Personal Wealth Management

Money Lessons From One’s Twenties

Jordan Wilson — Tue, 15 May 2012 16:55:31 +0000

If only. If only I knew then what I know now. Or at least what I think I know now.

A concept anyone over the age of thirty understands very well. Okay, maybe forty.

“If only I had this wealth management advice when I was twenty, rather than learning painful lessons for the next decade or two.”

That is the tale of one woman in today’s discussion.

Learning About Money In One’s Twenties

S.L. Bathgate seems like the typical young adult. Someone I can relate to.

Looking back on my twenties, I realized that I spent my money mainly because I wanted to feel richer than I actually was. This single desire was probably the most fundamental problem I had with money during my twenties, and admittedly, it is one that I still struggle with today.

I got my first office job in my early twenties, complete with a paltry, yet steady, salary. Suddenly, I was hungry to experience the full spectrum that life had to offer, and all too eager to ignore the wide disparity between my means and aspirations. It was still a time when everything in the world seemed novel, and by virtue of its novelty, was mandatory to experience. Bottomless mimosa brunches? Buying that $200 used guitar on a whim? Impromptu road trips? Yes, yes and yes.

I knew I shouldn’t have been spending my money so liberally, but for the first time, it felt like a relief to just have the nice things that always seemed missing from my life. Somehow, it seemed perfectly fine to drop at least $200 a month on sushi dinners, to purchase designer handbags, to drink endless rounds of American craft beers, and to have and to hold each new Apple product in my hands.

I do not know of too many people who did not follow this path. Present company included.

I remember when I first moved to the Cayman Islands. An acquaintance there said that you will live your first year like a rock star. And he was right, although I never could get the long, flowing hair looking quite right.

Many of my fellow ex-pats lived a few more years like rock stars. Making great money, living beach-front, out for dinner every night, and travelling the world on vacation.

Not the way to live if you want to accumulate wealth and retire comfortably. But after living like a pauper through school, once you start earning a little cash you want to enjoy it and make up for lost time. I know I did.

At Thirty, The Party Stops

After enjoying her twenties, Ms. Bathgate reaches thirty to find her financial situation less than stellar.

It was clear that I had refused to live within my means, and I needed to do something to change my situation. On one too many occasions, I had ransacked my short-lived savings to pay off mounting credit card bills. I still had an array of credit cards I had accumulated during my early twenties while playing the balance transfer game. And my credit score had taken a sizeable hit.

Fortunately, Ms. Bathgate came to her senses and sorted out her financial problems. Sadly, many individuals do not correct their errors at 30, nor even 40 or 50. And with each passing month, rectifying the problem becomes harder and harder.

Why?

The Power of Compound Returns

The longer one delays saving, the greater the capital required to catch up over time.

Consider a previous lesson on compound returns. Nicole starts investing $300 per month at age 25 and stops investing at age 40. Her total capital invested over 15 years is only $54,000.

Her twin brother Matt enjoyed his 20s and 30s a little too much. Matt only begins to save at age 40. To catch Nicole’s wealth level at age 70, Matt must invest $700 per month from age 40 to age 70. His total capital invested over 30 years is $252,000.

Matt needs to come up with almost five times the disposable income to end up with the same wealth as Nicole when both reach age 70. Not an easy proposition.

The power of compound returns is a big incentive to start saving early in life.

Her Plan Going Forward

Ms. Bathgate is planning on changing her (long-term) fortunes.

I’ve come up with some new goals for my thirties. I am going to contribute at least 10 percent of my salary towards my retirement. I am going to chip away at my student loan debt until it is paid off or forgiven, whichever one comes first. I am going to embrace the very simple concept that I must spend less than I earn.

A decent strategy. As is said, the first step is acknowledging you have a problem. Many do not.

I wish her the best of luck.

But f I was advising Ms. Bathgate, I think she could have improved her stated plan with a few simple amendments.

We will look at my suggestions next time.

Dangers of Dividend Funds

Jordan Wilson — Sun, 13 May 2012 23:45:33 +0000

Dividend funds are currently very popular with investors.

In many parts of the world, interest rate yields are quite low on a historical basis. To enhance returns, fixed income investors have turned to riskier investments that may offer higher yields. Such as dividends on preferred shares or dividend paying common shares.

As well, general equity investors are turning to perceived “safer” equity investments. Common shares in large, dividend paying companies. Shares that provide capital gains potential over time, but are back-stopped by a (hopefully) steady stream of dividend income.

Sounds like a good strategy to me. But there are always risks when investing.

Here are a few things to consider when assessing dividend funds (or dividend paying shares).

A Flight to Dividend Funds

The Wall Street Journal’s, “The Dangers of Dividend Funds”, looks at a few perils with dividend investments.

The first thing though that interested me was the flight of investors to dividend funds.

This year through May 1, investors have taken about $2.65 billion out of U.S. stock funds overall—while placing a net $12.72 billion in mutual funds and exchange-traded funds that focus on dividend-paying stocks, according to EPFR Global.

That is a lot of money, just in the U.S. alone. Given what is going on in the world right now – low interest rates, economic uncertainty, potentially higher inflation, volatility in the equity markets, etc. – I have no problem with investors shifting assets to dividend paying stocks.

If you are someone who wants to increase your asset allocation in dividend stocks, make sure you consider the following points.

Do Not Simply Chase Performance

Past performance is no guarantee of future results.

You will see that in every mutual fund prospectus you read.

Evaluate your needs going forward. What investments make the most sense in light of your objectives, constraints, and personal situation (i.e., Investor Profile).

Investing based on prior performance is usually not a recipe for long-term investment success.

Concentrate on Your Optimal Asset Allocation

Your Investor Profile will lead to an Investment Policy Statement with a target asset allocation for your unique needs.

Part of your optimal asset allocation will include fixed income and dividend producing investments. But the amount will reflect your individual circumstances.

Focus your investment portfolio on your asset allocation and not on chasing the flavour of the day. In the long run, I believe this will be the more successful approach.

Remember the Risk-Return Concept

I think that the major financial markets are relatively efficient. That means that the price of an asset should reflect its future. And the price of the asset is what drives the dividend yield.

Perhaps a one year Treasury bill (i.e., the risk-free asset) yields 4%. You can invest in that or you could invest in common shares of ABC company with a dividend yield of 7%. 4& versus 7%. A fairly easy choice.

But why is ABC yielding 7%? It could be because ABC is a forgotten stock or has been poorly analyzed, so that it is under-valued. And that could be true for small companies, companies in ignored markets, etc. Areas where a single, informed investor might gain a competitive advantage. But for larger companies in established markets, these companies tend to be analyzed to death.

So (again) why the 7% yield? Because ABC is significantly riskier than the Treasury bill. And that greater risk is reflected in the higher offered dividend yield.

Perhaps the company’s cash flow may not allow ABC to continue paying out the same dividend amount. That may cause future yields to fall. Or perhaps ABC’s business prospects are in question. That may hurt the future share price. While you maintain a 7% yield on the dividend, you may just find your capital slipping away as the share price falls. So you earn 7% annually in dividends, but perhaps you lose 25% on your initial capital investment. That may make your annualized total return much less attractive.

Bottom line: when seeing an investment that offers a very generous return, always ask yourself why? It could be an under-valued gem that you have found. Or the relatively high yield could indicate investment difficulties down the road.

Diversification

If investing in dividend stocks, make sure that you diversify within this category.

Some dividend funds concentrate in very narrow ranges and that can cause problems.

For example, bank stocks often pay good dividends. So you go out and buy a dividend fund that focusses on Canadian bank stocks. However, Canadian banks are highly correlated (they tend to move in lock-step). If you own a fund with 10 Canadian bank stocks, your diversification is poor. If you do want bank stocks, consider global banks to reduce some of the geographic issues. Better still, consider dividend paying companies from a variety of industries and countries.

Always watch the diversification within any one fund. If the fund’s holdings are too concentrated, the inter-asset correlations will be high, resulting in poor diversification.

Taxes May Be Your Biggest Expense

Always consider tax consequences.

Your investment focus must be on after-tax returns. Never focus on gross returns.

For example, in Canada, dividends receive preferential tax treatment versus interest income. Say you earn $10,000 in dividend income from shares in Royal Bank and $10,000 in interest income on Royal Bank bonds. You will pay less tax on the dividend income than on the interest. So your net return will be higher with the dividends.

But not all dividends. Only dividends sourced from an eligible Canadian corporation receive the dividend tax credit. Your $10,000 in dividends from Bank of America will receive the same tax treatment as your interest income.

And not all portfolios. Investment income earned inside a tax-deferred investment account is obviously treated differently than income earned in a non-tax-deferred account.

When assessing dividend funds, never consider the publicized rates of return. Understand your personal tax situation and then invest to optimize your net returns.

Sorry for the Break

Jordan Wilson — Sun, 13 May 2012 21:47:20 +0000

Bit of a break from postings due to other commitments. But back in business and normal posting volumes should resume.

Thanks for your patience.

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Top 100 Things to Do in London

Jordan Wilson — Thu, 26 Apr 2012 03:14:13 +0000

London, England, that is. Although I’m sure London, Ontario has its highlights too.

In advance of the 2012 Summer Olympics, the Telegraph has published their list of 100 of the best things to do in London.

A great city and well worth the visit. The Telegraph offers interesting recommendations.

Top 100 Best Things to Do in London According to the Telegraph

A good list. Many of the prime tourist recommendations – Buckingham Palace, National Gallery, Tate, etc. But also a lot of less famous things to do.

I have been fortunate to spend a lot of time in London. With the exception of a business trip there on July 7, 2005 (yep, I was in the middle of the city that day and week), I have always enjoyed my stays.

Not sure what would make my top 5 or 10 list.

How about I go with – British Museum and its mummified cats; the basement food court at Harrods; walking the Thames from Parliament to the London Bridge; a boat trip out to Greenwich; Temple Church and surroundings.

And if you visit London, find the time for a side trip to Jersey in the Channel Islands. Beautiful place, both history and beaches, excellent food, and fantastic people.

How to Pick a Passive Fund

Jordan Wilson — Tue, 24 Apr 2012 02:27:36 +0000

For most investors, I recommend a passive investment approach.

Exchange traded (ETFs) and open ended index mutual funds that focus on cost minimization and accurately matching relevant market returns.

There are a plethora of ETFs and mutual funds available for investors. So how do you choose the best fund?

Morningstar provides a good video, Tips on Picking the Best Passive Fund. Some thoughts on the video below.

The Definition of “Index” Keeps Expanding

But now with so many ETFs coming out, there are a lot of ETFs that take some pretty abstract strategies and use the word “indexing” maybe going a little bit too far. We do have a lot of cap-weighted indexes, which are going to be the very passive ones that are going to have low turnover and generally very low costs. But you also have to sort through some of the other names out there that will take an old strategy, say the S&P 500, and do something unique to it, say equal-weight it or put fundamental factors in there to pick the stocks in there. Now technically it’s still in index, but it’s not the same type of index that your grandfather is used to.

Just because an investment claims to be an index fund does not mean that it is as you think it is. Read the prospectus and/or other fund information. Know exactly how the fund invests and what its relevant benchmark is.

Lump Sum or Dollar Cost Averaging?

with mutual funds, oftentimes, if you’re going to be putting in smaller amounts of money very frequently, that’s going to be the better structure for you, so you don’t incur the transaction costs. But if you’re going to move a larger lump sum of money and you can find an ETF that’s going to have a lower cost for you–the lower expense ratio–that probably would be a good bet.

Mutual fund companies often allow investors to initially invest in a fund with a reasonable dollar outlay (say USD 1000). Then subsequent investments can be made automatically on a periodic basis with relatively small cash outlays (say USD 250). Assuming the fund is no-load, you can build a solid portfolio slowly over time quite cheaply.

Of course, if you are paying commissions on purchases, then you will incur costs on each purchase. So stick with no-load funds.

ETFs are purchased from stock exchanges, not mutual fund companies. Each purchase requires paying a transaction fee. The greater the frequency of purchases, the more fees you will pay.

Note that some brokerage houses offer no-fee ETFs as a way to reduce transaction costs.

Portfolio Construction

When you’re building a portfolio of passive funds, generally, it’s my opinion that you should stick within the same index family to minimize that overlap, and make sure you’re targeting the factor that you’re looking for. A lot of people understand the value premium; over a decade or longer, value tends to outperform growth.

Not bad advice for mutual funds. Also, staying within one family of funds is often the most cost effective option with funds. Investors usually can move cash between funds without fees and minimum purchases are often for the fund family rather than simply a single fund.

However, there may still be overlap between funds within the same family of funds. Always review portfolio holdings, especially the top 10 investments, to ensure you do not have too much exposure to any single holding throughout your funds.

Not discussed in the video, but also consider the actual construction methodology of the mutual fund or ETF. If trying to match a specific market, you want to make sure that your investment actually tracks the benchmark index as closely as is possible. Tracking errors impact your portfolio performance.

The Power of Profit

Jordan Wilson — Fri, 20 Apr 2012 03:04:40 +0000

I came across an interesting little economics video this week.

Economist Walter E. Williams discusses the power of profit.

How the profit motive explains why anything actually gets done in a free market system.

And why non-profit organizations, such as government agencies and public schools, are less efficient than they could be.

A short video, but one that explains how profit motives make the world go round.

http://www.youtube.com/watch?v=jmt2j0fWdYE

Thanks to Prager University for the video. If you visit the website, there are other videos that might be of personal interest to you.

A Formidable Investing Foe

Jordan Wilson — Sun, 15 Apr 2012 18:27:04 +0000

There are many variables that make successful investing a challenge.

And one of your biggest foes may just be you.

What do I mean by this?

Are You Your Own Worst Investment Enemy?

In my last post, Mutual Funds Lag Their Benchmarks, I linked to a Wall Street Journal article, It’s Not Your Fault Your Fund Can’t Keep Up.

According to the article, you are also at fault as to why your portfolio lags its benchmark.

The average equity-fund investor saw annual returns of only 3.49% in the 20 years through 2011, according to the latest analysis from Dalbar. Compare that with the average 7.81% annual return of the S&P 500.

For the average investor, that’s more than half the possible returns left on the table.

That is significant in both relative and absolute terms.

If you started with $100,000, made no additional investments, and earned 3.49%, over 20 years your capital would grow to $198,595. But had you earned 7.81% annually, that $100,000 would become $449,967. A lot of money to leave on the table.

Why the discrepancy?

The reason is most investors fail to hold mutual-fund investments for long enough, and instead try to time their investments. But they tend to enter the market after it has risen, Mr. Harvey says. So they are likely buying at a higher price. They also are apt to leave the market after it has dropped, therefore selling at a lower price.

The result: investments that will massively underperform against their benchmarks.

A lot of this is due to emotional investing based on lack of investment expertise. Individuals wait too long before buying – they want to see a clear upward trend first – and/or miss the price peaks. A good example of this would be investment bubbles.

Even many knowledgeable investors can get caught up in the hype. It is not easy or popular to take contrarian stances. Better to get it wrong like everyone else, than to get it wrong while everyone else is correct. The herd mentality is quite common in the investment world.

Also, it is extremely difficult to time market or stock movements. Or identify the best individual investments. Even if you manage to stay unemotional. That is why professional money managers typically underperform their portfolio benchmarks. And why the “best” investment analysts seem to change from year to year.

What to Do?

investors looking to close the gap should be buying mutual funds, whether they be stock or bond funds, for the long term. Don’t be tempted to bail when performance is poor because, over time, that has been shown to be a losing strategy.

And don’t try to chase performance by getting into funds that have performed well recently. This is the equivalent of buying high and selling low—the exact opposite of what investors should be doing.

You know me.

If You Cannot Beat Them, Join Them

If you cannot beat the market, try to match it as closely as possible. That means passive investing in open ended index mutual and exchange traded funds (ETFs). Keep costs low and replicate the benchmark as best you can. Actively invest under only a few scenarios.

ETFs Over Mutual Funds

As for the article’s comment on ETFs over mutual funds, I generally agree.

I prefer ETFs for their potential trading and cost advantages. But there are a wide variety of cost effective mutual funds out there. Many are extremely popular with investors. I still think they have a place in one’s portfolio. So long as you focus on cost and net performance.

Also, as the popularity of ETFs grow, so do the number of ETFs offered. Not all are cost-effective or simple structures that replicate clear benchmarks. Be careful if considering investing in such things as leveraged ETFs, actively managed ETFs, life-cycle ETFs, alternative asset ETFs, and ETF wraps.

Buy and Hold

Identify solid investments and invest for the long-term.

I like the buy and hold approach for funds, although not so much for individual non-diversified assets. The buy and hold promotes investment discipline and works well for most investors in shifting markets.

Note that you still need to periodically review your holdings and rebalance as necessary.

Dollar Cost Average

I also like a dollar cost averaging approach.

By investing a fixed amount on a periodic basis, you buy relatively more shares when the asset is cheap and less shares when the price is high. That smooths your purchase stream and provides some protection over time against volatile markets.

Mutual Funds Lag Their Benchmarks

Jordan Wilson — Thu, 12 Apr 2012 20:51:46 +0000

In the U.S., the Standard & Poor’s 500 stock index (S&P 500) is up 12.6% year to date 2012.

That is the good news. The bad?

Your mutual fund is likely not meeting or exceeding this benchmark.

Why the underperformance against investment benchmarks?

The Facts

From The Wall Street Journal’s, “It’s Not Your Fault Your Fund Can’t Keep Up”:

A Morningstar survey for The Wall Street Journal Sunday found that only eight of the 25 largest actively managed funds—all types, from bond funds to foreign—beat the S&P 500 for the quarter.

That’s right in line with previous analyses. On average, fully two-thirds of mutual funds lag behind their respective benchmarks, according to Morningstar. (Such studies stacked bond funds against bond indices; and stock funds were compared to stock indices.)

And over the long haul, according to fund guru John C. Bogle, virtually all fail.

If you own a mutual fund, there is a strong probability that it will underperform its relevant benchmark. There are a few reasons why.

Individual Asset Selection Is Not Easy

Part of the problem is that active mutual fund managers historically, and on average, do not beat the markets with their picks.

Timing market movements and/or identifying the best individual assets is not simple. Even the professionals get it wrong a fair amount of time.

Larger Funds Become the Market

Even if the asset manager is a great individual asset selector, the larger the fund becomes, the less impact an individual selection makes on the overall portfolio.

The linked article mentions a few large funds: USD 59 billion large-cap American Funds Investment Co. of America Fund (AIVSX); USD 54 billion American Funds Washington Mutual (AWSHX); USD 37 billion Vanguard Windsor II fund (VWNFX).

At those sizes, even if they find the next great company, how much can they add to their portfolios? There are limits as to what one can buy.

Large funds need to buy large companies. Investing in a small company will result in too few shares to have any overall portfolio impact. Or buying too many shares and running afoul of securities regulations in regard to ownership levels.

If stuck investing in large cap companies, large funds essentially become the market themselves. An advantage of small funds – and often a reason why funds are capped – is being nimble.

Consider AIVSX. 4.45% of AIVSX’s total fund holdings is Philip Morris (PM) stock as at December 31, 2011. So AIVSX owned about USD 2.63 billion of PM, which itself has a market cap of around USD 150 billion. AISVX could probably invest a few billion more without getting into problems. But that is because PM is a very large company. The same is true for their other big holdings – Microsoft, AT&T, Dow Chemical, Royal Dutch, Apple.

But are these stocks not simply the equity market itself?

What about investing in the best performing stocks of 2011?

According to The Street, the five best-performing S&P 500 stocks in 2011 were: Cabot Oil & Gas (COG); El Paso Corp. (EP); Intuitive Surgical (ISRG); Biogen Idec (BIIB); Mastercard (MA). The April 9, 2012 market caps of each were: COG, USD 6.5 billion; EP, USD 23 .2 billion; ISRG, USD 21.7 billion; BIIB, USD 30.0 billion; MA, USD 55.0 billion. With the possible exception of Mastercard, it would be difficult for AIVSX to acquire enough shares of these companies to have any real impact on the fund performance.

Fees Hurt Net Performance

I write about this a lot. Fees may be the biggest reason for underperformance.

You own a fund that beats its benchmark by 1%. Pretty good. Until you realize that you are paying a 2% management or total expense ratio each year.

You want to improve your performance, focus on fund fees. Stick with passively managed open ended index and exchange traded funds (ETF) to minimize costs.

For example, AIVSX has an annual expense ratio of 0.61%. Not bad for a mutual fund. Its top 10 holdings at December 31, 2011 were Philip Morris, Microsoft, AT&T, Dow Chemical, Royal Dutch, Apple, ConocoPhillips, Home Depot, Abbott Laboratories, JP Morgan. These stocks make up 27% of the fund, so a big impact on overall performance.

Yet consider the iShares Russell Top 200 Index Fund. Its top 10 holdings include Apple, Microsoft, AT&T, and JP Morgan. Significant overlap with AIVSX.

And the iShares ETF only charges 0.15%. Almost half a percent less than AIVSX.

Oh yeah, it is up 12.8% to March 31, 2012, versus AIVSX at 11%.

What to Do

The article provides some good advice for investors:

investors should look for funds with low expenses and pick fund managers with long, consistent track records of success. They should avoid newly established funds, or those with relatively inexperienced managers. Then, look for funds without wild year-to-year swings in investment return.

As I elaborate in Why Active Investing is not Optimal, avoid the expensive active management approach. The payoff is usually not worth the price. Keep costs low and try to match the market as best you can. That means passively managed open ended index mutual and ETFs.

If you do consider active management, look at long-term fund management performance.

You want to see how the manager does over time and in both up and down markets. Remember that a fund may be in place for a long time, but management can change. What a prior manager did 5 years ago may not be relevant to what the current manager will do tomorrow. So study the manager and not simply the fund.

Next time I will have a few words on the last part of linked The Wall Street Journal article. Namely that you face a formidable investing foe: yourself.

8 Keys to Financial Security

Jordan Wilson — Mon, 09 Apr 2012 18:01:53 +0000

Knight Kiplinger, head of Kiplinger financial media, created a nice asset management video.

8 Keys to Financial Security is exactly that. Tips for protecting your assets and growing wealth.

As per usual, I add my two-cents to Mr. Kiplinger’s wealth management recommendations.

Kiplinger’s 8 Keys to Financial Security

I like this short video because it reminds me of something created in the 1950s (it seems to have been created in 2011 though). Kind of like a Simpsons’ episode where Bart or Lisa is forced to watch an outdated instructional movie in school.

But while the video is a little quirky, the points are very relevant and useful.

http://www.youtube.com/watch?v=Lx3b9-5hHiI

1. Invest in Yourself

This is why I write about education and career issues in a wealth management blog.

Individuals invest their capital in stocks, bonds, and so on. But you need to create that capital first. The more wealth you can create, the more you can save and put to work for you. Therefore, the best investment that you can make is to invest in yourself.

Invest in, not spend on yourself. Always look at the cost-benefit of any expenditure.

That may be technical skills in high demand industries (not puppetry or poetry). Complementary skills – such as industry specific knowledge, basic business skills for technical graduates, or foreign languages – that add value to your core training. There are many ways to improve your chance of career success.

2. Protect Yourself and Your Loved Ones

The need for protection depends on your personal situation and job.

If you are young, with a new family, insurance is a great way to protect your family if something happens to you. But if you are single, maybe insurance is not a big need.

As you age, perhaps your family assets will provide all the security you require. Or perhaps your job includes disability and death coverage.

Examine your unique needs. Reevaluate your needs over time and whenever a significant event takes place in your life. Then decide if insurance is necessary. It just may be.

3. Borrow Sparingly

If it was me, I might say borrow prudently rather than sparingly.

I understand, and agree with, Kiplinger’s belief. Borrow for appreciating assets (home) or required large expenditures (car for work). Avoid borrowing on wasting assets.

I differ in that I am comfortable with prudently borrowing for investment purposes. Leverage, used responsibly, can enhance returns. But it must be used prudently and only by those who understand investing and its risks.

I also differ a little on borrowing for homes and houses. Do not borrow beyond your needs or ability to comfortably repay.

Banks like to lend money. They make great profits off consumer loans and mortgages. Banks will happily lend you as much as you can tolerate and repay. Not what you need.

You need a car for work? You have $15,000 in cash, but based on your financial situation the bank is happy to lend you $85,000. Should you take advantage of the entire offer and buy a brand new BMW? Or should you only borrow $5000 and buy a slightly used, but still under warranty, vehicle for $20,000? Borrow if you must, but borrow wisely. The interest you will pay on that $85,000 loan will cost you dearly in the long-term.

4. Pay Yourself First

Use direct deposits so that you never see the money. If you do not have that $100 (or more) in your account every month, you cannot spend it. And like rent, utilities, loan repayments, etc., you quickly get used to not having the cash on hand.

Most mutual funds provide direct debit investing options. Sometimes initial purchase requirements may be high for small investors (but not with all fund companies, so check around), but usually subsequent purchases are very reasonable in size.

You can also look at other investing options that simplify share acquisition. Dividend reinvestment plans (DRIPs), direct stock purchase plans (DSPPs), and employee stock purchase plans (ESPPs) may allow for direct investing in a company’s shares.

5. Don’t Go For the Home Run

Finding that next Apple or Google is great, but difficult to do. Individual investors strike out many more times than hit a home run.

That is why I typically recommend a steady, consistent investment strategy. One that passively invests in well diversified, low cost assets. Using dollar cost averaging and a general buy and hold approach.

6. Diversify, Diversify, Diversify

I might even add a fourth diversify.

Diversify between asset classes, within an asset class, and by time.

How you diversify is based on your unique investor profile and Investment Policy Statement.

7. Live Simply Today

Remember our discussions on compound returns?

A dollar saved today grows substantially over time.

You can try to keep up with the Jones’s now. Or you can scrimp a little today and surpass them in retirement.

8. Give Generously of Yourself

I shall leave the giving back to each of you.

My only comment on charitable donations is to know where your money is going.

There are too many charities that distribute too much money to staff salaries and advertising versus using that money for its stated purposes. Check out a charity’s financial statements before contributing your hard earned cash. Your money may be going to pay the President’s salary or lobbying efforts instead of helping that starving family or curing a disease.

Investors Shun Risk

Jordan Wilson — Thu, 05 Apr 2012 01:47:09 +0000

A relationship exists between investment risk and expected return.

The safer the asset, the lower the expected return. The greater the investment risk, the higher the required return. Or it can be a tad more technical if you like.

Investors should take an objective view of investment risk. Unfortunately, investors tend to be emotional creatures and these volatile times lead people to become fearful of investment risk.

So what is happening? And what should you do as an investor?

Investors Shun Risk

According to Morningstar, Shaken Investors Shun Risk.

The demographic bulge of aging baby boomers is becoming ever more risk-averse as it continues its march toward retirement. At the same time, investors as a whole have become financially and emotionally scarred by bear markets. The result, says financial-services consultant Goshka Folda, has been a flight to safety.

The first sentence makes sense. Younger investors have a significant time horizon. Young investors have more time to ride out the increased volatility of higher risk assets. As such, young investors should seek out relatively higher risk assets to reap higher expected returns.

As investors approach retirement, there is less time available to deal with highly volatile investments. Safety and certainty are more important. That is why you see older investors shift their capital into lower risk asset classes. And receive lower returns.

The second sentence though, reflects how emotions play a significant role with investors. Emotions should be avoided when investing. That said, I realize how hard it is to maintain a disciplined, unemotional, investment strategy when markets are moving like a roller coaster.

How This Impacts Asset Allocations

Of the more than $3 trillion in investible assets of financial wealth, more than $1 trillion is sitting in deposits (Source: Household Balance Sheet Report, 2011 Edition). In addition, close to another $1 trillion consists of short-term instruments with maturities of less than one year.

A lot of investors appear to be heavily invested in low-risk, low-return assets.

While this low risk approach might be reasonable for retirees (but beware that a 65 year old retiree may live until 90, so may still desire/need some higher risk assets to finance a 25 year retirement), a low risk strategy is probably not suitable for younger investors.

Asset allocation is extremely important for investing success. It should not be based on emotion and fear of loss. Your asset allocation should be unique for you, based on your personal situation.

What to Do?

“After so much damage, clients are now in a risk-averse stance,” says Folda, “But the reality is that many households still need growth, they need exposure to at least some equity.”

“So volatility, while damaging for everybody,” says Folda, “can be opportunity for advisors to even further underscore the importance of good advice and solid solutions in establishing the right risk profiles for portfolios.”

I think there are a few keys to effectively deal with volatile markets.

Investors need to construct investor profiles and Investment Policy Statements. These will determine a proper target asset allocation and help maintain long-term focus during periods of short-term volatility.

A properly diversified portfolio will reduce portfolio risk without lowering expected returns.

Low cost investments such as open-ended index mutual and exchange traded funds will help with diversification and cost-effective investing.

While I understand that many advisors, banks, brokers, etc., want to sell investors innovative new products (that usually are quite profitable for the seller), be cautious. Minimizing your costs is a key to maximizing long-term success. Do not pay someone else 1-2% of your capital each year simply to purchase the flavour of the day.

Dollar cost averaging will also assist in dealing with volatility and staying disciplined.

If you use these techniques you will reduce emotion in your investment decisions. This will improve your portfolio construction and your probability of long-term investment success.

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