Begin With The Goal

A better strategy for investment success is to find out how much risk must be taken to reach the goal. By starting with the amount of money you have now and calculating the length of time and cost of the goal, investments that reach the objective will become evident.

This process helps prudent investors evaluate investments and decide if they can stomach the risk needed to take to reach the destination. If not, there are some important decisions to make. Should you retire later or retire on less money? If it turns out that you need to accept more risk in the portfolio, use these tools to help preserve your capital and sanity.

Stop Losses

Investors who fear their stocks will plummet the second they walk away from the computer love stop losses. These allow conservative investors to lower the chance they’ll experience huge losses in their positions. Stop losses are a trade placed below the current trading price that only executes if the stock drops to the predetermined point.

While stop losses are good, they don’t guarantee you’ll get the price at which you place the order. Once this price is met it triggers a market trade. In a fast-moving stock market this preventative measure still could execute a trade far below the stop loss point.

Some investors in mutual funds would love to have stop losses on their account. Unfortunately, stop losses don’t exist for mutual funds because they only trade once per day after the market has closed. This isn’t a problem for patient investors who expect long term results, not daily rises in their account value.

Quarterly Meetings

Reviewing a portfolio’s performance quarterly is recommended by many financial experts. Compare mutual fund manager’s returns the past quarter to the competition. If the market is down, the portfolio may also be down, but shouldn’t have returns significantly below common benchmarks. Finally, compare the portfolio’s results to the end goal to see if objectives are being met.

Although quarterly reviews of your portfolio won’t automatically fix financial account problems, staying on top of financial accounts can help ease worries about a portfolio’s direction. It’s easy to think of the financial markets as magical when you don’t follow them on a daily basis. However, as you learn how investments work, it’s not hard to begin to understand downside risks and monitor those areas closely that are threats to the portfolio.

Annuity Provisions

Some investors hoping to be more aggressive with their investment strategy but worried about market downturns look to annuities. These can be attractive investments for investors with a low risk tolerance because of the insurance provisions offered inside of these tools.

Equity indexed annuities allow investors to lock in a portion of the gains enjoyed by the financial markets. The contract helps nervous investors unsure about the market because indexed annuities eliminate the risk of loss when financial markets tumble.

Variable annuities offer investments in stocks and bonds that often gyrate with the roller coaster activity of the stock market. However, investors with a low risk tolerance can purchase riders such as a guaranteed minimum withdrawal benefit. This rider allows variable annuity owners to withdraw funds from their account during retirement while guaranteeing that the contract holder won’t outlive their funds.

Cash Reserves

Investors nervous about investments are often afraid that funds won’t be available when a financial need arises. If this investor prudently places enough money in cash reserves to ride out a downturn in the financial markets, they can feel safer about taking risks with longer term portions of the portfolio.

Cash reserves are liquid but offer paltry returns. Successful investors find creative ways to boost returns while keeping cash reserve funds out of the financial markets. One method often used is to ladder CDs. An investor buys a one year CD once a quarter for a year. At the end of the year, if the investor had no need for cash, she has money coming due every three months and a significantly higher interest rate than a savings account.

Investors worried that their ability to sleep will be impacted by their portfolio should look into one or more of these options to control risk. Frequent portfolio reviews help investors stay on top of trends so they feel more comfortable with the many risks inherent in even conservative investment strategies. Large cash reserves shield riskier investments from being touched during protracted market downturns. Annuity provisions and stop losses are automatic levers that an investor can use to minimize downside risk to a portfolio. A few of these used by a conservative investor can have them sleeping soundly in no time.

Because everyone has different goals, there is no golden risk reduction strategy that works for every investor. By starting with your goals and deciding which risks you’re comfortable taking and which need to be minimized, you’ll create the perfect plan.

Write Out What You Want From a Broker

What are you trying to accomplish? Are you investing a large sum of cash into a single account or have a few smaller accounts that need a home? Do you often need help with forms and tools or work well alone? How often will you make transactions into our out of the account? Is research from the site important or do you prefer third party data found elsewhere? Answer each of these questions on a clean sheet of paper to begin finding the right home for your money.

Range of Investment Options

If you’re only interested in domestic stock trading, the vast majority of equities will be available to every brokerage service. Firms operate a separate platform for mutual funds, exchange traded funds, bonds, precious metals, real estate investment trusts, annuities and certificates of deposit. It’s not fun to be surprised when the broker can’t deliver expected services. Ask each online broker for a list of available investments.

Availability

Although you never want to make panicked trades, there may come a time when investments need to be moved quickly. If your broker’s site is down for maintenance or functions slowly, trades could slip away.

Visit your prospective broker’s site at different times over several days and click around. Watch how fast the site loads. Activity is highest in the first and last hour of normal trading days, so focus on those hours. If the site doesn’t respond quickly or is frequently down, you’ll want to look elsewhere for an online broker.

Sometimes you have questions that aren’t answered on the website. In this case, you’ll be forced to call the broker’s help line and ask questions. How prominently displayed is the help line phone number? Call the number listed and visit several menus. If the broker has a convoluted phone menu system, this may not be the service for you. Call the company’s help desk and dream up a question. If the help desk operator is less than helpful, move on to the next broker.

Flexibility

Online brokerage firms are fantastic while you’re seated in front of a computer monitor, but what happens when you’re on vacation? If you plan to be away from the computer screen at all, explore each of the methods a service offers to place trades. Many firms now offer smart phone applications, fax trading, and telephone trades with a live representative. These trades may be at an additional cost, so inquire about these fees.

Investing Tools

Some brokers brag about low fees because they offer stripped-down services and tools. If you want one-stop shopping for research and portfolio construction, review the broker’s toolset. Look for third party research offered through the site that originates from several reputable firms. Play with the site’s financial planning tools. Investigate whether how easy it is to find news and fundamental statistics on company stocks. Evaluate filters, fund analyzers and trading tools to find the one that best suits your needs.

Banking Services

You’ll need a firm offering robust banking services if there will be frequent transactions in and out of the account. Some brokers offer ATM and credit cards that link to the account, while others forgo these features. Some offer check writing, but may have stipulations on the number or amount of checking transactions. These services aren’t always free. If a firm offers attractive banking benefits find out how much money you’ll have to pay to enjoy these services.

Think twice before exploring the use of your brokerage account as a primary banking account. Many have draconian means to fund your account and don’t process deposits until your check clears. Explore direct deposit and instant access to funds, and ask about banking features that don’t limit the number or size of transactions. Review the company’s web support. You’ll want to be able to check your balance on the fly and balance the checkbook without a hassle.

Trading commissions

Lower cost doesn’t mean a better brokerage service, but fees still matter. After you’ve researched everything else, compare each brokerage’s schedule of charges. If two brokers seem similar on other important features, choose the one with lower fees. However, beware the low cost provider that doesn’t have features that you’ll need later. You’ll find yourself saving a few pennies and screaming at your computer screen.

New investors are often better served by an online brokerage service linked to a full-service operator. Because new investors often have many questions, the hand-holding these firms are designed to provide can be invaluable when you first begin. Remember that you’re paying for service. The moment you learn how the ropes work, investigate moving your account to a company with lower costs.

Online brokerage accounts spend lots of money advertising lower prices, but for many investors price is the last feature they should explore. By starting with a list of goals and working through the features each broker offers, a wise investor will find something better than the best online broker. They’ll discover the best online broker for their particular goals.

What is a bond?

A bond is an obligation between a company or government and a lender. Buyers of bonds own the right to collect a debt from the company or government issuing the note. Like a mortgage, bonds have a pay-off date, interest rate, and may have periodic payments of interest or principal until the debt is repaid.

Length of the bond

The day the issuer must repay the loan is called the maturity date. This may be as far away as thirty years, but is often five or ten years. When deciding on which bonds to buy, investors review contract terms to know the length of time until funds are repaid. Investors classify bonds as short term, intermediate term, or long term obligations. Most analysts categorize intermediate term bonds as those between one and 15 years long. Short term bonds are loans of less than one year while long term bonds have maturities longer than 15 years.

Although investors often sell bonds on the open market before the maturity date, they can be assured that the issuer will repay by the maturity date to avoid defaulting on the loan. The issuer repays the same amount originally borrowed, plus any interest due, but this may not be the same amount of money that the investor originally paid for the note. Many investors buy bonds on the open market for prices different than the amount originally borrowed.

Early repayment

The first date that a company may repay a bond is known as the call date. These are important to investors for a variety of reasons. Persons investing cash to receive a stream of interest payments want to make sure that they won’t have their funds returned quickly, forcing them to find a new bond. Investors hoping for capital gains will purchase a fund near the call date below the repayment amount, hoping to make some quick money. Any investor purchasing debt beyond the call date knows that a company may repay the loan at any time.

How to tell what a bond is worth

The amount of money that the company originally borrowed is called the par value. Most bonds count their debt in $100 increments, although preferred stocks—actually a form of bond—have a par value of $25. By knowing the par value of a bond, the investor can quickly learn if there is the opportunity for a capital gain or risk of loss. If the bond is trading above the par value, the prudent investor knows that the company will return less than the current price when repaying the debt.

This concept of par value is lost on some neophyte investors. Enamored with dividends, some investors only ask the size yield a bond pays. It’s possible that a bond will pay a seven percent dividend, only to still have this money lost when the bond is repaid, simply because the bond was purchased above par value.

Taxes and Bonds

Because stock dividends are paid at a lower rate than normal income, tax-adverse investors will sometimes opt to buy stocks instead of bonds. However, some bonds have tax benefits that a prudent investor should explore before accepting the additional risk of the stock market.

Municipal bonds are tax free loans to city governments. If you live in the same state as the municipality issuing the debt, your money is state and federally tax free. Municipal bonds issued in other states are federally tax free, but are susceptible to state income taxation. Older investors should know that municipal bond income is computed when finding whether an individual will pay tax on Social Security. This may make municipal bonds less attractive persons receiving Social Security payments.

Bonds may be held in an IRA and many variable annuities offer attractive tax-deferred bond investments. These shelters protect investors from some of the tax created by taxable bond investments in a portfolio.

Should new investors buy individual bonds?

Bonds trade in more obscure ways than stocks, so it’s difficult for a new investor to find information about many types of available bonds. Online brokers often allow investors to review bond prices, maturity dates and yields before purchasing, but you may need to visit several brokers before settling on a bond that fits the goal.

Mutual fund or annuity bond funds are attractive options for new investors or those who don’t have the time and energy to track individual bonds. Mutual fund buyers don’t have to worry about par value, call dates, maturity dates or yield on individual bonds. Instead, bond fund buyers can request a prospectus from bond funds of interest and compare funds by length, yield, manager tenure, star rating, and size.

Bonds are an attractive investment for people seeking income from their investments, but who don’t want the risks of the stock market. This doesn’t mean that bonds are risk-free. Investors should always read the company’s credit rating closely before investing. Buying a bond is similar to loaning money to a friend. You’ll want to know their ability to repay before parting with hard-earned dollars.

Begin With Goals

The U.S. Securities and Exchange Commission recommends that investors begin by making a list of goals they wish to achieve in the stock market. This helps avoid searching for the next elusive hot stock and instead focus on the end goal when buying stocks. List the time frame and amount of money needed to reach your goal. This will work as a filter to evaluate stock investments. Many stocks will be either too volatile or staid to fit your needs.

Ultimately, prudent investors need to know how much money each goal requires and what return it’ll take to achieve the goal. This will drive decision making around how much to invest in each stock and what return will be acceptable when monitoring the portfolio. Knowing the return you’ll need each investment to earn is paramount to picking the right stocks. It wouldn’t make sense look at a stock with a history of returning eight percent if the benchmark requires a 12 percent return.

Create a Watch List

Write down potential stock investing opportunities that may meet your goal. This won’t be a final list, but is going to be a place to start filtering. Ultimately, this list will include 40 to 50 companies to begin tracking.

Get to know these companies. Successful investor Peter Lynch preaches a doctrine of “buying what you know.” This means that companies you admire should be on the watch list. Look around your home. What products or services do you use often? These firms should make the cut for the watch list.

By focusing on familiar investments, you’re more likely to comprehend why stocks in the portfolio and watch list fluctuate. It’s easier to comprehend why a product isn’t selling as expected if you own it personally. Sometimes there are forces outside of a company’s control and you may decide to hold onto deflated shares. Other times, the product was inferior and the stock is taking an understandable hit.

Choose the Right Stocks

It takes time and energy to adequately monitor stocks and track news about invested firms. Diligent investors stand a chance of finding the next Google or Microsoft. If management decisions linger, the portfolio suffers because you didn’t react quickly enough to changing market conditions.

For some investors who are busy with other pursuits, mutual funds are a reasonable method of investing in stocks. Mutual funds diversify invested cash among many different stocks of a similar type. This helps you avoid the financial risk of a collapse to a single stock because the fund holds many stocks rather than only a handful.

Research Investments

Stock researchers use two different types of analysis: fundamental and technical. Fundamental analysis covers the management acumen and products of the company. If a company creates good products and makes a profit, stocks usually rise. Technical researchers track stock chart patterns. Stocks that rise tend to continue to rise. Stocks often will move based on trading patterns. Although some fundamental analysts believe tracking technical charts is a little like trying to read tea leaves, enough people believe and follow technical analysis that it often works.

To perform analysis, you’ll need to find out the basics of a company’s performance and track charts. Request from each company on your watch list detailed information, such as an annual report. Separate stocks based on earnings, revenues, recent chart performance, dividends, and market sector. If using mutual funds, ask each fund family for a prospectus and sort funds based on performance, manager tenure, expenses and investment category.

Know When To Fold

Sometimes investments don’t perform the way you’d envisioned, and selling is the only smart choice. A basic stock investing strategy that many otherwise successful investors forget is to have a sell discipline. Review the portfolio goals to know how much fluctuation your stocks can experience before underperforming stocks must be sold to preserve the cash value. If you own mutual funds, monitor each fund’s manager at least semi-annually to ensure they’re keeping up with other managers in the same category. Review each category and decide whether it still meets your investment goals.

Investors with individual stocks often use a tool called a stop loss to sell investments that are in retreat. Stop losses are orders to sell an investment if it reaches a predetermined trigger below the current trading price. Investors like stop loss orders because they allow you to step away from the computer screen without worry that a stock will plummet while you’re not watching.

In the end, most investors decide whether to buy based on a gut decision. However, by starting with a clear set of goals, choosing stocks based on those goals to watch, and finally weeding your watch list by using fundamental and technical research, you’re likely to pick stocks that meet your objective. By employing a solid sell strategy, you’ll hold onto gains and ensure that the portfolio keeps marching toward your end goal.

Set Goals

The National Endowment for Financial Education recommends that any diversification of investments begins with a discussion of goals. How you decide to diversify depends on where you want to end up. To diversify appropriately, make sure investments in the portfolio have a specific time frame that matches your goals.

While stocks are good investments for long term savers, they fluctuate too much to be useful for short term goals. Conversely, guaranteed investments such as money markets are good ways to protect short term opportunities, but have returns that are easily beatable for long term needs.

Compute the specific amount of cash needed to reach each goal. This amount, when compared to the starting nest egg, will help you compute how quickly investments need to grow. In essence, you’ll know whether to choose an aggressive or conservative mix of diversified investments.

Investment Correlation

Often, investors think they’re diversified because they have a mix of many different mutual funds or stocks. Surprisingly, many funds hold similar stocks. Likewise, many stocks move in tandem.

If you hold Exxon Mobil stock, any other oil company would add little diversification to the portfolio. Likewise, because Exxon Mobil is in the S&P 500, any other stock in this index wouldn’t diversify a portfolio as much as a stock in a mid-cap or small-cap index. Exxon Mobil, as an international conglomerate, also fluctuates based on international pressures, so this stock doesn’t help balance a portfolio against international companies as much as one that only operates domestically.

Because Exxon Mobil is in the oil business, it isn’t surprising that there is a strong correlation between the fluctuations of Exxon Mobil stock and oil prices. Investors seeking diversification by adding a natural resources fund to the portfolio will find that precious metals and timber fan out the portfolio risk more than adding funds with oil or gas.

Use this approach with each position in the investment portfolio to determine how much correlation there is among investments. Identify holes that’ll need to be plugged and overlapping investments that should be sold.

Move Outside your Comfort Zone

Often, diversification means exploring areas of the investment landscape you hadn’t considered. A recent ABC News poll revealed that 89 percent of the 77 million people lumped as “baby boomers” in the United States didn’t think they were on course for retirement. People hoping to send children to college or save for a first home also often find themselves with more goals than money. If you need to be aggressive about diversification, carefully plan out some calculated risks if reducing the end goals doesn’t seem to be a good idea.

To remain aggressive, skilled investors research many different investment categories to avoid large bets. Instead of taking a single risk in a hot sector such as technology, wise investors diversify risk into several different categories. That way, if one investment sours, the rest of the bets in the portfolio don’t fall prey to the same problem.

One investment category that some investors find uncomfortable is precious metals. On their own, precious metals fluctuate much more than stocks. However, studies have shown that a small allocation of precious metals added to a diversified portfolio can return significant results. In a 2007 study commissioned by the CFA Institute, researchers found that purchasing the stocks of precious metals companies added significantly to the returns of portfolio over the last 35 years.

Precious metal stocks move much differently than those of the S&P 500. Often when major markets fall, precious metals shine. At the same time, when the S&P 500 performs well, precious metals don’t necessarily fall. Instead of a negative correlation, precious metals are attractive to diversifiers because they have little correlation to the standard fare found in most portfolios. Explore other categories to diversify among which spread risk. Some of these include real estate stocks, high yield bonds, and small company stocks.

Tax Diversification

Some investors do a wonderful job of diversifying investments to shoot themselves in the foot with a lack of tax planning. A person investing only in a 401k plan is going to suffer huge tax consequences when withdrawing retirement dollars. Although the investor received nice tax treatment while saving, withdrawal options are minimal. A retired investor with only a 401k to draw from can either take funds to buy groceries and pay taxes to get the money, or avoid eating. There is no tax relief when funds are removed from this plan.

Individuals should also explore Roth IRA plans, tax-free investments and tax deferred annuities to achieve a well-rounded portfolio designed to create tax benefits while savings and when withdrawing assets.

Before embarking on a diversification plan, write down some goals. These will ensure you’re spreading assets to better achieve goals than simply to avoid having too much money in a single investment. Explore overlap in your current investment strategy, round out your portfolio with new categories that better spread the risk, and align your tax shelters with long range plans. Once you’ve accomplished this, you’ll be not only diversified but also on track to meet your goals.