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Saturday, December 8, 2007

$500 Challenge Accounts: Funding sources and strategies for Sharebuilder Account

Ok, we ended up yesterday stating that before we even make purchase in the Sharebuilder, we'd need about $680.00 for every $45.00 stock we purchase. But that account only has $130.00, and right now, we've been busy funding the optionsXpress Futures Options account. So where is that other $550.00 coming from in order to have this account start making money for us?

Two places.

First of all, just from outright donations that we'll start making to it in a few months. This is one of the rules that we have for these challenge accounts. That rule states that: Every month, we can contribute $100.00, that can be split amongst the accounts however I choose. In other words, I can send $30.00 to Sharebuilder, $70.00 to optionsXpress; or $100.00 to optionsXpress, and nothing to Sharebuilder, etc. Although we have added no money towards the long term account of Sharebuilder as of yet, it does not mean that we will not do so in the coming months. As our optionsXpress account balance grows, we are nearing the point when we can start trading that account, and then we'll be feeding part of that $100.00 monthly deposit to the Sharebuilder account.

The second source of funding? A small percentage of profits from the optionsXpress account. We haven't started making those yet, but the account is growing closer to the point of it's first trade. In my next blog, I will discuss the money management outlook we will make with that account, as I did yesterday with the Sharebuilder account. Risk analysis, Reward analysis and other money management strategies and principles that we shall employ with such a small account balance.

There is actually a third source, the interest paid to us in the Sharebuilder account, but over the long term, that's not going to get us the sort of returns we are looking for. So I'm not actually counting that as a source of 'investment' funding.

But for today, let's just discuss why we share a small percentage of the profits between the two different accounts. In order to do this, let's talk about the differences between the Stock market, and the Futures markets.

First of all, it's important to understand that as your possibility for a high return increases? So does your overall risk. You know the old expression - it takes money to make money? This is true. If you want a larger reward from the market, you have to risk more money. If you want more of a 'sure thing' - you generally have to risk less money. For example, if you stick $1,000.00 into something safe, say, a bank CD? Your return is all but guaranteed. Your risk is very low. But the percent interest you are paid, well your reward is also lower. How does this relate to the differences between the markets?

The Futures markets offer an unbelievable return for the amount of money you put down. But this also means that your risk is much greater. The stock market offers you a very nice return for the amount of money you put down, and though there is risk, it is not as high as the Futures markets. Is this the only difference. No. Here is the most important difference you will discover.

The Futures markets are akin to what we term a zero-sum game, or even a negative sum game when you consider transaction costs. This means that it more akin to playing at a poker table. Roughly speaking, when you lose money, someone else just made money. The advantage of the Futures market is the extremely high reward that is possible. Of course, this means our risk is also great. If you're not careful, you can lose much more than your original investment in Futures. You can put down $1,200.00, and lose $30,000.00. That's not an exaggeration, and it's one of the reasons I use futures options instead of outright contracts. Regardless, the point to remember here is that the Futures arena is akin to a poker table, or a zero-sum mechanism.

The Stock market can create wealth, where wealth did not exist before. This is very different from zero-sum. The return is not as great as the futures markets unless your a complete stock market genius. But here's the good news. You don't need to be a stock market genius to make good returns and build wealth. Some argue that the stock market is more akin to zero sum, but they fail to consider the investor, over the trader. The stock market has become 'trader crazy' in recent years, and fails to consider the investor. You have people like Jim Cramer (for all the good the man does for trader education) he did make one statement that still drives me to distraction when I think of it. "Forget the investors". I almost see red every time I even think of that statement. Time has demonstrated that perhaps stock trading can be more akin to zero-sum, but for the investor it is not. Stocks split based upon the perception of company performance and the stocks valuation. And dividends continue to be paid on those shares. As well, history has demonstrated that over the long term, good solid, long term companies stocks rise. And there, ladies and gentleman, we have the difference and why the stock investor (not trader) can work at building wealth with the stock market as a money making machine.. If you had started investing in the DOW stocks before the stock market crash of 1929, let's say, 1924 with $10,000.00 , in 2006 you would have about $1,000,000.00. Not bad. Not great when you look at it in the term of how many years it took. However, when you count dividends and dividend reinvestments into that figure? Then you are looking at $24,000,000.00 by 2006. That's how powerful dividend investing can be, and how the stock market can create different types of wealth.

So what does this have to do with our original point in sharing profits between the accounts? What we are doing is mitigating our risk and sharing the rewards amongst the accounts. Our % returns with the Futures options will be much higher. When we have them. Therefore, we can use a percentage of those profits as an income asset to fuel wealth creation with solid, long term companies in the stock market.

As I stated earlier, in the next blog I will discuss the money management outlook we will make with that account, as I did yesterday with the Sharebuilder account. Risk analysis, Reward analysis and other money management strategies and principles as to when we will start trading, the size of the rewards we will look for, etc. Some have asked me why I'm not trading yet. We'll get there. But let's do it safely. Patiently. If this is your first experience with trading and investing you are going to encounter emotions you may have never dealt with before. So before we get to that point, let's educate ourselves as much as possible as to what is going on, so that we are better informed, and have a greater degree of emotional control in our business when we do start trading.

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