bad return in 120 days.

Three Best Online Brokerages

Scottrade is the best, period. I also like Ameritrade Izone and BrownCo. One could make a defendable argument that Ameritrade Izone is better than Scottrade for regular brokerage accounts and BrownCo for IRA accounts.

All the other brokers, in my humble opinion, simply aren't worth the extra money.

I personally invest with Scottrade and have my Roth IRA account at BrownCo.

Here are my thoughts:

• Scottrade
  I consider Scottrade the very best online broker. $7 trades across the board - limit, stop loss, market - with no annual fees, fast execution, a great web interface, local branches all around the country, and excellent customer service. My emails to them always get answered within a few hours. Everyone should do their trading with these guys.
  http://www.scottrade.com/
  
  
• Ameritrade Izone
  They only offer regular brokerage accounts - no IRAs allowed. But, all orders, both limit and market, are $5.00. Ameritrade Izone is certainly the most economical way to go for regular brokerage accounts, though you give up the convenience of having a Scottrade branch near you.
  http://www.izone.com/
  
  
• BrownCo
  Like Scottrade and Izone, BrownCo also has no annual fees (an absolute must!). BrownCo beats Scottrade on market order commissions at $5.00 (awesome!), but their limit orders cost $10.00 (a tad pricier). The web interface isn't as complete as Scottrade's as well (no gain/loss tracker, a bit less intuitive) but it's got all you need to do the job. You also have to meet higher minimum requirements in order to get a BrownCo account - $50k net worth and $15k in initial funding for a regular brokerage account or $5k in initial funding for a Roth IRA.
  
  BrownCo's integration into E-Trade is a question mark. According to E-Trade, the BrownCo commission structure will stay the same through December 31, 2006, but it doesn't mention what will happen after that.
  
  What is interesting to me is that E-Trade offers unlimited ATM reimbursements to any of its banking customers that keep a minimum of $5,000 in their checking accounts or that have $50,000 in linked accounts - which will include BrownCo accounts, of course. I like the idea that simply having $50,000 in, say, a Roth IRA with E-Trade, would allow me to withdraw money free from any ATM anywhere should I open a checking account there.
  http://www.brownco.com/
  

That is my verdict! What about Schwab, Fidelity, Ameritrade, TD Waterhouse, E-Trade, and the others, you may ask? With Scottrade setting the bar with such great service at a $7.00 commission level, there is no reason to even consider these other guys IMHO. Companies like Schwab talk about adding value, but it seems like all they really do is offer more crappy sell-side research than their competitors and charge $10(+) commissions (Schwab's are $30) and annual fees for it. It's hard to make money investing if you're shelling out big bucks to your broker!

Highest-Yielding Savings Accounts

Everyone should park the lion's share of their cash-on-hand in one of these online savings account. You can't beat their 4.0%+ yields. For the sake of comparison, a Bank of America savings account yields 0.5% annually. If you assume a 3.0% inflation rate, the money in your Bank of America savings account is effectively losing ~2.5% of its purchasing power each year. That's a bad deal folks! The higher yields offered by online savings accounts allow you to maintain the purchasing power of your money.

Below are the best online savings account deals. If you are interested in an ING Direct account email me at tops123@gmail.com. I'll reply with a link entitling you to a free $25 just for opening the account!

• Emigrant Direct
  Current Yield: 4.25%
  http://www.emigrantdirect.com/


• HSBC Direct
  Current Yield: 4.80% through 4/30/2006 (after which the yield will revert to a lower rate - my guess is around 4.00%)
  http://hsbcdirect.com/


• ING Direct
  Current Yield: 4.75% through 4/15/2006 (after which the yield will revert to 3.80%)
  http://home.ingdirect.com/


• PayPal
  Current Yield: 4.48%
  https://www.paypal.com/

I have an ING Direct account and a Paypal account. I keep rainy day funds in these accounts (equivalent to three months' expenses) and the rest in other investments. I'll touch on those later.