Smart Saving and Investing

When you invest, you are taking some risk.

So if you think you don’t like risk or you think you don’t have any risky investments, then look again. You are taking some risk when you invest.

Below are 10 attributes of Investment Risk:

1. Market Risk

This is the ups and downs of the market. Lately, this has made a lot of folks sick. The sicker it makes you feel the more you should look at your portfolio and adjust it so you can handle the wild swings of the market. This could mean that you invest a higher percentage of your portfolio in bonds.

2. Inflation Risk

The cost of living goes up. If you invest in something that returns 2% and inflation goes up 4% then you’ve lost 2% of the value in your investment. My parents and parents-in-law thought they would be able to live their retirement years with $100,000.00. Back then, 1930s thru 1940s, $100,000.00 made people feel they were rich forever.

3. Opportunity Risk

Opportunity Risk is when you decide to invest in one type of investment, you’re also deciding not to invest in others. So if you commit money to a certain investment and it goes down in value, you’re stuck in that investment and are not able to participate in another investment that might be more attractive.

This is especially apparent when you purchase your own bonds for instance. You could be stuck in a 10-year bond and you want to get out because of high interest rates. You would then be forced to sell for a loss. It’s much better to invest in bond funds because the fund manager has the ability to invest in many different types of bonds.

4. Reinvestment Risk

Reinvestment Risk has to do with timed investments like CDs and bonds that you purchase yourself. A mutual fund manager has the ability to diversify a portfolio of these types of investments by selecting from a larger basket of different types of CDs and bonds to reduce the risk.

5. Concentration Risk

Diversification, Diversification, Diversification. Don’t concentrate your investment dollars in one type of investment. Read my article here on Diversification.

6. Interest Rate Risk

When the Fed messes around with the interest rates moving them up and down, the markets react. The value of bonds go up when interest rates go down. The value of bonds go down when interest rates go up. Keeping a well diversified portfolio will reduce the affects the Fed’s have on your portfolio.

7. Credit Risk

“The Credit Crunch” is what we’ve been in lately. The financial sector has taken a hit. The financial sector includes lenders like Countrywide Bank. On another note, I’m watching that sector with everyone else because it just might be getting ripe to pick. Since I write about options at this site that’s how I’d play it if something comes up that looks interesting.

8. Marketability Risk

Having the ability to sell you investment(s). This pertains to a low interest in stocks, bonds or CDs that you may personally own. By “low interest” I mean not enough buyers. This is reduced immensely if you invest in a mutual fund.

9. Currency Translation Risk

The value of the dollar goes up and down in the international market depending on what country. This is one reason why it’s good to just have 10% of your portfolio in the international market.

10. Timing Risk

The market goes down and you feel uncomfortable about it so you sell one of your investments that you shouldn’t sell - bad timing.

What to do

Invest in mutual funds and you’ll reduce a lot of this risk. Not completely, but enough to make you sleep at night while your money is working hard for you.

written by Bill Stevens

Are you diversified? What is Diversification? In the context of this blog, diversification has to do with your portfolio. Yea but what’s a portfolio?

View a portfolio as a big empty box. We’ll put stuff in this empty box to make up our portfolio. Let’s pick one mutual fund and take a look inside. We’ll pick the Hodges Fund, symbol HDPMX.

I talked about the Hodges Fund in my What is a Mutual Fund? article. If you look at their top 25 holdings they publish every week, some of them include the following:

• Cisco (CSCO) - Telecommunications
• Union Pacific Corp (UNP) - Railroads
• ConocoPhilips (COP) - Integrated Oil & Gas
• Costco Wholesale Corp (COST) - Broadline Retailers
• Legg Mason (LM) - Investment Services

Are you seeing the diversification here - Telecommunications, Railroads, Oil & Gas, Retailers, Investment Services. You should be thinking, hey, the one mutual fund we’re talking about is diversified.

In this example, diversification is owning a bit of stocks in many different sectors or industries. So yes, the mutual fund itself is diversified and we haven’t even put it in the box yet, our portfolio. So let’s put it in our portfolio.

The more we diversify our portfolio, the more resilient our portfolio will be to the crazy market swings that we’ve been seeing lately.

The beauty of this for the small investor who doesn’t have tons of money is that the mutual fund offers instant diversification.

Diversification reduces the risk and volatility of investing directly in stocks and bonds which usually don’t move up and down in the same direction at the same time.

If one type of investment is going up and the other is going down, your portfolio or in some cases, just your mutual fund is less volatile.

Now, imagine putting an International Fund into your portfolio. How about a sprinkling of a small cap value mutual fund and a small cap growth mutual fund. Keep going with a large cap value and a large cap growth mutual funds. That’s many levels of diversification within your portfolio.

written by Bill Stevens

Here are The Five Core Asset Classes Every Portfolio Should Have:

1. Large Growth - Large Company Growth
2. Large Value - Large Company Value
3. Small Growth - Small Company Growth
4. Small Value - Small Company Value
5. International

In addition to that you might add some of the following depending on your investment goals:

• Bond Funds
• Balanced Funds
• Sector Funds

written by Bill Stevens

If you’re one of the many folks who invests in index funds or are thinking about investing in them, then here’s a portfolio for you to own or to compare your current portfolio to. We’ll keep the following allocation that we’ve been talking about in other posts:

Large Growth - 35% (1 fund)

Large Value - 20% (1 fund)

Small Growth - 20% (1 fund)

Small Value - 15% (1 fund)

International - 10% (1 fund)

The 2007 Index Portfolio

This is an allocation with suggested index funds you could use when signing up for your employer’s retirement plan. However, your employer’s retirement plan would have to offer the Vanguard family of funds. I would use this allocation for anyone under 50 before looking at adding Bond funds to this portfolio.

Index funds track the market performance and their category’s performance. In this case, categories would include our allocation types - Large Growth, Large Value, Small Growth, Small Value, and International.

Here’s a table of the returns on these funds. Returns are what you would make on your money when invested in these funds. So if you invested $10,000.00 over a long period of time, your money would “make money”.

Let’s say 10 years later you decided to cash out (sell) your funds and received $20,000.00 back after you sold them, then that’s the return on your money. You made $10,000.00 over that time period, 10 years.

The table below expresses those returns in percentages, which is the typical way most investments report their return.

So there you go. These are set and forget (almost) group of index funds that will perform excellently for you over a long period of time making investing in these funds automatically simple in your employer’s retirement plan if Vanguard funds are available or in your Roth IRA.

In a Roth IRA you would have to pay a required minimum deposit and anytime you want to deposit more money into these funds there would be a minimum as well, typically $100.00.

Note: This is a portfolio I would use for myself if I was under 50 years of age and consider myself an indexer. I would look at adding a bond fund for anyone 50 and over.

The great John Bogle claims a general rule of 20% in bonds if your 20 years old and 70% bonds if you’re 70 years old. He says, others call that very conservative and so he mentions maybe your age minus 10 to give for a bond allocation. So if you’re 20, that would be 10% of your portfolio in bonds.

Of course for indexers, you’d want to have that percentage or some percentage you feel comfortable with in the Vanguard Total Bond Market Index, symbol VBMFX. Bonds make us feel more secure because they’re less volatile than the stock funds that we’ve been talking about.

We’ll revisit bonds at a later date.

written by Bill Stevens

To describe an Index Fund I’ll use the classic Vanguard 500 Index fund, symbol VFINX.

The VFINX fund is made up of stock in the 500 companies that the S&P 500 tracks. You would own a piece of all the 500 companies in the S&P 500.

The S&P stands for Standard and Poor’s. Standard and Poor’s is the leading provider of financial market information.

The S&P 500 is a leading benchmark for how the markets are doing. Many funds are compared to the S&P 500 performance. The 500 companies performance.

So if we take a look at the chart from Morningstar below, we can see that red, orange and green lines are stacked on top of one another. How in the heck can you see that if they’re stacked on one another!! Well, trust me.

The red line indicates the VFINX fund and its performance. The orange line indicates the category’s performance that the VFINX is in and the green line indicates the S&P 500 and its performance.

This is a great fund that a lot of folks invest in and it resembles the latest talk amongst those folks who want to make their lives simple by investing in index funds.

Some reasons include:

• The VFINX tracks the market, and we’ve been told that historically the market goes up. So if a person can hold the VFINX fund in their portfolio or as their only holding in their portfolio, and if they can stomach the downs of the market that we’ve been experiencing lately, then that is the promise. This fund will go up with the market and go down with the market. It will never do better than the market. In other words, it will NOT beat the market when the market goes up and it won’t try and lose less than the market when the market goes down. WOW!! What a mouth full.
• The expenses related to the VFINX are extremely low. The fund manager basically doesn’t have to do too much. At Morningstar it’s listed as 0.18%. We’ll talk through the “Express Ratio” in another post. But that is one indicator to look at that will tell you how much it costs to run a fund and the VFINX is good and low.
• The VFINX is considered tax efficient. Why? Because the fund manager doesn’t have to trade in and out of different investments that would cause a taxable event like selling a stock. There would be very little selling since the “makeup” of the fund doesn’t change often.

There is great power and trouble-free worry when it comes to owning the Vanguard 500 Index fund. Through the power of compounding over a long period of time this fund would do good for a lot of folks.

Of course, according to Morningstar it would cost you a minimum of $3,000.00 to get into this fund.

If it’s available to you in your employer’s retirement plan, you would most likely be able to get into this fund without the minimum. Check with your employer.

If you’re interested in holding the VFINX in your Roth IRA, you’re brokerage firm will list the minimum to get into this fund.

Disclaimer: Past performance is not a guarantee for future performance. Even owning this fund you are taking a bit of risk. The risk of the market.

written by Bill Stevens