Sensible-Investor: Principles -- Part 3
Caveat investor
If you’re a long-run investor (rather than a gambler), you should beware of personal finance advice that has these characteristics:
SPINNING THE ROULETTE WHEEL: Maybe you like to gamble, and maybe you are in a financial position where you can afford to devote a lot of time and a portion of your holdings to hunting for individual stocks that you can buy low and perhaps sell for a handsome profit. But that is not risk-averse investing, although personal finance publications and Web sites are full of it, because it's exciting and constantly changing. Only do this if it is a game that you like to play and a game that you can afford to lose.
PROPHESYING: Claiming to be able to forecast market movements. If someone really knew which way the market was about to move, that person could make billions by exploiting that knowledge, instead of a few bucks by writing or talking about it. As Malkiel writes, "With large numbers of people predicting the market, there will always be some who have called the last turn or even the last few turns, but none will be consistently accurate." ( Random Walk, p. 157) Paying attention to marketplace prophets can be a money-losing proposition if you pull your investments out of the market at times when you think it is about to go down. The reason: "market timers risk missing the infrequent large sprints that are the big contributors to performance." (Random Walk, p. 162) As Jonathan Clements puts it in The Wall Street Journal: "If you jump in and out of stocks in an effort to catch bull markets and sidestep market declines, you run the risk of being out of the market when stocks are bulldozing ahead. That is a real danger, because big stock-market gains are often concentrated in a few weeks or even days." (WSJ, C1, April 28, 1998) Andrew Tobias also agrees: "Clearly, if you knew which way interest rates were headed, you could profit in numerous ways. Many people therefore try to guess, and some, in any given year, guess right. Few, however, can guess right consistently, least of all you or I or the man on all-news radio." (Only Investment Guide, p. 70)
SHARING "SECRETS": Information about individual companies moves lightning-fast these days. If you hear see or hear a tip about a company in print or on the Internet, you'd be wise to assume that you're among the last to know. If there's any truth to the information, is there any reason to believe that full-time market watchers on Wall Street didn't learn it before you did? They can act in a split second to bid the stock price to a new level that reflects the new information. Don't expect to be able to move faster than they do and take advantage information you learn on television or on the Internet. As Burton Malkiel describes the situation, "The market is so efficient --“prices move so quickly when new information does arise -- “ that no one can consistently buy or sell quickly enough to benefit." ( Random Walk, p. 191) Further, he states, "There is a fundamental paradox about the usefulness of investment advice concerning specific securities. If the advice reaches enough people and they act on it, knowledge of the advice destroys its usefulness." (Random Walk, p. 456)
FEAR-MONGERING: People are remarkably adaptable. Children can attend college even if their parents saved little, although the education loans might be larger and the college less prestigious than if the parents had invested diligently. Senior citizens in the United States can still retire, even if their retirement savings are scanty. They may have to work longer, scrimp more on their weekly budget, have few or no options for entertainment and travel, and depend more than they would like to on family and the government. Stating this is not meant to discourage investing, but to encourage people to look at their prospects clear-sightedly, without despair or panic that can cause people to freeze rather than invest. Avoid personal finance advice that inflames emotions of guilty, avarice or panic. For your own peace of mind, resist the temptations of such emotions. As Andrew Tobias observes,
"Whether you choose mutual funds or a direct plunge into the stock market, bonds, or a savings account; whether you shelter your investments through a Keogh Plan or an IRA; and whether you spend now or save to spend later “ you will find that, by the prevailing American ethic anyway, you never have enough." (Only Investment Guide, p. 188)
What to look for in a Web site
These are six desirable qualities both in personal finance planning and in a personal finance Web site:
DIVERSIFICATION: Encouraging investors to diversify their holdings, as explained above.
ALLOCATION: Advocating and explaining proper asset allocation, as explained above.
EYE ON THE HORIZON: It's important to take into account how much time you have before you need to withdraw funds you invest. If you have 30 years to invest, you can tolerate lots of ups and downs in the meantime, as long as the investment's overall trend is up. By purchasing stocks or, much more simply, stock market index funds, you participate in the country's financial growth. "There is a long-run uptrend in most average of stock prices in line with the long-run growth of earnings and dividends." ( Random Walk, p. 143) But if you will need to withdraw your money in a short while, you should invest it where its ups and downs are limited. Otherwise, you'll be gambling – placing a bet that the value won't be down at the exact time when you need to withdraw your money.
DON'T WASTE YOUR TIME: You can spend as much time as you want monitoring your investments, but don't think that you must. Life is short, and you may not want to devote too much of it with your eye on your money. A buy-and-hold strategy that relies on index funds will reduce the amount of time you need to spend monitoring investments. A good personal finance Web site will explain this option for you. As Burton Malkiel notes, "simply buying and holding a diversified portfolio suited to your objectives will enable you to save on investment expense, brokerage charges and taxes; and, at the same time, to achieve an overall performance record at least as good as that obtainable using technical methods." ( Random Walk, p. 163) If you want to try to pick winning stocks and you have the resources to allow you to do so prudently, you can try. "The problem is that it takes a lot of work to do it yourself, and as I've repeatedly shown, consistent winners are rare." ( Random Walk, p. 432) Even if you didn't care about wasting your time, the evidence in favor of index funds is strong. Consider these comments from three personal finance advisors:
"Even if you stick with (specific) stocks through thick and thin, you could still suffer lackluster results, thanks to market-lagging performance by your stocks and funds. Because of that danger, consider using index funds for at least part of your stock portfolio. Index funds buy the stocks that constitute a market index in an effort to match the index's performance. By keeping a portion of your money in these funds, you guarantee that whatever the market delivers, that is what you will get." (Jonathan Clements, The Wall Street Journal, p. C1, April 29, 1998.)
With a stock index fund, "Over the long run, your performance will just about match that of the stock market as a whole ... which is better than most mutual funds, do, because most burden your investment with higher management fees. This is a very simple concept but profound: just by investing all the money you have earmarked in the (index fund), you will generally do better than most bank trust departments, mutual fund managers, and private investors ... with far less effort." (Only Investment Guide, p. 185)
"When you're buying big American companies, low-cost index funds outperform most of the active managers over time. So here's the question: If active managers can't beat the market on a regular basis, after expenses, why should you pay them to miss? Buy index funds instead." (Making the Most, p. 702)
FEES and TAXES: A good personal finance Web site should try to help you save money on both. Brokers' commissions, mutual fund sales charges and other expenses can and do eat into the profits of investors who trade stocks actively or who rely on mutual fund managers to do so for them. This means that, although finding a mutual fund manager who consistently outperforms the market is difficult or impossible, it's not hard to find ones who consistently fall short.
"This last point is important; although there can be no consistently superior performers in a fully efficient market, there can be consistently inferior performers. Repeated weak performance would not be due to an ability to pick bad stocks consistently (that would be impossible in an efficient market!) but could result from a consistently high expense ratio and consistently high portfolio turnover with resulting trading costs," according to Bodie, Kane and Marcus in their investment textbook.
You can also lose money by paying for bad advice, whether in print or on-line.
"Don't waste money subscribing to investment letters or expensive services," counsels Andrew Tobias. "The more-expensive investor newsletters and computer services only make sense for investors with lots of money – if then. Besides their cost, there is the problem that they are liable to tempt you into buying, and scare you into selling, much too often, thereby incurring much higher brokerage fees and capital gains taxes than you otherwise might. There is the added problem that half the experts, at any given time, are likely to be wrong." (Only Investment Guide, p. 135)
The same applies to actively managed mutual funds, according to Burton Malkiel:
"Most investors would be considerably better off by purchasing a low-expense index fund that simply bought and held a broad-stock index, than by trying to select an active fund manager who appears to possess a 'hot hand.' Since active management generally fails to provide excess returns and also tends to generate greater tax burdens for investors because they regularly realize capital gains, the advantage of passive management holds with even greater force." (Random Walk , p. 214)
SOCIALLY CONSCIOUS INVESTING: Many investors don't care whether their money is invested in tobacco stocks or in shares of a baby food manufacturer, as long as the dividends keep rolling in. But for other investors, morality plays an important role in investing. An ideal personal finance Web site would provide investors with whatever information they want to know about potential investments, but Sensible-Investor has found few sites that provide useful data about socially conscious investing.
Tuesday, September 23, 2008
LANGKAH INVESTASI UNTUK PEMULA PART 2
Sensible-Investor: Principles -- Part 2
Relax. Here's what you don't have to do
You don't need to pick next year's winning stocks, or even pick next year's winning stock-pickers. Identifying stocks that are undervalued and about to rise in price is so difficult a task that it's a job for professionals -- or it maybe a job that's simply impossible. So few stock-pickers are consistently successful that there's no telling whether they are skillful or merely lucky.
Ways to beat the market
Hundreds of theories have been proposed on how investors can beat the market. You may have heard about some of them:
Dogs of the Dow.
The January effect.
New spinoffs.
Buy what you know.
Technical analysis.
Fundamental analysis.
All such theories fall into one of the following categories, which buy-and-hold investors can ignore:
Theories that sound good but have been disproved.
Theories that apparently are true to a slight degree (such as the January rise in stock prices) but that affect prices so little that individual investors seeking to exploit the theory would lose money on transaction costs.
Theories that remain valid only until the general investing public learns about them and tries to exploit them.
It’s quite possible that stock-picking is no more a talent than coin-flipping. Consider a hypothetical group of 1,024 investment advisors who choose stocks to buy by flipping coins in a hypothetical world where stocks go up whenever the stock-picker tosses heads and go down when she tosses tails. On average, after one toss 512 of the stock-pickers will have a coin that came up heads. On average, after two tosses 256 of them will have a coin that came up heads twice. After three tosses, 128 will have consistently thrown heads. After four tosses, 64 will remain in the heads-only category. Fast forward to the 10th toss. On average, one stock-picker will have flipped heads 10 times in a row. Is she skillful or lucky? Should she write a book about her strategy for success? Should you buy it?
"It has been amply demonstrated that a monkey with a handful of darts will do about as well at choosing stocks as most highly paid professional money managers." (Tobias, Only Investment Guide, p. 6)
Many studies have shown that few or no mutual fund managers consistently beat the market. The following results are summarized from the textbook Investments by Zvi Bodie, Alex Kane and Alan J. Marcus (Irwin McGraw-Hill, Boston, pp. 372-376):
From 1984 to 1993, fewer than 30% of stock mutual funds had returns better than the Wilshire 5000 Index, which incorporates the returns of almost every American company with publicly traded stock. From 1971 to 1993, the Wilshire index achieved an average annual return of 12.0%. Managed funds averaged only 10.85%.
Managers of bond funds did no better. From 1983 to 1992, the annualized returns of managed bond funds averaged 1.5% below the Lehman Brothers Bond Index.
Individual fund managers' past records tell little or nothing about how they will do in the future. For example, in one study the later achievements of managers who excelled during 1983-86 were compared to those who did the worst during that period. During 1987-90, both groups had equally average records.
From 1965 to 1984, out of 143 stock mutual funds, 127 achieved returns that were statistically indistinguishable from the overall market. Only 12 did better and four did worse. As Burton Malkiel states,
"I have become increasingly convinced that the past records of mutual fund managers are essentially worthless inpredicting future success. The few examples of consistently superior performance occur no more frequently than can be expected by chance." (Random Walk, p. 442)
MIT economist and Nobel Prize winner Paul Samuelson is even more blunt. After examining the uninspiring record of money managers vs. the market as a whole, he writes,
"Do I really believe what I have been saying? I would like to believe otherwise. But a respect for evidence compels me to incline toward the hypothesis that most portfolio decisionmakers should go out of business,“ take up plumbing, teach Greek, or help produce the annual GNP by serving as corporate executives. Even if this advice to drop dead is good advice, it obviously is not counsel that will be eagerly followed." (Paul A. Samuelson, "Challenge to Judgement," The Journal of Portfolio Management, Fall 1974)
Like portfolio managers, individual investors don't want to hear that, either. "Telling an investor there is no hope of beating the averages is like telling a six-year-old there is no Santa Claus. It takes the zing out of life," Malkiel writes. (Random Walk, p. 459)
There's nothing wrong with investors who have the inclination and the resources to try their luck at picking a winning stock. But what they are doing is closer to gambling than to risk-averse investing. It does have one big advantage over lotteries and casino gambling: The odds are in your favor because stocks overall tend to rise. If you choose stocks at random, you're more likely to choose ones that will rise than ones that will fall, because the trend of the stock market is upward.
Except for their expenses, mutual fund managers don't have trouble making as much money as the market in general; but they have a great deal of difficulty outperforming it consistently.
Making money on the stock market is relatively easy in the long run, if you keep your holdings well diversified. With all its ups and downs, the overall stock market tends to rise an average of 10% to 12% per year, growing as the American economy grows. (Those percentages are average yearly returns. One -- the 10% average -- is calculated from the peak of stock prices in the 1920s. The other, the 12% average, is based on stock prices at the trough of the 1930s.) The problem for a short-term investor is that the stock market might hit that average by going down 5% one year and up 17% the next, or up 30% one year and down 15% the next. A short-term investor can end up with the 5% or 15% drop, while a long-term investor will get the 10% to 12% rise.
You can tap into the long-term growth by buying index mutual funds, or you can buy any reputable mutual funds run by professional mutual fund managers. In either case, your investment will be in good hands --“ just don't expect fund managers to beat the market consistently. If they do, consider yourself (and them) lucky.
More things not to worry about
Unless you want to, you don't need to pay attention to the daily financial news, check the stock tables, or try to guess the short-term future of interest rates and the Dow. Nobody knows which direction the market will go tomorrow. But you don't need to know that. All you need to know is that in the long term it goes up. If you try to outguess the market, you're likely to lose money. As Burton Malkiel states:
"Switching your investments around in a futile attempt to time the market will only involve extra commissions for your broker, extra taxes for the government, and poorer net performance." ( Random Walk, p. 405)
Checking on your investments too frequently can be hazardous to your financial health and fatal to your peace of mind. "If there's anything that makes it difficult to succeed in stocks, it's that investors can see how they're doing throughout the day," Tobias writes. "Stocks move up and down all the time, but that doesn't mean there is significance to every move." (Only Investment Guide, p. 132) Further, he states, "unless you get a kick out of it, you needn't spend a great deal of time reading investment guides, especially long ones. ... Because if you can find the right forest -- the right overall investment outlook -- you shouldn't have to worry much about the trees." (Only Investment Guide, p. 6)
Relax. Here's what you don't have to do
You don't need to pick next year's winning stocks, or even pick next year's winning stock-pickers. Identifying stocks that are undervalued and about to rise in price is so difficult a task that it's a job for professionals -- or it maybe a job that's simply impossible. So few stock-pickers are consistently successful that there's no telling whether they are skillful or merely lucky.
Ways to beat the market
Hundreds of theories have been proposed on how investors can beat the market. You may have heard about some of them:
Dogs of the Dow.
The January effect.
New spinoffs.
Buy what you know.
Technical analysis.
Fundamental analysis.
All such theories fall into one of the following categories, which buy-and-hold investors can ignore:
Theories that sound good but have been disproved.
Theories that apparently are true to a slight degree (such as the January rise in stock prices) but that affect prices so little that individual investors seeking to exploit the theory would lose money on transaction costs.
Theories that remain valid only until the general investing public learns about them and tries to exploit them.
It’s quite possible that stock-picking is no more a talent than coin-flipping. Consider a hypothetical group of 1,024 investment advisors who choose stocks to buy by flipping coins in a hypothetical world where stocks go up whenever the stock-picker tosses heads and go down when she tosses tails. On average, after one toss 512 of the stock-pickers will have a coin that came up heads. On average, after two tosses 256 of them will have a coin that came up heads twice. After three tosses, 128 will have consistently thrown heads. After four tosses, 64 will remain in the heads-only category. Fast forward to the 10th toss. On average, one stock-picker will have flipped heads 10 times in a row. Is she skillful or lucky? Should she write a book about her strategy for success? Should you buy it?
"It has been amply demonstrated that a monkey with a handful of darts will do about as well at choosing stocks as most highly paid professional money managers." (Tobias, Only Investment Guide, p. 6)
Many studies have shown that few or no mutual fund managers consistently beat the market. The following results are summarized from the textbook Investments by Zvi Bodie, Alex Kane and Alan J. Marcus (Irwin McGraw-Hill, Boston, pp. 372-376):
From 1984 to 1993, fewer than 30% of stock mutual funds had returns better than the Wilshire 5000 Index, which incorporates the returns of almost every American company with publicly traded stock. From 1971 to 1993, the Wilshire index achieved an average annual return of 12.0%. Managed funds averaged only 10.85%.
Managers of bond funds did no better. From 1983 to 1992, the annualized returns of managed bond funds averaged 1.5% below the Lehman Brothers Bond Index.
Individual fund managers' past records tell little or nothing about how they will do in the future. For example, in one study the later achievements of managers who excelled during 1983-86 were compared to those who did the worst during that period. During 1987-90, both groups had equally average records.
From 1965 to 1984, out of 143 stock mutual funds, 127 achieved returns that were statistically indistinguishable from the overall market. Only 12 did better and four did worse. As Burton Malkiel states,
"I have become increasingly convinced that the past records of mutual fund managers are essentially worthless inpredicting future success. The few examples of consistently superior performance occur no more frequently than can be expected by chance." (Random Walk, p. 442)
MIT economist and Nobel Prize winner Paul Samuelson is even more blunt. After examining the uninspiring record of money managers vs. the market as a whole, he writes,
"Do I really believe what I have been saying? I would like to believe otherwise. But a respect for evidence compels me to incline toward the hypothesis that most portfolio decisionmakers should go out of business,“ take up plumbing, teach Greek, or help produce the annual GNP by serving as corporate executives. Even if this advice to drop dead is good advice, it obviously is not counsel that will be eagerly followed." (Paul A. Samuelson, "Challenge to Judgement," The Journal of Portfolio Management, Fall 1974)
Like portfolio managers, individual investors don't want to hear that, either. "Telling an investor there is no hope of beating the averages is like telling a six-year-old there is no Santa Claus. It takes the zing out of life," Malkiel writes. (Random Walk, p. 459)
There's nothing wrong with investors who have the inclination and the resources to try their luck at picking a winning stock. But what they are doing is closer to gambling than to risk-averse investing. It does have one big advantage over lotteries and casino gambling: The odds are in your favor because stocks overall tend to rise. If you choose stocks at random, you're more likely to choose ones that will rise than ones that will fall, because the trend of the stock market is upward.
Except for their expenses, mutual fund managers don't have trouble making as much money as the market in general; but they have a great deal of difficulty outperforming it consistently.
Making money on the stock market is relatively easy in the long run, if you keep your holdings well diversified. With all its ups and downs, the overall stock market tends to rise an average of 10% to 12% per year, growing as the American economy grows. (Those percentages are average yearly returns. One -- the 10% average -- is calculated from the peak of stock prices in the 1920s. The other, the 12% average, is based on stock prices at the trough of the 1930s.) The problem for a short-term investor is that the stock market might hit that average by going down 5% one year and up 17% the next, or up 30% one year and down 15% the next. A short-term investor can end up with the 5% or 15% drop, while a long-term investor will get the 10% to 12% rise.
You can tap into the long-term growth by buying index mutual funds, or you can buy any reputable mutual funds run by professional mutual fund managers. In either case, your investment will be in good hands --“ just don't expect fund managers to beat the market consistently. If they do, consider yourself (and them) lucky.
More things not to worry about
Unless you want to, you don't need to pay attention to the daily financial news, check the stock tables, or try to guess the short-term future of interest rates and the Dow. Nobody knows which direction the market will go tomorrow. But you don't need to know that. All you need to know is that in the long term it goes up. If you try to outguess the market, you're likely to lose money. As Burton Malkiel states:
"Switching your investments around in a futile attempt to time the market will only involve extra commissions for your broker, extra taxes for the government, and poorer net performance." ( Random Walk, p. 405)
Checking on your investments too frequently can be hazardous to your financial health and fatal to your peace of mind. "If there's anything that makes it difficult to succeed in stocks, it's that investors can see how they're doing throughout the day," Tobias writes. "Stocks move up and down all the time, but that doesn't mean there is significance to every move." (Only Investment Guide, p. 132) Further, he states, "unless you get a kick out of it, you needn't spend a great deal of time reading investment guides, especially long ones. ... Because if you can find the right forest -- the right overall investment outlook -- you shouldn't have to worry much about the trees." (Only Investment Guide, p. 6)
LANGKAH INVESTASI UNTUK PEMULA
Sensible-Investor: Principles -- Part 1
You can understand personal finance
The basics of personal finance aren't all that complicated -- they can be understood by almost anyone. While the fine points of personal finance can be mind-bogglingly complex, the fundamentals are much simpler and less time-consuming than they are typically believed to be.
In part, personal finance seems complex because much of what's written about investments focuses on complicated but dispensable topics, including picking stocks that are about to rise, guessing which way the markets will go next, and finding market-beating mutual fund managers. All that is unnecessary. If you are an experienced investor, you may be convinced that such matters are crucial to your success. (In that case, you may want to skip immediately to a discussion of why you're wrong.) If you are a newcomer to the world of investing, you would do better to start with the next step-by-step advice for first-time investors.
For beginners, one step at a time
Many people cower before the daunting prospect of beginning an investment program. The task seems monumental. They don't know where to start, so they don't start at all. Instead, they feel guilty and inadequate. If this describes you, there are a few relatively simple, but quite important, steps you can take.
First, some preliminaries. Before you make your initial investments, you should make sure you have enough money saved in an emergency reserve so investing is prudent rather than foolhardy. If you don't, you are gambling that no unexpected occurrences will force you to withdraw funds from your investments at an inopportune (money-losing) moment. Take your pick as to how you define your emergency reserve. You might take a less traditional approach -- by simply thinking through how you would cope in case of a financial crisis. Even if you are laid off and fell ill simultaneously, perhaps your family support network is so strong that you would be provided for without any financial drain. Or, in such an emergency you might need your own funds, which you keep tucked away in a money market fund. In case you take the traditional approach, here are two traditional definitions of an emergency reserve fund from two personal finance writers:
"(U)ntil you have at least $5,000 or $10,000 someplace safe and liquid, like a savings account – unless you are so wealthy you don't have to worry about the contingencies of everyday living – you are crazy even to consider making riskier investments." (Andrew Tobias, The Only Investment Guide You'll Ever Need, Harcourt Brace & Co., New York, 1996, p. 60)
If you are running a balance on your credit cards, "your first priority should be getting rid of that debt. Then build a reserve fund of 3 to 6 months' living expenses in a bank or money-market mutual fund. With a fully funded reserve, you can start putting extra money into … longer-term savings and investments." (Jane Bryant Quinn, Making the Most of Your Money, Simon & Schuster, New York, 1997, p. 172)
If you have difficulty establishing an emergency reserve fund because your spending is out of control, those personal finance books by Tobias and Quinn, among others, can help you with budgeting and trimming unnecessary expenses, The following Web sites also might help: Ask Cash Flo, Kiplinger.com (Search for “budget”), and Quicken.com (the Saving and Spending section).
Step 1: Lining up money to invest
You’re now ready to select which money you will invest. If you can only invest chunks of cash sporadically, as they become available, do so, if that's the best you can manage. But you would be better off if you made your investments in regular installments. Even better, your employer may let you invest in regular installments that are deducted automatically from your paycheck. Best of all, your employer might match some of what you deduct. If your company offers this benefit, take advantage of it. Regarding employers' matching funds for employees' retirement accounts, heed what Tobias says: "This is free money. If your employer offers a deal like this and you're not taking full advantage of it, you're an idiot. (Well, I'm sorry, but c'mon: if your local bank decided to give out free money to attract deposits – say, $500 for each new $1,000 – there would be riots in the streets, so eager would people be to get in on it.)" (Only Investment Guide, p. 90.
Step 2: Setting your goals
Define the specific goal or goals you are investing to achieve – a house, your child's college education, retirement? The appropriate type of investment will vary, depending on how much time will elapse before you need the money. If you have several investment goals, you should make separate investment decisions for each and keep track of each block separately.
Step 3: How much risk can you stand?
Determine your level of risk tolerance, beginning by learning about the various types of financial risk that exist in the world, from inflation risk and default risk to the unpredictable variations of individual stock and bond prices. You may start out thinking that you'd be uncomfortable with anything riskier than a bank CD, but you may change your mind after you consider the long-term risks of such low-yield investments. As Wall Street Journal personal finance writer Jonathan Clements states, "(O)ver the long haul, … stocks actually seem safer because they are more likely to make you decent money, while bonds and money funds find it tougher to stay ahead of inflation, taxes and investment costs." (The Wall Street Journal, April 28, 1998. Page C1.) Andrew Tobias gives the same advice: "a very basic thing to know about your money is that, over the really long run, people who buy equities – stocks – will almost surely make a lot more money (if they're at all sensible in how they do it) than people who make 'safer' investments." (Only Investment Guide, p. 60) To help you think through your attitude to investment risks, Princeton University Economics Professor Burton G. Malkiel provides a risk-tolerance quiz in his book A Random Walk Down Wall Street. (W.W. Norton & Co., New York, 1996, pp. 414-415). A more accessible, though less sophisticated, risk-tolerance test is available on the MSNBC/CNBC site.
Step 4: Dividing up the money
Calculate how best to allocate your money among various types of investments, such as stocks, bonds and CDs. With properly allocated investments, you can achieve the same level of returns at a relatively lower risk than if you concentrated your investments in one category. That's because the prices of different investment categories don’t move in sync – and you can benefit from that fact. If you own some stocks and some bonds, for example, not all of your holdings will be at risk when stocks are up and bonds are down, or when the opposite is true. In the long run, you will have cut your losses without a comparable cut in your profits – a net win at a lower risk.
Don't skip this step because you’re put off by the phrase "asset allocation," which admittedly sounds mind-numbingly dull. Studies have shown that whatever decision you make about asset allocation, it will be by far the dominant factor in determining what you get out of your overall investments. Don't look for a one-size-fits-all allocation formula, such as those that some brokerages publish. The proper percentages for you will depend on your tolerance for risk and how much time you have until you need to withdraw money from your investments. For more suggestions about asset allocation, you can turn to any of several Web sites, or refer to Malkiel (p. 420 ) or Quinn (p. 595).
Step 5: Dividing up the money more finely
Determine how you will diversify your investments, which essentially means not putting all your eggs in one or two baskets. For stocks, you can accomplish this easily by investing in mutual funds. "Too many investors bet too heavily on just one or two stocks," warns Clements in The Wall Street Journal. "Sure, that may mean handsome gains. But if you bet wrong, you could suffer losses you will never recoup. The solution is simple enough. Use mutual funds to spread your money among a good number of stocks in a variety of market sectors, including large, small and foreign stocks." (WSJ, April 28, 1998, p. C1.) As Fidelity Investments veteran Peter Lynch puts it, “Diversify, diversify, diversify.” He recommends buying several different types of mutual funds for diversification beyond what one type of fund could provide.
Step 6: Taking the plunge
Start making the investments you have decided on. You'll want to make them through a reliable institution that charges low or no fees. Don't think you need to wait to invest until you find the very lowest-priced deal on an investment with the very highest expected return and absolutely the most advantageous tax consequences. The sooner you start investing, the more you’ll find that time is on your side. For children and young adults, the time advantage is astounding -- at 9 percent interest, $100 invested today will turn into $3,611 in 40 years. Using different rates and different time spans on a simple investment calculator, you can quickly convince yourself not to delay, even if you’re not confident that you’ve found the very best investment for you. You can move your money around later, as you become more savvy about the world of investments.
Step 7: Checking back later
Every 12 months or so, reassess your financial position and your progress toward your financial goals. Make adjustments, as appropriate.
You can understand personal finance
The basics of personal finance aren't all that complicated -- they can be understood by almost anyone. While the fine points of personal finance can be mind-bogglingly complex, the fundamentals are much simpler and less time-consuming than they are typically believed to be.
In part, personal finance seems complex because much of what's written about investments focuses on complicated but dispensable topics, including picking stocks that are about to rise, guessing which way the markets will go next, and finding market-beating mutual fund managers. All that is unnecessary. If you are an experienced investor, you may be convinced that such matters are crucial to your success. (In that case, you may want to skip immediately to a discussion of why you're wrong.) If you are a newcomer to the world of investing, you would do better to start with the next step-by-step advice for first-time investors.
For beginners, one step at a time
Many people cower before the daunting prospect of beginning an investment program. The task seems monumental. They don't know where to start, so they don't start at all. Instead, they feel guilty and inadequate. If this describes you, there are a few relatively simple, but quite important, steps you can take.
First, some preliminaries. Before you make your initial investments, you should make sure you have enough money saved in an emergency reserve so investing is prudent rather than foolhardy. If you don't, you are gambling that no unexpected occurrences will force you to withdraw funds from your investments at an inopportune (money-losing) moment. Take your pick as to how you define your emergency reserve. You might take a less traditional approach -- by simply thinking through how you would cope in case of a financial crisis. Even if you are laid off and fell ill simultaneously, perhaps your family support network is so strong that you would be provided for without any financial drain. Or, in such an emergency you might need your own funds, which you keep tucked away in a money market fund. In case you take the traditional approach, here are two traditional definitions of an emergency reserve fund from two personal finance writers:
"(U)ntil you have at least $5,000 or $10,000 someplace safe and liquid, like a savings account – unless you are so wealthy you don't have to worry about the contingencies of everyday living – you are crazy even to consider making riskier investments." (Andrew Tobias, The Only Investment Guide You'll Ever Need, Harcourt Brace & Co., New York, 1996, p. 60)
If you are running a balance on your credit cards, "your first priority should be getting rid of that debt. Then build a reserve fund of 3 to 6 months' living expenses in a bank or money-market mutual fund. With a fully funded reserve, you can start putting extra money into … longer-term savings and investments." (Jane Bryant Quinn, Making the Most of Your Money, Simon & Schuster, New York, 1997, p. 172)
If you have difficulty establishing an emergency reserve fund because your spending is out of control, those personal finance books by Tobias and Quinn, among others, can help you with budgeting and trimming unnecessary expenses, The following Web sites also might help: Ask Cash Flo, Kiplinger.com (Search for “budget”), and Quicken.com (the Saving and Spending section).
Step 1: Lining up money to invest
You’re now ready to select which money you will invest. If you can only invest chunks of cash sporadically, as they become available, do so, if that's the best you can manage. But you would be better off if you made your investments in regular installments. Even better, your employer may let you invest in regular installments that are deducted automatically from your paycheck. Best of all, your employer might match some of what you deduct. If your company offers this benefit, take advantage of it. Regarding employers' matching funds for employees' retirement accounts, heed what Tobias says: "This is free money. If your employer offers a deal like this and you're not taking full advantage of it, you're an idiot. (Well, I'm sorry, but c'mon: if your local bank decided to give out free money to attract deposits – say, $500 for each new $1,000 – there would be riots in the streets, so eager would people be to get in on it.)" (Only Investment Guide, p. 90.
Step 2: Setting your goals
Define the specific goal or goals you are investing to achieve – a house, your child's college education, retirement? The appropriate type of investment will vary, depending on how much time will elapse before you need the money. If you have several investment goals, you should make separate investment decisions for each and keep track of each block separately.
Step 3: How much risk can you stand?
Determine your level of risk tolerance, beginning by learning about the various types of financial risk that exist in the world, from inflation risk and default risk to the unpredictable variations of individual stock and bond prices. You may start out thinking that you'd be uncomfortable with anything riskier than a bank CD, but you may change your mind after you consider the long-term risks of such low-yield investments. As Wall Street Journal personal finance writer Jonathan Clements states, "(O)ver the long haul, … stocks actually seem safer because they are more likely to make you decent money, while bonds and money funds find it tougher to stay ahead of inflation, taxes and investment costs." (The Wall Street Journal, April 28, 1998. Page C1.) Andrew Tobias gives the same advice: "a very basic thing to know about your money is that, over the really long run, people who buy equities – stocks – will almost surely make a lot more money (if they're at all sensible in how they do it) than people who make 'safer' investments." (Only Investment Guide, p. 60) To help you think through your attitude to investment risks, Princeton University Economics Professor Burton G. Malkiel provides a risk-tolerance quiz in his book A Random Walk Down Wall Street. (W.W. Norton & Co., New York, 1996, pp. 414-415). A more accessible, though less sophisticated, risk-tolerance test is available on the MSNBC/CNBC site.
Step 4: Dividing up the money
Calculate how best to allocate your money among various types of investments, such as stocks, bonds and CDs. With properly allocated investments, you can achieve the same level of returns at a relatively lower risk than if you concentrated your investments in one category. That's because the prices of different investment categories don’t move in sync – and you can benefit from that fact. If you own some stocks and some bonds, for example, not all of your holdings will be at risk when stocks are up and bonds are down, or when the opposite is true. In the long run, you will have cut your losses without a comparable cut in your profits – a net win at a lower risk.
Don't skip this step because you’re put off by the phrase "asset allocation," which admittedly sounds mind-numbingly dull. Studies have shown that whatever decision you make about asset allocation, it will be by far the dominant factor in determining what you get out of your overall investments. Don't look for a one-size-fits-all allocation formula, such as those that some brokerages publish. The proper percentages for you will depend on your tolerance for risk and how much time you have until you need to withdraw money from your investments. For more suggestions about asset allocation, you can turn to any of several Web sites, or refer to Malkiel (p. 420 ) or Quinn (p. 595).
Step 5: Dividing up the money more finely
Determine how you will diversify your investments, which essentially means not putting all your eggs in one or two baskets. For stocks, you can accomplish this easily by investing in mutual funds. "Too many investors bet too heavily on just one or two stocks," warns Clements in The Wall Street Journal. "Sure, that may mean handsome gains. But if you bet wrong, you could suffer losses you will never recoup. The solution is simple enough. Use mutual funds to spread your money among a good number of stocks in a variety of market sectors, including large, small and foreign stocks." (WSJ, April 28, 1998, p. C1.) As Fidelity Investments veteran Peter Lynch puts it, “Diversify, diversify, diversify.” He recommends buying several different types of mutual funds for diversification beyond what one type of fund could provide.
Step 6: Taking the plunge
Start making the investments you have decided on. You'll want to make them through a reliable institution that charges low or no fees. Don't think you need to wait to invest until you find the very lowest-priced deal on an investment with the very highest expected return and absolutely the most advantageous tax consequences. The sooner you start investing, the more you’ll find that time is on your side. For children and young adults, the time advantage is astounding -- at 9 percent interest, $100 invested today will turn into $3,611 in 40 years. Using different rates and different time spans on a simple investment calculator, you can quickly convince yourself not to delay, even if you’re not confident that you’ve found the very best investment for you. You can move your money around later, as you become more savvy about the world of investments.
Step 7: Checking back later
Every 12 months or so, reassess your financial position and your progress toward your financial goals. Make adjustments, as appropriate.
Monday, September 22, 2008
Investing
Do you hear co-workers or friends talking about their investments and wonder how they got started? How'd they come up with the money to invest? How'd they know what to invest in? Many people don't know where to start, so they never start at all.
The vast amount of information about investing, the wide array of investment choices, and the risk are intimidating and can prevent you from taking those first steps. It doesn't have to be that way. You only need to know a few basics in order to begin investing in your future.
Basic Assumptions
First, some assumptions. This article assumes you have your credit card debt under control. It makes no sense to invest in stocks, bonds, or mutual funds if you have thousands of dollars in credit card debt at interest rates in excess of 10%. You don't have to be completely debt-free, but you should be making serious inroads into your debt each month, and you should be paying very low interest rates on that debt.
This article also assumes you have an emergency fund of at least three months worth of basic living expenses (preferably six months worth) in case of a job loss, disability, etc. And finally, this article assumes that if your employer offers a 401(k) plan, you're maximizing your contribution and diversifying your investments in the plan.
Where Do I Find the Money to Invest?
The first question for many people is "where do I get the money to invest?" There are plenty of stock mutual funds that allow you to invest with $500 or less. Use your next bonus at work, or your income tax refund, or put in some overtime for extra cash. If you just can't come up with $500 to start your portfolio, many funds will allow you to skip the initial lump sum investment if you sign up for automatic monthly withdrawals of $25 to $50 from your checking account.
How Do I Choose an Investment?
You're ready for some long-term investments. How do you choose? The first step is to know what your goals are. Are you saving for a house? A college education? Retirement? The type of investment you choose will depend on the amount of time available before you need the money. Stocks are considered long-term investments, and it's best to plan on holding stocks or stock mutual funds for five years or longer. If you need the money sooner than this, you may reduce your return by cashing in when the stock's value is down.
How Do I Determine My Risk Tolerance?
Next, you need to know your risk tolerance. If you hide your money under your mattress because you don't trust the bank, then you're probably not going to feel comfortable investing in volatile technology stocks. CNBC's Investment Risk Test can help you determine what level of risk you can tolerate.
How Do I Choose an Investment?
How do you decide where to put your money? Most experts recommend spreading your money over several different types of investments to reduce risk, because typically one type of investment does well when another doesn't. For example, usually when returns on stocks and stock mutual funds are high, returns on bonds are low, and vice versa. By having money in both types of funds, you're more likely to get a decent combined return if one category takes a downturn. Your asset allocation should be tailored to your risk tolerance and the number of years before you'll need to withdraw the money from your investments.
For beginning investors, I recommend stock mutual funds instead of stocks in individual companies. Why? It's all about risk. A well-chosen stock mutual fund is less risky than an individual stock because mutual funds invest in many companies, thus spreading out the risk. If one company does poorly, the fund as a whole may still have a good return. If you buy stock in one company and the company does poorly, you lose money.
Where Do I Find Information About Stocks and Mutual Funds?
Once you're ready to start choosing a fund to invest in, there are many excellent Web sites to help you. My personal favorite is Morningstar, the respected mutual fund rating company. Their powerful Fund Selector allows you to search for mutual funds based on what's important to you. For instance, if you want a list of funds that allow initial investments of $500 or less, you can click on the appropriate box, leave all the other boxes as is, and you'll get a list of funds that accept initial investments of $500 or less, with their YTD return, expense ratio (the amount of administrative and other expenses that the fund manager deducts from your return each year), their Morningstar rating, and more. Click on an individual fund name and get detailed information about that fund.
Once you've chosen a fund you feel comfortable with, call their 800 number and request a prospectus (a description of the fund, its investments, and the returns it's earned in the past) and an investor's kit. Fill out the form, send in your money, and voila! You're an investor.
The vast amount of information about investing, the wide array of investment choices, and the risk are intimidating and can prevent you from taking those first steps. It doesn't have to be that way. You only need to know a few basics in order to begin investing in your future.
Basic Assumptions
First, some assumptions. This article assumes you have your credit card debt under control. It makes no sense to invest in stocks, bonds, or mutual funds if you have thousands of dollars in credit card debt at interest rates in excess of 10%. You don't have to be completely debt-free, but you should be making serious inroads into your debt each month, and you should be paying very low interest rates on that debt.
This article also assumes you have an emergency fund of at least three months worth of basic living expenses (preferably six months worth) in case of a job loss, disability, etc. And finally, this article assumes that if your employer offers a 401(k) plan, you're maximizing your contribution and diversifying your investments in the plan.
Where Do I Find the Money to Invest?
The first question for many people is "where do I get the money to invest?" There are plenty of stock mutual funds that allow you to invest with $500 or less. Use your next bonus at work, or your income tax refund, or put in some overtime for extra cash. If you just can't come up with $500 to start your portfolio, many funds will allow you to skip the initial lump sum investment if you sign up for automatic monthly withdrawals of $25 to $50 from your checking account.
How Do I Choose an Investment?
You're ready for some long-term investments. How do you choose? The first step is to know what your goals are. Are you saving for a house? A college education? Retirement? The type of investment you choose will depend on the amount of time available before you need the money. Stocks are considered long-term investments, and it's best to plan on holding stocks or stock mutual funds for five years or longer. If you need the money sooner than this, you may reduce your return by cashing in when the stock's value is down.
How Do I Determine My Risk Tolerance?
Next, you need to know your risk tolerance. If you hide your money under your mattress because you don't trust the bank, then you're probably not going to feel comfortable investing in volatile technology stocks. CNBC's Investment Risk Test can help you determine what level of risk you can tolerate.
How Do I Choose an Investment?
How do you decide where to put your money? Most experts recommend spreading your money over several different types of investments to reduce risk, because typically one type of investment does well when another doesn't. For example, usually when returns on stocks and stock mutual funds are high, returns on bonds are low, and vice versa. By having money in both types of funds, you're more likely to get a decent combined return if one category takes a downturn. Your asset allocation should be tailored to your risk tolerance and the number of years before you'll need to withdraw the money from your investments.
For beginning investors, I recommend stock mutual funds instead of stocks in individual companies. Why? It's all about risk. A well-chosen stock mutual fund is less risky than an individual stock because mutual funds invest in many companies, thus spreading out the risk. If one company does poorly, the fund as a whole may still have a good return. If you buy stock in one company and the company does poorly, you lose money.
Where Do I Find Information About Stocks and Mutual Funds?
Once you're ready to start choosing a fund to invest in, there are many excellent Web sites to help you. My personal favorite is Morningstar, the respected mutual fund rating company. Their powerful Fund Selector allows you to search for mutual funds based on what's important to you. For instance, if you want a list of funds that allow initial investments of $500 or less, you can click on the appropriate box, leave all the other boxes as is, and you'll get a list of funds that accept initial investments of $500 or less, with their YTD return, expense ratio (the amount of administrative and other expenses that the fund manager deducts from your return each year), their Morningstar rating, and more. Click on an individual fund name and get detailed information about that fund.
Once you've chosen a fund you feel comfortable with, call their 800 number and request a prospectus (a description of the fund, its investments, and the returns it's earned in the past) and an investor's kit. Fill out the form, send in your money, and voila! You're an investor.
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