The Finance Professor: Investments for Grads

Answering your questions on gifts for graduates, how to keep cool when the market's hot, and more.
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Editor's note: In this installment of "The Finance Professor," Scott Rothbort answers a few reader questions.

I would like to provide an investment as a high school graduation gift to a friend of mine. I like Vanguard, but don't really want to commit to its high minimums. Can you offer a mutual fund and/or stock(s) that would be good for a smart high school grad, so they can understand the value of investing, compounding, etc.? -- Lynne F.

I have two suggestions: A DRIP and an ETF.

First, look for a solid stock with a DRIP, or

Dividend Reinvestment Plan, which will give the graduate the opportunity to not only reinvest

dividends, but to make periodic incremental investments at a low cost. I described this investment technique in

"Life Lessons for Aspiring Millionaires" and in a

follow-up segment on

TheStreet.com TV

.

Second, consider buying an ETF, or

exchange-traded fund. I would start with the

S&P 500 SPDRs

(SPY) - Get Report

or even the leveraged version, the

Ultra S&P 500 ProShares

(SSO) - Get Report

. SSO, while more risky, looks like it will provide greater long-term returns

and

help the holder develop a sense of patience.

Both of these investment alternatives can be bought for a fraction of what a

mutual fund would require as a minimum.

(To learn more about ETFs, visit the

TheStreet.com's ETF Center

.)

Is "beta" another measure of volatility? -- Rick G.

Volatility and beta seem to be similar but are indeed different. Volatility refers to the rate at which a stock will move relative to itself over a long period of time. Beta is a measure of how a stock will move relative to an

index over a long period of time. I touched on beta in

"Understanding Risk." Beta is also contained in our

glossary of investment terms.

I use our margin capacity to sell puts on stocks at price points that I'm willing to buy and hold long term. If the price doesn't come down, I keep the premium, and if it hits the strike price, I'm happy to buy the stock.I'm relatively new to managing our portfolio, having been the typical"buy and forget" investor. I don't see many people writing ortalking about this type of strategy. What am I missing? I've also used our margin capacity for short-term trades and account for theinterest in the net per trade. -- John Z.

Selling

puts is an interesting way of trying to get long exposure to a stock by using margin (

"Understanding Leverage"). However, it is more complex than meets the eye. I teach an entire course in

derivatives at Seton Hall's Stillman School of Business and will cover

options in "The Finance Professor" at a later time. From a risk perspective, selling puts is identical to buying stocks and selling covered calls. Thus, while selling puts will give you leveraged and

apparent

cheaper exposure to a stock, it will also require a margin deposit and your gains will be capped out unless you are first to put the stock (

"Getting Started With Options").

The psychology of the markets and one's decision-making with respect to risk is quite interesting. When markets are going up, investors should try to control greed and fear, yet maintain an appropriate investment strategy. Can you offer some advice on protecting gains in up markets? -- Fred B.

When a stock is doing really well, here is what I do and what I suggest for you. If you initially bought a stock based on an event, such as a new product introduction or a court ruling, sell it right away or place a

stop, so you can lock in gains but still have some upside.

However, if you bought a stock based on

fundamental research, then you should set a price target at the inception of your position ("

Ask TheStreet: Target Practice"). When the stock hits your target, use the opportunity to re-evaluate the stock.

How? First, given the most up-to-date fundamental data, look ahead to one year from now and estimate a price target that you might see down the road. If you determine that no higher target price can be obtained, then sell your holdings. If you raise your target, then consider selling a portion of the position to lock in gains or set a stop for all or part of your position. If you're a more experienced investor, selling covered calls could be worked into this strategy as well (

"Getting Started With Options").

At the time of publication, Rothbort was long SPY and SSO, although positions can change at any time. Scott Rothbort has over 20 years of experience in the financial services industry. In 2002, Rothbort founded LakeView Asset Management, LLC, a registered investment advisor based in Millburn, N.J., which offers customized individually managed separate accounts, including proprietary long/short strategies to its high net worth clientele. Immediately prior to that, Rothbort worked at Merrill Lynch for 10 years, where he was instrumental in building the global equity derivative business and managed the global equity swap business from its inception. Rothbort previously held international assignments in Tokyo, Hong Kong and London while working for Morgan Stanley and County NatWest Securities. Rothbort holds an MBA in finance and international business from the Stern School of Business of New York University and a BS in economics and accounting from the Wharton School of Business of the University of Pennsylvania. He is a Professor of Finance and the Chief Market Strategist for the Stillman School of Business of Seton Hall University. For more information about Scott Rothbort and LakeView Asset Management, LLC, visit the company's Web site at www.lakeviewasset.com. Scott appreciates your feedback; click here to send him an email.