Investment Corner – Part 1
These articles are written as a series because the topic is fairly large and investment information seems to abound everywhere these days.
As what I like to call a “seasoned” investor, I thought it would be fun to share some of what I
have picked up over the years. By the way – “seasoned” shows up at www.Dictionary.com as
“competent through trial and experience, or to accustom or to harden”. The old saying in the
investment world is everyone gets “a large dollar amount education” in the stock markets. Let’s
just say then I have an advanced degree …
Investing is considered to be a science, so don’t be fooled by anyone telling you it’s an art.
Perhaps at the pinnacle of investing knowledge it may be an art form, but for the most part it’s a
science. As our first foray, let’s consider what knowledge you should have and where to obtain it.
The knowledge you will need is quite fundamental and not too complicated. The first half of the
knowledge comes from you, while the second half comes from the investment community.
About YOU
The primary things you should know about yourself before making an investment are:
What is my investment objective?
What is my risk tolerance?
These are important questions you need to answer for yourself. All investment comes with some
degree of risk. Without knowing your objectives, it is hard to assess your risk tolerance.
I. Investment Objective: Your investment objective should be a tangible result, with a specific date.
The two primary examples of investment objectives are:
Saving for a child’s college education, with the date of college entrance
Saving for retirement, with your planned retirement date
The first is a huge change in expenses, while the second involves a large change in income. Both
will have a large change in your cash flow so planning ahead can mitigate these two events and
make them less stressful and less burdensome on your monthly cash management. The planning
portion for either of these involves saving money in advance and then placing those savings in the
right investment vehicle for your goals.
“We all work hard for our money, we should make certain what we saved works just as hard for
us!” – Often attributed to AL Williams.
II. Risk tolerance: Risk and Reward tend to go hand in hand. Only you can answer how much
risk you are willing to take. Even fixed return investments like bonds or savings accounts have
some risk.
On your risk tolerance – ask yourself some challenging questions:
How much risk would I tolerate to get a 24% average return on investment?
Would I be willing to:
Risk losing all of it,
Risk losing half of it,
Risk losing 10% of it.
Or even give my savings to a new start-up business?
Now ask the same question for a 10% return on investment, and for a 5% return on investment.
At each point stop and consider the implications – your money doubles roughly every 7 years at
10%. And it doubles nearly every 3 years at 24%. While at 5%, it doubles every 15 years. In
general, if you have time on your side then you can live with more risk and potentially higher
returns. See Table 1. If you are less than 5 years from your goal, you may need safer, less
volatile and lower return investment choices.
Table 1
Value of a $1000 savings account with $100/month added at annual returns of:
Year 3% 6% 9% 12% 15% 18%
0 $1,000 $1,000 $1,000 $1,000 $1,000 $1,000
1 $2,230 $2,260 $2,290 $2,320 $2,350 $2,380
2 $3,497 $3,596 $3,696 $3,798 $3,903 $4,008
3 $4,802 $5,011 $5,229 $5,454 $5,688 $5,930
4 $6,146 $6,512 $6,899 $7,309 $7,741 $8,197
5 $7,530 $8,103 $8,720 $9,386 $10,102 $10,873
6 $8,956 $9,789 $10,705 $11,712 $12,818 $14,030
7 $10,425 $11,576 $12,869 $14,317 $15,940 $17,755
8 $11,938 $13,471 $15,227 $17,236 $19,531 $22,151
9 $13,496 $15,479 $17,797 $20,504 $23,661 $27,338
10 $15,101 $17,608 $20,599 $24,164 $28,410 $33,459
11 $16,754 $19,864 $23,653 $28,264 $33,872 $40,682
12 $18,456 $22,256 $26,982 $32,856 $40,152 $49,205
13 $20,210 $24,791 $30,610 $37,998 $47,375 $59,262
14 $22,016 $27,479 $34,565 $43,758 $55,681 $71,129
15 $23,877 $30,328 $38,876 $50,209 $65,234 $85,132
About Investing:
“No risk – no return, there is no such thing as a sure-thing investment!”
We all have the same desire, get the largest return on investment with the least amount of risk.
Unfortunately, you cannot have one without the other. Stocks can offer very high returns, but
there are no guarantees, and you can lose money quickly should a company have any impropriety
or go bankrupt. Bonds offer fixed return rates, which are typically lower, but with less risk. If
inflation should suddenly increase, a fixed return may actually lose value! Mutual funds seek to diversify investments across several stocks or bonds or sometimes a combination.
Balancing Risk and Returns:
The most common way of balancing risks and returns are by making investment choices and the
diversity of those choices. Investment choices are what fixed assets or stocks or bonds or mutual
funds you buy. Investment choices have the largest impacts on your return. Diversity choices
are how many different items of each investment type you buy to lower risk, but which in turn
also lower returns.
Investment choices fall into two broad categories, I call them ownership and “loanership”. Ownership means owning a fixed asset, like a diamond, or a piece of a publicly traded company through some stock purchase vehicle, either directly or indirectly through a mutual fund. “Loanership” means owning a piece of a loan through a bond purchase or bond fund. While a stock’s value rises and falls as the value of the company rises or falls, a bond’s value is less volatile. Bonds are generally funding a loan to an institution, so they are typically fixed rates of return, but their value also changes a small amount as interest rates change.
Most financial planners will in general advise you to increase the bonds in your portfolio as you
get closer to your goal and can tolerate less uncertainty in the return rate. Typically this is within 5 years of your savings objective. And conversely, to increase the amount of stocks or stock purchase vehicles if you are very far away, say 10 or more years away from your goal.
Having a savings objective with a fixed date can be very motivational. As long as you are
realistic, it can even be fun to set down a plan and stick to it. If you are having trouble getting
started – write a few financial objectives down and talk them over with your spouse or a close
friend. Most of all, don’t worry about these things, just do something about them!
Self-Study:
Some great resources to begin your journey are located on the web.
Try visiting these sites:
http://www.nasd.com/Investor/Education/Teachers/basics_unit1_less1.asp
http://www.aaii.com/invbas/index.shtml
Or read these well known authors and books:
Suze Orman: The Road to Wealth, The 9 steps to Financial Freedom.
Jane Bryant Quinn – Everyone’s Money Book
Next time – Stocks and bonds vs. Mutual Funds…
Additional info may be found at:
http://www.sbtionline.com