10 Basic Investment Principles

10 Basic Investment Principles

 

Having an understanding of fundamental investment concepts is important for a number of reasons. Knowledgeable investors are more likely to follow their investment plan, are better able to evaluate investment choices, and stay rational in up and down market cycles.

 

Here are the basic principles everyone should know:

 

1. Invest to Create Wealth

Saving is different from investing. Putting cash in a bank account is saving. Investing involves buying an asset in order to give you the opportunity to earn higher returns while assuming a certain level of risk. History has shown that overtime, investing in stocks can be beneficial because the average return has been 12%.[1]

2. The Longer the Better

Investing on a regular basis over a long period of time is the best way to accomplish your long-term financial goals because of compounding interest. Compounding occurs as you reinvest your returns, those returns generate their own returns and increasing your wealth. If you invest $1,000 every year for 30 years (a total of $30,000), earning 8% every year, you will accumulate $330,240.

3. Diversify

Dividing your money among various asset classes such as stocks, bonds, commodities, and cash allows you to limit losses in any given period of time. Each asset class has different risk characteristics and the amount you put in each will influence your gains or losses over time. Include as many broad asset classes as possible to help make your returns more predictable.

4. Pay attention to Fees and Taxes

Investment costs reduce your returns. The average annual cost of an actively managed mutual fund is 1.5%. Add on the 1% fee to pay your financial advisor and you are in the hole 2.5% every year. Problem is the mutual fund is not outperforming the index and all the buying and selling they do creates taxes that you have to pay.

A better alternative are exchange traded funds (ETF’s) which offer low costs (Vanguard’s averages 0.16%) and little to no capital gains (Vanguard ETF’s had zero distributions in 2008).

5. Rebalance Often

When your asset allocation moves from its original plan the risk you could be more or less. In order to keep your investments aligned with your goals, your investments should be rebalanced at least annually. Either use new money to buy the asset that is low or sell some of the winners and use the proceeds to buy the laggards.

6. Frequent Buying and Selling Hurts

A 2004 Dalbar Study found that over the last 20 years the average investor earned only 3.51% per year while the S&P 500 averaged 12.98%.[2] This doesn’t account for the commissions for doing all the trades. The same rule applies to using actively managed stock mutual fund managers, 75% underperformed their benchmark in 2008 and 80% of bond fund managers underperformed their benchmark.[3]

7. Create a Plan and Follow It

Your plan will give you confidence when times are bad and when times are good. It will be comprehensive in addressing all your financial matters, spell out all the things you want to accomplish, risk profile, asset allocation, and specify dates/milestones.

8. Be a Contrarian

When things are up slow down your purchases. When things are down buy more.

9. You Decide if You Are a Long Term Investor

Be honest with what you want to accomplish and how the amount of money you are willing to lose. Nothing is worse than buying stocks, losing half of your money and then deciding you can’t handle that much risk. You worked hard for your money and you want to invest it wisely and in a way that makes you comfortable. Instead of making your decisions based on percentages, convert it into dollar figures. Losing $10,000 has a different feeling than losing 10%.

10. Work Only With a Registered Investment Advisor

Stockbrokers are not financial advisors. The SEC says so. Stockbrokers are salespeople, not advisors, says the Securities and Exchange Commission. If you want genuine financial advice that is in your best interests, work only with a Registered Investment Advisor.

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[1] Average return of the S&P 500 from 1926 to 2007

[2] http://www.dalbarinc.com/content/showpage.asp?page=2004040101&r=/pressroom/default.asp&s=Return+To+Press+Releases

[3] Wall Street Journal, January 8, 2009 by John Bogle

So Many Things Are On Sale!

When you go to the mall, would you buy a sweater at full price or would you buy the exact same sweater for 40% off? Do you drive a mile or two farther to buy gas that is a penny cheaper?

With everyone looking for deals and bargains these days, it is time for investors to put some money to work in stocks and other investments. The S&P 500 is down 46% from its all time high, the NASDAQ is down 47%, a diversified ETF for commodities is down 65%. The list goes on and on of assets priced well below their highs of a little over a year ago.

No one knows where the bottom is and most people wait until it's too late and the majority of the gains have already occurred. Going back to 1900, if you took away the ten best days on the Dow Jones Industrial Average, two-thirds of the cumulative gains over the last 109 years would disappear.

Things are scary right now and many people have lost faith in investing. History has shown that we have experienced up and downs before and that average returns over time are positive. If you have 5+ years before you will need to use the money, you really should consider buying a group of diversified index funds.

Buy while its on sale!

10 Financial Planning Principles for Singles

1.   Create an Emergency Fund. Just because you are single does not mean you won’t have unexpected bills or won’t retire one day or have future responsibilities. You will have to pay for things married people do like health care, everyday living costs, etc. Save enough in your savings account to cover at least 8 months worth of monthly expenses.

2.   Set a Budget. Because you are single, you have an opportunity to save more than your friends who are married with children. Use that extra money to speed up the accomplishment of your short term and long term retirement goals. Instead of retiring at 65 or 70 you may be able to stop working at 50 or 55.

3.   Stay Out of Debt. Accumulating even small amounts of credit card debt can derail your long-term financial plans and keep you working for many more years. If you carry a balance of $5,000 with 18% interest and pay the minimum of 2% of the outstanding balance, it will take you 46 years to pay off the credit card.

4.   Invest in Passive Exchange Traded Funds (ETF’s). These are low cost (average Vanguard internal cost is 0.167%), tax efficient (Vanguard ETF’s had zero capital gains in 2008), and diversified investments.

5.   Stay Away from Actively Managed Mutual Funds. The average internal cost of a managed mutual fund is 1.50%[1]. In any given year 75 to 80% of actively managed mutual funds under perform their benchmark[2]. 

6.   Buy Disability Income Insurance. Often provided by your employer, it should provide you with 60% of your income if you become disabled and cannot work.

7.   Buy Long Term Care Insurance. You will need this to pay for home caregivers or nursing home care. Because you are single, you do not need to buy life insurance.

8.   Find an Estate Planning Attorney. They will help you draft a will, establish durable powers of attorney, and determine who will inherit your assets.

9.   Don’t Pay Your Mortgage Off Early. By keeping your mortgage you get a tax deduction, a lower payment thereby allowing you to invest more and grow your wealth.

10.      Stop Getting a Tax Refund. Basically, you are giving the government an interest free loan for money that is yours. Instead, talk to a tax expert on the number of exemptions to claim on your W-4 and try to make it so you neither owe the government money nor will get money back.

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[1] http://www.investopedia.com/university/mutualfunds/mutualfunds2.asp

[2] http://www.reuters.com/article/pressRelease/idUS183834+13-Nov-2008+PRN20081113

10 Things to Do Before You Retire

1.    Establish Your Monthly Budget. Include all expenses including gifts, vacations, taxes, cars, and emergencies.

2. Accumulate 12 months of cash to cover monthly expenses. You never now what may come up (job loss, major house repair, medical problem). You want to have a cushion built up so if something bad happens you are prepared to deal with it financially.
3. Buy Long Term Care Insurance. Middle age can be the best time to buy because you have the highest likelihood of being eligible for the policy and the premiums can be much lower than if you wait until you are in your 70’s or 80’s.
4. Predict the Cost of Health Care. As everyone knows, health care costs are rising faster than inflation. In 2008, health care costs rose 1.6% faster than consumer inflation.*  Since 1970, health care costs have risen about 2.4% faster than GDP.
5. Refinance Your Mortgage. Most people in retirement cannot borrow money from in traditional forms. Especially now with new mortgage standards, it will be harder to finance major purchases without a job.
6. Determine Your Sources of Income. Make sure you and financial advisor know exactly how much and where all of your dividends, interest, and other income will originate.
7. Revise Your Investment Allocation/Strategy. What you did to accumulate your wealth while working will be different from how you spend it in retirement. You will need to adjust your investments to have less risk, more income, and be liquid.
8. Review Your Will and Trusts. These documents are very important because they can protect you and your assets so that you can leave a legacy behind. Get all beneficiaries up to date and make sure all documents reflect your wishes.
9. Set a Plan for Your Time. How will you spend your days? How often will you do your hobbies? Will this make you fulfilled or will you get bored after a month? Your kids may enjoy your company but not everynight.
10. Make Sure You Really Want to Retire. Just because      you are 65 does not mean you have to retire. Many people are taking on new challenges whether they be with the same company, a new company, or going back to school. Consider part time work to keep your mind fresh and some extra income coming in.

Retirement should be an enjoyable time where you get to do what you want, when you want. By evaluating and planning now, you can make “retirement” the best 30+ years of your life.

*http://www.healthinflation.com/

We will survive

I was sitting in my office today and started to think about the bad economy and what is to come. Suddenly I noticed cars were driving by, the power was still on, and there was still food in the frig.

For all of the negative news and proclamations about how bad the economy is and will continue to be, people are still working, playing and living their lives. Sure, things aren't humming like they were two or three years ago but things are never as bad as they seem. Just like things are never as good as they seem.

Realize, you live in the best country in the world with unlimited opportunities to succeed. You don't have to participate in the recession. and you don't have to accept the same fate as the negative people surrounding you. 

Smile, be positive, and work a little harder. You will be that much better and happier.

http://PetersonWealthAdvisory.com

chris@PetersonWealthAdvisory.com

Business Academy Stock Project

Today, I was a guest of the Melbourne High School Academy of Business and Finance where the students presented the results of their stock project. They researched and picked 10 publicly traded companies on the NASDAQ and/or NYSE to invest a hypothetical $50,000. They tracked the price of their stocks from the middle of November and concluded in the middle of December, and 2 groups of students that I saw made money.

The goal of the project was to introduce the students to the stock market, how to research publicly traded companies, and sell an investor on their recommendations. They learned how to look up stocks, quotes, ticker symbols, diversification, how the state of the economy will effect certain stocks.

Each group did a great job of diversifying amongst the different sectors and allocating their money depending on the perceived risk of a stock. Obviously, I would have liked to see them invest in index funds, but that will be in another lesson.

I am encouraged that the markets will thrive now and in the future because people are learning at younger ages about stocks, bonds, and other investment choices and how they can benefit their long term financial goals. I was proud to have helped these Mel High students learn some basics about investing.

Expire = Taxes Are Going Up

Yesterday, Mr. Obama said that he will let the current tax rates "expire" in 2010. "Expire" is code for tax increases and no one should be fooled. 

With this pronouncement, we will see people will hoard there money because of the expectation they will have less in the future. People are rational and when they know they will have less money in the future they make adjustments today. 

My question is why wait to 2010? If it is okay to keep tax rates low now, while the economy is bad, why wouldn't he keep them low forever? The answer is he knows low taxes stimulate the economy and give businesses and entrepreneurs incentives to innovate and grow their business. By saying the taxes you pay now will be higher in the future, he effectively erases any benefit of our current lower rates.

Another point to think about is, when new tax cuts are proposed, don't put a life expectancy on the tax rates. Liberals are using the 2010 "expiration" and acting like lawyers and twisting words to their liking. Any movement up is an increase. In 2011 the following will take place:

• The top income tax rate WILL go from 35% to 39.6%. THAT IS A TAX INCREASE.

• The Capital Gains rate will go from 15% to 20%. THAT IS A TAX INCREASE.

• The Estate Tax rate will go from 0 to 55%. THAT IS A TAX INCREASE.

A parting thought on taxes rebates. They give out rebates to make you think the government is paying you money from their own coffers. Remember, government exists because they take money away from working people through taxes and fees. If you receive a tax rebate and don't pay taxes, you aren't getting a tax cut. You are taking money from your fellow citizens who were forced to pay it to the government and then the government decides who should receive that money. It's called social engineering and it is detrimental to economic growth and capitalism.