With the recent US recession, the stock market took a plunge in the last year.  Since March, the stock market has  been steadily climbing and as of this weekend, the Dow is on the verge of hitting 10,000.  There has been much media attention towards a potential recovery and many people are starting to say that this recovery is here to stay. 

I think that ultimately, there will be a recovery in the stock markets.  However, I do not think the time is now.  At this time, the media appears to be, for the most part, bullish.  In my opinion, they are full of BS.  There is nothing that supports the level that the stock market has reached.  Here is an article that I read last week that sums it up very well – don’t worry, I’ll give you the gist of it so you don’t have to read it.

The article claims that we are due for another correction and that once the Dow hits 10,000, people will start selling.  I think the most telling piece of information mentioned in the article is that when you look at price to earnings (P/E) ratios of the current market, the market is extremely overvalued.

“Based on P/E ratios, the stock market is grossly overvalued, even at current prices. As per Standard & Poor’s research, the Q3 2009 P/E ratio is 138.97.  Historically, a P/E ratio north of 20 is viewed as expensive.  Also, historically, the market almost always corrects within a year of a 20+ P/E ratio.  Imagine the impact of a 140 P/E ratio.”

What the article is essentially saying is, there are no earnings to support the current prices of stocks.  The market is overvalued because everyone is so optimistic about the market.  The article claims that the stock market has not bottomed out because the P/E ratios have not completely reset.  In order for the stock market to bottom out, the P/E ratios have to fall below historical reset levels. 

I thought this article was a little too pessimistic, but I do agree that the current market rally is not sustainable.  Clearly if P/E ratios are so high, there is nothing substantial supporting the prices of stocks.  There will have to be a correction coming soon. 

What do you all think? Is the stock market overvalued or is this current rally the real deal?

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.

A few month’s ago, I signed up for Lending Club. If you have never heard of it, it is essentially a peer to peer lending platform. With the credit markets tightened up, some people who need to borrow money have chosen to borrow from other people through peer to peer lending companies such as Lending Club. Other’s see an opportunity to invest through providing money to fund loans with Lending Club.

I really like the idea of Lending Club. You can choose the different levels of risk associated with different loans in your portfolio. The higher the risk, the greater the interest rate and return. Of course, there is the risk of some loans defaulting, but if you diversify your loan portfolio, you can earn a decent return.

I actually have yet to invest any of my own money in Lending Club. I took advantage of an offer to try Lending Club out in which the company gave me a free $25 to start my account. I did it four months ago and invested the $25 into a loan with moderate risk and 12.53% interest. So far, the borrower has not missed a payment. Obviously, I do not intend to make any real money with this $25, but I am really just testing out the platform. So far so good.

If you want to try it out as well, you can also get $25 into your account for free (I also get a bonus for referring you). Here is how:

1. Click on this link to Lending Club
2. Sign up for an account and enter this promotion code: blee0408

You will need to input your social security number and some other personal information. Don’t be concerned, this is to verify your identity and etc. Give it a try and please let me know what you think of it by commenting below!

As a college graduate in recent years, I have some advice for those who have just graduated and are starting their “real lives.” Personally, I found it somewhat stressful to join the “real world” and take on actual responsibilities. I had to move to a city that was 300 miles away from my home town, pay bills that I never had before, learn about benefits at my job, feed and take care of myself, and develop a work-life balance. I am sure many young professionals can relate as they look back on their college days and realize how easy they had it and how little responsibilities they had compared to the ones they had now. Here are some of my thoughts on the transition from college to the real world:

1. Live a frugal life – Even though you are no longer a college student, live like one for at least one year. When you first exit school, you are probably not very financially stable and have a lot of student debt. Instead of living in a studio, find a roommate and live in a cheaper 2 bedroom or better yet, live in a large house and share the rent with many roommates. Instead of dining out multiple times a week, cook at home. Go out one less night of the week (you’ll find that it gets harder to go out as much as you used to as recovery time increases) and look for deals on everything. Understand that you are not yet financially stable and should make every effort to save. You were used to this lifestyle in college; why not extend that another year?

I live currently live with four of my friends from college. We all stayed in the same city and found a very inexpensive house to live in. Not only has it provided me with a way to ease into post-college life, but it has allowed me to save much more each month.

2. Be organized – This is even something I need to work on. My roommate and one of my best friends from college said I operate in organized chaos – meaning it appears that everything is in disarray, but I still know where everything is. I am going to work on making sure I know where everything is in a neat and tidy way.

The more organized you are, the easier your life will be. Make sure you have a filing cabinet or box to put all your important bills, records, and documents. Keep track of your tax information throughout the year so tax season is just a breeze and not a dreaded chore. Document what bills need to be paid at what time so you do not forget or miss any payments. I keep an excel file of all my bills that I use each month to track which bills I pay and how much I have paid.

3. Learn to be financially responsible and savvy – Educate yourself on personal finance. There are so many people out there who wish they had known more about personal finance at a younger age. There is so much you can do by empowering yourself with this knowledge. Read publications and different personal finance blogs (like this one =P) and educate yourself on how to save money, how to invest, how to manage your finances, and etc. The more your know early on, the easier your financial life will be in later years.

4. Start saving for retirement early – I have yet to post about the time value of money or the power of compounding, but these are critical concepts. Basically, the earlier you start investing the greater the potential you have for your retirement savings. Max out your 401k if possible. Start a Roth IRA or traditional IRA soon (I have not been able to do this yet, but am going to in the next few months).

5. Excel at work – If you have a job right now, it is your greatest asset. You don’t own a house, you don’t have a huge savings, and you don’t have a retirement nest egg. Put all your effort into excelling at work to get to a promotion or a raise or just to develop your skills. The more you learn and the more responsibility you have, the more valuable you are to a company. Eventually, this all equates to more earning potential and a better financial position.

6. Pursue your hobbies – Don’t forget to enjoy yourself. Do the things you enjoy. Who knows, maybe one day, you can make some money off of these hobbies. In the mean time, have fun doing those hobbies and pursue what is important to you. Financial stability is important, but so are your interests and happiness.