Making Safer Investment Decisions in 2009

It’s hard to say what 2009 will look like. While there are still several concerns (the housing market, rising unemployment, etc.), there will also be considerable government intervention to help improve the economy this year, both in the U.S. and worldwide.

So what should you do in 2009 to make your portfolio and overall financial picture better? Here are some general ideas to employ as markets and economies hopefully stabilize in the New Year:

Start with a plan (or review an old one): If you’ve worked with a financial planner in the past, now is a good time to review your plan to make sure you are still on track to meet your goals. If you haven’t worked with a financial planner before, or if you haven’t prepared a financial plan before, it might be time to meet with a Certified Financial Planner™ to create a plan. Much of the riskiest investing, overbuying and panic selling during the late 1990s and early 2000s could have been avoided if individual investors had sought advice for achieving long-term specific goals such as retirement or a college education.

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Should You Move to “Safer” Investments?

After watching their 401K balances shrink up to 40% in 2008, many people are wondering if they should change their allocation to include more “safe” investments, or if they should move completely to “safe” investments then move back into the market later.

Here’s what Walter Updegrave with Money Magazine has to say about this:

But as understandable as the urge may be to transfer all your money into the investments that seem safest – stable value funds, capital preservation funds, money market funds and the like – that would be a mistake.

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When the Road to Investing Gets Bumpy

Investing in the stock market is a lot like driving on a long road trip.  At some point, you’re going to run into pot holes and rough patches.  When that happens, you should definitely drive with more caution, but you have to keep on going if you want to reach your destination.

Similarly, if you’re investing for long-term goals such as retirement, you will encounter some market volatility, probably several times along your journey.  While you may be tempted to pull over and wait out the rough times, it will delay or may even prevent you from reaching your goals.

So what should you do when the road to investing gets bumpy?

Buy Low, Sell High:  The whole premise behind investing is to buy low and sell high.  You can’t do that if you pull out of the market or stop investing when the market goes down.  If you’re investing for the long-term, you should be glad when the market is down, because then stocks are “on sale” and you can pick up more shares at a lower price.  Who doesn’t love a good sale?

Diversify: One of the best ways to defend your portfolio against market losses is to have a portfolio that is properly diversified.  If you review the history of the stock market, you’ll see that the best performing assets vary from year to year and that it’s not easy to predict which asset class will perform well in any given year.  Therefore, by having a mix of asset classes, based on your risk tolerance, your goals and your timeframe, you are more likely to meet your goals.  In addition, having a mix of asset classes reduces your risk of loss, since you won’t have all of your eggs in one basket.

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Does the market have you feeling squeamish?

As you read the headlines and hear the news, it’s almost impossible to avoid feeling a bit squeamish in today’s volatile market. You’re probably wondering what’s in store for 2008 after such a bumpy first few weeks. Unfortunately, it’s impossible for even the most brilliant economists to accurately predict the future.

The most important thing you can do during volatile market times is to have a plan, and to NOT make rash decisions based on emotion. During volatile markets, planning is essential to minimize your stress level. That doesn’t mean that you won’t feel nervous if your investments decline, but focus and confidence will help you fight the natural human tendency when it comes to your own nest egg to sell when the market is down. Remember the old adage “Buy low, sell high”? Now is the perfect time to “buy low”.

A well diversified portfolio is one of your best allies when markets are volatile. Remember, you are investing for the long term; even if you are retired your investment horizon could still be 20+ years. Market downturns can be great buying opportunities for the long-term investor. For example, your regular 401K contributions this month are purchasing more shares than 6 months ago. When you actually need these funds in 5, 10, or 20 years, chances are very good they will have significantly increased in value. So by buying when the market is low, you are actually leveraging your money to work harder for you in the future.

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Why You Need Bond Funds in Your Portfolio

With the stock market doing so well, you might be wondering…

1.  Why aren’t my bond funds performing well?  or
2.  Why do I need bond funds in my portfolio?

The main purpose of bond funds (or bonds) is to provide diversification for your portfolio.  Diversification reduces the risk that your portfolio will lose money in a market downturn.

Bond funds typically go down when the stock market is performing well, and up when the stock market takes a turn down.  So when your stocks and stock funds are performing well, it’s normal for your bond funds to have a small or even a negative return. 

A balance of stocks and bonds in your portfolio reduces the volatility of your overall portfolio, and reduces your potential losses during market downturns.

Still not sure if you need bond funds in your portfolio?  Check out these returns of stocks and bonds during market downturns:

Total Returns of Stocks and Bonds During Market Downturns
	From December 31, 2000 to October 31, 2002	From June 30, 1990 to October 31, 1990	From July 31, 1987 to December 31, 1987	From December 31, 1972 to October 31, 1974
Bonds	29.07%	2.93%	2.97%	6.17%
Stocks	-37.39%	-14.09%	-21.39%	-32.99%

Source: Calculated by American Century Services, LLC, using information and data presented in Ibbotson Investment Analysis Software ©2007 Ibbotson Associates, Inc. All rights reserved. Used with permission. Stock returns are represented by the S&P 500 Stock Index, an unmanaged group of stocks considered to represent the stock market in general. Bond returns are represented by the Lehman Brothers Intermediate Government/Corporate Bond Index, an unmanaged market value weighted index of government and investment grade corporate fixed rate debt issues with maturities between one and 10 years. Stocks may be volatile. Past performance is no guarantee of future results.

Vanguard changes their fee schedule

Vanguard has eliminated several account related fees and replaced them with a single account service fee, effective April 26, 2007.

Here’s a summary of the changes:

The following annual $10 account-related fees have been eliminated:

• The custodial fee on traditional IRAs, Roth IRAs, and SEP–IRAs with a balance of less than $5,000.
• The maintenance fee on index fund accounts with a balance of less than $10,000.
• The custodial fee on education savings accounts (ESAs) with a balance of less than $5,000.
• The low-balance fee on all nonretirement accounts with a balance of less than $2,500.

These fees have been replaced with a single account service fee. This $20 fee will be charged annually for each Vanguard® fund in which you have a balance under $10,000 in an account.

The annual account service fee can be avoided by:

1. Signing up for account access on Vanguard.com® and choosing electronic delivery of shareholder materials, including statements, confirmations, fund reports, and prospectuses.
2. Consolidating your accounts or investing additional assets to bring all account balances in all funds to $10,000 or more.
3. Maintaining total Vanguard mutual fund assets of $100,000 or more.

To learn more about Vanguard’s new fee policy, please click here.

Tags: investment fees

Coping with market fluctuations

You’re probably aware that the stock market fell 400 points last week.  How did you handle the drop?  Did you panic and sell, or did you hold tight?

Market cycles are normal and should be expected.  You shouldn’t allow your emotions to influence your investing decisions.  Remember these important points when making investment decisions:

Diversify to reduce risk.  Spread your investments among various asset classes (stocks, bonds, cash) based on your goals, time frame and risk tolerance.  If your portfolio is properly diversified, a decline in one asset type will be balanced out by a gain in another asset type.

Focus on long term goals and your overall portfolio.  Short term blips are insignificant if you are investing for 10, 20 or 40 years.  In addition, it’s more important how your overall portfolio performs than how each individual investment performs.  Remember, 90% of your investment return is determined by how your portfolio is allocated, rather than the individual investments you choose.

Make market fluctuations work for you.  If you are in the accumulation phase, take adantage of a market drop to buy investments.  Remember the old adage "buy low, sell high"?  The best time to buy low is right after a market drop.  If you are close to retirement, use market fluctuations to evaluate your portfolio for appropriate risk tolerance and diversification.  If the drop in your portfolio was more than you can tolerate, consider rebalancing to an asset mix that is more appropriate for you – however, don’t make any rash decisions; wait a few days and use dollar cost averaging so that you don’t sell low and buy high.

Here are some great articles addressing the market drop last week, and how to handle financial anxiety:

How to cope with financial anxiety

Market misbehavior calls for wary eye, not grounding

Is that CD safe?

I frequently see ads for CDs in the local newspaper with higher than normal interest rates.  Many of my clients ask me if these CDs are safe.

You only want to invest in CDs, savings, or money market deposit accounts if they are insured by the FDIC.

The FDIC – short for the Federal Deposit Insurance Corporation – is a goverment agency that protects depositors against loss of deposits in the event the bank or savings institution fails. 

Your accounts are insured up to $100,000, per person and per bank.  Accounts covered by FDIC include checking, NOW, and savings accounts, money market deposit accounts, and time deposits such as certificates of deposit (CDs).

Investments such as stocks, bonds and mutual funds are not covered by FDIC, even if purchased through an FDIC insured bank.

To check whether a bank or savings association is insured by the FDIC, call 1-877-275-3342, or visit www2.fdic.gov/idasp.

Tips to protect yourself:

1. Never buy an investment you don’t understand
2. Understand the risks involved – non FDIC insured investments may earn a higher rate, but they are riskier as well
3. Know who you’re investing with – is it a bank, credit union, brokerage company?  What do you know about this company?
4. Make sure the investment is appropriate for you – a 20-year CD is not appropriate if you need income now.
5. Ask questions, ask questions, ask questions.  If you’re not getting satisfactory answers, don’t invest.

Are ETFs Right for You?

Exchange traded funds (ETFs) are gaining in popularity, but are they right for you?

ETFs are similar to index funds, but they trade like a stock, meaning they can be bought and sold throughout the day instead of just once a day.

Advantages:

Low cost – ETFs have a lower annual expense than most mutual funds, including most index funds.  According to Morningstar, the average expense ratio for ETFs is 0.30%, compared to 0.35% for no-load index funds, and 0.96% for all mutual funds.

Tax efficient – ETFs don’t have to sell stock positions to meet shareholder redemptions, which cuts down on taxable transactions.  Also, redemptions by large shareholders are paid in kind, protecting investors from unnecessary taxable events.

Disadvantages:

The main disadvantage of ETFs is that they can only be bought through a broker, which means you will pay transaction costs each time you purchase an ETF. 

Conclusion:  ETFs can be a great way to diversify your portfolio, especially if you are making a one-time purchase.  But if you make regular purchases, such as with dollar cost averaging, the transaction costs can end up costing you more than if you had purchased an index mutual fund.

To learn more about ETFs, check out the Exchange Traded Funds Center at Morningstar.  In addition, you can read more about iShare ETFs managed by Barclays Global Investors, or Vanguard’s ETFs.

The Importance of Low Costs

In SmartMoney’s Save 50% on Everything article, Anne Kadet says "Fussing over investment fees is a bore, but if you want to get rich, it’s a must."

I agree.  Keeping investment costs at a minimum is one of the most important things you can do to have a successful portfolio.

Investment costs (for mutual funds) include:

Annual operating costs – mutual funds have an annual operating cost to cover fund manager salaries, marketing costs, etc.  These can range from 0.20% up to 3.0%.  Index funds and Exchange Traded Funds (ETFs) will be at the lower end of the range, with specialized, actively-managed funds at the top end. 

Commissions – many mutual funds charge a commission, which goes to the person who sold you the fund.  Commissions can be charged up front, when you sell the fund, or continuously, and typically range from 3% to 6%.

Redemption fees – to discourage market timing, or active trading, some funds have a redemption fee.  Redemption fees average about 2% and usually occur if you sell shares of a fund within a certain time period, such as 6 months to a year.

Transaction costs – unless you purchase the mutual fund directly from the mutual fund company, you will probably have to pay a transaction fee to purchase or redeem shares.  This is true for ETFs, shares of stock, or individual bonds as well.  Transaction fees can be a flat fee per trade, or they can be a percentage based on the value of the securities traded.  Discount brokerages will have lower fees than full service brokerages, but fees vary widely, so you’ll need to shop around.

In addition, there are many other fees you may encounter, such as account maintenance fees, IRA fees, inactivity fees, transfer fees and more.

The bottom line is that money that’s not working for you is money wasted.  The more money you pay for investment fees, the less money that is working for you.  Saving 1% per year in investment costs, could mean 20% more money in your portfolio after 20 years.

More resources:

Don’t Let Brokerage Fees Undermine Your Returns
Mutual Fund Fees and Expenses
About.com – Mutual Fund Fees

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