Managing Your Investments
The investment landscape is littered with losses incurred by those who have invested their hard earned savings in instruments of risk based on little more than the simple hope that their money would multiply over time. Becoming a wise money manager requires that you take responsibility for your investments. It starts by beginning a personal program of self-study and incorporating an on-going awareness of how the economy and world situations can affect your investments (see Basics of Investing)
As you grow in your understanding of investing, no longer will it be necessary for you to turn to an investment professional and blindly transfer control of your financial future. However, as you gain independence in your ability to manage or direct your investments, the assistance of a good investment professional can be invaluable. A good investment professional should be more than willing to assist you in your journey to understand investing. Always remember that the investment professional works for you. If he or she is unwilling to take the time necessary to help you, you might want to consider hiring a new investment advisor. Make it your goal to always be able to explain to someone else the reason and logic behind your investment choices. You are ultimately responsible for your investments. There is no reason to be intimidated by the world of investing or those who make it a habit of using complicated financial jargon as a means of confusing you.
The first step in the investment process is to develop a plan. The key questions that you will need to address are:
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Is your financial foundation in place (see SAVING section)?
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How long will you be able to commit your savings to the investment?
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What are your investment goals and tolerance for risk?
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What is your current knowledge level and do you need the help of a professional?
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What are you doing now to grow in your knowledge of investing?
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If married, is your spouse in agreement with the plan and willing to learn?
Taking responsibility for your investments first requires that you understand that with ALL investments there will be RISK. The greater risk you are willing to take, the greater the potential is for gain. John Paul Jones once said, "He who will not risk cannot win."
Risk management is a key principle that you must consider when you begin investing. Different types of investments have various levels of risk and each person has a different tolerance for risk. As you develop your investment plan, you will need to decide on the level of risk you are willing to take. This is done with an understanding of the risk associated with the specific investments you are considering along with the overall environment that your prospective investments are associated.
For example, if you are considering investing in the stock market, you will need to evaluate the specific investment opportunities and how each will react to changes in the overall movement of the stock markets. Also, an understanding of the relative position of the overall stock market and the time period you are planning to commit to the investment will play an important part in the type(s) of investment you choose and how and at what rate you transfer your savings into the investment.
The main goal of the investment industry is to sell you a product (stock, mutual fund, etc.) and then manage that investment for you. They earn their money on the sale of the product and from the fees they charge you to manage that product. They will make more money if the investment goes up because they are usually paid a percentage of the gains in the account. If the account goes down, they will still make money, just not as much. So the bottom line is that they do not want you to be a seller of your funds regardless of the market conditions. This is why investment analyst have continued to remain bullish even when the markets are in obvious downtrends for extended periods of time. They will tell you that you are better off to "buy-and-hold".
William Fleckensteiin, writer for TheStreet.com has some interesting comments regarding the statistics about return rates.
"Let
me just state here that the main focus of my column has always been to try
to help people avoid losing money, as I have felt that the market was
headed lower. People sometimes underappreciate the value of not losing
money. Along those lines, I'd like to share a couple of recent statistics
from Jim Stack, in his ever-insightful monthly letter, found at
www.investech.com. It turns out that, measuring from 1928 to 2002, if you
started with $10 and you followed the famous buy-and-hold strategy, that
$10 would become $10,957. If you missed the 30 best months, your $10 would
only be $154. However, if you missed the 30 worst months, your $10 would
be $1,317,803. One can see from these numbers that missing the worst
periods is very important to long-run compounding."
"Interestingly
enough, if you missed the 30 best months and the 30 worst months, your $10
would still be worth $18,558, which is 80% higher than the buy-and-hold
strategy. This all comes about because stock prices tend to go down faster
than they tend to go up, and tend to do so in compressed periods. Wall
Street and most people tend to overlook the value of not losing money,
which is why this has been such a keen focus of mine. Someday, when values
return, and when the risk/reward equation is skewed to the long side, I
hope to be able to turn my attention more to making money, rather than the
avoidance of the loss of it."
Due to the time constraints of most people, the investment plan needs to be simple yet effective. An effective investment plan should not require daily attention. The best investment vehicles for the average investor are stock and bond mutual funds. The world's first mutual fund was introduced in Boston more than 75 years ago. Since then, mutual funds have evolved into a major industry, managing almost $7 trillion of Americans' financial assets. Among U.S. households, about half currently own shares of mutual funds, according to the Investment Company Institute, 2000.
A further way to simplify the process of choosing an investment vehicle while reducing the cost of management fees is with an index mutual fund. Traditional mutual funds typically contain hundreds of individual stocks that fit the objectives of the particular mutual fund. Mutual fund managers actively manage these funds by adding or deleting stocks that they feel do not meet the performance they are looking for. Index mutual funds seek to mirror one of a variety of stock and bond indexes or averages, such as the Dow Jones industrial average, Standard & Poor's 500-stock index or there are index funds that invest in the entire stock market by mirroring the Wilshire 5000. The Wilshire 5000 has more than 6,500 stocks and mimics the performance of virtually the entire U.S. stock market. This is the index the Federal Reserve Board uses to measure the ebbs and flows of the market. Index bond funds are also available that represent the entire bond market by mirroring the Lehman Brothers Aggregate Bond index. There are also foreign-stock index funds that are designed to represent a mix of the world stock markets (excluding the U.S.) found in Europe, Australia, Asia, the Far East and emerging-markets in small countries throughout the world. Rather than attempt to beat the market, these funds aim to match the performance of their index.
What's surprising is that the average index fund actually does better than the average actively managed fund, whose managers labor furiously to try to beat the market. According to the New York Institute of Finance Guide to Mutual Funds 1999, index mutual funds have outperformed actively managed funds about 70% of the time. Over the past five and ten years, the S&P 500 has beaten 62% and 78% of actively managed diversified U.S. stock funds, respectively.
Index mutual funds charge ultra-low expenses compared to actively managed stock mutual funds. They are able to do this because they don't require high-paid help. No analysts are needed to scour the country, searching for promising companies. There's no high-priced investment research to buy. Nor does the manager have to be gifted at selecting stocks. An index-fund manager relies largely on a computer to figure out how to invest money in all of the stocks in a given index, in the proper weightings. While the average actively managed stock fund charges investors 1.48% of assets annually, you can invest in S&P index funds for less than 0.2% annually. This can make a large difference in the growth of your investments over 20 to 30 years.
Depending on your age, investment objectives and the relative condition of the overall stock market and economy, you might decide to divide your investments into different index mutual funds. For example, you could allocate a percentage of your total investments in a stock index fund and the balance in a bond index fund since they tend to move in opposite directions. When the stock market goes up, the bond market typically goes down. In general, the moves in the stock market funds will be greater than the moves in the bond funds. Allocating a percentage of your investments in a bond fund will off-set declines in the stock market while not creating too much of a drag on your investments during periods that the stock markets advance. You might also want to gain some exposure to markets throughout the world by putting a small percentage of your total account in a foreign-stock index fund. By reviewing the performance of the funds you are considering you can decide on the allocation that would match your risk tolerance.
While it is important to remember that past performance is not indicative of future results, index funds have proven to be successful and economical.
There are many investment firms that offer well-run, low-cost index funds. The first indexed mutual fund was offered to individual investors in 1976 by Vanguard (www.vanguard.com or 1-800-635-1511). It was called "First Index Investment Trust", later named "Vanguard 500 Index Fund" which mirrors the S&P 500. By 2000, the Vanguard 500 Index Fund had grown to become the world's largest mutual fund.
The process of opening an account with the company you select is very simple. You can actually download all of the forms you need from the companies website. The contact telephone numbers are also available on their websites. Once the account is open and funded, you can set-up the allocation into the funds of your choosing either on-line or over the phone. The performance of your account can be monitored as often as you like from the companies website.
An example of four of the index funds offered by Vanguard and the indexes they mirror are:
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Vanguard Total Stock Market Index - Wilshire 5000
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Vanguard 500 Index Fund - S&P 500 Index
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Vanguard Total Bond Market Index - Lehman Brothers Aggregate Bond Index
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Vanguard Total International Stock Index - 90% Morgan Stanley Europe, Australasia, Far East index; 10% Morgan Stanley emerging-markets index.
Below is a simple, hypothetical lifetime retirement investment strategy using three of the four index funds shown above.
Example Plan A (for someone with more than 5 years until retirement):
Vanguard Total Stock Market Index = 75%
Vanguard Total International Stock Index = 25%
Example Plan B (for someone within 5 years of retirement):
Vanguard Total Stock Market Index = 55%
Vanguard Total Bond Market Index = 30%
Vanguard Total International Stock Index = 15%
Example Plan C (for someone who is retired):
Vanguard Total Bond Market Index = 50%
Vanguard Total Stock Market Index = 40%
Vanguard Total International Stock Index = 10%
From the return rates shown above for Example Plan A and Example Plan B, the recent losses in the stock market (beginning in 2000) could have been prevented with a mix of index funds. Learning to understand the overall movement and relative position of the stock markets will allow you to allocate your investments more efficiently to capitalize on the changes over the years.
The example plans above are not recommendations but only used for educational purposes. Your personal requirements might differ depending on your personal risk tolerance and specific needs. For example, a person could allocate a portion to the bond fund in Plan A to reduce risk of a declining market or put a percentage into a money market account which would not be exposed to any risk at all (Vanguard Prime Money Market Fund).
The return rates listed in the examples are based on the past performance and can not be guaranteed in the future. These example plans are used to show how one might adjust the allocations to increase diversification and/or reduce risk.
Qualified Plans and Company Matching
As outlined in the SAVING section, you don't want to start your long-term saving program until you first have your financial foundation in place. Investing is step 5, in the 5-step plan. When you are ready to start investing, you want to maximize your efforts by taking advantage of all government (IRS) plans and any company plans that might be available to you. Government qualified plans include things such as IRAs (both traditional and Roth). Company plans would included the 400 series plans (401k, 403b, 457) and others.
Lets assume that you are 30 years old, married (wife doesn't work outside of the home), annual salary is $80,000 and your company has a 401k plan that is available to you where they match 100% of the investment you make in the plan, up to the first 3%.
To maximize your investments, you might consider directing the first part of your retirement savings to your company 401k plan, up to the 3% level to insure that you get the matching funds from your company. This investment will be tax deductible and grow tax deferred.
The second part of your investment dollars could then be used to fund a Roth IRA for yourself and another Roth IRA for you wife to the annual limit. The Roth IRA will be an after tax investment but it will grow tax free (learn more about IRAs in the LONGTERM section).
The third part of your investment dollars can then be used to fund your company 401k plan up to the limit allowed.
