3 keys to safe and successful investing

An Investor’s Best Friends

Any investor would do well to call on three friends during the course of his or her financial life: diversification, patience, and consis­tency. Regardless of how the markets perform, these practices should be a part of your investment philosophy.

Diversification: a key to safe investing

The saying “Don’t put all your eggs in one basket” has real value when it comes to investing. In a bear market, certain asset classes may perform better than others. The same goes for a bull market. If your assets are held mostly in one kind of investment (say, mostly in mutual funds or CDs or money market accounts), you could be hit hard by stock market losses, or alternately lose out on potential gains that other kinds of investments may be experiencing. So there is an opportunity cost as well as risk.

This is why asset allocation strategies are used in portfolio manage­ment. A financial advisor can ask you about your goals and tolerance for risk and assign percentages of your assets to different classes of in­vestments. This diversification is designed to suit your preferred invest­ment style and your objectives.

When you look at investing, the goal is to increase your initial in­vestment dollars. This increase represents a return on your initial invest­ment. When discussing returns, the most common language is called financial or portfolio performance. The financial performance of your portfolio will come mainly from asset allocation and investment selec­tion. Studies conducted by Ibbotson Associates, Inc., show that more than 95 percent of an investor’s returns come from asset allocation and investment selection.

Asset allocation is simply the percentage of a portfolio allocated to different asset classes such as stocks, bonds, and cash. Investment selec­tion is the process of selecting choices within each asset class.

While financial markets are by nature uncertain, there are ways to reduce risk. For example, investments can be spread over a variety of companies within a given industry. They can be further allocated to a range of the more conservative asset classes, such as real estate and bonds. Diversification and allocation have been shown to reduce the probability and magnitude of investment losses. A portfolio should always be built upon the prudent concepts of diversification and al­location.

Portfolio Performance (based on Ibbotson Study):

• Asset Allocation 91.5%
• Investment Selection 4.6%
• Other Factors 2.1%
• Market Timing 1.8%

Solomon wrote in Ecclesiastes 11:2, “Divide your portion to seven, or even to eight, for you do not know what misfortune may occur on the earth” (nasb). Divide your wealth (investment capital) into several parts and don’t risk it all in one place. Diversification is essential regard­less of your age, personality, income level, or the time frame involved. As your savings grow, your diversity should grow, too. Diversification does not guarantee safety or success, but it does reduce risk. Make different types of investments: bonds, domestic and foreign stocks, real estate. Mutual funds offer a high degree of diversification within a single fund. Even there, invest in different types of funds: small-cap, mid-cap, and large-cap funds, emerging markets, growth and income, etc.

Here is a sample* illustration:

Asset Allocation Investment Selection

Stocks 45%

• Large Caps 20%
• Mid Caps 10%
  
• Small Caps 5%
  
• International 10%
  

Bonds 30%

• Corporate 15%
• Treasuries 10%
• Municipal 5%

Alternative Investments 20%

• Hedging Instruments 10%
• REITs 5%
• Precious Metals 5%

Cash 5%

• Money market 5%

* For illustrative purposes only.

The most important decisions that you will make in the investment world include those involving asset allocation and investment selection. As you incorporate your faith into your financial plan, this important element will help determine your financial success or failure.

Patience

Impatient investors obsess on the day-to-day doings of the stock market. Have you ever heard of “day trading” or “market timing”? These are attempts to exploit short-term fluctuations in value. These investing methods might seem fun and exciting if you like to micro­manage, but they will add stress and anxiety to your life, and they are a poor alternative to a long-range investment strategy built around your life goals. Some are good at day trading but most people fail at this form of trading. So unless you have specific training in this area, I would look to invest elsewhere.

Consistency

Most people invest a little at a time, within their budget, and with reg­ularity. They invest $50 or $100 or more per month in their 401(k)s and similar investments through payroll deduction or automatic withdrawal. In essence, they are investing on “autopilot” to help themselves build wealth for retirement and for long-range goals. Investing regularly (and earlier in life) helps you take advantage of the power of compounding as well.

Are diversification, patience, and consistency part of your investing approach? Make sure they are. If you don’t have a long-range invest­ment strategy, talk to a qualified financial advisor today.