Like many investors, you’re probably torn between greed and fear... On the one hand, you want to generate as high a return as possible from your investments in order to pay for a comfortable retirement, fund the high cost of college education, start a small business, pass money on to your heirs or finance a myriad of other major life expenses.
At the same time, you may fear the investment markets. Perhaps you’ve been burned by market declines, bad investment advice or taking on too much risk by grabbing for high returns. Or maybe investments and investing appear so complicated you’re afraid to venture beyond the basic savings accounts you know.
This brochure, produced by the Financial Planning Association, the premier resource for the public to find a financial planner who will deliver advice using an ethical, objective, client-centered process, offers 20 key steps to rein in that greed and ease your fears through the wise management of your investments. The brochure is not
designed to make you a great stock picker or predict the next market boom or decline. Rather, it shows you how to apply timetested investing principles and techniques so that despite the inevitable ups and downs of the markets, you can realistically achieve your family’s financial goals.
The information presented here is also valuable whether you intend to manage your investments yourself or work closely with a financial planner or other investment professional.
1. Understand the difference between saving and investing.
Saving is for smaller, near-term goals, such as the next family vacation, a car or a financial emergency. Keep cash in a savings account, money market or short-term certificate of deposit where you would have little or no risk of losing principal and can have immediate access to your funds. Investing is for larger, longer-term goals-at least five years away-such as retirement or college. Investing carries risk such as loss of principal or not earning as much as anticipated. But wise investing also provides a greater opportunity for earning a significantly higher rate of return over the long run than you can earn through savings.
2. Put the rest of your financial house in order first.
Before investing, consider tackling several other household financial issues. Create a budget, or spending plan, in order to free up money for regular investing. Pay off expensive credit cards or other high-interest consumer debt that eat up valuable investment dollars. Build a cash emergency fund and buy the right kinds and amount of insurance to protect against a financial setback - otherwise, you may be forced to raid your investment accounts for cash at a time when the market is down or with costly tax consequences.
3. Clarify your goals.
Smart investing means investing with a specific purpose - those life goals such as retirement or passing money on to heirs. Investing with purpose makes it easier to stick to your investment plan and to invest income you might otherwise spend. Goals should be realistic, with a specific amount to accumulate by a reasonable target date. "Retirement" isn’t a goal. What kind of retirement you want and when you want to retire are. Write down your goals and discuss them with your family.
4. Don’t just grab for the highest return.
One of the most misunderstood aspects of investing is the belief that investing is all about seeking the highest possible returns. This misperception is why so many investors got into trouble during the booming stock market of the late 1990s when they disdained "average" returns and began chasing the riskiest of stocks. Their purpose was simply to "make as much money as possible in the shortest time." This example illustrates why investment goals are important. With reasonable, specific goals, you can make informed, realistic investment decisions designed to accomplish your financial goals without taking unnecessary risk. Making decisions based on these investment goals is what steers you on an even course between the rocky shores of greed and fear.
5. Understand your own tolerance for risk.
In addition to understanding the risks of each type of asset and investment vehicle, you need to understand how much risk you’re willing to take and which types of risk worry you the most. Risk tolerance is partly a function of your investment goals, how much time you have to invest, other financial resources you have and, frankly, your "fear factor." Investments that keep you awake at night, regardless of how "good" they might be for your needs, are not the right investments for you. Accurately gauging your tolerance for risk can be tricky, however. It’s easy to feel confident when the market is up and conservative when it is down. A CFP® professional can help you assess where you truly stand. Questions you and your planner might ask include:
· Are you more concerned about losing principal or losing purchasing power?
· How much principal are you willing to lose?
· How worried were you about your investments during the recent market decline?
· Which of your current investments keep you awake at night?
· Do you track your investments daily (a possible indication of unease)?
· How diversified is your portfolio?
6. Educate yourself about investments and investing.
Even if you work with a financial planner or other investment advisers, you need to have a solid understanding of how different types of investments work, their potential returns, their risks and how you can assemble them in a cohesive portfolio that’s right for your needs and goals. Pay particular attention to investment risk. All investments carry some degree of risk. While stocks in general tend to perform well over long periods of time, for example, their short-term risk can be high, as many investors painfully learned during the market decline of 2000-2002. Risk is not limited to stocks, either. You can lose money in real estate, corporate bonds, gold and commodities. This is why it is important to note that diversification among
different asset classes may help reduce risk. Even so-called "safe" investments carry some risk. U.S. Treasury bonds, for example, are federally guaranteed against loss of principal as long as you hold them until they mature. Because they are subject to interest-rate risks like any other type of bond, however, it’s possible to lose money if you sell them before maturity. Don’t understand interest-rate risk? If you don’t understand how a particular investment works, or the risks that come with it, ask for help before you invest. Invest a little in education first. Ask your financial planner or investment professional for resources to help you make the best decisions.
7. Hold realistic market expectations.
One of the downfalls for many investors during the booming market of the late 1990s was their belief that high double-digit returns were normal for stocks. But historical investment returns reveal otherwise. According to Ibbotson Associates, large-company stocks, such as those found on the Dow and the S&P 500, returned an annual average of 10.4 percent from 1926 through 2001. During the same period, small-company stocks returned 12.7 percent and long-term government bonds averaged 5.4 percent. But these are only averages over many years. In any given year, you will probably not earn the annual "average" return. You’ll earn either more or less than the average. Knowing the historical average returns can keep these fluctuations in perspective.
8. Follow a detailed written plan.
Formally, this is called an investment policy statement. It’s a road map to keep you on course through good times and bad, to eliminate investment ideas that don’t fit your circumstances, and to provide a way to monitor the actual performance of your investments. This plan is, of course, subject to changes over the course of your investing lifetime.The plan outlines such things as:
· Investment goals and time horizons
· Minimum average annual return needed to achieve those goals
· Current income needs from the portfolio, if any
· Types of investments you will and won’t include
· What investment vehicles you’ll use, such as individual securities, mutual funds, separately managed accounts, or taxable and tax-favored accounts
· How assets are to be allocated within the total portfolio
· Rebalancing procedures
· Potential tax consequences
· Estimated risk level of the portfolio
· Updating income needs due to inflation and medical costs
9. Allocate investments according to goals and needs.
How will you divvy up your investment dollars among various asset categories such as large-company and smallcompany stocks, international equities, government and corporate bonds, cash, real estate, and other assets? The answer depends on several factors. Key among them are your investment goals and your timeline for achieving them. The sooner you’ll need the funds, usually the more conservative your investments should be. Also, what other financial resources are available to you? If Social Security and a good pension will generate most of your income needs in retirement, you may feel comfortable with a more aggressive approach to your investment portfolio. You may opt for a more conservative approach, however, if your investment portfolio will be a primary source of retirement income.
10. Diversify your investments.
Too often, individual portfolios invest heavily in a single type of asset, often to the near exclusion of other types. A popular choice in recent years has been large-company U.S. stocks, also called "large-caps." These stocks outperformed other major asset categories in 1989 and from1995 to 1998. Yet, in all other years between 1965 and 2004, large-caps were outperformed by small company stocks, international stocks, intermediate bonds or investment real estate.
Because it’s almost impossible to identify in advance which asset classes will lead the way during any given time, it’s wisest to spread dollars among several investment classes. Research has shown that this diversification reduces risk while at the same time maintaining or even improving portfolio performance. Investors also may want to diversify within broad categories. Among stocks, for example, they might divide their money between value and growth stocks, or between large-cap and small-cap. They may also want to include a variety of industries or sectors like technology, consumer goods and health care.
11. Don’t overload on company stock.
As many employees at Enron and other large bankrupt companies learned the hard way, loading up your 401(k) with your employer’s stock can be disastrous. Both your job and your retirement security are riding on the fortunes of a single employer and a single industry.
Financial planners typically recommend limiting company stock to no more than 10 or 20 percent of the account’s value. But this can be difficult to do if the employer will only match your plan contributions with company stock while restricting how soon you might sell the stock and diversify through other investment options offered. Consequently, you may need to try to diversify your overall portfolio through other types of assets you hold outside your 401(k) plan.
12. Don’t chase ‘hot’ performance.
Today’s hot investments are often tomorrow’s cold turkeys. The most recent glaring example of this was tech stocks, represented by the Nasdaq stock index. The Nasdaq returned a record-smashing 85.6 percent in 1999, but fell nearly 40 percent the following year, and lost another 21 percent the next year. The major problem with chasing the current hottest investments is that by the time most investors discover that an asset category or specific investment is "hot," the investment often has already realized much or most of its run-up in value. Consequently, investors often get in at about the time the investment is ready to fall. Calculations by DALBAR, a consulting firm, show that stock investors who frequently trade in and out of mutual funds earned a meager 3.51 percent annually between 1984 and 2003-dramatically below the 12.98 percent annual average earned by the S&P 500 stock index over the same period.
For the remaining 8 keys contact me via href="mailto:tejumadeh@yahoo.com">tejumadeh@yahoo.com or http://www.clubfreedom.biz/tejumadeh
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