The goal of financial management is to maximize shareholder wealth. If your managers aren’t shareholders, why should they care?

If managers held a substantial ownership stake in the company, they would be more inclined to behave in ways that would add value to the stock. Maybe their own personal greed could help their employers succeed?

Executive compensation and aligning the interests of owners and managers will always be hot button issues.

In the movie, Wall Street, Gordon Gekko (Michael Douglas) delivers a passionate speech to shareholders of his latest takeover target. “Greed is good” may be the most often referenced quote of the speech, but there are other points worth considering i.e. wasteful behavior, overstaffing and lack of management ownership.

Watch the clip below of Mr. Gekko exposing managers for their behavior at a shareholder meeting.

Where do you go for financial research? Yahoo! Finance, Google, Hoovers and Morningstar are just a few sources for investment research, but perhaps you should consider EDGAR.

EDGAR isn’t a finance guru, it’s the SEC’s Electronic Data Gathering and Retrieval archives.

The Securities and Exchange Commission requires publicly traded companies to periodically file certain documents, and the archives are kept electronically on EDGAR.

Photo by dannysullivan, courtesy of flickr

The required filings include:

Form 10-Q - Must be filed each of the first three quarters of each fiscal year. This form contains unaudited financial statements including the balance sheet, income statement and statement of cash flow.

Form 10-K - Must be filed annually. The report contains audited financial statements as well as an overview of the company’s business and financial standing.

Form 8-K - Known as a “current report,” the 8-K must be filed when shareholders need to be made aware of a major event. The events requiring an 8-K range from “completion of acquisition or disposition of assets“ to bankruptcy or receivership. (View the complete list)

EDGAR provides timely versions of these filings and EDGAR is free. You can access EDGAR by visiting www.sec.gov.

The approval of a 1:20 reverse stock split is bringing AIG back into the headlines. The stock appears to be up 1,500 percent today. Don’t get excited, a reverse stock split took effect yesterday at 5 pm. What is a reverse stock split and should it mean anything to investors?

As an investor, a stock split or a reverse stock split does nothing for your overall position. Let’s take a look at both.

Photo by Barrybar, courtesy of flickr

In a normal stock split, the number of outstanding shares is increased, typically by a 2:1 ratio. So, for every one share you owned prior to the split, you will own two after the split. However, since the number of shares doubled, the value of each share is now cut in half.

Cutting the shares in half maintains the company’s market capitalization and the size of your investment.

Think of it as taking two fifty-cent pieces to the bank and asking for four quarters. Even though you end up with more coins, you still have one dollar.

In the case of a reverse stock split, the number of outstanding shares is decreased and the value of each share is increased. So if you had ten shares worth a total of $100 prior to a 1:2 reverse stock split, then you will have five shares worth a total of $100 after the split. Each share has gone from $10 to $20 in value, but the overall value of your holdings remains unchanged.

Shares of AIG closed yesterday at $1.16 per share and are currently trading around $18 each, which is less than 20 times the pre-split price. Each share of AIG’s stock is now more expensive, and there are now fewer shares available, but the market capitalization has actually declined.

The bottom line: If a cake tastes bad, it doesn’t matter how you slice it.

If securities in your account are held in street name, then the registered owner is your brokerage firm, not you.

There are two types of accounts you can open with a brokerage firm: cash and margin.

If you have a cash account, then you are the owner of the securities, because their purchase was funded entirely by you. However, if you have a margin account, your stocks will probably be held in street name.

Photo by matze_ott, courtesy of flickr

Why would the broker want to own the stocks in your account?

In the case of a margin account, some cash comes from you and the remainder of the funding comes in the form of a loan from the broker.

If the stocks in your account lose substantial value, then you could receive a margin call from the broker.

You may be asked to contribute more cash or liquidate other securities in order to improve your equity position.

If you can’t comply, having securities registered in street name allows your brokerage firm the right to go into your account and sell stock.

Selling stock will improve your equity position and guard against the possibility of the securities in your account being worth less than the value of your loan.

With margin accounts, your broker is wearing the hats of a broker and a lender. Holding stocks in street name helps the broker maintain safety as a lender, in case you do not comply with the terms of your margin account.

What is the difference between a Treasury bill and a Treasury note? A note and a bond?

The government offers several alternatives for potential investors. T-bills, T-notes and T-bonds differ in terms of how long they take to mature and the types of payments attached to them.

Photo by woodleywonderworks, courtesy of flickr

Bills - T-bills are short term bonds with maturities of up to 52 weeks. A T-bill is a pure discount loan, meaning that the price you pay up front will be less than the face value you will receive at the bond’s maturity.

Notes - T-notes have maturities of greater than one year and less than ten years. T-notes and T-bonds are interest only loans. Because of their longer maturities, the government pays these bondholders periodic interest payments. The coupon payments are semiannual.

Bonds - T-bonds have long term maturities, typically thirty years. They also pay semiannual coupons.

The market for long term bonds began shrinking in the late 1990s and in 2001, the government actually stopped issuing 30-year bonds.  They were reintroduced in early 2006.

The smallest denomination for all three securities is $1,000. All three are backed by the full faith and credit of the U.S. government. 

Since the government has yet to default on an issue, T-bills are commonly referred to as risk-free securities. Notes and bonds are believed to be free of default risk, however they are still subject to interest rate risk and inflation.

To learn more about, or purchase government bonds, visit TreasuryDirect.

Have you ever invested in something and watched the value of your investment wither away?

If so, why didn’t you sell? Perhaps you suffered, or are suffering from a case of “get-evenitis.”

“Get-evenitis” is the layman’s term for loss aversion.

Photo by Triin Q, courtesy of flickr

Loss aversion is a reluctance to sell investments after they have decreased in value. It may also be referred to as the breakeven effect.

Research shows that many individuals suffer from loss aversion. Individual investors are approximately 1.5 times* more likely to sell a stock that has risen as opposed to selling a stock that has fallen.

For example, suppose you bought 100 shares of Citigroup (Ticker: C) in June 2007 for $47.31 each. One year later, shares were trading at $16.23 per share.

Would you sell the shares? If not, why? The decision to sell should not depend on the price you paid for the stock. It should depend on things like your research regarding the current value of the stock and expectations for its future cash flows.

If you held on to those shares last June, today they would be worth $3.02 each, representing a 93.6 percent loss on your investment.

As Kenny Rogers said, “You have to know when to hold ‘em, know when to fold ‘em.” Elsewise, the aversion to selling at a loss today can cause you to sell at a greater loss, later.

* = from Fundamentals of Investments, Jordan and Miller, 4th Ed.

How strong are your investments? Strength is relative.

One way of comparing the performance of one stock to another is by charting relative strength. The relative strength is calculated by comparing the value of one stock (or index), over time, to the value of another.

Photo courtesy of koka_sexton, courtesy of flickr

To start tracking relative strength, the stocks do not have to start with the same price, but the initial investment in each must be the same amount.

So, let’s suppose we start out with $250 and want to see which stock was stronger, Jet Blue (Ticker: JBLU) or United Airlines (Ticker: UAUA).

At the start of the year, with a $250 investment we would have been able to purchase 35.21 shares of JBLU ($7.10/share) or 22.69 shares of UAUA ($11.02/share).

The chart starts with a relative strength of 1.00, since both investments are worth $250. As prices change, the relative strength will reveal which investment is stronger by dividing the total value of our shares of JBLU by the value of our shares in UAUA.

Here are the monthly closing prices for JBLU and UAUA, from January to March.

JBLU: $5.63, $3.81, $3.65 and UAUA: $9.44, $4.91, $4.48

So at the end of January, JBLU shares are worth $198.23 (35.21 shares @ $5.63/share) and UAUA shares are worth $214.19 (22.69 shares @ $9.44/share). The relative strength is $198.23/$214.19 = 0.925. So, at the end of January, our investment in JBLU is worth 92.5 percent of our investment in UAUA.

Since we divide JBLU by UAUA, if the relative strength is less than 1.0, then JBLU has underperformed UAUA. If the relative strength is greater than 1.0, then JBLU has outperformed UAUA.

One flaw of the relative strength is that it doesn’t tell us that both of these investments lost money, but it does tell us which one lost more or less.

In this example, the relative strength was used to plot one company against another, but it can also be used to compare one stock to an industry or an index.

What makes investing so risky?

Investing will always be risky since nothing is guaranteed, but you can choose a combination of assets that makes investing less risky.

Diversification is a technique used to manage risk by adding different types of investments to a portfolio.

Photo by conorwithonen, courtesy of flickr

Diversification is not just creating a portfolio of ten stocks instead of two. To maximize the benefits of diversification, a portfolio should contain a mix of assets (bonds and stocks).

Within each asset class, there should be more than one type of security.

The choices should contain issuers who face different types of risk, or varying degrees of the same risk.

Combining the various securities will never completely eliminate risk, but it can balance the risks.

Here are some different risks that issuers may face: interest rate risk, inflation risk, sovereign risk, exchange rate risk, business risk, financial risk, liquidity risk and political and regulatory risk.

Some companies face all of these risks, while others face just a few. By picking companies with different levels of risk exposure you may be able to achieve average returns while assuming lower than average risk.

Risk comes in many forms, some of which cannot be escaped. Diversify with risk in mind and never put all of your eggs in one basket!

With the deaths of so many celebrities in such a short span of days, I had to write about the importance of investing in an estate plan.

Estate planning covers three phases of dealing with assets: accumulation, preservation and, finally, the distribution of those assets after death.

Photo by Jeremy Burgin, courtesy of flickr

Here are the most basic goals of an estate plan:

1. You should control who gets your money or assets, as well as when and how.

2. Your estate plan should minimize final costs. By cutting back on taxes, administrative work, etc. the bulk of the money can be passed on to your beneficiaries.

3. Your plan should also cover what should happen to your assets if you were to become incapacitated.

Developing an estate plan may require the services of several professionals including attorneys and accountants. A financial planner can help get you started and coordinate the activities.

Death is an uncomfortable topic to discuss, but it is one that we will all have to face. Having an estate plan can make things easier for those left behind.

The following links will show you some information needed to create an estate plan:

Abanet - Estate planning checklist

Estate Planning for Everyone - Provides explanations of wills, trusts, power of attorney and health care directives.

On a side note, I hope Ed McMahon, Farrah Fawcett, and Michael Jackson will rest in peace.

Similar to the many prices contained in one stock quote, bond quotes may contain many interest rates. The rates are all important because their relationship reveals how bonds are priced.

Here are some rates to be mindful of if you are in the market for bonds.

Photo by kugelfish, courtesy of flickr

Coupon rate - The coupon rate is the rate which determines the size of the bond’s periodic interest payments.

Interest can be paid annually or semi-annually. If the coupon rate is 5 percent, then the bondholder will collect 5 percent of the bond’s par value every year.

Current yield - The current yield is the coupon payment divided by the current price of the bond. The price of a bond can fluctuate, and as it changes so will the current yield.

Yield to maturity (YTM)- The yield to maturity is the overall rate of return on the bond assuming that the bond is held until it matures. The yield to maturity also assumes that all coupon payments are received and reinvested at the same rate.

Think of the yield to maturity as the going rate of return for bonds of similar risk and length to maturity. The coupon rate is determined by the bond’s issuer, and it does not have to equal the yield to maturity. How the two rates stack up will determine if the bond sells at a discount, premium or at par.

If the rates are the same, then the bond will sell at par. If the coupon rate is greater than the yield to maturity, then the bond will sell at a premium to par value. If the coupon rate is less than the yield to maturity, then the bond will sell at a discount to par value.

If you plan on investing in bonds, get familiar with interest rates. Bond prices depend on them and so can credit card, auto loan and mortgage rates. For more information on interest rate changes, here’s a link to one of my articles, “How Interest Rate Cuts Affect Consumers,” on Investopedia.