You panic when there’s news of a down market. You assume that your investment portfolio is doing well when there’s news of a thriving economy. You may be one of those people who shies away from investing or you invest ultra-conservatively because you’re afraid you’ll lose all your hard-earned money. You may be one of those people who hired an investment adviser and hope that the advisor is leading you in the right direction.
I’m not going to give you a hot stock tip. As a matter of fact, I think that investing in individual stocks is a bad idea for my target readership—hard working, upwardly mobile ordinary people looking to beat debt, save for future goals and retire rich. Instead, I’m going to share some basic fundamentals about investing. In this article you’ll find simple time proven practical information that will help you become a confident investor. This isn’t a complete self-help guide to investing. This advice will help you save time, money and frustration whether you chose to work with an investment broker or if you chose to go at it alone.
Below you’ll find eight key points that will make you a more confident investor:
Objective. Every dollar saved and every dollar invested should have a clear definitive purpose or goal. You could be saving for emergencies, down payment on a home, retirement, college, new car and/or vacation. Your objective can be whatever you want it to be. It’s simply important that you have a definitive goal. By establishing a purpose, it helps to determine where you’ll save and how much you need to save.
Time horizon. Now that you have a goal and you’re accumulating money to reach your goal, when will you need to access the money to fulfill your goal? If you’ll need to access the money in the next five years, it’s not safe to tie this money up in investments at all. You’re better off placing this money in safe, conservative saving account, money market account, certificate of deposit or money market mutual fund account. These types of accounts are also known as cash equivalents because they’re relatively safe and easily accessible. If you won’t need this money for five years or greater, you can consider investing in mutual funds. Saving for retirement and other long-term saving goals is a little different. Although you may access the money in the next five years, your retirement can last 30 or more years. As a result, you’ll want to keep this money invested in mutual funds. However, you can consider being a little more conservative within your mutual fund holdings
Risk tolerance. It’s important that you’re able to sleep at night and not be overwhelmed with the up and down swings of the market. Would you consider yourself a conservative, moderate or an aggressive investor? A financial game plan, accurate knowledge and a diversified investment portfolio will help you to better cope with and understand risk.
Diversification. Invest with mutual funds exclusively. A sure-fire way to minimize risk in your investment portfolio is to have your money spread around in various places. Mutual funds offer many benefits to the common investor. Its major benefit is that it allows you to take advantage of being invested in up to 500 different companies. If you have mutual funds that hold 200 companies in its portfolio, it’s highly unlikely that all 200 will rise, fall, or go belly-up at the same time. People who lose their life savings in the stock market do so because they’re heavily weighted in individual stocks. Employees of companies like Enron whose entire retirement portfolio went down the drain did so because they were heavily weighted in Enron stocks. If they would have held mutual funds with 100 or more companies in its portfolio and Enron was one of those companies, the losses derived from Enron would have been offset by the other 99 companies who remained stable and/or growing.
Asset allocation. The biggest decision you’ll make that impacts your return on investment is not which mutual fund you select. It’s how your investment is allocated between stock, bonds and cash equivalents. Stocks are riskier than bonds. Stocks have also been more rewarding than bonds over an extended period of time. According to Ibbotson, an independent research firm, stocks have an average rate of return 12 percent over the past 75 years whereas bonds have an average rate of return of 6 percent over the same time span. Cash equivalents averaged right around 3 percent. The more your portfolio is weighted toward stock, the higher your rate of return will be.
Track record. Before selecting a mutual fund, you want to look at its track record. The longer the mutual fund has been in existence, the longer the track record you can obtain. At a minimum you want to purchase mutual funds that have a five-year track record or better. A track record will give you a history of how well the mutual fund performed over the years. You can obtain unbiased information detailing the track record along with other details about mutual funds from Morningstar. Morningstar is one of the largest independent firms that rate mutual funds and other investment vehicles.
Dollar cost averaging. As opposed to trying to time the market or investing a large lump sum, it’s better to systematically invest money at regular time intervals over an extended period of time regardless of the fluctuation of the market. This allows you to buy more mutual fund shares when prices are down and allows you to buy fewer shares when prices are high. Those who contribute to company-sponsored retirement plans with each paycheck are practicing dollar cost averaging.
Expense ratio. The expense ratio details the cost that you’re paying for a mutual fund. Operating fees and marketing expenses are all factored into the expense ratio. Loads or sales commissions are not. The average expense ratio is 1.6 percent. This works out to cost to $16 per year for every $1,000 account value. I consider an expense ratio of 1.3 percent or lower to be fair. A lower expense ratio means more of your money working for you.
(Damon Carr can be reached at 412-856-1183.)