In a previous guest post, my friend Rich wrote a guest post about investing in Exchange Traded Funds (ETFs).  He mentioned that ETFs are an investing instrument that decreases the risk of the stock market.  Now, the question is, how does an ETF decrease risk?  This can be explained by the concept of diversification.  As Rich said, each ETF tracks a wide range of stocks.  Simply put, diversification means that you are not putting all your eggs in one basket.  Having exposure to a number of different stocks in one portfolio can help in that if the stock of a particular market or sector performs poorly, the other stocks could potentially counteract that poor performance.  An ETF provides diversification without the need for a large sum of money to buy a number of different invidual stocks.

Now, keep in mind, just because your portfolio is diversified, it does not mean that you are free from any risk.  You can never diversify away all types of risk.  There are two basic types of risks – systematic and unsystematic risk.  Systematic risk can affect a wide range of assets, while unsystematic risk impacts a small number of assets.   Systematic risk is sometimes referred to as market risk because it can impact an entire market.  Unsystematic risk is sometimes referred to as specific risk because it is specific to a certain number of assets.  For example, if the employees of a specific company stage a strike and the stock price tumbles as a result, this is unsystematic risk (specific risk) because this particular company was impacted by the risk.

Through diversification, you can only lower unsystematic risk and can never eliminate systematic risk.  This is because by diversifying your portfolio, you expose yourself to different asset classes or stocks.  If one or a few stocks are negatively affected by unsystematic risk, the other stocks are not impacted.  However, with systematic risk, the entire market is affected and  a large number of your stocks could perform negatively as a result.

The lesson here is that you always need to diversify your investments.  That means, spread your investments out between different asset classes.  Examples of different asset classes could be cash in a savings account, individual stocks, index funds, mutual funds, ETFs, CDs, treasury bonds, corporate bonds, international markets, different market sectors and many more.  If you do not diversify, you are not only exposed to the systematic risks, but also to the unsystematic risks.

This weekend, I went to Foxwoods Resort & Casino in CT for a good friend’s birthday party.  We went for two nights and had an awesome time going to the bars/clubs at night, relaxing by the pool during the day, doing a little gambling, and my favorite, gorging at the buffets.  This fun trip was not too expensive, but did require spending some discretionary income, which was well worth it for me since I had such a fun time.

As I said, we did some gambling during the trip as that is one of the major forms of entertainment at Foxwoods.  I am not a big gambler at all, but I do enjoy playing the games every once in a while.  It is obvious that the games are all created to favor the house (casino).  Every game has different odds and can be very fun.  I think there are some important points to understand before gambling:

1. Be prepared to lose – When you start playing any game at a casino, the odds are stacked against you.  If you want to make money by gambling, you are better off  not playing.  Unless you are an absolute professional poker player or can count cards in blackjack, you will never have the advantage.  The idea here, is that you are paying for entertainment.

2. Have a set amount you play with – It is so easy to play with more money than you should at the casino.  This is the problem many people run into which results in the loss of excessive amounts of money.  Go in with a set amount of money that you are comfortable with losing.  Once it is gone, you are finished.  It might even help to leave your ATM card at home. For me, $100-$200 is the limit.  I think to myself, I am willing to pay up to $200 for the entertainment.  Once I lose that, I am finished and not particularly unhappy (I hate to lose so it can still be upsetting) since I already determined that I was willing to lose that amount of money.

3. It is an incredibly low chance that you will win big – You always hear about how someone you know won a hundreds of dollars or even thousands at the casino.  What you don’t hear about are the 10 other times that person lost a lot of money at the casino.  People prefer to tell stories of when they win.  This gives us a false idea of how good our chances are of winning a lot at the casino.  Just keep in mind, the odds of every game are stacked against you.  The longer you play, the more likely you will lose money.

4. Be careful of being too risky – I wrote in a previous entry about the psychology of investing.  The psychology of gambling can be very similar.  People have a propensity to be more risk adverse when they are in the domain of gains.  That means when you are winning at the casino, you would probably want to take less risks because you don’t want to lose your winnings.  However, once you see those winning diminish and when you lose it all, you feel the need to play more to “win it back.”  When in the realm of losses, people are more open to risk.  This is where the casino will get you.  Since over time, the odds are in the casino’s favor, you are likely to lose all your winnings.  This will result in you wanting to play more to recover your losses.

I previously posted about the best job in the world.

Well, it looks like Thailand is going to have a similar job. Only instead of a job, its a free vacation with a chance to win a prize! Apparently, the tourism industry is not doing so well in Thailand, so this is a marketing effort to boost tourism!

Ok, maybe the lottery is not completely evil since state governments use the proceeds from lottery sales for funding some good things.  Still, the lottery is a horrible game for your wallet.  I’m sure everyone knows how incredibly unlikely it would be to win the lottery. To me, it is just like throwing money away.  Jim Wang of Bargaineering, describes very well how much money you could save instead of playing the lottery in one of his posts.  He also points out that the majority of people who win the lottery end up in a lot of financial trouble because they become reckless with the money.  This girl is a typical example. Perhaps these things happen when they don’t think about what to do with the money or don’t stick to a game plan.

I was talking to a friend who decided to buy lottery tickets for the MegaMillions, which had a jackpot above $300M.  She was very excited and was thinking of all the ways she would use the money.  Thinking about what you would do with a large cash windfall is actually a healthy thing to do.  Depending on the amount of money, I think I would save enough of it in cash so that I could live off of the interest alone.  This would ensure that if I blew the rest of it, I could still live off the interest on the cash in my savings.  I think I would then pay off my debt and my family members’ debt and then put a good portion of it into investments such as real estate, the stock market, and my businesses that I started recently.  If there were anything left after that, it could go to some splurging.  I think it would be most important to make sure that I can continue to generate money with the windfall above all else.

What would you do with such a windfall?

In my previous post about the basics of buying a home, I mentioned some point that you should be aware of.  One of the points is to know the right questions to ask.  Here is a list of questions I always make sure to ask:

1. Why is the seller selling? – This question is solely for negotiation purposes.  I wrote previous posts about negotiations, which you might want to check out.  In this situation, you want to know more information about the seller’s position.  Did they buy another place already? Are they moving out of state? Are they upgrading to a larger place? Essentially, you want to know how motivated they are to sell.  If the seller has already bought another house, they are likely paying two mortgages and are pretty desperate to sell soon.  This puts you in a strong position to negotiate.

2. How much of the building is owner occupied? – This is only if the property is a condo in an apartment building.  The % of owner occupancy can play a role in your financing options.  More on this later.

3. Does the tax figure include a residential tax exemption? – Usually, the seller will let you know what the tax expense is each year.  Many towns will give you a residential tax exemption and allow you to pay lower taxes each year that you live in the apartment.  If it is an investment property in which you are not living there, you won’t get the exemption. This is good to know, so you can see what your monthly expenses will be to own the house.

4. What kind of heating system and how old is it? – The type of heating system can make a big difference in your monthly costs.  Oil can be costly and annoying to have to get heating oil delivered to your property.  You want to make sure that it has been updated and is working well.  Of course, many of these things will come up in inspection, but it never hurts to know before you make an offer.

5. How old are all the appliances, windows, roof, water boiler, etc? – It is good to know how old things are and the last time they were renovated as they could impact your valuation of the property.  If the roof is likely to need to be repaired in the near future, you want to know that.

6. How is the condo association? Are there any anticipated extra condo association expenses? – Of course, this only applies to condos.  You want to know any future expense that could occur.  Sometimes, condo associations want to make repairs to the building as a whole and it is up to the condo owners to pay for this.  You want to know ahead of time if there are plans for this so you know that you will need to pay that once you own the condo.

7. Have you been showing the property a lot? – This is another question to gauge your negotiation strength.  If the house has been shown a lot recently, you might have a lot of competition.  If it has not been shown much at all, you know the seller doesn’t have many potential offers to choose from.

Does anyone else have any good questions to ask?