Investing 101: Even the Mattress Has Risks
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Investing has inherent risk, even for places that seem safe, like putting your money under the mattress or in bonds. You can do several things to protect yourself, including finding a reputable financial planner and spreading out your investments. Click here to view article.
When you hear the word “investing,” what comes to mind? The stock market, Bernie Madoff or do you simply get beads of sweat on your forehead? Every investment, whether it’s burying cash in the backyard or investing in your friend’s latest “get rich” scheme, has an element of risk, no matter what anyone tells you to the contrary. The first rule of investing should be, “If it sounds too good to be true, it probably is.” So walk away or, at a minimum, get a second opinion.
Finding a Financial Planner
When you consider seeking investment advice, you will want to find a competent and ethical financial planner. The Financial Planning Association and the Certified Financial Planner Board of Standards Inc. both have search engines to help you find a financial planner in your area. Both websites also have information regarding the questions you should ask any financial planner from whom you seek help. After getting a name, check with your state insurance and securities regulator for any disciplinary problems.
When you meet with a financial planner, ask for a free one-hour consultation, which allows you to meet the planner, ask questions and share your personal situation. No reputable financial planner will offer a solution at that initial meeting nor try to sell you any product. If he or she does, walk away and never return. Prior to discussing solutions, the financial planner needs to determine your goals, tolerance for risk, cash flow needs and your various sources of income. He or she needs to fully understand your personal situation. Be sure to ask for references.
Safest Place Isn’t Under the Mattress
Some people believe that putting cash under the mattress has no risk, but it comes with its own unique set of risks. Due to inflation, each year the money under the mattress buys fewer goods and services. Although by historical standards inflation has been low the last few years, some predict that as the economy improves, this will no longer be the case. A 3 percent rate of inflation doubles the cost of living every 24 years. So, the first risk you need to consider is inflation risk. Putting money into CDs isn’t much better today than putting it under a mattress, but you have taxes to consider, which is another form of risk.
Over the past several years many investors have sought the safety of U.S. government bonds. During that time, interest rates have fallen dramatically. As interest rates decrease, the price of bonds increases. If you bought a 10-year bond with a 3.5 percent rate of interest several years ago and now interest rates are 1.7 percent, your bond is likely worth more than face value if you sell it. Conversely, when interest rates go up, the price of bonds goes down.
Bond holders may be disappointed as the economy improves and interest rates rise. Their so-called “guaranteed” investment will decline in value. If you own an individual government bond and hold it until maturity you will get full value, but if you want or need to sell the bond prior to maturity, you may have a problem. Thus, when investing in bonds, you must seriously consider interest rate risk, which is very high today. In today’s environment, you probably want to buy short-term bonds, which won’t yield very much but will protect your principal.
Risk of Volatility
The next risk to consider is volatility—most commonly associated with the stock market. Clearly, over the past five years the stock market has had significant instability. This unpredictability has not been limited to the U.S., but to stocks all around the world, as many economies have had to deal with banking and fiscal issues since 2007. On a long-term basis, stocks, including dividends, have generally produced a return better than any other asset class, but with that higher return comes greater volatility.
We have all heard the expression, “don’t put all your eggs in one basket.” This is certainly true when it comes to investing. Based on your comfort zone, risk tolerance and need for cash flow in retirement, you will want to work with your financial planner to set up an asset allocation plan that works best for your unique situation. In other words, you will want to have cash, bonds (domestic, foreign, corporate and government) and stocks (big, medium, small and both foreign and domestic), sprinkled with some real estate and perhaps some broad commodity exposure. Investing money to make money is not so much about how much you can earn in the good times, but rather about how little you lose during the tough times. Yes, there will be times any portfolio will likely lose money, but, generally speaking, different assets don’t all go up at the same time nor do they all go down at the same time. There are exceptions, and we saw one of those exceptions during late 2008 and early 2009.
Stick to the Plan
Once you have your asset allocation set and have an investment plan, the most important thing to do is to follow the plan. Unfortunately, some people’s tendency is to panic and get out of investments at exactly the wrong time and unfortunately either not get back in at all or, as is usually the case, jump back in when prices are higher than when they sold. It takes discipline and patience, but with the allocation and investment plan, you should be able to achieve a reasonable degree of success.
Finally, it is important to monitor the investment plan and visit with your financial planner at least once each year to make sure nothing has changed in your financial picture that might warrant a change in your investment approach.
In our next article we will look at different types of investments for different types of investors.
Checklist for Interviewing a Financial Planner
- Do you have experience in providing advice on the topics below? How many years?
? Retirement planning
? Investment planning
? Tax planning
? Estate planning
? Insurance planning
? Integrated planning - What are your areas of specialization? What qualifies you in this field?
- How long have you been offering financial planning advice to clients?
- How many clients do you currently have
- Briefly describe your work history
- What are your educational qualifications? Give area of study.
- What financial planning designation(s) or certification(s) do you hold?
? Certified financial planner™ or CFP®
? Certified public accountant-personal
financial specialist (CPA-PFS)
? Chartered financial consultant (ChFC) - What licenses do you hold: insurance, securities, CPA or other?
- Are you personally licensed or registered in a state(s) as an investment adviser representative? If no, why not?
- Are you or your firm licensed or registered with the state or federal government as an investment adviser? If no, why not?
- What services do you offer?
- Describe your approach to financial planning.
- How are you paid for your services: fee, commission, fee and commission , salary or other?
- What do you typically charge? If fee, is it hourly or flat, and how much? If percentage of assets under management, what is the percentage? If commission, what is the approximate percentage of the investment or premium you receive on stocks and bonds, mutual funds, annuities or insurance products?
- Do you have a business affiliation with any company whose products or services you are recommending?
- Is any of your compensation based on selling products?
- Do you have an affiliation with a broker/dealer?
- Are you an owner of, or connected with, any other company whose services or products I will use?
- Do you provide a written client engagement agreement?
Adapted from the Certified Financial Planner Board of Standards (CFP Board)
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