9. Choose your Ratio
Investments can be divided roughly into two categories, those whose value is fixed, and those whose value can vary. Bonds with high ratings, CDs, and Money Market Funds are examples of investments whose value is generally predictable. Stocks will lose and gain value on a daily basis in an unpredictable way. The key to managing risk in a portfolio is to choose the ratio between those investments whose value is predictable, and those whose value is not. The more of your portfolio that is taken up by investments whose value is predictable, the lower your risk. Unfortunately, under most circumstances, that also means your returns will be lower. Once you’ve chosen this ratio, it’s easy to look at your portfolio to determine whether your investment choices represent the right level of risk. There are two major factors that go into choosing this ratio:
- Your tolerance for risk. If you rely on your investments to pay your daily expenses, you’d probably want lower risk than someone who has extra money to invest.
- When you need the money. If you’re saving up something you want to buy next year, you’ll want your money in investments that do not fluctuate. If they routinely gain or lose value, you risk having them worth less on the day you need the money. On the other hand, if you’re in your 30s saving for retirement, for example, you won’t need the money for another 30 years. Since win-win investments tend to go up over time, you’re not as concerned about frequent fluctuations.
It is possible to find tools on the Internet for calculating your ideal ratio. It’s also something a competent investment advisor will help you choose.
10. Focus on fees
All investments have fees. The people who make their living in the financial world are paid through fees that are collected as part of the investment process. Your financial advisor will charge a fee for buying or selling an investment and if you own shares in a mutual fund, the fund will collect a fee to manage its assets. Mutual funds are attractive and important because they allow you instant diversification. You don’t want to concentrate your stock investments only in a few companies (if one of them runs into problems you lose money from bad luck). However you don’t want to spend all your time researching whicht companies deserve your financial backing. Mutual funds will do that work for you and provide you with a diverse array of stocks while you only need to buy one type of share. However, they charge you for that service in the form of a fee. Often it’s taken out of the investment returns so you don’t see it, but know that it is there. Fees have a very strong effect on the investment return you get from a mutual fund. When you buy a mutual fund it pays to research the level of fees it charges. Funds are required to disclose their fees. Often funds with lower fees will offer the best return among those funds with the same objective. There are mutual funds that put no money into figuring out what investments to include. Instead they hold exactly those investments that make up the index for that particular objective, i.e. the investments whose values are used by the financial industry to determine how investments in that category are doing. These funds have much lower fees because much less is required to manage those funds, so they are popular with many investors. Examples of these type of funds are index funds and SPDRs.
11. Paying off loans is often your best investment
If you have debt, whether it be student loans, a mortgage, or credit card debt, it is often the case that paying off the debt is a better investment than any other kind.
- It is risk free – In contrast to stocks and even bonds, you are guaranteed to be given a return on your investment.
- Tax advantages – You need to pay taxes on investment return. If you earn $100 on a $1000 investment, that $100 is normally considered income and subject to some sort of tax. On the other hand, if a $1000 investment saves you $100 in interest, you don’t need to pay taxes on that savings. (For some types of loans, such as home mortgages, the interest can be deducted from your taxes, so this advantage wouldn’t apply).
Many investment advisors encourage their clients to borrow money (with interest) to invest at a higher return than the interest being paid. This may sound like a good idea and easy money, but I don’t agree. You are making an investment that earns less than investments of similar risk, by the amount of interest you need to pay. In other words, you have the worst of both worlds: the lower returns of less risky investments but without the lower risk.
12. Avoid unsecured debt
This could be more simply stated, don’t carry balances on your credit cards. Don’t charge anything to your credit card that you are not already able to pay off. Credit card interest is many times that of other types of loans. The reason for that is that you are offering nothing to guarantee you’ll pay. For a home equity loan, in contrast, the bank can sell your house if you default. For a car loan, the finance company can repossess and sell your car to pay off a delinquent loan. But credit card companies have nothing to sell, so they charge high interest rates to make up for the fact that they lose money on a much larger percentage of loans. This isn’t really investment advice, but it probably is the single most important financial tip to hang onto your money.