# Calculating cost basis

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```					Business101	                                                                                                                                               By Mary Yanni, The Star-Ledger

Calculating cost basis
E
veryone likes to watch her investments grow.                                                                including fees or commissions. Subtract your cost basis from
But when it’s time to reap the rewards, a lot of                                                        the sale price, and you get the amount that will be taxed.
people get tripped up.                                                                                          In reality, though, cost basis can be tricky.
Often, it’s cost basis that does the tripping.                                                                    Here’s a look at the basics of cost basis — and some
Cost basis is the key to how much tax you have to pay.                                                        specific situations that tend to trip up
The higher your cost basis, the less your capital gain — and                                                      shareholders.
the less tax you owe.
In theory, cost basis is easy — it’s simply
the amount of money you spent

iSTOCKPHOTO.COM

capiTaL gain

cosT Basis

The basics                                                                                                                                      if you inherited your shares
Keeping TracK
There are a few ways to calculate                                                                                                               Your cost basis is the value of the stock or fund on
the cost basis (sometimes called                         The lesson from all of this is to keep good records. You should keep                   the date of death. You get the value by averaging
“tax basis”) of stocks and mutual                        any statements you receive from your broker, but you also can keep a                   the high and low prices on the date of death.
funds. Which method you choose is                        cheat sheet, like this one. Just enter any purchases or adjustments as
On occasion, an estate’s executor may choose to
going to affect how much tax you                         they happen. Then you can figure your cost basis at a glance.
use an “alternate valuation date” of six months
owe, so it may be worthwhile to                                                                                                                 after the death for tax purposes — but only if
look at all the alternatives before                      	                            Acquired             Adjustment	to	     Adjusted          the estate is subject to federal estate taxes. This
you pick one.                                            Stock	             Date	 Shares	 Cost/share	      basis	per	share	   basis	per	share   typically happens if the value of the estate drops
There are two methods you can use                                                                                                               significantly in the months after the death. If this
for both stocks and mutual funds:                        ABC	Corp.	        11/1/04	     100	     \$40	      	                  \$40
happens, the alternative date has to be used for all
n FirsT in, FirsT ouT: FIFO                              	               	       	                	        Reinvested	div.,                     assets, including the shares you inherit. The execu-
simply means the first shares                            		              	       	                	        \$80	(1.5	shares)	 \$40.20             tor will let you know.
you bought are the first to be                     reinvesTeD DiviDenDs                                                                         It’s best to figure out your cost basis on inherited
sold. It’s the easiest method,                           	               	       	                	        Split,	2-for-1	    \$20.10
If you reinvest dividends paid by                                                            shares right away and start keeping track — every
but it also may lead to the                        stocks or funds, you	need to add                                                             dividend paid and stock split changes things. If you
Spinoff	of	DEF
biggest tax bills — the longer                     their 	value to your cost basis.
(0.75)	     \$15.08            don’t start keeping records right away, you’ll need
you’ve owned the stock, the                        Your broker or mutual fund likely                                                            to track down all of that information later on.
bigger your capital gain.                          will have these records. Simply
n speciFic shares: If you                          multiply the per-share dividend by                   “average cost” option: Take the         if you got an investment as a gift
the number of shares you owned                       total investments you’ve made,          This is trickier. It all depends on whether the person
keep meticulous records, you
when the dividend was issued and                     including reinvested dividends and
can ask your broker or mutual                                                                                                                   you got it from was giving it away at a gain or a loss.
add the total to your cost basis.                    capital gains, and divide by the
fund to sell specific shares.                                                                                                                   if the donor gives it away at a gain, you use her
total number of shares you own.
You can really manage your                                                                                                                      cost basis, no matter what your end result:
tax bill this way. You could,                                                                           You can do this two ways:
for instance, look at all the shares                 It’s tougher because fund inves-                                                              originaL     price on DaTe                   your
n Single category: Lump all your
you’ve owned more than a year                        tors tend to buy shares regularly                                                          per-share Basis    oF giFT      saLe price    cosT Basis
and reinvest dividends and capital                 holdings together and do the above
and pick the ones you paid the                                                                          calculation. This is how most fund            \$20             \$25          \$35           \$20
gains. By the end of a long invest-
most for. This gives you the lowest                                                                     companies figure it out for you.              \$20             \$25           \$5           \$20
ing career, you may have dozens of
capital gain and lets you pay tax at
transaction dates and adjustments                  n Double-category: Split up your
the lower rate for long-term invest-                                                                                                            if the donor is giving it away at a loss, it then
to contend with.                                   holdings into long-term (held for
ments. Of course, eventually you’ll                                                                                                             depends on how much you sell it for.
have to sell those old, cheap shares                 The good news is, you probably                     more than a year) and short-term
won’t have to figure it out yourself.              (held for one year or less).               n Sell at a loss, and your cost basis is the value
— unless you leave them to your                                                                                                                    on the date of the gift.
kids, who then can use their value                   Most brokers or fund companies                     Think carefully before you decide:
on the date of your death as the                     will do that for you.                              Once you use the average cost              n Sell at a profit, and you use the donor’s cost
cost basis.                                          When it comes time to sell, you can                options for a particular fund, you         basis.

MuTuaL FunDs: Dealing with fund                      use both the specific shares and                   have to stick with it as long as you       n Sell for something in between the donor’s
shares is at once far more difficult                 FIFO methods detailed above.                       own that fund. But you can use a           original cost basis and the value on the date of
and far easier than stocks.                          But mutual funds also allow for an                 different method for another fund.         the gift, and the IRS gives you a pass.
originaL     price on DaTe                   your
per-share Basis    oF giFT      saLe price    cosT Basis
where To geT The DaTa
splits                                                                            If you don’t have the paperwork, chances are                        \$20             \$10           \$8           \$10
If a stock splits, and you receive additional shares,                             you’ll need to dig up historical prices, stock splits               \$20             \$10          \$35           \$20
your total cost basis remains the same — but your                                 and dividends — at least. There are a few ways
per-share basis changes. Just divide your total basis by                                                                                              \$20             \$10          \$15           \$15
you can find the information you need:
the number of shares you have after the split:
n your broker or accountant. Either one may be                (In the rare event Aunt Emilie paid gift tax on the
BeFore The spLiT                                   aFTer                    willing to do the legwork for you.                            shares she gave you, you may be able to add the
# oF      ToTaL      per                  # oF          ToTaL      per           n The company’s web site. Look for the                        tax she paid to your cost basis. See a tax pro on
shares     Basis     share      spLiT     shares         Basis     share
“investor relations” link. Most companies at least            this.)
50       \$1,000     \$20       2-for-1       100     \$1,000         \$10          list dividends and stock splits, if applicable. In
most cases, you also can find historical prices just          if you have an ira
50       \$1,000     \$20       3-for-1       150     \$1,000        \$6.67
by entering a date. Some companies even have a                Most of the time, you don’t have to worry about
50       \$1,000     \$20       1-for-5       10      \$1,000        \$100
cost-basis calculator that will do the work for you.          cost basis with an IRA — when you invest tax-free
n yahoo Finance (finance.yahoo.com). Historical               money, your basis is zero. You simply pay income
spinoffs                                                                          prices are easily available here, but splits and              tax on what you withdraw. (Unless it’s a Roth IRA, in
Every so often, a company will “spin off” a part of                               dividends require some digging. They are                      which case withdrawals aren’t taxed.)
itself, creating a separate public company. Investors                             included with the price data, but you need                    Sometimes, though, you end up with nondeductible
then get shares of the new company in addition to                                 to page through month after month to find them.               contributions mixed into your IRA — and that’s what
their original stock.                                                                                                                           you have to keep track of. Your cost basis is sim-
At the time of the spinoff, the company assigns a                                                                                               ply the total of these nondeductible contributions
(including rollovers).
percentage of its value to stay with the parent and a                          The aT&T family
percentage to go with the spinoff. You use those                                                                                                When it’s time to take distributions from your IRA,
The convoluted history of AT&T gives us a toxic
numbers to figure your basis in the stocks. Here’s how:                                                                                         you’ll need to figure out what percentage of your
cost-basis cocktail. Stock splits, reverse splits, spinoffs,
total holdings is taxable.
BeFore The spinoFF                                                            mergers — pretty much every special circumstance
coMpany          cosT Basis     # oF shares            per share             you can think of rears its head in this calculation. And         To do that, add up your nondeductible contributions
the longer you’ve owned the shares, the trickier it is.          and any after-tax money rolled over from another
ABC Corp.           \$3,000             100                  \$30                                                                                retirement plan and divide that by the total amount
The easiest thing to do is see an accountant. Here in
in The spinoFF                                                                                                                                 of money in all your IRAs. You will not have to pay
New Jersey especially, the AT&T conundrum is old hat
coMpany              shares           percenT oF vaLue                 for tax pros.                                                    taxes on that percentage.

ABC Corp.              100                     75                       If you’re determined to go it alone, try visiting the Web        eXaMpLe:

DEF Corp.               20                    25                       site of the company whose stock you’re selling. These            Non-deductible contributions                   \$10,000
folks know cost basis is a nightmare for shareholders,
aFTer The spinoFF                                                                                                                              After-tax rollover                        +    \$50,000
and they do their best to make it easy — or at least
originaL      % oF     new             # oF         per share         not impossible — for you. Most offer either worksheets           ToTaL Basis                               =    \$60,000
co.     cosT Basis     vaLue cosT Basis        shares             Basis        or cost basis calculators.                                       TOTAL IRA BALANCE                         ÷ \$600,000
ABC       \$3,000 x     0.75 = \$2,250 ÷ 100                   =     \$22.50      Still, with all the help they offer, they suggest calling a      percent of distributions
DEF       \$3,000 x     0.25 =        \$750 ÷         20       =     \$37.50      tax expert. It’s good advice.                                    that will noT be taxed                                             10

Business 101 is available online at www.nj.com/business/ledger/biz101. Mary Yanni may be reached at myanni@starledger.com or (973) 392-1720.
SOURCES: Internal Revenue Service; Morningstar; SmartMoney.com; Investopedia.com
Business101                                                                                                                                              By Mary Yanni, The Star-Ledger

T
he upheaval surrounding “subprime” mortgage loans has
prompted all kinds of calls for increased consumer protections.
One proposal, put forth by Alex Pollock, a resident fellow at
the American Enterprise Institute for Public Policy Research, would
require lenders to tell borrowers in plain English exactly what their
loan entails a week before they sign the papers.
DOING THE
No jargon. No impenetrable language. No kidding.                                                                                                                       MATH: An online
No matter what you think of government regulation, it’s hard                                                                                                          mortgage calculator
to argue against the idea that the best protection a consumer                                                                                                            is a valuable tool when
you’re trying to get a
can have is knowledge.                                                                                                                                                 feel for how different
So don’t wait.                                                                                                                                                    interest rates would affect
The following worksheet is based on Pollock’s disclosure                                                                                                         your monthly payment.
BankRate.com has a very
form, which he calls the “Pollock Prototype,” and the two                                                                                                           good one; just click on
pages of definitions that accompany it. (Find the original                                                                                                          “calculators.”
online at www.aei.org.)
Take it to your lender. Fill it out. Figure it out.
Power to the people.

The appraised value of a house often differs from the sale
price. It’s important to know, because you don’t want to owe
more on a house than a professional appraiser thinks it could
Amount of loan                                                                \$
sell for in the current market.

Loan as a percentage of the home’s appraised value
Length of the loan                                                                                       years                   kind of ARM you have determines how long the initial interest
rate will last and how often the rate and, thus, your monthly
Final maturity date                                                                                                              payments, will change.

Type of loan                                                                                                                     This indicates what your normal interest rate would be,
after the teaser rate goes away. It is calculated by taking the
Beginning interest rate                                                                                                          published rate your ARM is based on, known as the “index
rate,” and adding a certain number of percentage points,
This rate is good for                                                                          months/years                      the “margin” on the loan. If, for instance, a loan is based on
the 1-year Treasury rate (currently 4.5 percent) and has a
The date your interest rate and payment can go higher                                                                            margin of 3 percentage points, your fully indexed rate would
be 7.5 percent — significantly higher than the “teaser” rate of
How frequently the rate and payment can adjust after that                     every ______________ months                        about 5.5 percent available now. To get a sense for what your
normal payment might be, be sure you know what the index
Today’s estimate of how high the rate will go,                                                                                   rate is, and ask your lender what the margin is.
called the fully indexed rate                                                                         percent
The highest your interest rate can possibly go. Most ARMs
The maximum possible rate on your loan                                                                percent                    have caps that limit how high the rate can go at any given
time, or for the lifetime of the loan.

This is your household’s total income before taxes.

This loan is based on your monthly income of                                  \$
This part of the worksheet illustrates how taxes and
Your monthly loan payment, based on your beginning rate                       \$                                                  insurance, plus a changing interest rate, will affect your
payments. The monthly loan payment estimates only include
This payment as a percentage of your income                                                       percent                    interest and principal on the loan. More important are your
monthly payments including taxes and insurance, which
based on your beginning rate                                                  \$

This payment as a percentage of your income                                                       percent                    These numbers are critical. The first indicates what your
monthly payment would be right now, absent the teaser rate.
Your monthly loan payment, based on the fully indexed rate                    \$                                                  Gut-check time: If you couldn’t afford this payment, you
probably can’t afford this loan. The second number is your
This payment as a percentage of your income                                                       percent                    “fully indexed housing expense ratio,” and it tells you how
much of your monthly income this payment would eat up. A
conservative lender would tell you this number should not
Your monthly loan payment, including taxes and insurance,
based on your fully indexed rate                                              \$                                                  be more than 28 percent of your gross monthly income, but
some lenders will accept a ratio of 40 percent or higher.
This payment as a percentage of your income                                                       percent
Some lenders charge a fee if you pay off your loan early —
including through refinancing. Most mortgages do not have
have a prepayment fee, but be sure to ask.

Is there a prepayment fee?                                                                                                       A balloon payment is a large payment due at the end of the
loan. A seven-year balloon, for instance, means the balance
If yes, what is the fee, and when must it be paid?                                                                               of the loan is due after seven years. (Most people pay it by
getting another loan.)
Is there a balloon payment?
A “payment option” loan lets you decide how much to pay
If yes, how much is it, and when is it due?
every month. In some cases, you can pay less than the
interest due — which means the balance on your loan goes
Is this a “payment option” loan?                                                                                                  up every month. Bad news: You can end up owing more than
the house is worth. More bad news: These loans often come
Total “points” plus estimated costs and fees due at closing                                                                       with very large increases in monthly payments later on.

Mortgages usually come with a number of fees and costs that
have to be paid at the time the loan is made — the closing.
As a buyer, expect to pay 2 percent to 4 percent of the value
For questions on the loan, who do you contact?                                                                                   of the loan.

Phone number
This should be a specific individual who is handling your loan
E-mail                                                                                                                           application — and you should never hesitate to call if you
have any questions at all.

Business 101 appears occasionally in The Star-Ledger’s Business section. Some past installments can be found online at nj.com/business/ledger/biz101.
Mary Yanni may be reached at myanni@starledger.com.
Business101                                                                                                                                                              By Mary Yanni, The Star-Ledger

Recession
T
here. I’ve said it: Recession.
Everywhere you look these days, people are
and on the TV news, it’s the euphemism of the day.
The economy certainly is showing signs of strain —
unemployment is rising and inflation is outstripping income
gains, to name just two grim signs.
But there is no reason to whisper about “you-know-what.”
Recessions are a natural part of the business cycle. After
long periods of growth, trimming away the unhealthy bits
can allow for more growth later. And recent recessions
have been mercifully short. The past two — the only two
in the past 25 years — each lasted eight months.
In an effort to knock some of the teeth out of this
beast, here’s a look at what defines a recession,
and what can be done about it.
iStockPhoto.com

Hard to pin down
A recession is defined as a significant decline in economic activity spread across the economy and lasting more than
a few months.                                                                                                                                                    What you can do
That amorphous description comes                                                                                                                                 Let’s assume a recession is still months
from our arbiter of economic cycles,                 A different definition: You                     GDP, annualized percent change                              away — and may yet veer away from us.
the private, nonprofit, nonpartisan                  may hear recession defined as                    6
In that case:
“two consecutive quarters of
National Bureau of Economic Research.                                                                                                    Recession               Your sAVinGs: You should always have
decline in the GDP.” That often                  4
The NBER considers indicators such                                                                                                                               enough money in the bank to pay your
turns out to be true, but not
as jobs, income, Gross Domestic                                                                                                                                  normal expenses for about six months. If you
always. Consider the most recent
Product, industrial activity and retail                                                               2
don’t, start putting some money away
recession, which began in March
sales and marks when recessions                      2001 and ended that November:                                                                               in case of emergency.
begin and end, but not until months                  The economy suffered three                       0
or, sometimes, years after the fact.                                                                                                                             Your JoB: Employment is the most fragile
quarters of falling GDP, but not
thing during a recession, since it’s so easy
slow without stopping? If the                        consecutively — and not entirely                –2                                                          for businesses to save money by cutting
decline isn’t broad enough or lengthy                within the eight-month period
defined as the recession.
2000           2001            2002                staff. Take a look around your industry and
enough to be considered a recession,
get an idea of how strong it is. Know who’s
it’s simply a slowdown.
hiring and who’s cutting back. And if you
really want to be prepared, update your
Where do we stand now?                                                                                                                                           résumé. It’s something you really should do
Pinpointing a recession’s beginning and end is important from a historical perspective, but it’s not very useful from a                                          once a year anyway, just so you don’t forget
policy perspective. It’s more important for us to be able to see the decline before it begins and soften it as much as we                                        what you’ve accomplished.
can. So, are we heading for recession? Things are slowing down, for sure, but they may yet bounce back.
Your inVestMents: If you’re in it for the
eMPLoYMent: Businesses continue to                      Prices are rising faster than income,                  long run, and you’re happy with how your
EMPLOYMENT                                     hire, but not fast enough. The economy                  and that’s eroding our buying power.                   portfolio is allocated, feel free to sit tight.
Monthly change (thousands)                     must add about 150,000 jobs a month                     retAiL sALes: Wall Street was shocked                  If you do want to tinker, remember the
300                                           just to keep up with population growth.                 to find out retail sales fell during                   companies that tend to weather recessions
We only topped that number four times                   December, but economists didn’t seem                   best are big and have good cash flow. Small
250                                           last year, and that’s why the jobless                   to be as worried, noting November                      companies don’t have a lot of cushion
rate has ticked up to 5 percent.                        sales were especially strong. Retail
200                                                                                                                                                          when there’s a downturn in business. And
industriAL Production: The most                         sales are expected to keep growing                     companies that sell necessities — food,
150
recent reading on the state of the                      during the first quarter, but more slowly              energy, drugs — tend to do better than
nation’s factories — a survey released                  than last year.
those that sell luxuries.
100                                           last week by the Philadelphia Federal                   consuMer confidence: This isn’t
Reserve — was nothing short of dismal.                                                                         Feeling bold? Recessions often pummel the
part of the NBER’s watch list, but it
50                                           Other measures agree manufacturing is                                                                          stock prices of good, solid companies. Now is
is a useful early warning sign. And
slowing, but not dramatically.                                                                                 a good time to go bargain-hunting.
right now, it’s waving a bright red flag.
0                                                                                                                                                         Finally, if you have debt, your best
PersonAL incoMe: Income is rising                       Worried consumers tend to be tight-
2006             2007               more slowly than it was a year ago, but                 fisted, and confidence has been falling                investment may be to simply pay it off.
it is still rising. The problem is inflation:           since summer.

driving the economy
It’s one of those business truisms that consumer spending makes up about two-thirds of the economy — which is why so many stimulus proposals rely on tax cuts or rebates
Driving the hopes of jump-starting their spending. But businesses and governments play a significant role as well. Here’s a more detailed look at what made up
for individuals, ineconomy
Spending by consumers, businesses and in government makes for which we have complete data):
the \$13 trillion Gross Domestic Productthe 2006 (the last yearup the \$13 trillion U.S. economy. Here’s how that spending is divvied up:

69.9%                                                                                                                                            19.1%                                16.7%
Consumer spending                                                                                                                                Government spending                  Private investment

8.0%            20.4%                                     41.6%                                                                                 7.1%             12.1%                10.6%              5.8%
Durable         Nondurable goods                          Services                                                                              Federal          State                Business           Residential
goods

NOTE: The percentages above add as furniture, appliances and cars; nondurable goods include total, but not from the individual categories.
durable goods include things such up to more than 100 because imports are subtracted from thefood, clothing and energy. Business investment includes computers and industrial equipment;
residential investment is largely home construction. The percentages above add up to more than 100 because imports are subtracted from the total.

What the government can do
The rush is on to draft an economic stimulus package.                     course, but that’s another issue). That amounts to more                    to cash it and spend it — and then some.
The trick will be hammering out a deal during this                        than \$1,000 for every household in the country.
extend sociAL Benefits: Putting more money toward
heated political season. President Bush has his own                       The government is likely to use a combination of the                       unemployment benefits, food stamps, Medicaid and
ideas, as do the presidential candidates and                              tools it has available to boost spending:                                  housing and heating assistance puts money in the
congressional leaders.                                                                                                                               hands of low- and moderate-income households.
Whatever plan is ultimately presented, it will have to                    break can encourage hiring and spending — and even                         interest rAte cuts: This is the Federal Reserve’s
be big to have any force. It takes an enormous amount                     make their balance sheets look better, helping their                       bailiwick. Lower interest rates encourage everyone to
of money to make a meaningful impression on an                            stocks on Wall Street.                                                     spend — consumers and businesses, rich and poor.
economy as large as ours.                                                                                                                            The Fed already has lowered rates three times since
tAx reBAtes for indiViduALs: This puts money back
To add just 1 percent to GDP, the government would                        into the hands of consumers quickly and directly. Most                     September, and it is expected to go further when it
have to come up with \$130 billion (by borrowing it, of                    people who get a check from the government are going                       meets again late this month.

Business 101 is available online at www.nj.com/business/ledger/biz101. Mary Yanni may be reached at myanni@starledger.com or (973) 392-1720.
SOURCES: National Bureau of Economic Research; Bureau of Economic Analysis; Bureau of Labor Statistics; Moody’s Economy.com; Federal Reserve; Associated Press
Business101                                                                                                                                     By Mary Yanni, The Star-Ledger

Housing market futures and options
E
veryone has met a Chicken Little lately, warning that the sky
is falling — on the housing market.
Now, you can tell those Chicken Littles to put their
money where their mouths are.
The Chicago Mercantile Exchange last month started
offering futures and options based on home real estate
prices in 10 metro areas, including New York.
This means optimists can invest in housing markets
around the country, with relatively little money down —
and pessimists can try to make a profit from falling
prices.
Futures and options — whether on corn, oil or
housing prices — aren’t as simple as stocks and
mutual funds. They are designed for sophisticated
investors, in this case institutions with a lot of
money tied up in the real estate market, such as
builders and lenders.
They are available to individual investors, but
they are by no means right for everyone — the
market is fast-paced and risky and requires constant
attention.
Even if that isn’t your thing, it’s worth knowing how
housing market futures work, if only so you can tell Chicken
Little where to go the next time you see him.

Three hot markets
The Chicago Mercantile Exchange’s housing futures are based on the S&P/Case-Shiller Home Price Indexes for 10 metro areas, plus an overall index.
Here’s a look at three of the hottest markets in the nation. The charts track each market’s index for the past year and in earlier five-year increments.

NEW YORK                     One-year change: 10.63%             MIAMI                       One-year change: 27.40%              LOS ANGELES                    One-year change: 18.29%
300                                                              300                                                             300
274.50
268.23
250                                                              250                                                             250

212.57
200                                                              200                                                             200

150                                                              150                                                             150

100                                                              100                                                             100

50                                 ALL INDEXES                  50                                                               50
100 = January 2000

0                                                                0                                                               0

’90 ’95      ’00   ’05                           ’06             ’90 ’95    ’00   ’05                            ’06             ’90 ’95    ’00    ’05                             ’06
MARCH                                                            MARCH                                                           MARCH

The full list
These are just three of the markets covered by these
How money is made … and lost                                                                                                   housing indexes. Here’s how they compare with the
Let’s put Chicken Little in the hot seat for an extremely simplified illustration of how futures                               others.
MARKET                   MARCH        % CHG.           PEAK    PEAK
STEP ONE: Little finds a futures broker, who may or may not also be a stock broker.
STEP TWO: He sets up an account. This requires a minimum deposit, known as margin,                                             Miami                   274.50        27.40     Current
which is determined by the futures exchange. There are two kinds of margin:                                                    Los Angeles             268.23        18.29     Current
Initial margin: The amount of money you have to deposit for                                                                 Washington, D.C. 248.94               14.27     Current
each futures contract you want to control.                                           Marginal difference
San Diego               248.09          4.87    Nov. 05        0.90
Maintenance margin: The minimum you must have in your                                This isn’t like stock
account in order to hold a futures contract.                                                                                Las Vegas               232.38        10.14     Current
market margin,
These margin requirements differ for every contract, and they                           which is essentially                   Overall                 231.31        12.10    Current
can change any time, without warning.                                                   money you’ve                           San Francisco           216.03          8.96    Current
Chicken Little has his eye on New York area housing market                              borrowed from your
New York                212.57        10.63     Feb. 06        0.12
futures, which require initial margin of \$1,688 and maintenance                         broker. This is your
margin of \$1,250 for each contract. That means his initial                              money, deposited as                    Boston                  177.12          0.11 Sept. 05          2.92
investment has to be at least \$1,688. That doesn’t leave him                            an act of good faith                   Chicago                 164.95          8.63    Current
much room for error: If his investment loses more than                                  — and to prove you                     Denver                  136.93          3.16    Oct. 05        0.55
\$438 — about 1.6 index points — he’ll have to either close                              can sustain a loss.
out his position or pony up more money.

avaIlablE     balaNcE HEld by        lOSS/gaIN                                                                                               The basics
balaNcE        clEarINg fIrM          TO daTE
Options and futures started off as tools
STEP THrEE: Chicken Little deposits \$2,000 — enough to control                            for farmers and merchants who wanted to
one futures contract and have some wiggle room. The contract                              control costs and reduce the risks related
itself is worth \$250 for each point in the index — a little more                          to changing prices for things like corn
\$2,000                                           than \$53,000 for the New York area contract.                                              and wheat.
STEP fOUr: He directs his broker to sell one contract on the                              For instance, an orange juice producer
New York index. The maintenance margin is transferred to an                               might enter into a futures contract in
account to be held by the exchange’s clearing firm until the                              February to set a price for the oranges
contract is closed out. This is still Little’s money, but the exchange                    he’ll need in August. He’s guarding against
holds on to it, basically as collateral against any losses greater                        the chance of dramatic price increases
\$750     \$1,250     \$1,250                     than his available balance. Then he waits, and watches.                                   during hurricane season. For his part, the
The next day, the index goes up 1.2 points — a \$300 loss for                              farmer enters into the deal to protect
Little, who is betting on prices falling. Each 0.2-point tick — the                       himself against falling prices.
minimum price fluctuation for this type of futures contract — is                          But many futures and options are based
worth \$50. The loss is transferred from his available balance to                          on things such as stock indexes, interest
\$450     \$300       \$1,550         (\$300)      the clearing firm.                                                                        rates and, now, housing market indexes.
Because there is no physical product
Two days later, the index gains another 1.2 points. Again, the
\$150     \$300       \$1,850         (\$600)      \$300 loss is deducted from his available balance.                                         involved, contracts are settled with cash.
Both futures and options allow you to bet
The next day, the index slides 0.8 points, producing a \$200 gain                          on either rising or falling prices, but they
\$350       \$200     \$1,650         (\$400)      for Little. The gain is credited to his available balance.
have some important differences:
A few days later, the index rises 2.6 points, costing Little \$650.                        futures obligate you to buy or sell an
The loss drops Little’s available balance below zero. This kind                           asset at a specified price on a specific
of one-day change is not unusual, because there is little trading                         future date, unless you sell your contract
(\$300)     \$650       \$2,000       (\$1,050)      volume now, which makes contract prices potentially volatile.                             to someone else. Options give you the
right — but not the obligation — to buy
Little now has two choices. He can close out his position, in which case the \$1,250 maintenance margin                                          or sell at some point before the option
is returned to his account, minus the \$300 he owes. His total losses are \$1,050 (not including fees and                                         expires.
commissions). Or, he can put more money into his account — \$300 to cover his loss and \$438 to get back
above the initial margin requirement. The \$438, when added to the \$1,250 held by the clearing firm, brings                                      futures contracts have no upfront cost,
him back above \$1,688.                                                                                                                          other than commissions, while investors
In this example, Chicken Little lost his feathers because he bet housing prices would fall, but they didn’t.
It just as easily could have gone the other way. If the housing-price index had fallen, the equations would                                     that premium, though, that’s all you can
have been reversed, and he would have made 50 percent on his investment, rather than losing half of it.                                         lose. If you invest in futures, you can lose
(Although it may seem like it, this is not a worst-case scenario. Futures market investors can lose more than                                   more than your initial investment.
their initial investment, if they’re not careful.)                                                                                              All in all, the obligation to buy or sell
The upside of Little’s loss is that while he was speculating home prices would fall, they have actually risen                                   and the unlimited potential for loss
— his home is worth more, and that offsets his loss in the futures market. Had it gone the other way, he                                        make futures riskier than options for
would have mitigated a loss on his home with gains through futures.                                                                             most individual investors.

Business 101 is available online at www.nj.com/business/ledger/biz101. Mary Yanni may be reached at myanni@starledger.com or (973) 392-1720.
SOURCES: Chicago Mercantile Exchange; Kansas City Board of Trade; “The Complete Idiot’s Guide to Options and Futures,” by Scott Barrie (Alpha, 2002); MarketWatch; Investopedia.com
Business101	                                                                                                                   By Mary Yanni, The Star-Ledger

Bank failures
I
ndyMac Bancorp last week became the fifth bank to fail in the
United States this year. With \$32 billion in assets, it was the
second-largest bank collapse in U.S. history.
IndyMac was no ordinary bank. It aggressively pursued
so-called Alt-A mortgages — loans to people who couldn’t
properly document their income. And now, it is reportedly
under investigation by the FBI for fraud in its lending
practices.
Still, although IndyMac was an exceptional case, it is
likely to get plenty of company soon.
Industry analysts forecast as many as 200 banks
may fail during the next 18 months to two years.
Here’s a primer on bank failures,
past and present.

Frightfully familiar
Even if 200 banks collapse during the next two years, the failures will pale in comparison with the carnage
When a bank fails                                  that was the savings & loan crisis of the 1980s and early ’90s, when more than 2,000 institutions failed. Not all
Bankruptcy isn’t an option for banks;              the banks that failed during this period were savings & loans, but thrifts were particularly hard-hit. They were
when one can no longer pay its bills,              cripped by a combination of sky-high interest rates and inflation, the oil-price shock of 1980 and lax regulation.
the government shuts it down and it                Add a real estate boom not unlike the one we’ve just been through, and it was a recipe for disaster.
goes into receivership with the Federal
Deposit Insurance Corp.
The FDIC then finds a buyer for the
bank’s assets. This often happens im-
mediately; in the case of First Integrity
Bank, a tiny Minnesota institution that
failed in May, its branches closed on a
Friday and opened on Monday under
new ownership. Customers can keep
writing checks and using their ATM
cards; it’s almost seamless.
If the FDIC can’t find a buyer, it’s more
complicated. ATM and debit cards
won’t work, and checks are returned,
stamped “bank closed.” The FDIC
writes checks to cover insured
deposits within a few days.
For those who have uninsured
deposits, they get the check for what
the insured amount is and become a
creditor of the bank. The FDIC says
they eventually get back an average
of 72 cents on the dollar.

When a bank is in trouble, customers               The granddaddy of them all                                                    TBTF today
are the last to know; the government               The bank was growing like wildfire, making increasingly aggressive            Besides Fannie Mae and Freddie
isn’t going to tell you, because the last          and risky loans. Wall Street loved it. Then: the bubble burst, loans          Mac, who is “too big to fail” now?
thing they want is a run on the bank.              went bad and, finally, there was a run on the bank.                           The government won’t say. And
If you want to look into the soundness             This isn’t the story of IndyMac. It’s the story of Continental Illinois       Treasury Secretary Henry Paulson
of your bank, try Bankrate.com’s                   National Bank & Trust, which was bailed out by the government in              last week said most financial com-
“Safe & Sound” rating system, which                1984 and remains the largest bank collapse in U.S. history. At the            panies should be “allowed to fail.”
rates banks based on their capitaliza-             time of its failure, Continental Illinois was the nation’s seventh-           Most, but not all.
tion, asset quality, earnings and                  largest bank, with \$40 billion in assets.
liquidity. You can find it at bankrate                                                                                           In January, Moody’s rated the odds
.com/brm/safesound/ss_home.asp.                                      Although the story sounds familiar, the details are         of a rescue for a number of large
different. The bubble that helped bring this         banks if they got in a bind:
How accurate is it? IndyMac had the                                              bank to its knees wasn’t in real estate
lowest rating before its failure last                                                                                                                ChanCe
week.
Are                      — it was in oil and gas exploration.         banK                OF bailOUt

you insured?                    When the government stepped in,            Bank of America     Very high
it went to extraordinary lengths                              (70-95%)
IndyMac was widely known for                    Bank accounts are insured by
to calm investors, guaranteeing
being deeply involved in risky                 the FDIC for up to \$100,000, or                                                   Bank of New York    Very high
no depositor or creditor would
home loans. When those                       \$250,000 for individual retirement
suffer any loss (never mind the       Citigroup           Very high
loans started looking like                   accounts. But there are all kinds of
\$100,000 FDIC insurance cap).        JPMorgan Chase      Very high
losers, it would not have                  work-arounds — for instance, a married
In the end, the bank’s failure
been a stretch to figure this             couple can be insured up to \$400,000, if                                               State Street        High (50-70%)
cost taxpayers \$1.1 billion.
bank would get into trouble.              they have one joint account plus an indi-
Besides being the largest bank       U.S. Bancorp        High
vidual account for each of them. If you
But often, banks run into                                                                 collapse ever, the Continental         Wachovia            High
want to figure out how much of your
trouble a customer could                                                                 Illinois case is important today
money over \$100,000 is insured,                                                    Wells Fargo         High
never anticipate, so it may                                                             because it gave rise to the idea
the FDIC has an online calcu-
be wiser to put your effort into                                                      there were some banks that were            SunTrust Banks      Low (≤30%)
lator to help. Go to
making sure all your deposits are                                                   simply too large to be allowed to
fdic.gov/EDIE.                                                           Washington
insured.                                                                         collapse — “too big to fail.”                   Mutual              Low

SOURCES: Federal Deposit Insurance Corp. (FDIC); Bankrate.com; Federal Reserve
Business101                                                                                                                                                                                                                  By Mary Yanni, The Star-Ledger

How
drugs                                                                                            get to market

M
erck’s withdrawal of the painkiller Vioxx — a \$2.6 billion-a-year product for the company —
shines a light on the lengthy and expensive process of shepherding a drug from the laboratory
to the pharmacy shelf.
For a company trying to discover a successful medication — especially one that will be a
billion-dollar blockbuster — success is a long shot.
Of every 5,000 compounds identiﬁed in the lab, only ﬁve make it to human testing, and only
one winds up being approved by the Food and Drug Administration. Developing and testing
one drug costs an estimated \$896 million and takes an average 8 1/2 years. Add almost
17 months for an FDA review, and it’s 10 years from concept to consumer.
As long and exacting as it is, the process is far from perfect.
A drug is approved based on studies of just a few thousand patients. Once it hits
the market, many more people use it — and those people are a much more complex
bunch, maybe taking several medications or suffering multiple medical problems.
That’s when many adverse reactions show up.
A study published in the Journal of the American Medical Association in 2002 found
10 percent of the 548 drugs approved by the FDA from 1975 through 1999 were either                                                                                                                                                                      KRT ILLUSTRATION

withdrawn or later received a “black box” warning, the agency’s red ﬂag on side effects.
Here’s a look at how the pipeline works.

The development process                                                                                                                                                                                                        What’s the ‘fast track’?
There is no deﬁnitive timeline for a drug’s development — one step can take weeks or months, months or years. The following timeline is based on FDA estimates.                                                                The FDA is criticized from all sides —
it approves drugs too slowly or too
s PRECLINICAL RESEARCH                                s CLINICAL STUDIES                                                                                                                                                       quickly, applies standards that are too
Drug discovery starts with researchers                Once preclinical testing is done, the company tells the FDA it                     have been diagnosed with the condition meant to be treated,                           stringent or too lax. But it most often
who identify biological factors in                    plans to start human studies, describing the results of the                        and last from six months to three years. Most Phase 2 and 3                           is attacked for being frustratingly slow.
diseases and search for compounds                     animal studies and detailing the planned human trials. If the                      studies are randomly divided into groups — one gets the drug                          In the mid-1990s, the agency acted
that target them. For instance, they may              FDA does not disapprove the proposal within 30 days, the                           and one gets a placebo or a current treatment to which the                            to streamline the process of getting
look for ways to inhibit an enzyme that               human trials may start. During human studies, scientists want                      new drug will be compared. Neither the researchers nor the                            potentially life-saving drugs into
plays a key role in a disease or a gene               to ﬁnd out if a compound is safe and effective; whether it has                     patients know who is in which group. Of the drugs that start                          the hands of desperate patients,
known to promote cancer.                              side effects; if its beneﬁts outweigh its risks; how it should be                  Phase 2 trials, 53 percent fail; some because they are not                            particularly those with cancer or AIDS.
labeled; and whether it can be manufactured safely and reliably.                   effective, and others because they are unsafe or have
Once a compound is identiﬁed and                                                                                                                                                                                               The result is the “fast track.”
Human studies are done in three phases:                                            serious side effects.
synthesized, researchers test it on                                                                                                                                                                                            A drug can only be fast-tracked if it
animals to measure its toxicity and see               PHASE 1: Initial tests determine if the drug is safe for humans.                   PHASE 3: Once the drug is shown to be effective, the test
targets a serious or life-threatening
how it behaves in the body. Short-term                They also look at how the drug acts in the human body — how                        population expands to as many as 3,000 patients in clinics and
condition for which no other treatment
tests take two weeks to three months,                 it is absorbed, metabolized and eliminated — and what the                          hospitals. Phase 3 studies, which last one to four years, provide
exists. Cancer and AIDS drugs are at
while long-term tests last from a few                 best dosage is. Phase 1 studies generally involve 20 to 80                         more information about effectiveness and safety, and participants
the top of the list, but treatments for
weeks to several years. Some animal                   healthy volunteer subjects and take six to nine months. Seventy                    are monitored for adverse reactions from long-term use.
Parkinson’s disease and rheumatoid
tests continue after human trials begin               percent of drugs that enter Phase 1 trials move on to Phase 2.                     Importantly, these studies provide the basis for the drug’s
arthritis also have been speeded to
to determine if long-term use of the                  PHASE 2: The second phase shows how effective the drug is                          labeling. Of the drugs that start Phase 3 trials, one-ﬁfth fail.
approval.
drug may cause cancer or birth defects.               and provides information on dosing, safety and short-term side                     The rest — about one-fourth of all the drugs that start human
trials — are submitted to the FDA for approval.                                       There are two ways in which the
effects. These tests involve between 100 and 300 people who
approval process for a fast-track drug
may differ from a typical drug:
YEAR 1                     YEAR 2                      YEAR 3                     YEAR 4                      YEAR 5                     YEAR 6                      YEAR 7                     YEAR 8
Priority review: This sets a target for
Drug discovery                                                                                                                           FURTHER TRIALS: Drug companies often keep studying                                  FDA approval at six months after the
Animal testing                                                                                                   a drug after it is approved. They may want to learn more                            drug is submitted for approval. The
about how it compares with other treatments, or see if it                           standard target is 10 months, but the
SHORT TERM                                                                                                                                                                                         average is 16.7 months.
will work on other conditions. (This is how concerns about
LONG TERM                                                                                            long-term use of Vioxx surfaced.) The FDA also may require                          Accelerated approval: This allows
more studies, usually to see how the drug works in certain                          a drug to be considered based on
Human testing                                                                      types of patients who weren’t included in Phase 3 studies,                          preliminary evidence when a clinical
The FDA meets with a drug’s
x     PHASE 1                                                                          or to see how safe it is in very large numbers of patients.                         beneﬁt to patients has not yet been
proven. Accelerated approvals are
the development process, to                                                    PHASE 2
considered provisional, pending further
discuss test results, protocols
x    PHASE 3                                                                     x        clinical studies. If the FDA is not happy
for further testing and plans for
with the results, it can withdraw the
the application for approval.                             q Accelerated development/approval may begin
drug more easily than usual.
from the process of development and
The approval process                                                                                                                                                                                                           approval. For that, it has won praise
When clinical trials are ﬁnished, the company analyzes the data and, if it looks like the drug is safe and effective, ﬁles a massive application for approval with the FDA.                                                    from many patient advocates, but it
The application — which may run 100,000 pages or more — contains all the scientiﬁc information researchers have gathered. The FDA receives about 110 applications                                                              has not been without controversy.
each year, and each is subjected to a rigorous review, which takes an average 16.7 months. This is what happens to a typical application for approval:
In early 1997 — the ﬁrst days of the
s INITIAL REVIEW                 s THE TECHNICAL REVIEW PROCESS                                                                           s YES OR NO                                  s FINAL STEPS                           program — the FDA approved the
diabetes drug Rezulin. The drug was
The application is               The FDA makes an exhaustive review of the application, in which teams of                                 When they are ﬁnished with                   An approved drug still                  quickly linked to scores of liver-related
screened to be sure              experts try to verify that a drug is safe and effective. The application is broken                       their work, reviewers write                  faces two ﬁnal reviews:                 deaths. Rezulin was withdrawn in
it includes enough               down into ﬁve or six parts, depending on the drug:                                                       evaluations of the application               Labeling: Every word on                 Great Britain in December 1997, but it
information to justify                                                                                                                    and make recommendations.                    the package insert has to               stayed on the market in the United
Medical: Clinical reviewers, primarily              medical team determine how well
a formal review. If not,                                                                                                                  An advisory committee — a                    be backed up by data,                   States until March 2000. In its three
doctors, take the lead. They boil down              results from a few thousand patients
the FDA sends a                                                                                                                           panel of outside experts —                   including warnings and                  years on U.S. shelves, it generated
the results of animal and human                     might apply to the general population.
“refuse-to-ﬁle” letter                                                                                                                    also meets and offers a                      description of side effects.            more than \$2 billion in sales for its
testing to form a basis for a decision.             Chemistry: The reviewing chemist
detailing how the                                                                                                                         recommendation.                              If it doesn’t pass muster,              maker, Warner-Lambert.
application is deﬁcient.         Biopharmaceutical: These experts                    studies how the drug is made to see if
The FDA then either approves                 the company must rework                 That brings up another group that
This is how ImClone’s            look at how the drug behaves in the                 it is stable and can be reproduced. If
the drug; sends an “approvable”              it until the FDA is happy.              beneﬁts from fast-track approvals: the
cancer drug Erbitux              human body — how it is distributed,                 not, the validity of the clinical studies
metabolized and eliminated.                                                                              letter to the company, indicating            Manufacturing: FDA                      drug makers. Drug makers receive
was derailed (the ﬁrst                                                               is undermined because it wouldn’t be
the drug can be approved but                 inspectors visit the sites              20-year patents on their discoveries,
in a line of dominoes            Pharmacology/toxicology: This team                  clear just what compound was really
asking for minor changes, often              where the drug is made.                 but by the time the drug is approved,
that eventually landed           focuses on results of animal tests —                being used in the patients.
including labeling; or asks the              If they are unhappy with                there may be just 10 years left on the
Martha Stewart in jail).         such as potential cancer-causing                    Microbiology: This only applies to                   company to agree to do post-                 anything, the company                   patent. Cutting development time by
It took ImClone nearly           effects — and tries to determine what               drugs that ﬁght infection, since they                approval tests; or sends a “not              has a chance to rectify it.             three years effectively extends the life
two years to resubmit            they mean for humans.                               affect microbes, rather than human                   approvable” letter, explaining               Only when both are                      of the company’s patent, adding three
its application, which
Statistics: The statisticians look at               physiology. This review looks at an                  why the drug can not be                      acceptable can the drug                 years to the length of time it can sell
was approved early
how the studies were conducted and                  array of issues, including any known                 approved.                                    be marketed.                            the drug without competition from
this year.
the data analyzed. This helps the                   path of resistance to the drug.                                                                                                           generic versions.

Mary Yanni can be reached at myanni@starledger.com or (973) 392-1720. For a free copy of a special Business 101 section on topics ranging from 529 college-saving plans to gas prices, e-mail askbiz@starledger.com,
call (973) 392-4229 or mail your request to Business 101, Business News Desk, The Star-Ledger, 1 Star-Ledger Plaza, Newark, N.J. 07102.
SOURCES: Food and Drug Administration; Aventis; Wyeth; Pharmaceutical Product Development; Tufts Center for the Study of Drug Development; Bain & Co.; Pharmaceutical Research and Manufacturers of America; Journal of the American Board of Family Practice

The jobs report
T
his morning, as they do on the first Friday of every month,
economists, politicians and everyday investors will study the
government’s employment report.
The numbers that will make headlines are the unemployment
rate (expected to remain steady at 5.6 percent)
ALL THE DATA
referenced here      and the number of jobs created (expected
is available free at to be 220,000, up from 112,000 last month).
the Bureau of Labor      These numbers — numbers that move
Statistics Web site,
www.bls.gov.         markets, sway interest rates and could swing
the presidential election — come from
interviews with 60,000 households and 160,000 businesses. There
is much more to the monthly jobs report than the headline
numbers.

The household survey                                                                                                            The employer survey
Each month, 1,500 Census Bureau employees hit the                                                                               While Census Bureau workers are knocking
streets, interviewing one person in each of 60,000                             What the critics say                             on doors, 160,000 businesses are filling out
households to gather information on everyone in each                           The household survey is often criticized         forms detailing how many people they
home. Most interviews are done in person, with the                                                                              employ and how much they pay them. The
for painting a picture that is too rosy
interviewer entering answers into a laptop computer;                                                                            BLS says these companies represent about
because:
others are done by phone. These interviews are the basis                                                                        one-third of all paid workers. Unlike the
for the national unemployment rate, which tells us the                         I Its threshold for employment is very           household survey, the “establishment”
percent of the labor force that is out of work. That’s                         low. Individuals are considered employed         survey excludes the self-employed and
different from the percent of the population, in that the                      if they did any work at all for pay during       domestic workers, among others. Employers
labor force only includes people who are working or who                        the previous four weeks.                         provide the following information for the pay
are available and are looking for work.                                                                                         period that includes the 12th of the month:
I The overall unemployment number
The results aren’t perfect. The Bureau of Labor Statistics                     only includes people who are actively            All employees: The total number of people
says the monthly estimate of the number of unemployed                          looking for work. Among those who                who were paid for any part of the pay period.
likely comes within 230,000 of the figure that would be                                                                         That includes full- and part-time workers;
don’t count are those who have given up
found if every household in the country were interviewed.                                                                       salaried officers; executives and their staffs;
looking and those who are in the process
In June, the survey found 8.25 million unemployed, a rate                                                                       anyone on paid vacation, sick leave or
of retraining for a new career.
of 5.6 percent. Add 230,000, and you get a jobless rate of                                                                      other paid leave; and trainees. It excludes
5.8 percent; subtract 230,000, and it’s 5.4 percent.                                                                            proprietors, pensioners, striking workers,
THE CRITICAL QUESTION: Who is unemployed and who isn’t? The computer decides. Interviewers never                                anyone who is on leave without pay and
ask a subject if they are unemployed, because the government’s definition is very specific. It requires a                       outside contractors and their employers.
person to be out of work, looking for a job and available to work. Often, the classification is obvious. Other                  Women employees: The number of employ-
times, it’s a little trickier. Here is how some people would be classified:                                                     ees from the first category who are women.
THE SITUATION                                                             THE VERDICT                                           Nonsupervisory employees: The number of
Lisa spends most of her time at home, caring for her                      Employed, identified as an “unpaid family worker.”    employees from the first category who are
children. But she spends 16 hours a week helping her                                                                            not responsible for supervising, planning or
husband in his store, for no pay.                                                                                               directing the work of others. This excludes
Lisa’s oldest son, 16-year-old Seth, also works in the                    Not in the labor force, because he works fewer        executives and superintendents.
family store for no pay, but only 10 hours a week.                        than 15 hours per week.
Nonsupervisory employee payroll: The total
Joe lost his job at the local manufacturing plant and has                 Not in the labor force, because just looking at ads   gross pay earned during the pay period by
been reading the help-wanted ads but has not replied                      is not considered active job-hunting.                 nonsupervisory employees. It includes
to any ads.                                                                                                                     overtime, any kind of paid leave and incentive
pay, but excludes commissions, retroactive
Kate also lost her job at the plant and has been                          Not in the labor force, because she is not
pay, travel expenses, pay advances and pay
attending a job-training program to prepare her for a                     actively looking for work.
for unused leave.
new career.
Commissions: The total commissions paid to
Bob was laid off temporarily while his factory is                         Unemployed, because he is waiting to be               nonsupervisory employees. This amount
retooled. He expects to be recalled, but he is not                        recalled from layoff.                                 excludes base pay.
looking for a job while he waits.
Nonsupervisory employee hours: The total
Bethany has filed applications for summer jobs, but                       Not in the labor force, because she is not            number of hours worked during the entire
she won’t be available to work for two months.                            currently available.                                  period by nonsupervisory employees. This
includes overtime hours, stand-by time and
Marie works part-time, but she needs to find a full-time                  Employed.
paid time for vacations or sick leave.
job to keep up with her bills. She has been sending
résumés and interviewing for full-time jobs.                                                                                    What the survey tells us
John has been out of work because of a strike at his                      Employed, identified as “with a job, but out of       The business survey provides data on the
plant. Last week, he was actively looking for a temporary                 work.”                                                number of workers, their hours and pay,
job to tide him over until the strike is over.                                                                                  including:
I The change in private employment for
Amy lost her job Wednesday and spent the rest of the                      Employed, identified as “working part time for
the month, which tells us if businesses are
hiring or not. It is one of the most important
What the survey tells us                                                                                                        numbers in the jobs report every month,
along with the unemployment rate.
The household survey is the basis for the overall unemployment rate, which also is broken down based on
age, gender, race and education. But there is much more to it, including:                                                       I Total employment and change in
employment for a variety of industries,
I The percentage of the              Various ways to look at the unemployment rate for June                                     including construction, manufacturing, retail
population in the work                                                                                                          and the service sector.
The official unemployment rate     5.6%
force — either working or
I Average weekly hours worked and wages
looking for work — an                           Overall plus marginally attached workers                6.5%
paid, overall and broken down by sector.
indication of confidence             Overall plus marginally attached plus those working
in the job market.                      part time because they can’t find a full-time job
9.6%               I Overtime worked in the manufacturing
16.8%    sector, which can foreshadow hiring.
I Average length of                                                              Ages 16-19
unemployment in weeks.                 NOTE: “Marginally attached”
workers aren’t actively looking             Men, 20+          5.0%
I How many people have                 for work, but they say they want                                                           What the critics say
quit or been laid off from             and are available for a job.            Women, 20+            5.0%                         The establishment survey often is
their jobs.                                                                            White         5.0%                         criticized for giving an incomplete picture
I How many people work                                                                                                            of the job market, in part because:
Black or African-American                   10.1%
part time because they                                                                                                            I It relies on a small sample to estimate
can’t find full-time jobs.                                                 Hispanic or Latino           6.7%                      employment for the whole economy.
I The number of                                           Less than a high school diploma                   8.8%                  I It is slow to account for jobs created
discouraged workers,                                                                                                              by start-up companies.
those who would like a                                  High school graduates, no college             5.1%
I It doesn’t count the self-employed, a
job but have quit looking                                   Less than a bachelor’s degree            4.2%                         category that grows fast when big
because of a gloomy job                                                                                                           employers aren’t hiring.
market.

Mary Yanni can be reached at myanni@starledger.com or (973) 392-1720. For a free copy of a special Business 101 section, e-mail askbiz@starledger.com,
call (973) 392-4229 or mail your request to Business 101, Business News Desk, The Star-Ledger, 1 Star-Ledger Plaza, Newark, N.J. 07102.
SOURCE: Bureau of Labor Statistics
A D V E RT I S E M E N T   Page 59                                                                      THE STAR-LEDGER                                                       Thursday, February 22, 2007

{ in            5 easy steps }

B Y M A R Y Y A N N I • w I T H I L L US T R AT ION S B Y M A R K MOR R I S S E Y • T H E S T A R-L E D G E R

Step 1             Pick a few stocks to research
How do you narrow down the universe of thousands of stocks to the                              of small companies. (The section on
market capitalization on the next page               where To geT bad ideas
one that will launch your investment career?
covers what a company’s size means to                You’ll get lots of pitches by phone
Start by coming up with a list of companies you’re interested in —                             investors.)                                          and e-mail — especially once you’ve
You can browse the components                        opened a brokerage account. Ignore
businesses you would enjoy following in the news, industries you
of these and many other indexes at                   them. It’s one of the few certainties
www.standardandpoors.com. Click on
indexes, then “S&P 500.” If you’re                   vestment, they’re not going to have
Put your feet up, relax and brainstorm.                                                                                                             to cold-call you to drum up money.
looking for the mid- or small-cap lists,
Think about products and services                                                              click on “US indexes.”                               A corollary to this rule: Anyone
you and your friends use. Do you wear            fair warning                                                                                       promising “guaranteed” returns or
Under each index, the stocks are sorted
Sketchers? Have coffee at Starbucks              Your hobbyist’s interest doesn’t                                                                   saying anything along the lines of
by industry — this makes it easier to
every day? Tell everyone who will listen         give you much of an edge. We’re                                                                    “you can’t lose” isn’t to be trusted.
browse through several hundred stocks.
about the wonders of Netflix?                    not trying to discourage you here.                                                                 Just hang up the phone.
Try “consumer discretionary” for
Put them on your list.                           It’s just that if you’ve read the             companies like Harley-Davidson,
financials, so has everyone else.             Coach and Nordstrom — the ones any
How about the company you work for?
If you’ve seen the news, so has               red-blooded American consumer could
Its competitors? (If you already own your                                                                                                        ideas, but just remember — by the time
employer’s stock through a retirement            everyone else. That doesn’t mean              be interested in.
you can’t make money — a rising                                                                 they’re trumpeting their investment
plan, cross it off your list. You don’t need                                                   The besT comPanies To work for: If                prowess, their biggest gains may be
more of it.)                                     tide lifts all boats, even on Wall
you want to pick a company that’s good            behind them.
Street.
Try to spot a trend early — before it                                                          to its work force as well as its investors,
has taken over the world. When Apple                                                           this is a good place to start.
introduced the iPod in 2001, its stock         Still Stumped?                                  Every year, Fortune magazine compiles a           from big names such as Value Line
was worth about \$9 a share. Today, it’s                                                        list of 100 companies that are well-loved         Investment Survey to one-person
around \$85. If you’d put the \$400 cost         If you need a jump-start, consider:
by their employees. To find the list, start       shops run out of basements to outfits
of the iPod toward Apple stock instead,        The big sTock indexes: Browse the               at Money.CNN.com; then click on “Jobs.”           that are just doing PR. Before you take
you’d have about \$3,800 today. (Sigh.)         companies that are members of the               It’s a diverse list, with businesses of           their advice, consider the source. Are
Make a list of up to 10 or 12 of these         benchmark stock indexes.                        all sizes and a range of industries               they independent? Will they make money
stocks. Then, pick five or six you want to                                                     represented.                                      if you buy what they’re selling? Does
n The dow Jones industrial average:
research further.                              Thirty “blue-chip” stocks — big, reliable       These companies often have performed              what they’re saying make sense?

Not sure if the company is public? Go          companies — are on this list. Download          beautifully on Wall Street — this year’s          stock screeners: The financial Web
to its Web site and look for an “investor      the list from www.djindexes.com. Just           No. 1 is Google — but that’s not a criteria       sites all offer screeners, which sort the
relations” link, which might be under an       click on “components” next to Dow Jones         for the list, so you still have to do the         universe of stocks based on the financial
financial Web site — Yahoo Finance is                                                                                                            (MSN Money has one of the best, includ-
n s&P indexes: Standard & Poor’s                And finAlly ...
a good place to start — and click on                                                                                                             ing pre-designed “power searches.”)
manages dozens of indexes, including
“symbol lookup.” Enter part of the                                                             There are millions of investment ideas            Like newsletters and Web sites, this is
the S&P 500 index of large companies;
company’s name, and if it’s public, you                                                        floating around, with varying merits:             a great resource for people who have
the mid-cap 400 index of medium-sized
should come up with its ticker symbol.         companies and the small-cap 600 index           Your friends: They might have great               developed a little stock-picking savvy.
Page 60                                                                                                                                                                Thursday, February 22, 2007                         THE STAR-LEDGER                       Thursday, February 22, 2007                                                                                                                                                                                       Page 61

step	2               Do the research                                                                                                                                                                                                                                                                                                                              step	3                 pick a broker
Okay, so you love your Skechers. Adore your Prius. Couldn’t live without your iPod. That’s a great start.                                      THe TReNd: Look at the numbers going back several years.                                                                                                                                                           If you need a pair of shoes, you can’t just buy them direct from the factory. You
The company might have gotten a 30 percent sales boost                                                                                                                                                             need a middleman — a retailer that deals with the manufacturer and with the
Any one of the companies on your list might be one you could follow for fun, reading news reports and                                          last year, but was it a fluke? You want to see a company                                                                                                                                                           customers. In the case of stocks, the middlemen are brokers. There are two kinds:
dissecting financial statements.                                                                                                               steadily gaining strength.                                                                    Netflix           (NFLX )                                                                                            n FUll-SeRViCe: These folks call you with investment ideas and do a lot of the legwork for you.
But how can you tell if one of them will be a good investment? By checking out their fundamentals.                                             THe CoMPeTiTioN: Some of this information, like the
You’ll pay a combination of commissions and account fees that add up to much more than you
price-to-earnings ratio, is only useful when you put it
In this step, you want to answer four critical questions:              Put each of the stocks on your short list through its paces. If
in context with its industry peers and, to a lesser                                         Market ca                                                                                                              would pay a discount broker — but you won’t be going it alone. Many full-service brokers also have
n Where does this company stand on Wall Street?                     none measures up, go back to your list and pick another five or                                                                                                               p       \$1.6 — mid                                                                                           been rolling out lower-cost options, but they often are for customers with established (that is, not
extent, the market at large.
-cap, bare
n Is it growing?
six to research.
52-wk ran                                      ly                                                                        small) accounts. Best for: Someone who is serious about building and managing a stock portfolio.
Start by listing the criteria we’re going to look at on a sheet of
In the end, whether or not a company is a good
ge \$18.1
n Can it pay its bills?                                                                                                                     investment for you is entirely subjective.                                                                         2-\$33.12 (a                                                                                     n diSCoUNT: You do most of the work yourself. You pick the stocks, do the research and place
paper — one sheet for each stock.                                                                                                                                                                         bout \$23.5
n Is its stock selling at a good price?                                                                                                                                                                                                                                                    0 now — e                                                           your order online. You’ll pay \$10 to \$20 a trade and little or nothing to maintain your account. Most
A few of these concepts seem suspiciously like accounting, but
takes a st                                       very time                                             discount brokers offer research tools, including access to the data you need to evaluate stocks, and
Do you feel in your heart that Apple has nowhere to go                                                                   ab at Netfl                                      Blockbuste
Under each question, you’ll find one or two key data points            don’t think of it that way — think of it as gossip, like peeking in
ix, the sto                                   r                            some offer advice, for a price. Best for: Hobbyists or serious do-it-yourselfers.
(and, in one case, a few intangibles) you can use to answer it.        the window of the biggest house on the block to see if they’re          but up? Then you’ll probably sleep well at night if you
has never                                  ck swo ons
, but Block                                      WHiCH iS RigHT FoR YoU? The more money you’re managing, the larger your stock portfolio, the
With each step, you will flesh out a picture of the company’s          sitting on milk crates.                                                 drop \$425 on five shares.
really man                                           buster
Sales grow                                      age d to m                                                                 more sophisticated your needs will be — and the more likely you’ll want a full-service broker. But
prospects: In the long run, will it be a good investment?
With all of these indicators, it’s important to remember that no        Do the best you can, and promise yourself to have no
th Histor                                       ake any in
You’ll come across far more data as you do your research, but                                                                                  regrets, even if you lose money.                                                                                  y — huge                                       roads)                                            this is your first stock — it’s fun money, not the cornerstone of your retirement plan. Not yet,
single number, on its own, means much of anything. Instead,
growth, bu                                                                          anyway. Give it a go on your own; you can always transfer your account to a full-service broker
stick with these for now, so you don’t get overwhelmed.                you want to put it in context:                                                                                                                                                                                       t it’s only
Yaho o Financ
Next year                                       been arou                                                later, or augment it with another account.
on “analyst es
e — click
— 32% vs.                                     n d since ’0
timates”                                   14% for in                                   2                              s hoppi ng F or a Di s c oU n t B r ok e r
n Where	does	it	stand?                                                                                                                                                                                                                                  Next 5 yr                                  dustr y (mu
s (per yea                                sic & video                                       Cost is only one factor in choosing a broker — discount or not.                          try	a	dry	run
r) — 30%                                    stores)
You know what the company does. That’s why it’s on your list. Now you should explore a little more about the business and its stock.                                                                               Morningstar       Cash flow                                                 vs. 14%
If you’re not making many trades, slightly higher fees shouldn’t                         Not ready to play with real
Cash from                                                                                                 be a deal-breaker. Besides costs, which are covered in the chart                         money?
operations
Start with a few basics — some concrete, others a little more fluid.                                                                                                                                                                                                                 — 4.6x net                                                                   below, also consider:                                                                    Most financial Web sites
Free cash                                    income                                                        HoW MUCH Will YoU TRAde? If you just plan to buy one                                     let you set up virtual port-
M a r k e t c a pi t a l i z at io n                                                                                                                                                                                                                                 flow — stil
P/E                                            l 4x net in                                                                     stock and hang on to it, be sure your broker doesn’t charge                              folios to track investments,
The most common measure of a company’s size, “market cap” is the total value of its stock — its share price multiplied by the number of shares it has outstanding. A big company might
21.2 vs. 23                              come afte                                                         an inactivity fee. On the other hand, if you plan to trade a lot,
have 10 billion shares outstanding and trade for \$33 a share, giving it a market cap of \$33 billion; a small company might have 15 million “shares out” and trade for \$8 a share, giving it a                                                                       .7 (“recrea                              r R&D                                                higher trading fees will add up faster.
real or imaginary.

market cap of \$120 million. Knowing how big a company is can give you some idea of its stability and its growth potential. Typically, the bigger the company, the lower the risk for losses                                        PEG ratio                                      tional activ                                                                                                                                                             Try Yahoo Finance or
0.8 vs. 1.5                                ities” in du                                                     WeB SiTeS: Assuming you’ll do most of your work online —
— and the chance for huge gains. Small companies go the other way — they are very risky, but can give you pulse-pounding returns. Here’s how companies are typically sorted:
( ditto )                                 str y)                                              placing orders, tracking your portfolio — be sure you’re happy
MarketWatch, which have
simple interfaces tailor-
Category	      Value	                      examples	                                                             pros	and	Cons                                                                                                 Notes                                                                                                                            with the Web site. Is it easy to navigate? Are you comfortable                           made for beginners.
– It’s got
an amazin                                                                                       with it?
large cap      \$10 billion or more         At the low end, there’s Bed Bath & Beyond (at \$12 billion);           Big companies are safer investments because they’re well-established, but                                                                                   g head sta                                                                                                                                                                  Enter your stock picks,
rt in its fi                                                         CUSToMeR SeRViCe: Call the customer service phone number.
at the high end, Wal-Mart (\$202 billion) and Exxon Mobil              they have less room to grow, and growth is what powers stock price.
– Competit                                           eld, but ...                                                                                                                                     the number of shares you
(\$431 billion, the granddaddy of them all).                           You’re looking at low risk here, but also low rewards.                                                                                         ors are nip                                                                                     How hard is it to reach a human being? Are they helpful? Can                             would buy and the price
ping at it,
but analys                                                          you place a trade by phone if you can’t get online when you                              you would pay at the time
still has ro                                         ts think it                                           need to?
Mid-cap        \$1 billion-\$10 billion      A lot of familiar names populate this category, including Ethan       Mid-caps have some of the advantages of both their bigger and smaller
om to grow                                                                                                                                                                           you’re setting up the
Allen (\$1.23 billion), Cheesecake Factory (\$2.12 billion), Wiliams-   cousins — they still have room to grow, but they are more stable than                                                                                            .                                                                             oTHeR SeRViCeS: Some brokers let you consolidate all your                                portfolio.
Sonoma (\$3.9 billion) and Abercrombie & Fitch (\$7.3 billion).         small-caps. Medium risk and reward.                                                                                              – What ab                                                                                                     accounts under one roof, including checking, and give you ATM
out new te                                                                                                                                                                                It’s a great way to get your
chnologies                                                                         access and online bill-paying capability. Some have a few
? It’s work                                                                                                                                                    feet wet without putting
Small-cap      Less than \$1 billion        These are mostly little-known companies, but if you dig deep,         A small company has tremendous growth potential — for its business                                                                 delivery, b                                         ing on digit                                            local offices, in case you want to check them out in person.                             any cash on the line.
ut it’s still                                        al                                        See what’s available, and decide what’s important to you.
you may come up with some familiar names, such as Trump               and, by extension, its stock price — but it’s mountain climbing on stilts.
a big ques
Entertainment (the Donald’s casino company, with a market             There’s a much bigger chance it will fall off the mountain than reach the                                                                                                  tion mark.
cap of \$584.5 million) or Coinstar (\$812.5 million).                  summit. There’s high risk here, but the chance for big rewards, too.
CoMPARiNg CoSTS
Feel good iF: You’re comfortable with the amount of risk the company’s size implies. If you’re risk-averse, a business with a tiny market cap probably isn’t for you.
On the other hand, if you’re all about walking on a high-wire, the giants probably won’t give you the exciting ride you’re looking for.                                                                              Where	to	get	the	data                                                                                                                           This chart compares seven brokers with low-cost online trading options. In most cases, the
This guide focuses on the information that’s readily available — for free — online. The                                                         lowest commissions and fees are reserved for the most frequent traders with the biggest
5 2 -w e e k r a ng e                                                 t he in ta ngiBl es                                                                                                                            following are some of the best Web sites for investors of all stripes.                                                                          accounts or for those who pay monthly subscription fees. Study what each broker is offering
carefully before picking one.
The highest and lowest prices for which a stock traded during         Most of the indicators you’re looking at can be pinned down nicely. But equally important are a few things that                                BeST BeT: The best source for data, including some of the more sophisticated valuation
ratios and industry comparisons, is Morningstar.com. Many ratios you can’t find elsewhere                                                       Vanguard and Fidelity are included because they are two of the biggest providers of 401(k)s,
the past year. This can tell you at a glance where a stock’s          are a little more subjective. To get a bead on these things, read news on the company and look for analyst
— including the PEG ratio — are available here. A free registration gives you access to                                                         and they also offer online stock-trading services. While they may seem expensive per-trade,
current price falls in comparison.                                    reports. Heck, read press releases, if you don’t mind wading through the fluff. Look for:
basic data, along with Morningstar’s investor education tools. A paid subscription, which                                                       it may be worth it to you to stick to your 401(k) provider if you’re interested in keeping all
In spite of the whole “buy low, sell high” thing, in most cases       its “competitive moat”: Is the company well-insulated from its competitors? Coca-Cola and Nike have classic                                                                                                                                                                                    your investments in one place.
goes for about \$15/month, gets you analyst research and Morningstar ratings, too.
you want to buy when a stock is on the upswing — as long as           moats, wide and deep. Try as they might, no one can seem to get near these industry leaders.
it meets your other criteria.                                                                                                                                                                                        CloSe SeCoNd: Reuters (www.reuters.com/investing) also provides clear and abundant
Market share the company can steal: If you’re looking at a smaller company, consider whether it can make                                                                                                                                                                                                                            MiNiMUM oPeNiNg BAlANCe                                  Fee PeR TRAde
data with industry comparisons, although it is missing some of the key ratios Morningstar
Feel good iF: The stock has a history of growth, and is on            inroads against its established competitors. Does the industry have one dominant player (a Nike)? Or are                                                                                                                                                                                                                                    Cash          Margin       Retirement
provides. Reuters also provides some great educational tools, including data definitions.                                                                                                 account         account          account                             online
the upswing. Price — like any of these indicators, really —           there a lot of small companies jockeying for position — none better off than the next?
can’t stand alone as a reason to buy or pass on a stock. A                                                                                                                                                           AlSo TRY: Yahoo Finance and MSN Money. Yahoo has all the right data, but its industry
Catalysts: In chemistry, a catalyst is an agent of change — an accelerant. It’s the same in                                                                                                                                                                                Scottrade                                    \$500          \$2,000              \$500                             \$7.00
company at its 52-week high can easily be terrifically over-                                                                                                                                                         comparison isn’t as thorough as it could be (it does, however, compare companies to
business. Catalysts can be small — a press release that gives the stock a one-day bump — or
priced and waiting for a fall — just as a stock near its 52-week                                                                                                                                                     specific competitors, which can be useful — and fun).                                                                                           TD Ameritrade                             \$2,000           \$2,000           \$1,000                              \$9.99
huge — an iPod that will change a company’s entire future or a dynamic new CEO
low can be just momentarily out of favor. Read all the signs,                                                 in the front office. Look for a stock that has some accelerant behind it.                                                                                                                                                                              ShareBuilder **                             None           \$2,000             None                            \$15.95

Charles Schwab                            \$2,500           \$5,000           \$2,000                    \$9.95-\$12.95
n	Is	the	business	growing?	                                                                                                           n	Can	it	pay	its	bills?	                                                                                                   n	Is	the	stock	price	fair?
Fidelity                                  \$2,500           \$5,000           \$2,500                        \$8-\$19.95
s a l e s g r ow t h                                                                                                                  c a s h F l ow                                               Di v i De n D                                                 p/ e r at io                                     pe g r at io
Vanguard                                  \$3,000           \$3,000           \$3,000                            \$25.00
It’s not enough for a company to bring in \$100 million every                                                                          The most commonly quoted measure of a company’s              If you’re buying your first stock, chances are you            The mother of all valuation ratios, the price-   A slightly more sophisticated cousin of the
** ShareBuilder also has an automatic investment plan, which lets you buy stock for \$4 per trade if you do it regularly
year without fail.                                                                                                                    health is its net income, or profit. Although it certainly   aren’t worried about current income — the quarterly           to-earnings ratio compares a company’s           P/E ratio, the Peg (price, earnings, growth)       — say, buying shares on the second Tuesday of every month.
What’s important to Wall Street — and therefore to the stock’s                                                                        drives stock prices, it may not be the most reliable         dividends some companies pay their shareholders.              stock price to its earnings per share for the    ratio measures a company’s stock price
price — is that the company is bringing in more money every                                                                           measure of a business’ health.                               And if you’re only buying a few shares, that 26 cents a       past year. If a stock is selling for \$20 per     against its potential for future growth. It’s      deFiNiTioNS
year — \$100 million this year, \$110 million next year,                                                                                When a company is balancing its books, there are a           quarter isn’t going to add up to much anyway.                 shares and had earnings of \$2 per share          calculated by dividing the company’s P/E                                                                                         SkiRTiNg
The types of accounts are covered in more detail on
over the past year, it has a P/E ratio of 10.    ratio by its projected growth in earnings per                                                                                    THe MiNiMUM
\$125 million the year after.                                                                                                          lot of things that can happen between the top and            But, dividends still may tell you something important.                                                                                                            the next page, but for now:
bottom lines of the ledger — accounting rules can            A company that pays a big dividend is likely to be a          (There’s no such thing as a negative P/E         share for the upcoming year. So, if our                                                                                          Can’t come up with \$2,000 to
This is sales, or revenue, growth. And it’s one of the most                                                                                                                                                                                                                                                                                                          Cash account: You can only invest the money you have
distort the company’s financial health, or management        strong, sound business that’s been around for a while.        ratio — a company that’s losing money            company with a P/E of 10 has projected                                                                                           open an account? There are a
important things to understand.                                                                                                                                                                                                                                                                                                                                      deposited in your account.
won’t have a one at all.)                        earnings growth of 5 percent next year, its                                                                                      few ways around it:
can (gasp!) manipulate the numbers.                          if there is no dividend: Don’t be put off if a company                                                                                                            Margin account: You can borrow money from your bro-
Past performance: It’s easy to track a company’s growth                                                                                                                                                                                                                                                           PEG ratio is 2.                                                                                                                  n Start with a broker that
Enter cash flow, a measure many analysts and inves-          doesn’t pay a dividend and never has. It’s common,            The P/E ratio typically measures past                                                               ker to buy stocks.
history. Most financial Web sites show at least year-over-year                                                                                                                                                                                                                                                                                                                                                                                     doesn’t have a minimum —
tors prefer because it’s less subject to distortion.         especially among young companies. They’re putting             performance, not future prospects. Even so,      Not all financial Web sites carry the PEG
growth, plus an average for the past three or five years. This                                                                                                                                                                                                                                                                                                       Retirement account: Either a Roth or traditional indi-                        ShareBuilder — or has one you
their extra cash back into the company, hopefully to          it often reflects the expectations investors     ratio, but you can find it at Morningstar.com      vidual retirement account, or IRA.
is useful, but it’s more telling to look at annual growth rates                                                                       There are two good ways to measure cash flow:                                                                                                                                                                                                                                                                can meet (Scottrade).
lay the groundwork for long-term growth. That can             have — a high P/E typically means high ex-       and Yahoo Finance. It’s also easy enough to
over the past several years. You can find them going back                                                                             Cash flow from operations: This is the cash                                                                                                                                                                                                                                                                  n Open a retirement account.
only be good. (Microsoft didn’t start paying dividends        pectations, and a low P/E, investors are not     calculate yourself.                                AddiTioNAl FeeS
a decade — if the company has been around that long — at                                                                              generated from a company’s business operations                                                                                                                                                                                                                                                               Some brokers have no minimum
until 2003 — when it had about \$40 billion in cash in         expecting much. (Sometimes you will see          Feel good iF: Like the P/E ratio, a low            There’s another layer of costs associated with online
Morningstar.com.                                                                                                                      — typically revenue minus the cost of running the                                                                                                                                                                                                                                                            for IRAs; others have a much
the bank.)                                                    something called “forward P/E,” which uses       number in comparison to its peers is the           brokerage accounts: fees.                                                     lower threshold.
Future prospects: It’s harder to pin down                                                                                             day-to-day business. This number is found in the                                                                           an estimate for the coming 12 months.)
Feel good iF: The company steadily increases                                                                   sign of a bargain, while a high number may         Most brokerage firms no longer charge account                                 n Pick a broker that will allow
how the company will do next year or the                                                                                              company’s financial statements, which are provided
dividends — this is a sign of good health. Decreases          Feel good iF: The P/E ratio is low in            mean you would be paying too much for the          maintenance fees — or there are so many ways                                  you to set up an automatic
year after. Estimates usually come from                                                                                               on most financial Web sites.                                                                                                                                                                                                   around them that they’re irrelevant. For instance,
are a serious red flag — companies don’t cut their            comparison to its industry and peers.            stock.                                                                                                                           monthly investment. Many
industry analysts, the pros who track                                                                                                 Free cash flow: Take operating cash flow and subtract                                                                                                                                                                          E*Trade charges an annual service fee of \$40, but it’s
dividends lightly. It’s usually a last resort. And if the     Comparing it to the S&P 500 can be mis-                                                                                                                                           will waive the minimum if you
companies for investment banks. They                                                                                                  the money spent on capital projects to get free cash                                                                                                                                                                           waived if the account is an IRA, if it has been open less
dividend is suspended altogether, the company likely          leading — industry norms vary widely, so                                                                                                                                          agree to put \$200 or so into the
use the company’s estimates and past                                                                                                  flow — in essence, how much money the company is                                                                                                                                                                               than a year, or if you make just one trade during the                         account each month.
is looking at serious cash-flow problems. For the             it’s best to stick close to home.
performance, plus their own expertise                                                                                                 really making. This number is a little trickier to find,                                                                                                                                                                       year — among other loopholes.
investing newbie, the message is clear: Run fast,             Think of the P/E ratio this way: The less you                                                                                                                                     n A few companies allow you
to estimate a long-term growth rate. Most                                                                                             but Morningstar provides it (look for “10-year cash                                                                                                                                                                            There are other nickel-and-dime fees to watch out for,
run far.                                                      pay for each dollar of earnings, the better                                                                                                                                       to bypass the middleman
of the financial Web sites include this data in                                                                                       flows” in the financial statements section).                                                                                                                                                                                   too. For instance, you will likely have to pay extra if                       and buy shares directly from
their “analyst estimates” section.                                                                                                                                                                                                                               the value. A high P/E ratio may mean you’re                                                         you want a printed statement mailed to your home,
Feel good iF: The company’s operating cash flow is                                                                                                                                                                                                                                                           them. These are typically big
paying too much for the stock. But you may                                                          rather than an electronic statement e-mailed, or if you
Feel good iF: It’s a great sign if the company shows                                                                                                                                                                                                                                                                                                                                                                                               companies — IBM, Coca-Cola,
bigger than its net income. Don’t rule out a company                                                                       not care — if you plan to hold the stock for                                                        request a printed trade summary.
steady year-over-year growth over the long term, especially                                                                                                                                                                                                                                                                                                                                                                                        McDonald’s — that won’t give
with negative free cash flow, especially if it’s a young                                                                   a long time, the price eventually may be
if its growth rate has picked up in recent years. But you also                                                                                                                                                                                                                                                                                                       The discount brokers all have a conspicuous “pricing”                         you huge gains in the stock
company investing a lot of money in its future. But                                                                        worth it.                                                                                           or “commissions and fees” links on their Web sites, so                        price. The upside is, they do let
want its five-year growth estimate to outstrip its peers’.                                                                            more mature companies should have significant free                                                                                                                                                                             check them out before you sign up.                                            you start small.
cash flow — the more, the better.
Page 62                                                                                                                    THE STAR-LEDGER                                                                           Thursday, February 22, 2007

STEP 4               Open	an	account                                                                                          ROTh IRA                                    TRAdITIONAl IRA                            TAxABlE ACCOUNT

COMPARING ACCOUNT TYPES
If you choose an online brokerage, there are three
Contribution limit        Up to \$4,000 per person,                    Up to \$4,000 per person,                   None
ways to open an account:                                                                                                        depending on income; catch-up               depending on income; catch-up
n ONlINE: It takes about 10 minutes, and you can transfer a                                                                     provisions allow people older than          provisions allow people older than
balance into the account electronically so you can get going                                                                    50 to contribute more.                      50 to contribute more.
right away.
n BY PhONE: Not quite as quick, but reasonably convenient.
n BY MAIl: The slowest way to go. You can download an                                                 Income limit              Up to \$160,000 if married and filing        None. If you are under age                 None
application, fill it out and send it back with a check. Or, if                                                                  jointly; \$110,000 if single.                70 1/2 and have any income, you
can open an IRA. Whether or not
you’re really feeling all tortoise-and-the-hare, you can call and
the contributions are tax-deductible
have an application mailed to you. If you’re that tech-averse,                                                                                                              depends on your income.
though, maybe an online brokerage isn’t your best option.
All three options work, but you might as well get comfortable
with doing things online. It’s easiest — and cheapest — to make your
Contributions             Never tax-deductible                        Fully or partially deductible, if you:     Never tax-deductible
Although each brokerage is different, the following walk-through
covers most of the choices you’re likely to encounter.                                                                                                                      n Are not covered by any kind of
retirement plan at work.
W H AT	K I N D	 OF	 AC C OU N T ?                                                                                                                                           n Are covered at work and have
The first decision you’ll have to make is what kind of account to open.                                                                                                     adjusted gross income of less than
The choices:                                                                                                                                                                \$60,000 (if single) or \$85,000 (if
married)
n INdIvIdUAl: An account with just one owner — you.
n Married but aren’t working and
n JOINT: An account for you and someone else, typically a spouse.                                                                                                           your family’s AGI is less than
If you are opening a joint account, you’ll have to choose between an                                                                                                        \$160,000.
account in which your share would go to the other person on the
account in the event of your death (known as “rights of survivorship”)
or one that would pass to your estate (“tenancy in common”).                                          Age limits                None                                        No contributions after 70 1/2              None
n CUSTOdIAl: An account you manage in a minor’s name.
n RETIREMENT: Individual Retirement
YOUR ACCOUNT                 Accounts allow you to make investments                                 Withdrawals               Not taxed; you may take out initial         Taxed; mandatory starting at age           Taxed. You can take the money out
You can buy and              without having to deal with tax issues                                                           contributions any time without              70 1/2; penalties may apply for            anytime.
until later. IRAs come in two flavors:                                                           penalty, but penalties may apply            withdrawals before age 59 1/2.
sell all kinds of in-
traditional and Roth. Traditional IRAs let                                                       for taking out earnings before age
vestments through                                                                                                             59 1/2.
the same account             you deduct your investment from taxes
— stocks, bonds,             today, but you’ll pay taxes when you
mutual funds,                withdraw the money in retirement. Roth
IRAs work the opposite way — you pay                                   Bottom line               Almost always the best option if            Best if you need the tax deduction         Best if you don’t meet the above
exchange-traded                                                                                                               you are eligible and can afford to          now, or if you think you will be in a      income limits, or if you expect to
funds, you name it.          tax on what you earn this year, but not
skip the deduction now.                     lower tax bracket in retirement.           spend the money on something
on the earnings of your investments over
If you chicken out                                                                                                                                                                                                   other than your first home before
the coming years. Both accounts have                                                                                                                                                    you hit 59 1/2.
investment and/or income limits, which
that’s fine. Put your
are detailed in the accompanying chart.
money in an index
fund that tracks          WhICh ONE IS fOR YOU? It largely
the S&P 500 or the        depends on when you want to use the
total market. Most        money. IRAs restrict withdrawals until
will give you steady      you’re retirement age, but there are                                                                                                     	 STEP 5              Place	the	order
expenses.                 home or paying college bills or certain                                                                                                  Now that you have an account and you know what stock you want to
medical expenses. Stick with a cash                                                                                                      invest in, it’s time to place the order.
account if you plan to spend the money
before retirement on anything else. But if you’re buying your first                                                                                                  Brokerages give you options for this, too:      will apply if you do it by phone — they’ll
stock to start a retirement nest egg, open a retirement account.                                                                                                      n ONlINE: Easy and reliable, just log in       ask you the same sort of questions.
This does not mean you have to hang on to that stock until                                                                                                              to your account and place your order.        After you log in to your account, navigate
you’re 65 — you can buy and sell stocks and funds within                                                                                                                  n BY TOUCh-TONE PhONE: If                  to the page for trading. Each broker is a
your account and settle up with the government later.                                                                                                                      you want to pick up the phone, a          little different, but the steps are going to
recording will walk you through           be similar:
C A s H 	 Or 	m A r g I N ?
placing your order. This will cost        1. Select an option — in this case, “buy.”
At this point, you may be offered one more option: a cash account or                                                                                                       more than going online.                   2. Enter the stock’s ticker symbol and
a margin account.
n BY TAlkING TO A PERSON:                 the number of shares you want to buy.
A cash account is a little like a checking account just for investments                                                                                                Lastly, you can make a “broker-               3. Select the order type: market or limit.
— you can spend only what you have in the account.                                                                                                                           assisted trade.” This is the most       Select market order if you want to buy
With a margin account, you can borrow money from the broker to                                                                                                                 expensive option, and is likely       right away at the current price or limit
make investments. While margin trading can amp up your returns,                                                                                                                 to cost at least double what         order if you only want to buy at or below
it also can seriously magnify your losses — you can wind up losing                                                                                                              making the trade online would        a specific price.
even more than your initial investment. Margin accounts typically                                                                                                              cost. But why pay \$40 just to
4. If you want to make a limit order, you
require a higher opening balance than cash accounts.                                                                                                                        place an order when you’ve done
have to tell them the price you want and
Which is for you? You’re just dipping your toe in the investment                                                                                                      all the legwork yourself?
select an order expiration. Limit orders
waters. Start with a cash account. You can always convert it later,                                                                                                  The following outlines how you place a          typically expire at the end of the trad-
when you get more comfortable with stock investing.                                                                                                                  real-time trade online, but similar steps       ing day when the order is placed or are
F U N DI N g 	 T H E	 AC C OU N T                                                                                                                                                                                    “good ’til canceled” — GTC.

Finally, you need to put some money in your                                                                                                                                                                          5. Review the details of your order.
account before you can buy anything. The                                                                                                                                                                             6. Click “place order.”
quickest and easiest way is to do it electronically                                                                                                                                                                  Once you’ve placed your order, you can
— transfer the money from your bank account                                                                                                                                                                          check its status to see when it’s been
into your brokerage account. Or, you can send a                                                                                                                                                                      executed. And then — you’re on your
check. There are other options, but if you’re just                                                                                                                                                                   way!
starting out, one of these will be your best bet.

The	aftermath:	managing	your		investment
Congratulations! You’re the proud owner of a tiny piece of a                                                         you will get regular statements from             start to think about selling it. Here are       n The company has taken a wrong turn.
company. Now what? Here are a few things to keep in mind.                                                            your brokerage.                                  some red flags to watch for:                    If you think the company is veering into
dIvIdENdS: If your company pays                  n The reason you bought the stock is            a business it isn’t any good at — or you
kEEP UP WITh ThE PRICE: Of course,              time you hear about it, you can bet all                              dividends, it will send your brokerage a         no longer valid. If you bought Apple            don’t understand — think about bailing
you’ll want to keep an eye on how your          the professional traders already have                                quarterly check, which will be credited          because the iPod is today’s must-have           out. Ditto if there seems to be disarray
investment is doing. Visit your broker’s        processed the information — but it will                              to your account. Some brokers let you            gadget, that’s cool. But if your friends
in management.
Web site regularly, or set up a portfolio       keep you informed.                                                   set up a reinvestment plan, in which             start chucking their iPods for something
at one of the financial Web sites.              TAxES: If you’ve opened an IRA, you                                  dividends are put toward additional              more slammin’, take the hint.                   n It’s lagging. Times are changing,
kEEP UP WITh ThE NEWS: Stay                     won’t need to worry about taxes until                                shares of the stock.                             n Its stock is tanking. All stocks go           and fast. If your company can’t keep up
up-to-date on the company, its                  you start withdrawing money (if you                                  If the account is an IRA, you won’t have         through ups and downs, so a dip isn’t           — like Kodak clinging to film in a digital
competitors and its industry. One good          opened a Roth, you won’t need to worry                               to pay taxes on dividends until you              always a “sell” sign, but you can’t just        age — it might be time to bail.
way is to set up a few news alerts              about it at all). If you’re trading in a                             start making withdrawals. If you’re in           ignore it. Look for the reasons behind it,
dON’T fAll IN lOvE: This can be
through MarketWatch, Yahoo or Google.           taxable account, you will have to think                              a taxable account, you will have to pay          and ask yourself if you think the com-
tax each year. Dividends are taxed at            pany can right itself — or not.                 terribly hard, especially if you love the