You’ve heard it all before. Now it’s time to listen.
#1- Know your investor-self
We all have investment parameters and constraints unique to us. Considerations like risk tolerance and tax consequences are two common investment parameters. Time and money are investment constraints. You may be fed up with work and want to retire tomorrow, but with the cost of living so high, you may not have enough money for a secure retirement just yet. You must know your investment parameters and constraints as they should serve to govern how you invest.
What is your risk tolerance? I have found it helpful to ask clients to state their risk by grading it on a scale of 1 to 10. It helps to quantify your risk tolerance. For help with that, I suggest 6 to be the risk “Of the Market,” or the S&P 500. So, a risk number greater than 6 on the scale is saying you are willing to take on more risk than the market index. A more conservative risk tolerance (below 6) is the opposite. An investor’s asset class and investment allocation should be consistent with their risk number.
Your investment income needs, time horizon, and tax consequences also need to be known before you invest. These are critical variables in any sound investment plan. Here is a classic case of less being more, especially in our high tax state: A high income earner in California seeking safe investment income is typically best advised to buy state bond issues (a municipal bond) paying less interest than a comparable corporate bond because the lower interest rate from the “muni” may be higher on a “taxable equivalent yield” basis. So he would earn less interest, but keep more income net of taxes.
The results of the answers to your investor-self should be clearly and simply reflected in your personal Investment Policy Statement (IPS). If you are not a DIY investor, be sure to only have an investment advisor who provides you with an IPS.
#2 – Know your investments
The one constant element inherent in all investments is risk. Bernard Baruch said, “There is no such thing as an investment without risk.” Know your investment risks. Bonds fall as interest rates rise. Stocks can decline dramatically due to market and unique risk. Even CD’s, or other short-term time deposits have risk. This is not the risk of principle loss, but what’s called, “Opportunity Risk.” That is the risk of not receiving a greater return, especially over a long-term. Even a U.S. guaranteed government obligation has the risk of losing money if sold before it matures.
The risk list is long. There are currency risks, political risks, market risks, systematic risks, timing risks, and as mentioned, interest rate risk, which is related to inflation risk. Market and economic risks are manageable, so don’t worry. Just know the risks to begin with. “Surprise!!” Should only be experienced at your unexpected party, not in your investment portfolio.
All investments have costs. Know them. Even “No Load” mutual funds and “Free” ETF’s have costs. In fact, these fund’s management fees and other expenses combined often exceed 1% per year. They are all disclosed in their prospectus. Like lunch, there are no free investments. Further, low, discount investments and services are often costly. “Caveat Emptor.”
Looking forward to sharing more investment concepts and strategy in next month’s Investor’s Edge column. ~ John
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