9 Investing Rules For a Rocky Market
The economic signs are mixed, and the stock market has replied in kind. One positive signal and equities soar; then a disappointing report comes in and your portfolio dips again. The experts say things are getting better and we're in a recovery. Or maybe it's a double-dip recession.
Recent months have felt like a never-ending tennis match and your financial future is the ball, lobbing this way and that with no clear path to the endgame--a healthy nest egg for retirement. Should you stay the course? Or is there something more you could be doing with your long-term savings?
While the economy remains unpredictable, your plan for financial security should be designed to withstand whatever is thrown your way. That means you need a smart and diverse portfolio created with your age, risk tolerance and retirement time frame in mind to reach your goals.
Here are nine investing rules to help you build financial security.
1. Pay Yourself Every Month
Consider savings to be a monthly expense, like paying the mortgage or the grocery bills.
"Saving should be automated to avoid getting your hands on the money since it has a tendency to disappear before you save it,'' says George Papadopoulos, a certified financial planner and certified public accountant in Novi, Mich. "If it's not there, you cannot spend it.''
That may sound easy, and it is--once you set it up. Participate fully in your 401(k) or 403(b) at work, telling your employer to take a certain amount out of your check each pay period. (Learn more about managing your 401(k) here.) This may sound obvious, but studies show that many employees don't take advantage of workplace 401(k) plans, which often come with at least a partial match of worker contributions (free money) by employers.
If your employer doesn't offer a plan, set up an Individual Retirement Account (IRA) at your favorite financial institution. Instruct your bank to regularly transfer funds from your checking account to your retirement account.
If you're over age 50, remember that you can save an additional "catch-up contribution" of $5,500 to your employer plan or your IRA in 2010. (Future contribution increases will be based on inflation.)
2. Set Savings Goals
You'll never reach your goals without a plan. Start by making a list of what you hope your savings and investments will enable you to achieve. (Use the SecondAct Take Charge Financial Guide for help.)
Be specific with your goals, and write them down. Putting pen to paper will force you to think seriously about what you want to accomplish. For example, your list may say "Work only part time after age 55" or "Save enough to travel every year."
"Once you establish your goals, you can then decide on your path to achieve them--how much to save and what types of investments are appropriate based on time horizon,'' says Linda Homsey, a certified financial planner with Freya Financial Services in Winchester, Mass.
Every year, it's important to revisit your goals. For example, a divorce or a job loss may significantly alter your view of your future and your savings plan. Your portfolio strategy should reflect any life changes.
The current market's volatility doesn't mean you should pull your savings out of stocks. Instead, make sure your investment strategy reflects your age and your time frame. As your expected retirement age draws nearer, your portfolio should grow more conservative. You don't want to completely divest of stocks, which you'll need for growth to keep up with inflation, but you shouldn't be "all in," either.
Consider the next step as you weigh the proper balance for your portfolio.
Simply choosing stocks or bonds isn't enough to grow or protect your portfolio. You need to diversify.
Diversification is spreading risk among different kinds of investments. It's the opposite of "having all your eggs in one basket." The goal is that your portfolio will have a variety of investments that are not correlated--when some go up, others may go down--but over the long term, studies show that diversified portfolios gain in value. Check BankRate.com's Asset Allocation Calculator to get started or work with your financial advisor.
Having numerous mutual funds doesn't mean you're diversified. There are only so many stocks and bonds in the investing universe, and many of your funds may hold the same securities. That means your portfolio could be over-represented in some areas. To see if your investments overlap, try Morningstar.com's Instant X-Ray tool. Enter the names of your mutual funds, and the tool will compare the funds' holdings, and you can see if you have excessive overlap.
Consider putting small stakes in alternative investments, too. These won't always run in tandem with the overall market, so they will help you further diversify. Look at funds that specialize in real estate (REITs) or commodities, for example.
4. Understand Your Risk Tolerance
The past few years of stock market gyrations have put investors' stomachs to the test. Some people who thought they were willing to take risk with their savings have spent sleepless nights as stocks--and their bottom line--tumbled.
It's important to understand your risk tolerance, or how much risk you're willing to take in exchange for the possibility of higher investment returns. Try this risk tolerance test as a starting point.
If you decide you have a weak stomach, that doesn't mean you should completely steer clear of stocks. It means you need to find the right balance.
5. Consider Expenses
Be aware of fees. Most investors rely on mutual funds, which can be purchased independently or through a 401(k) plan, for their long-term savings. Mutual funds cost money to manage, and as investors, we pay the pros to manage the fund in the form of an expense ratio.
If you choose investments with soaring expense ratios, those costs will eat into your overall return. For example, a $10,000 investment in a mutual fund with a 0.50 percent expense ratio will cost you $50 a year. That same $10,000 in a fund with an expense ratio of 1.75 percent will cost $175 a year. That's a huge difference.
Look closely at your mutual funds and make sure they're not overly expensive compared to their peers. Go to Morningstar.com, enter the name of your mutual fund, and then view the fund's expenses. The average expense ratio for a domestic stock fund is about 1.5 percent. International funds are higher, and index funds are far lower. If your funds are costly, consider other options.
6. Review Your Portfolio
You have to keep tabs on your portfolio. Advisors recommend that you rebalance your funds twice a year to stay close to your original investment strategy.
Let's say you've decided 50 percent of your money should be in fixed income and 50 percent should be in stocks. And let's say this year, your stock investments lose 5 percent and your fixed income investments gain 5 percent.
Your portfolio is now out of balance, with 55 percent in fixed income and 45 percent in stocks.
To stay on track, you must rebalance your portfolio--sell some of the fixed income and buy some more stock, bringing your allocation back to the original 50-50 split.
The easiest way to do the rebalancing is with a simple Excel spreadsheet. Create your own or download these templates for help.
7. ... But Don't Review Your Portfolio Every Day!
Sure, when the Dow drops 150 points, you may be curious about how your portfolio fared. But looking--and seeing bad news--may cause you to react and make rash investment decisions based on fear, rather than sticking to your long-term game plan.
8. Leave Emotions on the Sidelines
Investing is no place for emotion.
Perhaps you've inherited a stock from a parent, and even though it doesn't mesh with your financial plan, you're loathe to sell and lose the family connection. Or perhaps you're prone to knee-jerk reactions when you see the stock market swing wildly.
Remember your long-term plan. You had a reason when you chose your investments, based on a strategy to help you reach certain financial goals. Don't let your emotions take you off track.
If you're not sure how much your heart--or your stomach--play into your investing decisions, try the The Investor Psychology Quiz.
If you cannot separate your emotions from your portfolio, consider hiring someone to manage your investments for you.
9. Don't Be Afraid to Ask for Help
It takes a substantial time commitment to create and monitor a financial plan.
Even if you're motivated to manage your investments on your own, you might want to consider engaging a pro to help. (Read my previous column for tips on choosing an advisor.)
A savvy advisor may offer suggestions you haven't considered or point out flaws in your plan. An advisor is also helpful in bridging the gap if you and your partner disagree about money strategies.
"There is real value in having an objective financial planner help you or you and your spouse/partner sort out your financial affairs,'' says Homsey. "This third-party partner can be a good sounding board and help you hold yourself accountable for your financial behaviors.''