The decision to start an investment program is very important for a worry free financial future, whether to fund a retirement, kid’s college expenses, or just to have extra funds for great holiday vacations. The best place to start is through a company’s 401K investment program ( or 403b if it is non profit). If 401K’s are not an option, then setting up your own IRA account ( Roth type IRA’s are a good way to go ). Because the financial markets have their up’s and down’s your investment timing is best if done on a regular, monthly or quarterly type contribution. Maxing out your contribution is the best way to go, along as there is sufficient funds available for you other financial needs. In some cases, companies will match a percentage of your contribution — this is the one to really max out on.
So you make the decision to put some of your hard earned income into an investment program and you are presented with many options of where to place your contributions. It was real easy when I first made 401K contributions, as my company had only 3 options — a stock fund, a bond fund, or a money market fund. The choice was easy for a beginning career to place contributions into a stock fund to allow for maximum long term growth. In later years some of this money would go into bonds and near retirement more into fixed income type investments. Being a technical kind of guy, I looked at the long term growth charts the company provided and did some once a year moving of funds into bonds as there were time periods lasting up to 10 years when the stock market never gained anything (from 1972 to 1982, for example).
In today’s investment option list, there are usually many options to select from, and this can become confusing at times. This is where diversification comes in. There has been a lot written about Modern Portfolio Theory (more on this in later blogs) which points out how diversification of your investments can not only reduce your risk to market variations, but also provide a more stable growth of your assets.
By the way, for companies that give you their stock as matching funds to a 401K program, we have all learned about Enron and how that stock crashed, thus being careful about how much of your retirement assets are connected to your company is very important to not allow this to be your main source of assets (although I’m sure if you are lucky to have Google or Apple as your contributor, you may question this — yet look back at what happened to SUN (symbol now JAVA) when the bubble collapsed in the 2000-2002 time frame)
Now you are looking at investment choices for investing your 401K dollars. The usual way is via a selection of mutual funds offered by either your company’s 401K program or a brokers list of mutual funds for IRA’s. Starting out with your investment dollars, usually a good way is to used Open Ended Mututal Funds or Exchange Traded Funds (called ETF’s). There will be more the differences in upcoming chapters, but for now look at these as an instant way to diversify your investments as these investment vehicles will purchase a broad basket of stocks, bonds or hold cash in an interest bearing account. These funds have associated with them what is called “Style” and along with this “Size.” Below is a box for a Mid-Cap Blend fund, found on Yahoo’s Financial Website when a “profile” option is selected for such a fund.
| Mid-Cap Blend [View Category Definition] |
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This Category box basically suggests that not all mutual or ETF investments are created equal. The Style Value, for example indicates a company with solid earnings, whereas a Growth style indicates a company that is growing in size, but may not have great earnings. Blend funds are a combination of the two. Companies are also categorially identified by their sizes, smal to large. Size is defined as the number of outstanding shares times the price per share — Google being one of the largest, for example.
Now you ask, how is picking a mutual fund by style and size so important? To answer this, first go to this link,
http://www.callan.com/research/institute/download/?file=periodic/free/256.pdf
which is a periodic chart of investment results from 1988 to 2007. Looking just at 2007, the chart shows that the group of stocks represented by the Russell 2000 Value Index (small stocks with value orientation) did the worst and the best performers were foreign stocks represented by the MSCI EAFE (Europe, Asia and Far East) Index did the best. Notice though that over the years, there is no consistency — 1988 was great for Large Growth Stocks, but then by 2000 this same group was near the bottom.
This is why diversification for investments is important. You do not want to be the person who put all their investment eggs into a category right at the top (perhaps foreign stocks now?) only to find a year later that you lost 20 or more percent of that investment. This is why you not only spread your investments out over time, but also into many categories.
All for now — happy investing,
Don
