Here Are Three Simple Secrets to Investment Success

Jane M. Young, CFP, EA

Build a Portfolio to Support Your Investment Timeframe

Investment timeframe is a major consideration in developing an investment portfolio.  Start with an emergency fund covering about four months of expenses in a cash account with immediate access.  Next, put aside money that is needed over the next few years into fixed income vehicles such as CDs, bonds or bond funds.  Invest long term money into a combination of “stock based” mutual funds and fixed income investments based on your tolerance for investment risk and volatility.  Historically, stock has significantly out-performed fixed income investments but can be volatile during shorter timeframes.  Stock is a long term investment; avoid putting money needed within the next five years in the stock market.

Diversify, Diversify, Diversify

Once your emergency fund is established and funds have been put away for short term needs, it’s time to create a well-diversified investment portfolio.   We cannot predict the next hot asset class but we can create a portfolio that will capitalize on asset categories that are doing well and buffer you from holding too much in asset categories that are lagging.  Think of the pistons in a car, as the value of one asset is increasing the other may be falling.  Ideally, the goal of a well-diversified portfolio is to have assets that move in opposite directions, to reduce volatility, while following a long term upward trend.  It is advisable to diversify based on the type of asset, investment objective, company size, location and tax considerations.

Avoid Emotional Decisions and Market Timing

The best laid plans are worthless if we succumb to our emotions and overreact to short term economic news.  Forecasting the short-term movement of the stock market and trying to time the market is fruitless.   We can’t control or predict how the stock market will perform but we can establish a defensive position to deal with a variety of outcomes.  This is accomplished by maintaining a well-diversified portfolio that supports our goals and investment time horizon. 

The stock market can trigger our emotions of fear and greed.  When things are going well and stock prices are high we become exuberant and want a piece of the action.   When things are bad and stock prices are low we become discouraged and want to get out before we lose it all.  The stock market is counterintuitive, generally the best time to buy is when the market is low and we feel disillusioned and the best time to sell is when the market is riding high and we feel optimistic.  We need to fight the natural inclination to make financial decisions based on emotions.   Don’t let short term changes in current events drive your long term investment decisions.

No one knows what the future holds so focus on what you can control.  Three steps toward this goal are to create a portfolio that meets your investment time horizon, create and maintain a diversified portfolio and avoid emotional decisions and market timing.

 

 

10 Investment Principles that Never Go Out of Style

Jane M. Young CFP, EA

Frequently people talk about how everything is different and we should change the way we invest. Yes, we have just experienced a very difficult year with some major changes in our economic situation. However, every time we go through a major market adjustment if feels like “this time is different”. We could take numerous comments made at the end of the last bear market and insert them into today’s headlines without missing a beat. I call this the “recency effect”; bad times always feel more desperate while we are experiencing them. We need to step back and look at the big picture; don’t throw the baby out with the bathwater. Good, sound investment fundamentals are still valid. Some people may reassess their tolerance for risk, start saving more money or cut back on their discretionary spending – but the following investment principals are good, time tested guidelines that everyone should follow in any market.

1. Don’t time the market – The stock market is counter-intuitive. Generally, it may be better to invest when things seem most dire and sell when everything is rosy. It is impossible to predict the movement of the stock market and history shows that those who do frequently miss out on big upswings.

2. Dollar Cost Average – This enables you to invest a set dollar amount every month or every quarter regardless of what the market does. As a result you buy more shares when the price is low and fewer when the market is high. Dollar cost averaging helps you mitigate risk because we don’t know what the stock market is going to do tomorrow.

3. Maintain at least 3 to 6 months of expenses in an emergency fund – This is especially important in difficult financial times when stock market values are low and unemployment is high. Unless you have a very secure job I currently recommend a 6 month emergency fund.

4. Don’t invest in anything you don’t understand – If you just can’t get your head around something after it’s been explained or you have done a reasonable amount of research don’t invest in it. If an investment opportunity is overly complicated something may be rotten in Denmark.

5. Don’t Chase Hot Asset Classes – Today international funds may be skyrocketing and tomorrow it may be small cap domestic stock funds. Don’t forget what happened to the stock market after the dot.com bubble burst.

6. Diversify, Diversify, Diversify – Everyone needs to diversify with a mix of fixed income and equity investments that is consistent with their own unique investment goals and objectives. Although most stocks dropped in unison over the last year, I still think there is value in diversifying between different types of stock mutual funds. I believe we will see some categories of stocks outpace others as the market rebounds. Depending on your risk tolerance, a small allocation in commodities and real estate may be advisable.

7. Don’t Make Emotional Decisions – Many investment decisions are triggered by fear and greed and they are equally damaging. Don’t make rash decisions based on emotion. Remember the stock market is counter-intuitive.

8. Don’t put more than 5% of your assets in one security – Any given company can go bankrupt as we have seen with many financial and automobile firms over the last year. I encourage the use of mutual funds over individual stocks to help mitigate this type of risk. If you do invest in individual stocks don’t put too much faith in any one company. If you are investing in your own company and you have a strong understanding of the firm’s performance you could go up to 10%.

9. Be tax smart – Take advantage of tax advantaged retirement plans such as Roth IRAs and 401k plans. Consider tax consequences when re-balancing your portfolio. Use a bear market to harvest some tax losses and off-load some bad or inappropriate investments.

10. Be aware of fees and surrender charges – When selecting investments be aware of high fees and commissions. Tread cautiously with anything that contains a contingent deferred sales charge. Many clients have come to me with a desire to sell or transfer previously purchased investments, usually annuities, only to find they have a 5-10% surrender charge if they sell within ten years of purchase. A surrender charge can have a big impact on your flexibility. If you really want a variable annuity buy one with low fees and no surrender charges.