Over the past several years, I’ve gradually moved my family portfolio and my corporate portfolio away from individual stocks and into Index Mutual Funds and Exchange Traded Funds (ETF’s). Although both portfolios have sported excellent recent double digit returns, not every holding was a winner. In the case of two stocks, I did not fare well.

First a bit of background, I have been investing for decades with excellent outcomes. Many years both the portfolios I manage have outperformed the S & P Index handily. I am not a frequent trader or market timer, but stick to a well thought out asset allocation in line with the goals of my family for our personal portfolio and the goals of the corporation for the professional portfolio.

As anyone in the investing field understands, no matter how many winners one holds in a portfolio, there are bound to be a few losers.

Over the years, I tired of the hours of research required to invest in individual stocks. On top of that, finance research convincingly supports the out-performance of index fund investing over that of stock picking. In fact, in a typical year, a majority of actively managed mutual funds do not beat the returns of their index fund benchmarks. And those managed funds that outperform one year, rarely repeat that performance year after year.

The takeaway is simple; it is quite difficult to beat the overall market consistently.

In spite of my resolve to transition to mutual funds and exchange traded funds (ETFs), I did not immediately sell all of our individual stocks.  I decided to get rid of them gradually, after analysis and determination that their growth prospects were fading.

In the case of Nokia (NOK) and Best Buy (BBY), I waited a bit too long to sell.

Best Buy and Nokia = Terrible Performance

Best Buy has been a remarkable growth story over the years with nationwide store expansion and offerings of any electronic one could want, either in the store or online. With the closure of Circuit City, I thought Best Buy would go through the roof and pick up all of their growth. Several years ago, when I purchased Best Buy, it’s future looked promising and its growth initiatives and store expansion foretold an expansive future for the company.

Nokia a former technology darling seemed like a sure fire holding. With a market share topping 40% in 2008, how could the company falter? Here’s how, with the advent of the smart phone, Apple and the android, Nokia’s market share fell to its current 29%, with no rebound in sight. At present, the fortunes of this company are going in the wrong direction and suffered a $1.2 billion loss its most recent quarter.

Take a look at the five year performance of Best Buy and Nokia;

As the Yahoo Finance chart so graphically illustrates, both stocks have plummeted during the past five years.

When investing in individual stocks there are some key factors to consider;

• Accept that individual stock prices are random in the short run. Some will rise, others fall, and some prices won’t move much in either direction.
• Before purchasing an individual stock it is crucial that you study its growth prospects, competitive landscape, valuation, and financial statements.
• This type of analysis should be ongoing during the time you hold the stock.
• Before purchasing a stock, it’s important to write down the reasons to buy the holding and what would cause you to sell.

Investing Caution

 Can’t Get Enough Investing Information? Check out these websites;

We have records of the performance of the stock market dating back to 1870. During that time we have experienced four stock crashes. The market tops came in: (1) 1900; (2) 1929; (3) 1965; and (4) 2000. Stock returns were poor for the 20 years immediately following each of the first three crashes and so far for the first 12 years immediately following the fourth crash.

Crashes obviously hurt all investors (and, indeed, even non-investors — the losses suffered in crashes cause economic crises which dramatically diminish economic growth for the entire society in which they occur). But they don’t hurt all investors to the same degree or in the same way.

This column looks at how crashes affect investors at four stages of the investing life cycle in different ways. The four stages are:

(1) Young Investors (age 25 to age 45)

(2) Investors Approaching Retirement Age (age 45 to age 65)

(3) Investors in the First Decade of Retirement (age 65 to age 75)

(4)Investors Beyond the First Decade of Retirement (age 75 forward).

 Young Investors (Age 25 to Age 45)

The dollar hit delivered to these investors is minimal. In fact, looking only at the dollar hit, it can be argued that stock crashes benefit this group.

An investor close to retirement age might have $1 million in his portfolio. A price drop of 65 percent would cost him $650,000. That’s a devastating hit. It’s far better to take the hit at a time when you only have $100,000 in your portfolio. The $65,000 loss might seem like a big deal to the person with only $100,000 of life savings. But crashes only occur once ever 35 years or so. So getting the crash out of the way when you are 35 means not needing to worry about the next one until you are 70. The investor who experiences a crash early in his investing lifetime will see huge gains uninterrupted by crashes in the years of greatest wealth accumulation (the late 40s, 50s and early 60s).

There’s another side to the story. Crashes cause economic crises. Younger workers are far more in need of job opportunities than older, better established workers. Experience a crash in your 20s or 30s and you may never see the career growth you need to see to be able to retire at a reasonable age. It’s good to experience your stock crash when you are young if you have a good job before the crash hits. If the crash hits before you are established in your career, it could be that the hit you experience from not being able to obtain a good job will be far larger than the hit you experience as a result of a drop in your portfolio value.

For young investors who have established themselves in good careers before a crash hits, the crash can actually be a big plus. Stock valuations always go to one-half of fair value before the bear market comes to an end. When stocks are priced at one-half fair value, the most likely annualized 10-year return is 15 percent real. Young investors experience small dollar losses in a crash and are then positioned to experience huge gains in the years when they are earning enough to invest heavily in the market.

Investors Approaching Retirement Age (Age 45 to 65)

Since crashes only come once ever 35 years or so, those experiencing crashes in the years leading up to retirement enjoy a good number of years of compounding returns before the crash takes place. This gives them the opportunity to accumulate large amounts of wealth.

The problem is that investors who accumulate large amounts of wealth without suffering a crash often come to believe that they are immune to the market laws that insure that we will see crashes ever 35 years or so. Investors who enjoy big gains for decades often ramp up their spending on the presumption that there will never again be a crash. This hurts them in three ways.

One, they become accustomed to a living standard far beyond what they will be able to afford after the effect of the upcoming crash is taken into consideration. Two, they lose the ability to see gains on their portfolios once the crash hits (remember, stocks provide poor returns for 20 years following a bull market top). And, three, these investors take their hit at the worst possible time for doing so, when their portfolio values are nearly large enough to finance a middle-class retirement.

Investors in the First Ten Years of Retirement (Age 65 to Age 75)

This is the worst time to experience a crash. The historical data shows that retirees that survive ten years without being wiped out in a crash almost always work until the investor’s death. But even portfolios that appeared on the day the retirement began to be plenty large enough to support a long retirement can fail if there is a big hit in the first ten years of the retirement.

The problem is the compounding returns phenomenon. Investors who count only direct dollar losses greatly underestimate the price they pay for living through a crash. Each dollar lost is a dollar that would have been generating compounding returns for many years to come had the crash not taken place.

Non-retired investors can mitigate this effect by making new contributions to their portfolios, contributions likely to earn big returns because the market always dishes out truly mouth-watering returns in the years following the end of a bear market. But retirees are not able to make new contributions. They suffer all the downside of a crash and none of the upside.

Investors Who Have Been Retired More Than Ten Years (Age 65 and Up)

These investors suffer the smallest hit. It’s scary to see a huge drop in your portfolio value at an age when you are not able to return to the workforce. But the financial reality is that, if your retirement was adequately funded at the outset and you went 10 years without seeing a major hit, you have experienced enough gains that your plan should work even if you live a long life.

The one big downside to a crash for investors who have been retired for more than ten years is that it reduces the amount that they will be able to leave to heirs and to charities.

Barb’s comments; I would be remiss without giving a remedy to the chilling impact of large scale stock market investment declines. Asset allocation, tailored to your age and risk tolerance will soften the blow of market drops. If you are in retirement, you should have a large portion of your investment dollars in cash and fixed assets, so that when the stock portion of your portfolio falls, the impact will be cushioned by the stable value of cash investments.

How have the recent stock market delines impacted your investing strategies?

image credit; astrycula

Many of my readers have specific personal finance questions. The extra information in the WEALTH TIPS NEWSLETTER (sign up on right) seems to spur even more questions. I love sharing my financial experience with others, so here is this weeks question.

John wrote in and asked for advice for himself and his daughter;

HISTORICAL RETURNS

I would like your opinion and advice on how I should allocate my investments and my daughter’s investments among mutual funds. Both our accounts are with Fidelity. I am 56 and plan to retire at 60. I have $400,000 in IRAs (Traditional and Roth). My daughter is 24 and has $65,000 in an individual acct and $50,000 in both Roth and rollover IRA. There are so many funds to choose from and I feel overwhelmed. Any suggestions would be helpful.

Caveat; This article will touch on the topics to consider when choosing mutual funds. Please do not take this as personal advice for your individual situation. There are many considerations when planning an investment portfolio. For any specific investing information, please contact your own investment advisor or CPA. Fidelity has advisors on staff that can help with investment questions as well. Personal disclosure-I have an account at Fidelity.

Too Much Information is Not Always Better

There is scientific evidence that it is more difficult to make a decision when confronted with a large number of choices, than when given just a few choices. I think this is particularly true when it comes to investing in mutual funds. Did you know there are more individual mutual funds than individual stocks? How is someone able to decide among the over abundance of offerings?

Determine Your Risk Level First

Before considering how many and what type of funds to choose, you must figure out how much volatility or risk you can stomach. Those who cannot sleep when their investment portfolio goes up and down, should have less invested in stock investments and more in fixed or bond type investments. Additonally, the more time available before you need access to your funds, the more agressively you can invest.

Stocks and stock mutual funds are quite volatile and over the short term (which can be up to five years) can go up or down in value. Over periods of more than ten or twenty years, their normal trajectory is upward.

Never put any money in stock type investments which you will need within the next five years.

Bonds are less volatile, yet long term historical data suggests that they offer lower levels of return than stocks. Contrary to the past few years.

In general, if you are close to retirement and cautious about risk you should have a more conservative portfolio with a larger percentage of your funds in bond type investments than stock type investments.

John’s 24 year old daughter has a long working life ahead of her, time to make up any investment losses and should think about investing a bit more agressively.

Which Mutual Funds to Choose?

Actually, this is a much easier question than you would think. You only need a few index funds to have an optimal portfolio. Since John’s accounts are at Fidelity, I’ve included some Exchange Traded Funds (ETFs) which can be bought commission free at Fidelity. Most of these funds and ETF’s are generic index funds with low expense ratios.

Most low cost, broad based index funds of the same type are comparable. Vanguard has the largest selection of low fee index funds.

Pick an index fund from each category:

Total U.S. Stock Market Index Fund

• Vanguard Total Stock Market Index Fund (VTSMX)-Fidelity charges a fee to buy this mutual fund
• Russell 3000 Index Fund (IWV)- Exchange Traded Fund with no commissions from Fidelity

Broad-based International Index Fund

• Fidelity Spartan International Index Fund (FSIIX)

Diversifed Bond Index Fund

• Vanguard Total Bond Market Index Fund (VBMFX)-Fidelity charges a fee to buy this mutual fund.
• Barkleys Aggregate Bond Fund (AGG)-Exchange Traded Fund with no commissions from Fidelity

The percentages invested in each fund depend on your risk tolerance and preferred asset allocation. To learn more please sign up for my Wealth Tips Newsletter and get a free e-copy of 20 Minute Guide to Investing (top right of this site). There are sections on determining your risk tolerance and asset allocation.

The most important factors in investment wealth building are to pick an asset allocation and stay invested through thick and thin. The chart of historical returns illustrates that long term asset performance is generally positive. If history is any guide and if you believe the USA and world economies will continue to prosper, your investments will increase in value over time.

For more commentary on Index Funds:

Save Money with Index Funds at Invest it Wisely

Index ETF’s vs Index Mutual Funds; Which are Better? at My Personal Finance Journey

Money Help for Christians provides a Beginner’s Guide to Index Funds, Mutual Funds, and ETFs.

Are Actively Managed Funds a Fools Game Compared to Index Funds? at Squirrelers.

Consumerism Commentary offers a sophisticated debate; John Bogle and Jeremy Siegel Debate Index Funds.

What are your preferred investments?

SIMPLE ASSET ALLOCATION

MBA Series #1

“Don’t put all of your eggs in one basket.”

The beginning of the year is portfolio rebalancing time for investors. I write a lot about investing as I believe it is an achievable path to long term wealth. If you don’t know what asset allocation is or much about investing at all, then this article is for you.

Modern Portfolio Theory is the science that drives most of the writing about investing today. As I put the finishing touches on the university class I’m teaching this winter in Investments, I’m going to share some of the basics with you; FOR FREE!

Tried and True Investing

Diversification in investing means don’t put all of your money in one investment or one type of investment.

Why?

When that investment goes down, there goes the value of your invested assets-down.

Buy different types of investments, so that when one goes down in price, the others may go up, or at least remain stable.

Diversification smooths out the ups and downs of the value of your investments.

For example, it is rare for bonds and stocks both to go down at the same time. During the past decades bonds have outperformed stocks, an historically unusual occurrence. Over long periods of time stocks have outperformed bonds, but a combination of both asset classes reduces your portfolio volatility.

There are all types of asset classes such as, international stocks, country specific stocks, small cap stocks, commodities, real estate, corporate bonds, government bonds, international bonds and many more. All of these types of assets can be bought as individual holdings, or combined in mutual funds and exchange traded funds (ETF). But, you don’t need to worry about the wide variety of asset classes unless you are passionate about investment management. You can obtain a satisfactory amount of diversification with just  two ETFs or mutual funds.

Asset Allocation means selecting specific asset classes and choosing the percentage amount invested in each asset class. The chart above illustrates a simple asset allocation model.

Simple Portfolio Management

The research abounds that a basic asset allocation of a certain percent in stock investments and a certain percent in bond investments has led to long term wealth creation.

With annual rebalancing to make sure the percentages in each asset class remain in alignment with your stated preference, you can grow your assets with little time spent in managing them.

Index funds and ETFs are perfectly suited to a simple and effective portfolio management approach. The two asset portfolio shown in the chart above combines a world stock market index ETF with a total US bond fund. Depending upon your age and risk tolerance, place more or less in each asset class.

Rebalance your portfolio at the end of the year to get back to your originally selected asset allocation. In other words buy or sell from each holding to get back to the desired percentage amount invested in each fund. Paul B. Farrell of Market Watch has a wonderful series called the Lazy Portfolios with several asset allocations and performance metrics. For more ideas on this topic, it’s worth a read. The ten year annual returns of the 8 Lazy Portfolios ranged from 4.8% to 6.8% versus a ten year return of the S & P Index of 2.86%.

Consider this easy approach to investing to grow your wealth over time. This method is ideally suited for use with a workplace retirement fund.

For more on this topic, subscribe to my Wealth Tips Newsletter and receive a free ebook, 20 Minute Guide to Investing. (Sign up on the right)

Caveat; This article is for information purposes only and is not a recommendation to buy or sell any specific securities. For investment advice see your own personal advisor.

If You Can’t Get Enough Asset Allocation, Here’s More

Asset Allocation by Age at Couple Money

Doug Warshau wrote about Asset Allocation for People in their Twenties at Sweating the Big Stuff

The Absolute Importance of Asset Allocation at Money Help for Christians

My Personal Finance Journey shares his Asset Allocation

For those asset allocators out there, what is your asset allocation and why?

And Barb Recommends Links

Sign up on right to get free WEALTH TIP’s Newsletter, and FREE bonus eBook; 20 Minute Guide to Investing!

For whatever reason, I find talking about Roth IRA’s boring. Nevertheless, they are an unbelievable way to amass great wealth. To minimze the disomfort of talking about the subject, I’m going to give you the Cliff Notes Version.

INVEST IN A ROTH IRA

Background; I’m one of those finance nerds who started investing in my 20′s and have not stopped. I was decades younger than the other attendees at my first retirement investing seminar. When a way to invest and save taxes came up, I dove in! Thus, as soon as self directed IRAs became accessible, I started contributing the max. When I met El Carino in my mid-20′s, after just a few months of dating, I got him to contribute to an IRA as well.

This article will tell you why you must contribute to a Roth IRA and how to do it.

WHAT IS A ROTH IRA?

According to Money Chimp a Roth IRA is a tax advantaged investment vehicle which allows your money to grow over the long term and only get taxed one time! You put money in an investment account after taxes, invest it in your preferred investments, and pay zero taxes as the money grows and zero taxes when you take the funds out!

That’s correct, you pay no taxes at retirement when you withdraw the funds.

HOW MUCH COULD YOU EARN?

Assumptions:

Put $5,000.00 in an investment account once every year from ages 25 to 65.

Invest in 3 funds:

40% in Vanguard Total Stock Market Index Fund (VTWMX)

40% in Vanguard FTSE All World ex-US Index Fund (VFWIX)

20% in Vanguard Total Bond Market Index (VBMFX)

Earn an average return of 7% over 40 years.

At age 65 your investment account will be worth $998,175.56

When you withdraw the funds, you pay zero taxes.

HOW TO SET UP A ROTH IRA?

Contact a discount broker such as Vanguard, Fidelity, Charles Schwab, Etrade, or other.

Either on line or by phone, follow the required steps to set up the account.

Transfer money into the account either directly from your bank account, paycheck, or mail a check (very old school).

Choose the funds and indicate your preferred percentage for each one. Instruct the brokerage to transfer this money and future contributions into your funds.

WHAT IF I DON’T HAVE $5,000.00 PER YEAR TO INVEST?

No worries. Invest any amount you can. Start now, and set up an automatic transfer every month. Increase the amount as your income grows. Check out an online calculator to find out how quickly even small amounts can grow into large sums over time.

Barb Recommends

Holding Cash is Not a Sin at Morningstar.com by Liana Madura.Even big time fund managers hold cash in their portfolios. It may be your best move on occasion.

How Much Money is Actually Enough in More Magazine is one of those articles that really inspired me. It changed my perspective and allowed me to loosen some of my negative money thoughts. Read it to be uplifted.

Wealth Informatics asks, Is Gift Giving a Waste of Money? My charity contributions are automated quarterly through Charity Navigator. No muss, no fuss. What do you think of Wealth Informatics approach?

This is a recommend as well as an article where I’m mentioned ; Best Tips for Fixing Your Finances, by Donna Freedman over at MSN Money. This article is jam packed with stellar personal finance recommendations from the best money minds on line. If you are looking to learn more about money, you’re certain to find a resource here.

Priorities by Jason, at Live Real Now got me thinking about my own. This article reminded me that the difference between success and failure is putting limited time towards the most important tasks. While you’re there, don’t forget to enter his 2nd year GIVEAWAY.

The Three Stages of Financial Freedom at Invest it Wisely, also got me thinking. Let this article prompt you to consider what financial freedom means in your life.

The Reasons I Like Money Over Gift Cards at Money Reasons. This article echoes the belief of Clark Howard renowned saving guru. Give money and you can be sure it will not go unused.

20s Money writes about why the Outlook is Not Good for 20 Somethings. As a worrier, I tend to get fraught with concern about future generations. This thoughtful article talks about the perils ahead for the Gen Yers.

The 30K Online Challange at 20s Finances drops down the gauntlet for others to participate in this money making competition. Are you a blogger motivated by competition? If so, why not join in?

 Barb Across the Blogosphere

FindtheBest published,  Should You Buy Investment Products at Your Consumer Bank?

Free Money Finance published Dividend Investing is Not the Perfect Solution for Investing

Benzinga Brain Trust Column, Are IPOs worth the Risk?

Emily from Creditcards.com mentioned my Pro Shopping article

Carnival of Personal Finance, at Afford Anything, promoted my Shopping Video.

Totally Money Blog Carnival at BankNerd, published How to Get Rid of Debt; Start Here.

What type of retirement accounts are you using? What asset allocation do you prefer?

image credit; newsusacontent

What’s Your Asset Allocation?

Sign up on right to get free WEALTH TIP’s Newsletter, and FREE bonus eBook; 20 Minute Guide to Investing! And be sure to pick up my RSS feed or email subscription and follow me on twitter so you get the word immediately.

I was fascinated by an article at Oblivious Investor entitled,  Why I Don’t Overweight Small Cap or Value Stocks. Mike cogently laid out the research that over time, value and small cap stocks have ourtperformed a broad based index fund. This is widely accepted information from Modern Portfolio Theory and is considered one of the market anomalies of the efficient market hypothesis. The efficient market theory purports that over time the stock market is generally efficient and that prices reflect all available information and revert to their fair value. This Efficient Market theory is the basis of the indexing approach to investing and states it is very difficult t beat the overall market returns.

Yet, the anomaly rebuffs the efficient market theory and shows that small cap stocks and value stocks, over decades, tend to outperform the overall stock market. Although this is so, there are long periods of underperformane of these asset classes as well. In spite of awareness of this research, Mike decides not to act on the overperformance of value and small cap stocks.

How the Small Cap and Value Stock Outperformance Impacts My Investing

Personally, after studying this research in my MBA program, I added an extra bent towards value and small cap ETF’s to my portfolio. I decided to add those asset classes to our asset allocation and purchased two low cost index ETF’s; one specializing in value stocks and the other in small cap stocks. I was well aware that although small and value stocks outperformed in the long term there were also long periods of underperformance. That doesn’t bother me, as I’m quite disciplined and don’t change my well thought out investing strategy easily.

What About Mike?

In his own words,

“If, however, you’re somebody who would start to doubt your choice–and potentially back out on it at the worst time–during a period of relative underperformance, you should think twice about implementing a tilted portfolio. And that’s the boat I’m in. For whatever reason, I’ve come to have a strong suspicion of anything remotely clever when it comes to investing.”

I was completely taken by his rationale.

In lieu of the possibility of a higher long term rate of return, Mike decided to create a portfolio in line with his self knowledge and investing comfort level. He understands his risk tolerance and is interested in sticking with a simple and clear cut investing strategy in line with his personality.

Very wise.

A Favorite Asset Allocation Site

For more ideas on efficient market influenced index fund investing, take a look at the Lazy Portfolio site. Paul B. Farrell of MarketWatch follows several passive asset allocation approaches and aptly names these portfolios the Lazy Portfolios. From the Margaritaville Portfolio with three holdings to the Aronson Family Portfolio of 11 funds, these all index fund strategies are aptly called lazy because once the money is placed in their respective funds, all you do is rebalance every 6 months or yearly and maintain the allocation.

I highly recommend checking out these portfolios if you are looking for an easy way to manage your investment dollars. This set it and forget it strategy beats most actively traded portfolios!

Finally, I was intrigued by Mike’s disclosure and his discipline to act within his own self knowledge.

How do you decide which investment approach to follow?

image credit; posarma

The question came up during my mammogram (yuck), after learning I taught Investments at a local university.

The technician was an attractive single woman putting the max into her 401(K). I asked about her investments and she said they were through her employer and that they were aggressive. She was worried because the stock market was rocky and her investments weren’t going up enough.

She followed up by asking, “Are you investing in real estate?” When I replied, just my own home, she followed up with the query, “Isn’t real estate how someone gets rich?”

I replied that there were multitudes of ways to get rich.

“Have you considered investing in index funds?” was my next question.

She wasn’t sure what they were.

My final question was this, “When do you expect to retire?”

To this she replied, “About 20 years.”

The Analysis

This brief dialogue represents the gap in financial knowledge of many investors. This intelligent and well employed woman is doing great by putting money into her retirement account. But that step alone is not enough to secure her financial future. Let’s break it down a bit.

What she is doing well

She is contributing over $1,000.00 per month into her retirement account. She is invested aggressively. With 20 years until retirement, it’s not a bad idea to invest aggressively. The more risk one takes, the greater the possibility that she will earn outsized returns. (Notice I said, possibility, as there are no guarantees that her investments will perform to her expectations.)

What She Needs to Improve Upon

This investor must know in what she is invested, the characteristics of that investment, as well as the expected risks in relation to their returns.

She needs to know some investing basics such as types of investments, which ones to choose, and how to allocate her assets among the available financial assets.

My Recommendations

A quick caveat; I am not a registered investment advisor, nor do I want to be. Furthermore, no one should offer investment advice without a thorough understanding of the individual’s personal circumstances. So please do not come running to state that my advice is out of line, it’s for educational purposes only.

In spite of our minimal time together, I wanted to help her gain some basic investment information. Here’s what I suggested:

• Subscribe to Money Magazine
• Read The Elements of Investing by Malkiel and Ellis
• Download the 20 Minute Guide to Investing from the top right of this web site
• Visit Barbara Friedberg Personal Finance.com

The Takeaway

It’s an awesome start to contribute as much as the law allows to your 401(K). The more you contribute when you are young and throughout your life, the wealthier you will be at retirement. But plowing money into the account is not enough. Everyone must have someone in their family who understands investing basics in order to make the appropriate investment choices, even if they have a financial advisor.

There is no substitute for knowledge. Your future is your responsibility and you must educate yourself in order to secure your financial destiny.

Action Step:

Get a notebook and label it: “(your name) Personal Finance” and keep it by the computer. Use it to keep all of your personal finance goals, thoughts, activities, and plans.

• Read an investing book, blog, or magazine for at least 15 minutes a day and take charge of your financial future.
• If you have someone depending on your income, don’t forget to buy some cheap term life insurance.

For a quick overview of Investing Strategies, pick up my FREE eBook; 20 Minute Guide to Investing (top right of the page). If you like what you’re reading, sign up for my RSS feed or email subscription and follow me on twitter so you get the word immediately.

How aware of your personal retirement investments are you? What commitment will you make to increase your financial understanding?

image credit; luannemckibbin

For a quick overview of Investing Strategies, pick up my FREE eBook; 20 Minute Guide to Investing (top right of the page). If you like what you’re reading, sign up for my RSS feed or email subscription and follow me on twitter so you get the word immediately.

I’m regularly asked to explain economic news. “What does this news mean? What are the implications for me?” In response to these questions, following are three recent news clips with a lay persons guide to their meaning. Next, get an update on any implications for you, personally.

With the preponderance of economic news on television, on line, and in print, you are well served to separate the wheat from the chaff and spend your precious time on the news that has personal value.

Review the quotes and decide for yourself if they have implications for you, or not.

“I am very pleased the Fed took a pass on knee-jerk reaction that could have produced QE3. I hope this will take more air out of the commodity bubble in the ensuing weeks.” Robert Johnson, Morningstar.com, in No Knee Jerk Reaction, 8/27/2011.

What does this mean? This comment suggests that that in spite of slowing economic growth the fed did not react in haste by pumping more money into the economy and creating additional economic stimuli.  There is a hope that commodity prices, which are at unsustainably high levels will come back to more reasonable valuations.

What should you do? Nothing. That’s assuming you have structured your investments with a sensible asset allocation and are investing regularly in your retirement account. Do not succumb to the hype and start investing in gold or other overpriced commodities. You will not win buying “high.”

“The latest sign of trouble for the economy came Friday when the Commerce Department revised down its already low estimate for second-quarter growth in gross domestic product. The economy grew by an annual rate of only 1.0% in April through June, not the 1.3% rise that was previously estimated. That was after GDP increased by just 0.4% in the first three months of the year.” Dow Jones wire, Morningstar.com, in Bernanke says Fed Ready to Do More 8/27/2011

What does this mean? The economy continues with slow growth. This means the gross domestic product (total goods and services produced in a year + exports – imports) or aggregate business growth will likely be sluggish.

What should you do? Don’t expect exceptional growth in your equities (stock investments) and diversify your investments internationally.

“Economic growth and stock prices don’t move in sync. If they did, Chinese stocks would be up 10% for the year, not down 2%, and U.S. equities would be flat.” Paul J. Lim and Susie Poppick @Money How to Invest in a Scary Economy, August 26, 2011.

What does this mean? Common knowledge and research purports that stock prices follow economic growth. Although true in the long term, the relationship is not linear nor does it hold true in the short term.

What should you do? Invest some of your assets in faster growing economies as they have a good likelihood of superior growth. Keep some of your asset allocation in faster growing international index funds or etfs. Understand that the out sized growth may not be reflected in the short term and that patience is required.

ACTION STEP:

Get a notebook and label it: “(your name) Personal Finance” and keep it by the computer. Use it to keep all of your personal finance goals, thoughts, activities, and plans.

Listen or read the current economic news with a critical viewpoint. Do not react impulsively to the headlines or you will be changing your investments daily, an unwise practice.

What is your method for evaluating the media?

image credit; brizzle born and bred

UPDATE; Over the next month my family is moving across the country to a new home. Please enjoy a variety of guest articles from top notch bloggers and sponsors. Also, catch up with earlier favorites from Barbara Friedberg Personal Finance.  

 The following is a guest post by Kevin from Invest It Wisely.

Many personal finance blogs have different themes; some focus on investing, while others focus on retirement. Some look at the lifestyle aspects which others focus on getting out of debt. I personally look forward to financial independence and getting out of the rat race.

I write a lot about my thoughts and beliefs and where I would like to end up, but sometimes leave out the process to get from here to there. I’ve taken it for granted that everyone has good financial records and can thus easily plan for the future, but if that hasn’t always been true of myself, how could I expect it from others?

Data is information, and information is power. Before we can make decisions about retirement, where to invest, or which debt to pay off next, we need to have a good sense of where we are, and where we’re heading. I want to share what I have been using as my own personal compass, as well as learn from you, the reader, on how you keep track of your bearings.

I’m a young guy, but I’m pretty old school when it comes to tracking my finances. I personally didn’t track anything until around 2004 or 2005 or so, when I slowly started to accumulate a bit of savings and I actually had something in the bank worth keeping track of. From then on, I made good use of plain old spreadsheets using Excel and later Open Office.

WHAT I LIKE ABOUT A SPREADSHEET

A spreadsheet is simple, but it can be a powerful way to keep track of your finances. It shows all of your expenses, income, assets, and liabilities at a glance, even if you update it only once a month and only keep track of aggregate data. When you keep track of it at this level, it doesn’t take much time but you have easy access to a record and history to see where you’ve been, and where you’re going.

Income and Expenses

• For individual expenses, rough data is okay. Keep track of how much you spend on gas, food, debt repayments, and other regular expenses. (Barb’s comment; don’t let perfectionism keep you from this step, ballpark the numbers.)
• I also like to keep track of my total gross income so I can see how much I am losing to income taxes. (Barb’s comment; For Canadians like Kevin, this is even greater than those in the USA)

Assets and Liabilities

• For assets and liabilities, it is more important to have a good record of the most recent balances. (Barb’s comment; Assets are what you own and include your investments, and real property. Liabilities are what you owe, like loans and mortgages.)
• Usually this will be no more than recording the balances from your online banking and investment accounts.
• You can further categorize your investment assets by type of asset; stock, bond, real estate, etc.
• It can be helpful to include additional assets such as cash and bullion you have at home or the current value of your car. As your car depreciates, you can see the impact it has on your net worth and the necessity of putting money aside to save for a newer car.

Make Better Decisions

Once you are armed with the basic knowledge and data, you’ll be in a much better place to make decisions. You’ll know if something is eating up too much of your money and time, and you’ll see if your investing strategy is still in line with your goals. By recording this data month after month, you can also chart your progress over time.

Kevin’s dream is to get out of the rat race and achieve financial independence. He writes at Invest It Wisely, where he shares his thoughts and experiences and loves to receive feedback and learn from others.

For a quick overview of Investing Strategies, pick up my FREE eBook; 20 Minute Guide to Investing (top right of the page). If you like what you’re reading, sign up for my RSS feed or email subscription and follow me on twitter so you get the word immediately.

So, reader, what is your own preferred way to keep track of your finances? Spreadsheets served me well for many years and I still make use of them. I also use GnuCash these days, which is a free and very powerful financial accounting tool. Which tools do you use, and why? I would love to hear your thoughts.

image credit; nist6ss

For a quick overview of Investing Strategies, pick up my FREE eBook; 20 Minute Guide to Investing (top right of the page). If you like what you’re reading, sign up for my RSS feed or email subscription and follow me on twitter so you get the word immediately.

Welcome to encore month at Barbara Friedberg Personal Finance. We are caravanning across the country to our new home in a new land. During this major transition, please enjoy guest articles and some of my best previously published posts. Please be patient with my responses and keep visiting!

This first week of July, check out my MBA series and get some of the same material I taught my Portfolio and Investing students.

a version or this post originally published; June 13, 2010

BONDS

“The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelope our future” John Maynard Keynes

One of the foremost economists of the last century succinctly states a reason to invest. Learn the simple principles of investing through this MBA series taken directly from the graduate course I’m teaching in Investing & Portfolio Management.

Main Topic: What are BONDS & do I Need Them?

Earlier in the week I talked about risk versus reward. In investing, the greater the risk, the more opportunity for reward or a high return.  Risk means that your investment is going to go up and down in value; with higher risk investments  exhibiting greater volatility.

A BOND is a loan to a corporation, municipality, or government. When you buy a bond you are making a loan to the bond issuer. In exchange for the loan, you receive an interest payment. The amount of interest you receive is directly related to amount of risk you are taking. (Bond interest is called a coupon payment).

Buy a corporate bond from a corporation with financial troubles, you get a high interest rate because if that company goes bankrupt, you might lose all of your initial investment.

Buy a U.S. government bond, you usually receive lower interest rate, because your money is invested with a secure government who will pay you back your original investment when the bond matures.

A government bond is the safest bond to buy; it also has the lowest interest rate. Riskier bonds pay higher interest rates.

Here’s why you need bonds:

Jose is 33 years old, married, with term life insurance, 6 months cash in a savings account, and pays off his credit card bill in full every month. Three years ago, he and his wife invested in 2 index mutual funds:

1. Vanguard total stock market index (VTSMX)
2. Vanguard total international stock index (VGTSX)

He believed that since these 2 funds held lots of different companies from various parts of the world, he was sufficiently diversified and did not need any other investments.

Look what happened to the value of his investment portfolio during the past 3 years.

What if he added BONDS to the portfolio 3 years ago?

Notice, with no bonds, Jose’s portfolio returned 0.74% over 3 years; with bonds, his portfolio garnered 2.44%.

PRACTICAL APPLICATION: What is the takeaway?

• Investing is only for money needed in 5 years or more, because in the short term, the returns are volatile. These last 3 years prove that point.
• As long term returns of stocks and bonds are almost always positive and greater than returns in savings accounts, these investments are beneficial for generating long term wealth.
• Combine bonds, stocks, and some cash to an investment portfolio to lower risk (volatility).
• A combination of stocks, bonds, and cash will likely beat the investment returns of a cash savings account over the long term.

Wouldn’t it have been preferable to invest all his money in bonds?

It’s always a great idea to invest in the highest performing asset. But, there’s a problem with this approach; unless you are a psychic, you don’t know what the best performing asset will be IN THE FUTURE. That is why you divide your assets about among varying asset classes.

Remember these Investing Maxims

• Historically long term returns for stocks are about 9%, bonds near 5%, and cash in the low single digits.
• Combine the three assets, reduce risk, and increase returns over cash alone.
• Invest in mutual funds to simplify. No need to pick individual stocks or bonds.

ACTION STEP:

Get a notebook and label it: “(your name) Personal Finance” and keep it by the computer. Use it to keep all of your personal finance goals, thoughts, activities, and plans.

Learn more about bond investing at Money Chimp.

What percent of your portfolio is invested in bonds?