So, in today's volatile market, investors may need to return to a few basic principles of money management. Personal Finance Adviser Ray Martin shares some advice on The Saturday Early Show.
How you invest and where you invest is paramount to finding financial success.
Simple rules for investors:
- Investing is not a game. If you want to invest, learn the business. Don't treat it as a game.
- Readjust your expectations. It's an unrealistic dream to think you will double your money every five minutes. If you are lucky, an annual return is 10 percent.
- Don't chase hot investments. Don't rely on average returns. Don't chase the hot ticket. Look at the details and understand the risks you are taking.
- Diversify your portfolio. While stocks have a history of generating the best returns over the long term, there is nothing wrong with buying money market funds, CDs, and Treasuries. True, you may not catch many big fish with this approach, but at least you won't perpetually be moaning about the one that got away.
Martin says he can make the case for almost any investor to allocate a portion of their money in each of these asset classes. The percentages chosen in each is called an asset allocation strategy and every investor should have one before they make a single investment move with new money or old.
The trick is to get the allocation in each asset class aligned with your needs now, over the next five years and over the long term. Even trickier is to get this allocation aligned with how you would react in a worst-case environment for investments.
There is also the need to diversify within each asset class. Asset categories are subsets within an asset class, and investors who thought that they were following the rules by owning some bonds with their stocks are apt to be left disillusioned about the benefits of diversification.
Martin says he has a particular distaste for "rules of thumb" that attempt to apply investment wisdom to all investors; these lack the ability to combine individual needs, risk tolerance and investment purpose. Investors should diversify their investments among asset classes and among asset categories.
How to choose where to allocate your money? Each investor must onsider two things: Their financial time frame (how tied up their money can be and for how long) and personal risk tolerance (how emotional they are about investing their money).
Money that is likely to be spent in less than five years should be invested primarily in cash.
If you are a junior in high school itching to score big, do not scratch that itch by investing your college tuition money in stocks.
If you are in the midst of your earnings career you should have some cash available for unforeseen events.
If you are near or in retirement, make sure to include at least two to three years of cash needs in your portfolio and revisit the opportunity to trim from other investments to keep this cash allocation on a regular basis every year.
Cash categories generally include bank deposit accounts, certificates of deposit, treasury bills and money market funds. The most practical of these categories to use are money market funds.
Two years ago, talking about bonds was a sure way to get folks to tune out. With bonds holding up well and actually providing solid returns during the stock market plunge, the case for holding bonds has more supporting evidence than ever.
Martin says he knew the word was getting around when more people started asking him for bond fund recommendations, and clients are now eager to build up the bond portion of their portfolio. That tuition money that's due in five years could be allocated in a bond mutual fund. Bonds also provide the income (from bond interest payments) for individuals who rely on portfolio earnings to meet their living expenses.
Bond categories include short-term (mature in five years or less), intermediate-term (mature in five to 12 years) and long-term bonds. They also include government, municipal and corporate bonds. You can also combine each category, e.g. short-term government and intermediate-term municipal bonds. A single, diversified bond fund will suit the needs of many individual investors. Those with more money to invest and with specific needs should look towards individual bonds. At the current level of interest rates, investors should stick with short and intermediate-term bond categories.
We all know the case for "stocks for the long run". The percentage to allocate towards stocks has as much to do with an individual's ability to hold onto his investments as it does with long-term investment periods.
Stocks are not for every investor with a long time to invest. But every investor who can stick with a well-thought-out investment plan should consider allocating a portion of his or her long-term money in this asset class.
Investors who followed this rule but did not diversify among stock categories got badly burned. Simply identifying the portion of a portfolio to invest in stocks is only part of the work. It's equally important to spread the stock portion among stocks of large, small and internatonal companies and among different industries (financial, technology, heath care, etc.).
Diversification in stocks also means that you'll need to include several categories of large company stocks: including various industries and manager styles. The same holds true for small and international stocks. Including only stocks of large technology companies falls woefully short of completing this important step. And we all know how that turned out.
Investors must first decide on these allocations before they make any specific investment choices.
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