Three Questions for Investors
1. Why do we need to Invest?
The “One Goal” everyone has is to achieve financial security – to save for a “rainy day” fund, to pay for kid’s college, secure retirement, down payment on a home, and to have enough money to live the lifestyle we desire.
The two biggest obstacles to achieving financial security throughout our lifetimes are inflation and taxes. (Others are self-inflicted – procrastination and spending habits)
2. What types of investments (securities) are available?
Two main categories:
a) Those that don’t generate returns above inflation: anything with fixed income (bonds, CDs, savings accounts, life insurance policies,etc).
b) Those that do*: stocks, real estate
*Precious metals, oil & gas provide inflation protection but generally with higher risks.
3. How do I effectively implement an investment plan?
Before implementing a plan, here’s a primer for beginning investors:
Understanding Diversification
No one has the ability to predict the future.
Past Performance is never a guarantee of future performance.
The best performing investments rarely are the same from year-to-year. Some years it’s government bonds, other years it’s emerging market stocks.
Buying just one stock or one market sector is a “hit or miss” strategy— win big or lose big. So we diversify across a variety of asset classes and market sectors to “be approximately right rather than precisely wrong.”
Understanding Risk
Stocks fluctuate. Small cap stocks fluctuate more than Large cap. International/emerging market stocks fluctuate more than US stocks.
Bonds fluctuate, but not as much as stocks.
CDs, savings accounts, checking accounts, life insurance cash values do not fluctuate.
Gold fluctuates a lot. In fact it fluctuates more than stocks.
“Standard deviation” is a measure of risk or fluctuation in an investment:
Over long periods of time Gold does not provide a higher return than stocks. Bloomberg’s gold index has a standard deviation of 19.6 since 1970, compared with a 15.4 standard deviation of the Standard & Poor’s 500. Between 1970 and 2006, the gold index earned 7.5% annually and the S&P 500 earned 11.3%.
Implementing an investment plan
“Buy Low/Sell High” (or Sell High then Buy Low) through Diversification and Rebalancing.
Picture a Pie Chart – all pieces of the pie (stocks, bonds, real estate, etc.) add up to 100%
Determine the appropriate mix of investments based on your personal financial situation, return requirements, risk tolerance, liquidity and income needs, time horizon, and goals. Each investment in the portfolio has its own set of “risk and return” characteristics such that each investment fluctuates more or less than the others.
Reasons to rebalance the portfolio:
New deposits
Withdrawals
Market Volatility causes the asset allocation to drift from its target.
Major changes in emotional risk tolerance, changes in marital status, children, change in income or expenses
Investing for Income in Retirement
Systematic Withdrawal Plan – schedule a monthly withdrawal from your account. “Dribble” the money out at a rate of 4-5% per year (widely accepted as a “safe withdrawal rate.”) Allow the portfolio to fluctuate. Rebalance as needed. Maintain appropriate cash levels. Allow dividends and interest payments to build up into cash.
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