Dennis Smith
If you were invested in technology stocks over the past year, you are now probably singing the blues. Maybe you are still hopeful that the NASDAQ will climb up again to early 2000 levels. I will hope along with you, for technology, after all, is the future of the American economy.
But, as I write this, the NASDAQ is lower than it was two whole years ago, and that should give all of us pause. What happened is that we had an economic pummeling. There were six interest rate hikes in 2000, a declining euro overseas, rising and uncertain energy expenses, and the embarrassing election turmoil, all of which were then added to uncertain corporate earnings in a slowing economy – slowed because of all of the above.
I believed that Alan Greenspan raised rates too much last year, and has not lowered rates enough this year. The country needs to see that the economy is down but not out, and has as much life and potential as ever. But, until we have significant rate reductions and meaningful tax cuts there won’t be much to spur our confidence forward. Right now, it looks like a prolonged tough time for technology – which to me is a dubious commentary on what is undoubtedly the hub of our future’s wheel.
Like all your investments, though, your holdings in technology should be weighted and balanced, and protected, within a broad plan. What do I mean by weight and balance in the context of protecting your well-earned money? Diversifying. Diversifying means not putting all your eggs in one basket. It means investing in different industries, different geographical areas and different types of financial instruments so that gains from some investments offset the occasional, inevitable losses in others. By diversifying, you stand a much better chance of seeing your portfolio march on a steady climb upward, year after year, instead of suffering the angst of erratic, wild, up-and-down swings. If your investments are not balanced, then they are at risk.
Each investor needs an appropriate mix of stocks and bonds. How can you determine the mix that is right for you? You start by determining your tolerance for risk, since investments that hold promise of high returns always (and I mean ALWAYS) carry greater risk of losing value. Ask yourself three questions:
1. How long will I keep this money invested?
2. What will I use this money for?
3. How much can I stand to see my investment lose before I become nauseous?
The length of time your money is invested matters a great deal because long time periods allow market fluctuations to smooth out. If you are investing for a retirement that is 30 years away or for college expenses for a newborn, you can afford to be quite aggressive with your funds. On the other hand, if you’ll be accessing the money in five years or less, you don’t want to risk having to withdraw it when the market is in the garbage dump, so you should be more conservative.
The use you will put your money toward affects your risk tolerance as well: if you are absolutely counting on the funds for your survival, such as your sole support in retirement, you should be more conservative. If you’re saving for a boat, trip or other luxury, you may be able to take more risk.
Your personal feelings about risk should not be ignored. Some people just don’t have the stomach to see their investments plunge 25% or more. If you can’t sleep at night knowing that your investments may be losing value, high-risk investments just aren’t worth it.
Once you have a good idea of how much risk you can assume, how should you select your investments? This is a matter of opinion among financial advisors. My rule of thumb is that conservative investors should place 50-60% of their portfolio in fixed income (bonds), with the rest in stocks. Moderate investors may want to use 20-30% bonds, while 100% equities portfolios should be reserved for the most aggressive investors.
Consider Dan, 35 years old, married with two children and a mortgage. Dan plans to retire from the fire department in 20 years and has been wisely stashing $2,000 a year into his IRA (Individual Retirement Account), accumulating $40,000 over the years. What should he do with it? Well, since he has a long investment horizon, he may be able to take an aggressive approach. However, he’s really going to be counting on that money to support himself in his old age. And, he’s by nature not a real daredevil: he wants to be sure that his hard-earned money will be there when he needs it. Dan would be wise to choose a moderate investment strategy. A portfolio that includes 30% low-risk bond mutual funds, and 70% widely diversified stocks would be suitable for Dan.
Why should Dan choose mutual funds, when there are many quality stocks and bonds available? Because mutual funds give you broad diversification along with professional management, even with a small investment. There are over 11,000 mutual funds, ranging from ultra-conservative Treasury bond funds to ultra-aggressive stock growth funds – plenty of choices to meet the needs of every type of investor.
When investing in mutual funds, it’s crucial to ensure that the funds you select are properly diversified. Many funds invest only in one industry or geographical area, making them too concentrated and risky for most investors. Check the holdings of the fund. You should have investments in nearly all the major market sectors: financial, industrial, utilities, energy, durables, stables, services, retail, health and technology. Some mutual funds include an even balance of several industries, while others concentrate in just one or a few.
Since no one can tell which sectors are going to be the hot performers in coming months, it’s best to own a little of each. In short, the prudent investor is one who properly diversifies. Choose mutual funds that are compatible with your risk tolerance, and that have a solid track record and are broadly diversified. If this process of investing seems too confusing, there’s nothing wrong with seeking professional investment advice. A professional can help you determine your investment goals and select appropriate instruments for reaching those goals.
Whether you choose to go it alone or seek professional guidance, the ultimate responsibility for your money is still yours. By crafting a prudent plan and sticking to it, you will be well on your way to financial success.
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About the Author - Dennis Smith
Dennis Smith is the founding editor of Firehouse Magazine and the best selling author of
Report From Engine Co. 82 and other books. He has completed the federal Series 7, Series
63 and Series 65 exams and is a licensed financial advisor. Dennis Smith will be providing
some financial insight beginning with the January issue of Firehouse Magazine, as well as
authoring regular on-line commentary for Firehouse.com.
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