Diversifying your investment portfolio

Diversifying your investment portfolio

Identify your goals early and know your threshold for volatility.

The ultimate financial goal, of course, is retirement. How soon you retire - and in what style - can be greatly affected by your decisions on asset allocation made earlier in life. In accounting for risk in your asset allocation, it's more productive to think in terms of your tolerance for volatility.

This is because one of the greatest investment risks is the risk of doing nothing - and missing out on superior returns.

Those retiring in 15 years but with little tolerance for wild swings may want to keep 50% in stocks and 40% in bonds, with 10% in a money market account.

If this person is planning to retire in 25 years, he or she might ratchet the equities holdings up to between 70 and 80%.

Those retiring in five years are faced with the daunting task of allocating their assets for maximum return without betting the farm. A nasty market dip could occur immediately before retirement, leaving your nest egg drastically short.

Achieving the right mix of stock types (small-, mid-, and large-caps) and bonds (short-, medium-, and long-term) to achieve maximum return for your volatility tolerance while maintaining adequate diversification is a tricky business, so you may want to consider  consulting a qualified planner financial or adviser

Before you actually invest in accordance with your newly minted allocation plan, you will want to do something that few individual investors do: Find out specifically what you own.

Most people don't know precisely what they own because their portfolios are dominated by an accumulation of mutual funds. If you strip away the marketing veneer of each fund and do some investigating, you can not only find out what the fund says it invests in, but also what it actually owns.

For example, some funds may call themselves small-cap. But, these same funds may veer into large-cap territory to boost their returns if their sector is out of favor. Your fund's 800-number reps should be able to give you information on this.

The need to determine what you already own is another reason to hire a qualified financial adviser; he or she would have a good handle on most funds. As your adviser would tell you, you must break these funds into their component parts to know what percentage of your assets is in small caps versus large, or in long-term bonds versus short-term.

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                                            Best practices for asset allocation

Practicing asset allocation is the single most important thing an investor can do. Here's how to get started.

1. Time is on your side.

Those with more years until retirement can afford to put a greater percentage of their assets in the stock market.

2. Stocks mean risk and return.

Those with a higher tolerance for volatility should put more money in the stock market than those in the same age group who have a lower tolerance.

3. College savings funds need stocks.

Since college costs are rising faster than inflation, no other investment will keep pace as well as stocks. Invest more in stocks when your kids are young, and as they get older move more money into bonds.

4. Get professional advice.

One of the best ways to develop an effective asset allocation plan is to consult a qualified financial planner.

5. Allocation is the key to achieving your goals.

Studies have shown that asset allocation is the single most important factor in determining returns from investing.

6. Know your stock funds.

Before you set up your asset allocation plan, you must find out the nature of the companies purchased by the mutual funds you own. It's not enough to go by the names of the funds themselves, either. In search of performance, far too many fund managers buy stocks that barely fit their portfolio's explicit investing parameters. So your "income" fund may, in practice, contain many stocks that should be considered "growth," or vice versa.

7. Know your bond funds.

Similarly, you must learn the same about the bond funds you own.

8. Don't rely on software alone to build a savings plan.

Software programs might not go far enough to devise your asset-allocation plan.

9. Determine your long-term goals.

Do you want to buy a sailboat after you retire? Or pay off your mortgage so you can write a novel? Figure out what your long-term goals are, and what they will cost.

10. Get started.

It's never too late to get started, and it's never too late to revamp or revise an asset-allocation plan.

Understanding The Ten (10) Financial Stages of Life

Understanding The Ten (10) Financial Stages of Life

The Cambridge Financial Life Cycle is a benchmark that divides your life into ten typical financial stages. There are specific wealth building strategies for each stage and financial ratios that mark the transition from one stage to the next.

The Formative Stages 
The first three stages are The Formative Stages. These include:

1. Toddler Years (0-5)
2. Childhood Years (6-12)
3. Teenage Years (13-19)

It is during these years that we acquire our beliefs about money. Most of these beliefs are acquired by the time we are 12 years old. Our money beliefs are derived from our family of origins, our childhood experiences and the economic age in which we grew up. Those beliefs may be shaped one last time during the teenage years.

Many of the beliefs acquired during our formative years are dysfunctional. Dysfunctional does not mean you need to consult a therapist, although in some cases that may be your advisor’s recommendation. Dysfunctional simply means a belief about money that does not work. We all have such dysfunctional money beliefs, even financial advisors.

In our Toddler years (0-5) we have no beliefs about money. From our behavior, it appears we believe money is something to eat! Our parents help us overcome this first dysfunctional belief, when they teach us, “Don’t eat the money!”

As our intellectual capacity grows, we enter the Childhood years. In this stage our parents pass on more beliefs about money. They may give us a piggy bank or help us open a savings account to teach us the concept of accumulation or saving. When they take us shopping we learn the concept of convertibility. When they tell us that a dime is worth more than a nickel even though the nickel is bigger, we learn the concept of relative value.

During our Teenage Years, we may reject or adapt our parents’ beliefs as we develop our own money belief system.

In the teenage years we usually experience our first job and hopefully acquire three more valuable financial beliefs:

1. Income is earned by exchanging labor/services for money
2. Budgeting or cash flow management
3. Money makes money

Often people get stuck at this stage or the next because they have not fully understood the importance of concept #3 – Money makes money. This refers to the magical power of compounding. Comprehending the increasing power of money to make money provides motivation to save and invest. Can you envision your “pile of money” growing through the magical power of compounding? Can you imagine it becoming so big that it makes more money annually than what you earn at your job? Belief #3 that money makes money is the key to financial independence and peace of mind.

Dysfunctional spending or savings behaviors are caused by dysfunctional emotions which are triggered by dysfunctional beliefs. In Charles Dickens novel, The Christmas Carol, Ebenezer Scrooge illustrates the devastating impact of dysfunctional beliefs about money. In Scrooge’s mind, accumulating and hoarding money triggered powerful emotions of satisfaction and security. Fortunately for him, the ghosts of Christmas changed his dysfunctional beliefs. For many Americans, spending triggers only emotions of pleasure. The Great Recession appears to be changing some of the dysfunctional beliefs that trigger those emotions.

Is either saving or spending a problem behavior for you? Then ask yourself why. What do you believe about saving/spending that make it a problem behavior?

Overcoming dysfunctional money beliefs is a journey of intellectual and emotional development. We call it the Journey to FIPOM. FIPOM is an acronym for Financial Independence & Peace Of Mind. We earn, spend and accumulate money because we want to feel free and happy. (To learn more about your money personality and the road to FIPOM read Facing Financial Dysfunction – Why Smart People Do Stupid Things with Money!, pp.1-56, by Bert Whitehead, MBA JD.)

The Accumulation Stages 
The next three stages are the Accumulation Stages. These include:

4. Building the Foundation Years (20-29)
5. Early Accumulation Years (30-49)
6. Rapid Accumulation Years (40-54)

During the formative years we acquire our beliefs about money. During the accumulation years we put those beliefs into practice. To track progress through these stages we measure the ratio of our net worth to our gross income. Because we have different standards of living, using the ratio of our net worth to income is much more useful than comparing the size of our financial portfolios.

When we graduate from high school or college, we enter the Building the Foundation years. At this stage our net worth is usually less than our annual income. Our income makes us feel as if we are rich. This may be our first taste of financial freedom because we are no longer dependent on our parents for financial support.

Building a pile of money big enough to give us freedom from work requires laying a solid foundation. We lay this foundation with The Five Fundamentals of Fiscal Fitness. People who practice all five fundamentals, move through all the stages of the financial life cycle.

When your net worth equals your income (1x) you transition into the Early Accumulation years. Implementing the Five Fundamentals of Fiscal Fitness will triple your net worth during this stage. As your wealth grows, so does your capacity to take on more risk. You can become more aggressive in your asset allocation. See the Asset Allocation row in the Cambridge Financial Life Cycle.

When your net worth exceeds 3x annual income, you have most likely entered the Rapid Accumulation years. During this stage the magical power of compounding begins to kick in. Your investment earnings often exceed your savings. In some years your investment earnings will exceed your job earnings. As you experience the power of money to make money, the belief becomes reality.

You may also be approaching your peak earning years. The combination of growing wealth and increasing income further enlarges your risk capacity. During this stage your asset allocation plan is designed to focus your risk where you can build wealth the fastest. Before long your net worth increases to 7x your annual income and you enter what is for many the most enjoyable and yet challenging stages of the financial life cycle.

The Conservation Stages 
There are two conservation stages. They are:

7. Financial Independence Years (55-69)
8. Conservation Years (70-84)

The Financial Independence years are a transitional period between the accumulation years and retirement. For many these are the peak earning years. Your portfolio regularly generates income that is equal to 50% or more of your annual living expenses. At this stage, our life may be more than half over and time becomes more important than increasing our standard of living. Many people begin to freeze their standard of living, in order to have more freedom with their time. The focus now changes from your gross income to your living expenses. We need a new ratio to measure your progress. The key ratio from now on is the size of your financial portfolio to your annual living expenses. If you are willing to freeze your standard of living, you may experience Financial Independence!

This is a transitional stage because you can start doing what you really want to do. You can start your own business or semi-retire. You can change careers or work part-time at a job you love. All these choices are possible for you because you can supplement your earned income with income from your portfolio.

This can be a very enjoyable, but also very challenging transition. In order to generate the stable income necessary for covering up to 50% of your living expenses, you must reduce the risk in your portfolio. For more than 30+ years, accumulation has taken priority over conservation; growth and volatility have taken priority over safety and predictability. Now preserving wealth becomes more important than accumulating, and safety becomes more important than growth. Psychologically it can be a very difficult change to make. To reduce the portfolio’s exposure to stocks, even modestly, when your capacity for risk is at its height, often seems “wasteful”. But as advisors we always ask, “Why should you risk going backwards, if you have already arrived?” You have achieved Financial Independence (FI), so why not also secure Peace of Mind (POM) by changing your asset allocation to emphasize both Conservation and Accumulation equally?

Even with a more conservative asset allocation and the withdrawal of income, the power of compounding and additional saving continue to work their magic. The portfolio continues to grow because inflows still exceed outflows. Depending on your age and other sources of income, when your financial portfolio reaches 10-15X your annual living expenses you have entered the Conservation years. You can stop working entirely, if that is your desire, and live off your pension and investment earnings.

The Distribution Stages
There are two distribution stages. They are:

9. Distribution Years (85+ )
10. Sunset Years (Less than 12 months to live)

When your portfolio exceeds 15 times your living expenses you have entered the Distribution years. You have more wealth than you can spend in your lifetime without violating some of your deepest values about stewardship. It is time to convert your wealth into a financial legacy that will influence future generations long after you are gone. Increase gifts to charities that match your values and promote your favorite causes. Take your children on a cruise or in other ways initiate family events that your children and grandchildren will always remember. ”Invest in memories” that leave a legacy and shape future generations. Review and put the final touches on your values-based estate plan. The manner in which you distribute your wealth gives you one more opportunity to pass on the values that contributed to your own happiness and success.

We enter the final stage, called Sunset, when we have less than 12 months to live. Most of us will not know when we enter this stage. For those who have not created their estate plan, the focus is on distributing assets and reducing estate taxes.

10 steps to making a financial budget

Learn how to budget by following these 10 steps on how to bring your spending under control.

1. Budgets are a necessary evil.

They're the only practical way to get a grip on your spending and to make sure your money is being used the way you want it to be used.

2. Creating a budget generally requires three steps.

- Identify how you're spending money now.

- Evaluate your current spending and set goals that take into account your long-term financial objectives.

- Track your spending to make sure it stays within those guidelines.

3. Use software to save grief.

If you use a personal-finance program such as Quicken or Microsoft Money, the built-in budget-making tools can create your budget for you.

4. Don't drive yourself nuts.

One drawback of monitoring your spending by computer is that it encourages overzealous attention to detail. Once you determine which categories of spending can and should be cut (or expanded), concentrate on those categories and worry less about other aspects of your spending.

5. Watch out for cash leakage.

If withdrawals from the ATM machine evaporate from your pocket without apparent explanation, it's time to keep better records. In general, if you find yourself returning to the ATM more than once a week or so, you need to examine where that cash is going.

6. Spending beyond your limits is dangerous.

But if you do, you've got plenty of company. Government figures show that many households with total income of $50,000 or less are spending more than they bring in. This doesn't make you an automatic candidate for bankruptcy - but it's definitely a sign you need to make some serious spending cuts.

7. Beware of luxuries dressed up as necessities.

If your income doesn't cover your costs, then some of your spending is probably for luxuries - even if you've been considering them to be filling a real need.

8. Tithe yourself.

Aim to spend no more than 90% of your income. That way, you'll have the other 10% left to save for your big-picture items.

9. Don't count on windfalls.

When projecting the amount of money you can live on, don't include dollars that you can't be sure you'll receive, such as year-end bonuses, tax refunds or investment gains.

10. Beware of spending creep.

As your annual income climbs from raises, promotions and smart investing, don't start spending for luxuries until you're sure that you're staying ahead of inflation. It's better to use those income increases as an excuse to save more.

Mutual fund fundamentals

           Mutual fund fundamentals

Mutual funds offer a simple way to diversify your portfolio - albeit at a cost

The theory behind mutual funds is simple: you need the advantage of being able to pool your money together with that of a lot of other investors. Then, a professional manager can invest that money across enough investments to reduce the risk of being wiped out by any single bad bet.

That's how a mutual fund operates. The fund is essentially a corporation whose sole business is to collect and invest money. You join the pool by buying shares in the fund. Your money is then invested by a team of professionals, who research stocks, bonds or other assets and then place the money as wisely as they can.

The managers charge an annual fee -- generally 0.5% to 2.5% of assets -- plus other expenses. That puts a drag on your total return, of course. But in exchange, you get professional direction and instant diversification, factors that have helped propel the number of funds to 7,600 in 2010, according to the Investment Company Institute

There are several flavors of mutual funds. Funds that impose a sales charge -- taking a cut of any new money that comes into the fund, or a cut of withdrawals -- are called load funds; those that do not have sales charges are called no-load funds.

Funds can also be divided into open- and closed-end funds. Open-end funds will sell shares to anyone who cares to buy; essentially, they are willing to invest any new money that the public wishes to pump into the fund. Their share price is determined by the value of the underlying investments and is calculated anew each evening after the close of the U.S. markets. Closed-end funds, on the other hand, issue a limited number of shares that then trade on the stock exchange like stocks. The price of such shares can fluctuate above or below the actual value of the underlying shares held within the portfolio.

Index funds

When people talk about the long-term performance of stocks, they're usually talking about the Dow Jones industrial average, the Standard and Poor's 500-stock index, or some other broad market index. Funds based on the S&P 500, by definition, will never outperform the market. But because they are so cheap to run -- you'll typically pay just $2 a year in expenses for every $1,000 invested compared to $14 a year for the average stock fund -- they outperform the vast majority of actively managed funds over time.

Growth funds

These invest in the stock of companies whose profits are growing at a rapid pace. Such stocks typically rise more quickly than the overall market -- and fall faster if they don't live up to investors' expectations.

Value funds

Value-oriented fund managers buy companies that appear to be cheap, relative to their earnings. In many cases, these are mature companies that send some of their earnings back to their shareholders in the form of dividends. Funds that specifically target such income-producing investments are often called equity-income or growth-and-income funds.

Sector funds

Sector and specialty funds concentrate their assets in a particular sector, such as technology or financials. There's nothing wrong with that approach, as long as you remember that a hot performing sector one year could crash the following year.

Others

Since there is a lot of overlap in the stocks held in each of these fund types, you'll need to branch out to get any kind of meaningful diversification. That's where the more aggressive funds, like aggressive growth funds, capital appreciation funds, small-cap funds, midcap funds, and emerging growth funds, fit in. Typically, these funds, which tend to be more volatile than large-cap funds, pursue one or more of the following strategies:

- Invest in smaller companies, where earnings aren't as reliable as at bigger firms but where the potential for gains (and losses) is higher.

- Invest in pricey, high-growth stocks.

- Invest in stocks that are in "hot" industries, such as technology or health care.

- Invest in just a handful of companies.

International

Funds that invest outside the U.S. come in three basic flavors. The first, international funds, typically buy stocks in larger companies from relatively stable regions like Europe and the Pacific Rim. Global funds do likewise, but they can also invest heavily in the United States. Emerging market funds invest in riskier regions, like Latin America, Eastern Europe and Asia.

Investing your money basics

Investing your money basics

1.Over the long term, stocks have historically outperformed all other investments.

Stocks have historically provided the highest returns of any asset class -- close to 10% over the long term. The next best performing asset class is bonds. Long-term U.S. Treasurys have returned an average of more than 5%.

2. Over the short term, stocks can be hazardous to your financial health.

On Dec. 12, 1914, stocks experienced the worst one-day drop in stock market history -- 24.4% . Oct. 19, 1987, the stock market lost 22.6%. More recently, the shocks have been prolonged and painful: If you had invested in a Nasdaq index fund around the time of the market's peak in March 2000 you would have lost three-fourths of your money over the next three years. And in 2009, stocks overall lost a whopping 37%.

3. Risky investments generally pay more than safe ones (except when they fail).

Investors demand a higher rate of return for taking greater risks. That's one reason that stocks, which are perceived as riskier than bonds, tend to return more. It also explains why long-term bonds pay more than short-term bonds. The longer investors have to wait for their final payoff on the bond, the greater the chance that something will intervene to erode the investment's value.

4. The biggest single determiner of stock prices is earnings.

Over the short term, stock prices fluctuate based on everything from interest rates to investor sentiment to the weather. But over the long term, what matters are earnings.

5. A bad year for bonds looks like a day at the beach for stocks.

In 1994, intermediate-term Treasury securities fell just 1.8%, and the following year they bounced back 14.4%. By comparison, in the 1973-74 crash, the Dow Jones industrial average fell 44%. It didn't return to its old highs for more than three years or push significantly above the old highs for more than 10 years.

6. Rising interest rates are bad for bonds.

When interest rates go up, bond prices fall. Why? Because bond buyers won't pay as much for an existing bond with a fixed interest rate of, say, 5% because they know that the fixed interest on a new bond will pay more because rates in general have gone up.Conversely, when interest rates fall, bond prices go up in lockstep fashion. And the effect is strongest on bonds with the longest term, or time, to maturity. That is, long-term bonds get hit harder than short-term bonds when rates climb, and gain the most when rates fall.

7. Inflation may be the biggest threat to your long-term investments.

While a stock market crash can knock the stuffing out of your stock investments, so far -- knock wood -- the market has always bounced back and eventually gone on to new heights. However, inflation, which has historically stripped 3.2% a year off the value of your money, rarely gives back what it takes away. That's why it's important to put your retirement investments where they'll earn the highest long-term returns.

8. U.S. Treasury bonds are as close to a sure thing as an investor can get.

The conventional wisdom is that the U.S. government is unlikely ever to default on its bonds - partly because the American economy has historically been fairly strong and partly because the government can always print more money to pay them off if need be. As a result, the interest rate of Treasurys is considered a risk-free rate, and the yield of every other kind of fixed-income investment is higher in proportion to how much riskier that investment is perceived to be. Of course, your return on Treasurys will suffer if interest rates rise, just like all other kinds of bonds.

9. A diversified portfolio is less risky than a portfolio that is concentrated in one or a few investments.

Diversifying -- that is, spreading your money among a number of different types of investments -- lessens your risk because even if some of your holdings go down, others may go up (or at least not go down as much). On the flip side, a diversified portfolio is unlikely to outperform the market by a big margin.

10. Index mutual funds often outperform actively managed funds.

In an index fund, the manager sets up his portfolio to mirror a market index -- such as Standard & Poor's 500-stock index -- rather than actively picking which stocks to purchase. It is surprising, but true, that index funds often beat the majority of competitors among actively managed funds. One reason: Few actively managed funds can consistently outperform the market by enough to cover the cost of their generally higher expenses.

How To Get a Pay Raise

How To Get a Pay Raise

Do you feel underpaid? Are you thinking about asking your boss for a raise? To increase your chances of success, it's important to know what your job is really worth and how to effectively approach your boss about a salary increase. Many employees make the mistake of asking for a raise because they need more money, can't pay their bills, etc. Your personal budgeting and financial problems are not your company's problem.

Need has nothing to do with it, so it's best not to talk about need when asking for a raise. Base your request on your evaluation of your skills, productivity, job tasks, your contribution to the company, and the going rate, both inside and outside the company, for what you do. Look at the entire situation from your company's perspective, and base your approach on THEIR needs, and on what YOU can do for THEM.

The first step is to evaluate your skills and your job description, both your formal written job description, if there is one, and the tasks you do that may not be part of your formal job description.

Gather copies of your last few performance evaluations, if your company does written reviews. Concentrate on showing/reminding your boss of your tangible contributions to the company. Make a list of your accomplishments, and if possible, the dollar value of each to the company. For example: "I saved the company $20,000 this year by researching and negotiating contracts with new vendors."

When comparing and analyzing salaries, it's important to consider the financial value of your benefits and perks. If your company pays for all or part of your health insurance, this is as good as money in your pocket. The same is true of a 401(k) match, tuition assistance (if you're taking college courses), etc.

Dos and Don'ts of Asking For a Raise

First, find out your company's policy on salary increases. Are all employees reviewed at the same time each year and are raises given only at that time? Is there a budgeted amount that your department must stay within for each employee and the department as a whole? For the highest chance of successfully getting the raise you want, you have to know the company's policies regarding compensation. If your boss has no authority to exceed the budgeted amount handed down from higher ups, you may have wasted your time and effort.

Know what you're asking for. You don't have to state what it is up front, but you should have a good idea of the amount you'd find acceptable and be able to defend it.

Be aware of your company's financial state. Are they struggling to stay afloat? In a budget crisis? If so, your chances of getting that raise are not good. Not all companies are in a position to raise salaries. However, they may be able to offer you additional benefits instead, such as extra paid leave, tuition assistance, stock options, overtime, etc., or a promotion, if one is warranted.

Don't give ultimatums. This just puts your boss on the defensive, and may put you in the position of either quitting your job or eating crow. Your goal is to convince your boss that you're worth more money because you do an exceptional job and perhaps that you've taken on additional responsibility that warrants a higher salary or promotion.

Timing is everything. Ask your boss for an appointment at a time that is good for him or her. Don't schedule your discussion for a Monday morning or a Friday afternoon, as these are busy times for most people. Don't schedule it during your boss' busiest time of month. Try to pick a time when your boss won't be distracted and pressured by deadlines, if possible.

If, after all this, you don't get the raise you realistically deserve, DON'T respond with sour grapes. Ask your boss what you'd have to do to receive an increase, or a promotion accompanied by a pay adjustment and then renew your efforts to improve your performance. Make sure your boss is aware of what you do and how well you do it, and document your accomplishments in preparation for your next opportunity to discuss salary.