Dollars & Sense
You can do it! Investing isn’t splitting the atom
By Daniel Roccato
The challenge of investing intimidates most of us. Stocks, bonds, and mutual funds, oh my. Did you hear about them in school? Probably not. Most schools don’t provide any type of financial curriculum. While some of us may have been fortunate enough to have our parents teach us something about investing, the reality is that most of us didn’t.
But, here is some good news: It is never too late to learn to be a successful investor. In fact, to become a successful investor, you need just three basic ingredients: a little knowledge, some common sense and a good measure of discipline. Let’s start with the knowledge part.
If the seemingly complex world of investing stumps you, it’s easy to understand why. The financial services industry has gone to great lengths to create complexity. Why? It’s simple. By making things more complicated than they need to be, the industry providers can offer equally complicated solutions to “help” you make sense of it. This may seem nonsensical until you realize that complex problems requiring complex solutions are the necessary ingredients to justify high fees.
The reality is that you don’t need a fancy MBA degree nor do you need to pour over massive amounts of financial analysis to develop a sound long-term investment plan. Let’s demystify the investment process by breaking it down into three basic components. I want you to think of an investment pyramid that has three sections: a base, middle and top. The base of the pyramid is the most important section since it will form the foundation of the investment process. It needs to be strong and endurable.
In our investment process, the base of the pyramid is something called “Asset Allocation.” Don’t become intimidated by the fancy name. Three basic types of financial assets or investments exist: cash (e.g. Certificates of Deposit), stocks (equities) and bonds (fixed income). The investment strategy of Asset Allocation simply means maintaining an ideal balance of cash, stocks and bonds. By investing in all three asset classes, you are on your way to creating a balanced portfolio.
In order to determine your proper Asset Allocation, you need to consider your age, your time horizon and your tolerance for risk. Generally, younger parents have longer to save and accumulate wealth. Therefore, it is reasonable for them to assume greater risk by allocating a higher percentage of their assets to stocks. While stocks pose the greatest risk of the three asset classes, they have rewarded investors with the best returns in the long term. The key is that a stock can and will experience dramatic swings in value and therefore should only be used as a long-term investment vehicle (e.g. more than five years).
Regardless of your age, however, there is a good reason to have at least some exposure to all three asset classes-diversification. For example, even a retired couple can benefit from holding some portion of their investments in stocks. With people living longer, it would probably benefit them to hold at least a small portion of their overall portfolio in a conservative, high quality stock mutual fund. As a rule of thumb, you can subtract your age from 100 to determine the percentage of your assets you should invest in stocks. For example, a 60-year-old person might consider 40 percent to be an appropriate allocation.
Next, you need to consider your time horizon. When will you need the money? Is it for college tuition in 10 years or for retirement in 30 years? The sooner you need the money, the safer the investment must be. Bonds and cash are usually safer choices for parents who will need to access their money within a short to medium timeframe. For example, if you need to make a tuition payment in three years, you should not invest the money in the stock market no matter how rosy the investment outlook might be. Instead, you should consider investing the money in short-term bonds or CDs.
Finally, you need to give serious thought about your appetite for risk. Are you willing to live through periods where your investment will go down in value? There is a simple way to think about this. I call it my Sleep Index. What kind of sleeper are you? There are plenty of things in life that will keep you awake, and as parents, you are all too familiar with them. But, don’t make your money one of them. No investment in the world is worth keeping you up at night. There is real value in having peace of mind. Let’s keep your sleep index high by avoiding any investments, no matter how promising, that make you run for a bottle of Tylenol PM.
Next month, Daniel will dive into greater depth and explain the “investment pyramid” to help you become the savvy investor you need to be.
Daniel Roccato, MBA, is a Managing Partner with Lane Bridgers Associates (LBA) Wealth Management in Moorestown, NJ. LBA is an independent financial planning and investment management firm serving people throughout the Delaware Valley. In addition, Daniel is an assistant professor of business at Mercer County College. You can reach him at 856.638.1855 or dan@lanebridgers.com for a no-fee initial consultation.
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