Don't Invest and Forget: A Look at the Importance of Having a Comprehensive, Dynamic Investment Plan
By Pat Vitucci
()
About this ebook
Dont Invest and Forget takes a step back from the often confusing world of investing. Managing money is a full time job and requires the time, energy, and know how of a professional. As the maddening rollercoaster of the market rises and falls regularly, adjustments may need to be made. Having a comprehensive investment plan can prove to be an important step to a healthy financial life. Investing, and then forgetting about it may be the largest mistake on the road to meeting your goals. Chart a course to financial comfort with Pat Vituccis candid view of the investment world.
Pat Vitucci has over 30 years of experience in the financial services business, including serving as President of a subsidiary of a major financial institution. He has been working with clients to help plan their investments for many years, serving them as a family financial counselor, and forging a strong, trusting, relationship. His weekly one hour radio show, Your Financial Life, can be heard every Saturday and Sunday on several radio stations throughout the San Francisco Bay Area.
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Don't Invest and Forget - Pat Vitucci
Copyright © 2007 by Pat Vitucci.
All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without permission in writing from the copyright owner.
This book was printed in the United States of America.
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Contents
1
2
3
4
5
6
7
8
9
10
11
12
Glossary of Terms
Reference Section
Resources
About the Author
Endnotes
I dedicate this book to:
* Teresa Newkirk—whose tireless help was invaluable in the preparation of the book.
* My wife, Elaine, and my son, Jason,—for their wonderful support and encouragement.
* My staff—without whom all of this would not be possible.1
1
Understanding Market Risk
Money frees you from doing things you dislike. Since I dislike doing nearly everything, money is handy.—Groucho Marx
Chances are you’re interested in achieving a financial goal
that will involve investing in order to fulfill your dream. Whether it is being able to easily afford an Ivy League education for your children or a comfortable retirement for yourself, we all have goals that we realize will need careful planning and investing to achieve. It’s very important to not only plan ahead for your financial future, but to carefully evaluate which investments you choose. So to begin, let’s take a look at market risk.
Simply stated, when the stock market declines, it tends to pull down most stocks with it. This is market risk. Stocks and most other investments are affected by market risk. We’ve all heard fabulous stories of lucky people who have invested a small amount of money in an unknown company and are now extremely wealthy thanks to that tiny investment. Likewise, there are countless stories of unlucky people who have eagerly placed their hard-earned dollars into the market and now have nothing to show for all their hard work.
Warren Buffett, one of the most thriving investors and one of the world’s wealthiest men, commented in Harry Dent’s book, The Warren Buffett Way, To be successful, one needs good business judgment and the ability to protect oneself from the emotional whirlwind that the market unleashes.
Buffett believes, investors must be financially and psychologically prepared to deal with the market volatility. Investors should expect their common stocks to fluctuate. Unless you can watch your stock holdings decline by 50% without becoming panic-stricken, you should not be in the stock market.
(p.184)
One way to hopefully avoid disaster is to first gain a clear understanding of the risks involved with investing. As with any financial decision, the better educated you are about where your money is going—the better off you will be. Entering the market is no different. Let’s take a look at specific types of market risks that are out there and then you can decide which ones are right for your peace of mind. Please keep in mind: no investment is worth losing sleep over, regardless of the potential gains.
Investments offer a complete spectrum of risks, from very low risks (such as a CD or money market account1 ) to very high risks (such as individual company stocks.) Naturally, the lower the risk is the lower the expected returns will be on your money, and vice versa. There are a number of other risks involved with investing. You need to understand what factors can affect your investments so that you are able to choose the right investment for your financial goals.
missing image fileSome investments are subject to inflation risk. Some alternatives such as savings accounts may fail to outpace inflation2 . If the rate of inflation is higher than the return on your investments, they may actually lose purchasing power over time. Yes, your money is very safely tucked away in the bank vault, but it isn’t likely to grow over time at a high rate. So you’re in fact losing money in the long term by not allowing it to grow. Savings accounts are ideal for immediate money reserves and contingency funds, but not for your retirement fund. Other investments are subject to interest rate risk. The value of a bond falls if interest rates rise. If you buy a bond at 3% and interest rates rise, new bonds will be offered at higher rates. If you need to sell your bond before it matures, you’ll have to sell it at a discount. Once again, your money is in a safe investment (U.S. Treasury bonds are backed by the full faith and credit of the U.S. government3 ) but this money is still not going to grow at a desirable rate. Ironically, some people feel safe keeping much of their money in low yielding Treasury bonds issued by the U.S. Government. Lending your money to the government has some patriotic value, but it certainly is not 100% risk free.
Just as Inflation Increases Everyday Costs
Likewise, Your Investments Need to Keep Pace
missing image fileSome stock investments are subject to economic risk. We’ve seen plenty examples of this exact situation recently. As you remember, following September 11, 2001, many companies faced severe economic hardships. This resulted in a complete domino effect: loss of jobs, downturn in the stock market, lowered inflation and many other elements to a downturn in the economic cycle. Even after the stock market began to regain its momentum, the tide did not turn quickly. One of the overpowering effects of economic risk is that it can have such a big impact on so many different industries. Some large companies are especially vulnerable to changes in economic conditions. Automakers, airlines, technology, and various others suffered more with the onset of a recession than manufacturers of consumer goods. However, this was a natural occurrence with today’s world economy. We can all be impacted by what not only happens in our country, but also by the political and economic twists and turns in other areas around the globe. There will always be periods of upswings and downturns in the stock market, which is why investors must always be thinking long-term.
Long-term investing, that is the length of time you have to reach your goal, will help you choose appropriate investments. With time on your side, you may be able to take bigger risks in order to take advantage of greater potential returns. A 25-year old investor will definitely be discouraged by a sharp drop in the economy; but a 75-year old investor could be devastated. The 25-year old has the element of time on her side to recover losses, while the 75-year old might not enjoy the luxury of time to recover his losses. So when you consider your investments, you must always take into account what type of risks you are willing to consider and at what level. This involves assessing your own personal appetite for risk.
There are an incredible amount of issues that affect the market’s performance. The following list is but a small sampling:
The Federal Reserve’s monetary policy
Inflation Rate
Housing Starts
Manufacturing Index
Consumer Price Index
Gross Domestic Product
Sentiment Indicators
Consumer Confidence Index
Blue Chip Index
Unemployment Numbers
The Political Climate
It is the combination of these and several hundred other indices, sprinkled with the emotions of the day throughout the globe, which dictates whether the markets will rise or fall.
Your individual portfolio should maintain a diversified approach utilizing a variety of the segments of the economy that behave very differently based on current conditions. Listed below are several components that could make up a portfolio (certainly the make-up of any one portfolio is based upon the risk tolerance and goals of the individual):
Large Company Stocks
Small Company Stocks
Mid-Size Company Stocks
Growth Company Stocks
Value Company Stocks
Corporate Bonds
Utilities
Real Estate
U.S. Government Securities
Emerging Markets
Cash
International Markets
Global Markets
All investments carry risk. As with your day-to-day life, some risks are much more apparent than others. One of the best ways to reduce investment risk is to buy
yourself some insurance
via diversification4 . Diversification simply means that you place your investment dollars into various investments that perform differently under particular economic circumstances. People who worry a lot may easily justify diversifying since they can easily dream up possible calamities.
While the stock market is more volatile in the short-term than the bond market, stock market investors have earned far better long-term returns than do bond investors1 . Remember that bonds will generally outperform keeping your hard-earned nickels in a boring old bank account. The risk of a stock or bond market fall becomes less of a concern the longer the time period you plan to invest. In fact, over any 20-year period, the U.S. stock market investors have never lost money, even after subtracting for the effects of inflation5 .
Skittish investors may desire to keep all their money in bonds and money market6 accounts. The risk in this strategy is that your money will not grow enough over the years in order for you to accomplish your financial goals. In other words, the lower the return that you earn, the more you need to save to reach a goal. A 40-year old seeking to accumulate $500,000 by the age of 65 will need to save $722 per month if she earns a 6% annual return. But that same smart lady will only need to save $377 per month if she can earn a 10% annual return (this may require assuming some more risk). As Albert Einstein once said, the two most beautiful words in the English language are compound interest.
Younger investors should pay very close attention to the risk of generating low returns, but so too should the younger senior citizens. At the age of 65 in today’s world, you should recognize that a portion of your assets will probably not be used for a decade or two.
Some catastrophes can be avoided by doing your homework. When you purchase real estate, a whole gamut of inspections can save you from buying a pig in a poke. With stocks, examining some measures of value and the company’s financial condition and business strategy can reduce your chances of buying into an overpriced company or one on the verge of major problems. With that in mind, you can easily see one of the advantages to investing in mutual funds. A mutual fund offers professional management and oversight as well as diversification2 .
Lessons Learned from the Dot.com Boom-Bust
The second half of the 1990’s witnessed one of the most impressive periods of economic prosperity in recent economic history with low unemployment, low inflation, substantial growth in real GDP and high real wages. Many analysts impressed with the spectacular performance of the economy were moved to declare the end of the business cycle. The problem with the prosperity of the 1990’s was that the period also coincided with one of the greatest financial bubbles in U.S. economy history. Share prices of technology, media,