KEYS TO BEING A SMARTER INVESTOR - -PART 2
6. EDUCATE YOURSELF ABOUT INVESTMENTS AND INVESTING
Even if you work with a financial planner or other
investment professionals, 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 2006. 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 and should be reviewed periodically.
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
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 small company
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 time line 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
from 1995 to 1998. Yet, in all other years between 1965
and 2006, 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.
6. EDUCATE YOURSELF ABOUT INVESTMENTS AND INVESTING
Even if you work with a financial planner or other
investment professionals, 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 2006. 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 and should be reviewed periodically.
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
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 small company
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 time line 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
from 1995 to 1998. Yet, in all other years between 1965
and 2006, 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.