Investing is the commitment of money or capital to make a profit. That’s an easy definition and many of us know it. So why are so few of us truly good at it?
Because investing lessons are among the toughest we’ll ever learn. When it comes to money, we can be tempted by greed, overenthusiasm and our own ignorance; mostly we learn our lessons through the mistakes we make.
But it doesn’t have to be this way.
Before you consider a move into stocks, real estate, or another kind of investment, it helps to understand what sensible investment strategy is and how various investments may perform over time. It’s also worth considering getting help from a financial adviser or tax expert such as a Certified Financial Planner professional. Many people come to the financial planning process expecting dramatic gains in their portfolio. Gains are great, but in a down market, most people appreciate a portfolio that shows resilience and allows for flexibility in protecting capital.
Investing money
What is asset allocation?
Asset allocation is how you divide your investments among different categories-such as stocks, bonds, real estate, precious metals, collectibles, and cash-so your risk tolerance is in balance with your investment goals.
What’s interesting about asset allocation is that it’s less cut-and-dried than it used to be because people are living longer, in some cases working longer because they want to, and in others, taking breaks from work throughout their working lives. It used to be the case that someone approaching 65-what used to be known as the “traditional” retirement age, began to downshift their investment portfolios into bonds and cash equivalents to protect their principal. After all, if they lived another 20 years, they’d be lucky, right?
Today, asset allocation is a whole new ballgame. It’s a lifestyle issue, not merely a money issue. It starts with examining life and career goals throughout a life and career that may end at 50, at 65, or much later. And then it involves balancing the investments and other assets an individual has to minimize specific risks that could happen in that individual’s situation.
In general terms, asset allocation is a risk-management tool that fits you and your goals.
Where do you start? Start with a financial and tax expert (it makes sense to talk to both) who can review your current finances and ask you important questions about your goals. If they’re good at their jobs, they’ll ask you about what you want to do with your life, not simply when you want to retire. They’ll ask if you plan to have kids. They’ll ask if you want to own more than one home, or if you want to own one at all. They might ask you if you want to build “sabbaticals” into your working life over the decades. They should behave a bit like shrinks-getting you to admit goals you never really knew you had, money problems you never knew existed, or sources of cash you never realized could be channeled into something more productive. With all this knowledge in place, then you begin to allocate your assets.
What changes an asset allocation? Sudden or expected changes in life events. A family member gets seriously ill. A child gets ready to go off to college. You quit work lo go back to school. You lose your job and are unemployed for months. We’re talking about dozens of variables based on an individual’s unique situation.
The reason so many people are disappointed with their investments is because they don’t have a unified plan that links those choices to what they really want out of life.
Whatever the media tells you, only the foolish walk into an investment without an overall idea of how it should fit into their total financial picture. Nobody starts a new job expecting every day to go perfectly, but it’s amazing how many people expect their investment ideas to be foolproof going in.
But to get whatever you want, you have to ask yourself how soon you want those things and what risks you’re willing to take to get them. Take a minute and do the following quiz.
Learning to look around you
Investing isn’t just about making money. It’s learning to learn all about the world around you. If you’ve never read a business page in the newspaper or watched the daily stock market roundup on TV, it might not be an automatic source of fascination. But you need to try. That’s because what happens in business and the economy will affect pretty much everything you invest in.
If you are reading this, it’s a good start. But set aside 20 minutes a day to learn what happened in the business world. That will get you thinking not just about investments to buy, but why they go up and down.
However, as you learn about the daily movements in business and markets, that doesn’t mean you should change your money strategy on a daily basis. The critical benefit of a solid financial strategy is diversity that can protect a portfolio for the long haul.
AR/SK QUIZ
Getting involved in any type of investment should start with a definition of what you’re willing to risk for a profit. Ask yourself the following:
- Am I more concerned about maintaining the value of my initial investment or about making a profit from that investment?
- Am I willing to give up that stability for the chance at long-term growth?
- How would I feel if the value of my investment dropped for several months?
- How would I feel if the value of my investment dropped for several years?
- Am I in a financial position to handle any losses at all?
Completing the above quiz doesn’t mean you have an investment strategy. It’s a starting point to help you develop your investment strategy.
Investment choices that make up a portfolio
A balanced portfolio is typically made up of a variety of different investments that have their own behaviors. Here are descriptions of asset categories that may make up a diversified portfolio:
Stocks. A stock is a share of ownership in a corporation. Stocks are generally the “go-to” investments for long-term retirement and college savings because they blend the greatest risk and biggest returns among the three leading asset categories that make up most investors’ retirement plans and investments. As an asset category, stocks generally offer the greatest potential for growth, and for those who remember 2000, the greatest potential for loss. Stocks hit home runs, but also strike out. The volatility of stocks makes them a very risky investment in the short term. Large company stocks as a group, for example, have lost money on average about one out of every three years. And sometimes the losses have been quite dramatic. But investors who have been willing to ride out the volatile returns of stocks over long periods of time generally have been rewarded with strong positive returns.
Cash. Cash and cash equivalents-such as savings deposits, certificates of deposit, Treasury bills, money market deposit accounts, and money market funds-are the safest investments, but generally offer the lowest returns. The chances of losing money on an investment in this asset category are generally extremely low.
Bonds. Bonds are “debt instruments” -meaning that each bond entitles the holder to a portion of the company’s borrowings that are typically paid back with interest. But bonds aren’t issued only by corporations nonprofit entities as well as governments also issue them to fund programs and expansions. Bonds are generally less volatile than stocks but offer more modest returns. Some people hold bonds of high quality to offset volatility in stocks.
Real estate. Real estate investments can include houses, office buildings, apartment buildings, condos, or other types of commercial and residential properties. They can also be held in a real estate investment trust (REIT). Real estate can be risky in overheated markets, but investors who hold properties in good or improving neighborhoods generally see returns over a substantial period of time.
Precious metals. This category includes gold, platinum, even precious coins. People view precious metals as wealth that can be carried, held in their hands. People who have lived through the Great Depression have a particular love for it and have been known to put it in safe-deposit boxes.
There is a school of thought that jewelry, bullion, or any other form of precious metal can be used as currency in an emergency. Yet most experts will tell you that despite price spikes during national and international emergencies, metals can be among the most stagnant investments out there.
Energy. Energy stocks sometimes behave like precious metals. When there is world strife, particularly in oil-producing countries, people like to hedge their energy costs. We’re not talking only about gasoline. Oil prices push pricing of other energy resources such as natural gas and electricity because when one energy source gets expensive, both business and consumer users lean on other resources, boosting their use and making it easier for producers to raise prices.
Understanding Stocks
Stocks are shares of ownership in a company. When you buy a share of a company, you own a piece of the company equal to the ownership value assigned to that share.
So why do companies issue stock? To raise capital for a variety of purposes, including expansion. There are other ways a company can raise money-they can issue bonds or they can take out a loan. But stock is a way to raise money without incurring debt.
Why do investors buy stock? Because they expect the value of their investment to rise more than other investment alternatives.
How do you evaluate a stock?
This is the question that everyone argues about and there is so much more to learn than we have room for here. The answer is part numbers, part knowledge, and part art. And nobody does it exactly the same.
Here are some questions and tools to get you started:
Start with what the company does. Is the company a leader in its field? Does it have a product or service that positions it to be a leader someday? ls it able to charge a good price for this product or service and is it a popular choice among consumers or businesses that buy it?
Is it a respected brand within its industry? A company’s brand is more than its name; it is the value the name suggests. When someone mentions the company’s name, it should suggest that its products, management, and standing in the community and its industry are good.
How is its management? We hear so many horror stories about corporate management that we almost believe that good managers don’t exist. In truth, they exist many places, but you’ll have to look closely. Does the company you’re looking at have management with experience in this field and proven talent? We’re not just talking about the man or woman at the very top. Quality management has many layers, all productive and creative.
How are its sales? Sales are also called revenues. This is the amount of money coming in the door before the company pays workers, benefits, taxes, and other hundreds and thousands of individual operating expenses. Institutional investors-another term for Wall Street insiders-pore over the company’s numbers closely and decide whether sales are on target or not. If you’re interested in a particular company, see what the experts are saying about their sales.
How are its earnings? This actually may be the more important question. Have you heard that old saying, “It’s not what you make but what you keep”? Earnings are a very good indication of how a company really manages itself. If a company has good earnings after paying all of its necessary expenses, taxes, and operating costs, that means it’s keeping a close watch on where the money is going. This is what shareholders want. Keep in mind, however, that you’ll see some pretty wide variations in earnings at younger companies because they’re getting their footing. If their management, products, and operations are solid, this is exactly the kind of company you might want to take a chance on at the start.
What measurements do I watch? Financial experts have pages and pages of indicators they use to measure the investment attractiveness of companies. One of the first ones you should become aware of as an individual is the price-to-earnings ratio, which measures the ratio of a stock’s current. price to its earnings. Why should you care? Because the P/E ratio shows when the price of a stock is getting excessively ahead of the earnings the company is actually producing. So suppose the stock you have your eye on is selling at $30 a share. Earnings over the last 12 months were $1 a share. (Some analysts use projected earnings instead.) You divide 30 by 1 and find that your stock has a P/E ratio of 30.
Remember the tech wreck in 2000? Stocks were trading at 40, 50, even 100 times earnings back then-and many made a very quick fall to earth. Is there an ideal P/E? Again, this is up for discussion, but many people looking for stock bargains like to aim for a 20 P/E or lower.
Who do you trust for advice?
The answer is that you need to learn a considerable amount by yourself to judge the quality of the information and advice you’re given on stocks. Some ways to learn:
Start reading a leading national business newspaper like the Wall Street Journal or Barron’s.
- Watch business wrap-up shows on TV each night or when you get time.
- Join an investment club that focuses on education not the money.
- Take the time to talk with a financial advisor like a Certified Financial Planner professional.
How to buy stocks
Typically, stocks are bought through a brokerage firm, and you’ll have to pay trading fees to purchase them. However, certain companies sponsor dividend reinvestment plans (DRIP) that allow individuals to buy stock directly through the company, with a small fee to a transfer agent. The advantage of DRIPs is that small investors can come on board for relatively small amounts of money, and sometimes DRIP stock is sold at a discount to current market price. They’re worth checking out if you feel strongly about owning an individual stock.
For individuals who don’t want to do all that work and would prefer to diversify with the help of investment professionals, the solution may be mutual funds.
