Featured | Jun 29, 2010 | 2 Comments

Financial Rebel Fund: The $300 Monthly Investor—Report 01

New On-Going Series . . .

The other day I wrote an article about cutting expenses and I showed you how I managed to put $464 back into my pocket each month, so I could invest more. This gave me a great idea for the site and you, my valued reader.

I’m starting a new series on Financial Rebel called the “Financial Rebel Fund” that will detail how I’m going to take $300 each month and invest it. The goal is transparency, so you can follow along. In this article, I’ll be setting up the ground rules for the new Financial Rebel Fund and as we go along, I’ll provide news and thoughts about investments made and possible future investments. And of course, I’d love to get your comments along the way.

Let me also point out that I’m calling it the Financial Rebel Fund and even though there’s real money and action, this is not a real fund. It’s my own personal setup.

Starting Capital

Most brokerages I know of won’t let you walk in with $300 and open an account. However, there’s a good discount broker that will work for us. That broker is Scottrade. You can open an account with $500 there.

And since we’re investing on the lower end of things, we don’t want pointless fees eating up our capital. As the capital grows, I may look into moving it to another broker, like ThinkOrSwim.

My first investment will come in July 2010. I will set up an account with $500 (July’s $300 and $200 from June). If I were just starting, I’d need to wait two months so I had the $500 to open an account, but I don’t want to wait until August to get this series going.

Capital: $500

Risk & Reward

Progress always involves risk, but risk needs to be managed. Let me give you one disclaimer. I’m not providing official financial advice. I have no idea how the Financial Rebel Fund will end up. It might crash and burn for all I know. If you make investments based off anything said here, you’re responsible for your own actions and outcome.

While I’m willing to take some risk, I’m not willing to throw caution to the wind. Here’s one way to look at it. Let’s say there’s a $15 stock that might go up $5 per share. After evaluating it, you also realize that it could go down $6 – $7 per share too. Is this stock a good risk? The answer is it depends.

If you have a portion of your capital set  aside for high speculation, then yes this is potentially a good risk. However, for your main capital allotment it is not. You are risking 40% – 46% to gain 30%. That’s a losing proposition that forces you to be right far more than you’re wrong. Ideally, we want a 1:2 ratio (risk/reward). An example would be a $15 stock that might go up $5, but might decrease by $2.50 per share. While no one knows the future, as far as our analysis goes, this is a good risk. We can be wrong more than we’re right and still make money.

One last example. Let’s imagine you invested equally (100 shares each) in 10 of those $15 stocks and 4 of them worked out perfectly ($5 gain), but 6 of them didn’t ($2.50 loss). You were wrong 60% of the time, so you lost money right? Wrong.

You lost $2.50 per share on the losers times 600 shares (-$1,500), but you gained $5 per share on the winners times 400 shares (+$2,000), so your net gain is actually a profit of $500. Despite being wrong 60% of the time, you’re still making money.

However, for this to work, you still need to be correct 40% of the time and more importantly, you need to let go of losers when they reach your stopping point. In our example above, if you were to hold onto the stocks past your stopping point—thinking they’d come back—you’ll end up losing a large amount of capital.

Trading Style

Given the amount of capital we have to use, doing something like day trading is out. However, we can engage in short term trading if something looks good. Ideally, we want investments that will work over the longer term though.

One example is a stock I’ve been watching since last month. It’s about $20 per share, but I expect a $2 – $4 upswing in September. This might be a stock I pick for the shorter term.

Another example might be a stock that pays a good dividend that I want to potentially keep for a couple years or longer.

Because I want you to follow along and I don’t know your current ability level, I’m going to try my best to stay away from anything involving a lot of time or know-how. For example, I won’t be engaging in currency trading or bonds or options (most likely).

Trading Plan

I’ve been giving this a good deal of thought and I’ve come up with the following principles I need to apply.

1. No penny stocks. I want the stocks I invest into to have a good blend of security and growth. However, taking on too much risk is not an option. If you’re in your teens or twenties, you may wish to take on a lot of risk. However, for those who are in their mid thirties or higher, I don’t recommend it.

2. One trade. The last thing I want to do is watch Scottrade’s $7 commissions eat my money up. Given the fact that I’ll be using just $300, I really can’t divide it up. Think about this. Even with these low commissions, each trade costs $14 ($7 buy, $7 sell). Imagine I pick 3 stocks per month, that’s $42 in commissions, which would be 14% of my capital. So, I’d need a 14% gain just to break even. No thanks. However, if I do just a single trade per month, that’s $14, which is 4.6%. I can live with that.

3. Visible companies. The companies I choose to invest in must be highly visible. I want to see many reports, lots of news, conference calls and so on. In other words, I’ll be staying away from very small companies. While I may select a small cap stock, the company will need high visibility.

4. No averaging down. I don’t believe in adding to a losing position. While little ups and downs are one thing, if a stock I’m in is down say 10%, I’m not buying any more of it. I think it’s foolish. Some people would say to do it, because then if it just goes back up halfway, you’re even. I would say that if it continues the trend of going down you’re now losing twice as much. I will add to winners only.

5. All or nothing. Given the capital size and commissions, I really can’t dabble around adding just part of a position, waiting to see where the stock goes and then adding more. That’s something I can do later on when my working capital is higher. For this fund, I’m going to buy all possible shares at once and sell all at once (until a position gets to be larger).

6. Diversification. I think many people can get in trouble here. They diversify their stocks just for the sake of diversification. We have to keep in mind the working capital and the goal. In my opinion, I don’t need to diversify into many sectors. While it may come out that way, I’m fairly open to just being in one or two sectors and working them well. This is also where exchange traded funds come into play (see my article on how to buy them here).

What’s Next?

Now the fun begins. It’s the end of June and at some point in July I need to find the first trade for the Financial Rebel Fund. I’ve got some ideas already.

While I’ll be posting frequently, I’m thinking of doing a monthly fund report at the beginning of each month. The next full report will be the first week of August 2010.

As always, I welcome your comments.