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Money Guide – Investing

The following is adapted from “Living in the Village: Build Your Financial Future and Strengthen Your Community” by Ryan C. Mack.

– A Diversified Investment Strategy Will Weather Economic Storms
– Dollar-Cost Averaging Automates Your Investment Strategy

– The Four Stages of Retirement Income
– How to Research a Stock
– What to consider when selecting a Mutual Fund
– Steps to Begin Real Estate Investing

Let’s start with a quick pop quiz….Which of the six below is the best place to invest your money?
a. Stocks
b. Bonds
c. Real estate
d. Business
e. Gold
f. Oil

The answer is simple: the BEST place to invest your money is in all of them! Not to say that you should run out now and invest in every asset class because we all have different risk tolerance. You may never invest in a business, you may prefer bonds to stocks because you are in or near retirement, or you may prefer stocks because you are young and ready to take on lots of risk. However, what we are saying is there is no singular “best” investment, but only the mixture of investments that are most appropriate for you.

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It is said by many that asset allocation is the single most important aspect of any portfolio. Each investor will have a different risk tolerance therefore will have a different asset allocation. If you’re young, you might have an asset allocation of 70% stocks and 30% bonds. Stocks are more volatile than bonds but tend to have a higher return over time. As a younger investor, you have time to recover from major market fluctuations. In contrast, if you’re older and near or already in retirement, you might have an asset allocation of 20% stocks and 80% bonds. If you’re thinking of retirement, you should primarily be concerned with conserving capital and not investment appreciation.

Consider the four stages of your retirement income when approaching asset allocation:

The Accumulation Stage is the stage when you have just started working, are roughly between the ages of 21 and 38, and have many years before retirement. This is the stage where you can take the most risk because you have more time to recover from a downturn in the market. In this stage you typically have 80% or more of your portfolio in stocks and precious metals.

The Conservation Stage occurs when you’re roughly between the ages of 39 and 50. During this stage, you may have accumulated a nice-size nest egg in your early years, and maybe you’re just starting to think about retirement but still have more than 10 years to go. In this stage, you are more concerned about losing the money you’ve accumulated and you may have a 50/50 split of stocks and bonds.

The Distribution Stage occurs roughly between the ages of 51 and retirement. During this stage the person’s ultimate goal is the conservation of capital and outpacing inflation. You may have as much as 75% of your portfolio in bonds. In the distribution stage, you don’t have much time to recover from downturns in the economy.

The Transfer Stage occurs when you pass away. It’s easy to overlook this stage, but it’s just as important as the others, if not more important. Make sure that all your accounts have up-to-date beneficiaries so they are not subject to probate when you pass away. Probate is the legal process of validating your will, assigning your assets and paying your debts. The process is long and costly and can be avoided by simply designating beneficiaries for your retirement and investment accounts.

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Reducing your risk is very important when investing. Let’s say you purchase just one stock…Nike. You follow Nike, love Nike, and feel it’s a great purchase, so you dive into the stock market. If this is the only stock you own, you are at the whim of Nike. If they have a strike in a major factory, a bad year of sales, or hire poor management, you are screwed. Consider what happened to Enron. Many of the employees of this energy company had as much as 80-90% of their portfolio invested in just this one stock. It’s estimated that when Enron went bankrupt, the loss to the company retirement plans belonging to Enron employees was $1.2 billion.
Diversifying your portfolio is wise to mitigate the risk that is inherent in all investments; however, there are certain things that you can’t apply a diversification strategy to such as the weather, a rise in gas prices, the Fed deciding to raise interest rates, or if the general economy gets weaker. These things are called systematic risks-risks that are inherent in the market. However, there are risks that are only specific to individual stocks that you own such as management decisions, strikes, or poor marketing strategies that you can diversify. If you own Nike and management makes poor decisions, this will not have an impact on the other stocks in your portfolio. This is called unsystematic risk (risk that relates only to Nike stock).

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Dollar-cost averaging is the investment of a fixed amount of money at regular intervals, usually each month. This process results in the purchase of extra shares during market downturns and fewer shares during market upturns. Dollar-cost averaging is based on the belief that the market will rise in price over the long term. By following this investment strategy, you eliminate trying to time the market to take advantage of market highs and lows. Regardless of what direction the market is moving, you are remaining active and continuing to invest.

For instance, if you are purchasing $200 of securities per month, when the market goes lower you are able to purchase more stocks because the price is cheaper. However, when the market goes higher the same $200 will purchase less stock because it is more expensive.

If you’re enrolled in your company retirement plan, you’re already taking advantage of dollar-cost averaging. Based on Dow Jones reports from 1999 through 2009, those people that dollar-cost averaged in their company retirement plan were able to purchase cheap stock during those years of great recessions bringing their average cost of the total amount of stock they purchased down. Likewise, if you have a brokerage account you can achieve similar results by setting up a deposit schedule to follow regardless of market conditions.

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When someone says investments, what’s the first thing that comes to mind? For most people it’s stocks. Simply put, stock is partial ownership of a company. You can go to Starbucks and purchase coffee to be a customer. However, you can purchase stock in Starbucks and become an owner of the company. As an owner, you have a stake in every cup of coffee that is purchased. The more shares you purchase, the larger your stake becomes.

Stocks are traded on “exchanges.” An exchange is “an association of stockbrokers who meet to buy and sell stocks and bonds according to fixed regulations.” There are many exchanges that buy and sell stocks. Starbucks trades on the National Association of Dealers Automated Quotations exchange (NASDAQ). A stockbroker is a broker or an individual “employed by a member firm of a stock exchange, who buys and sells stocks and other securities for customers.”

History has proven that over time, stocks generally go up in value. However, there is a great deal of risk involved in purchasing stock as there is no guarantee that your stock will increase in price. “Playing the stock market” can be a somewhat volatile way of investing, but there are some tricks that will help you keep risk at bay. The best way to manage risk when owning stocks is to diversify your holdings.

How to Research a Stock
A man sits in front of his computer and checks his email to see this message:


The man reads this message, thinks for a second, and grabs his calculator. He thinks aloud, “If I put in $100 at .001 then I can buy 100,000 shares! If it goes to .02 I will have $2000! Wait a minute, if I put in $1,000 I can buy 1,000,000 shares. If it only goes to .01, half of what they predict, I will have $10,000! This is a no-brainer! WHERE DO I SIGN?!”

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What he doesn’t know is that he has just been scammed by one of the oldest tricks in the book…the “pump and dump trick.” What he doesn’t realize is that the person who sent that message already owns the stock WXLYQ, and has sent that same message out to thousands (sometimes millions) of people. If just a small fraction of them take the bait, then he will create a small volume fluctuation. Many traders have their alerts set to these volume fluctuations and will purchase the stock just because they saw a spike in volume. The end of this chain reaction is that the original sender of the message will sell all of his stock at .01, and leave all of the other buyers holding a piece of crap! As the stock goes back to .001 because nobody is left to purchase the stock, it remains at that price level until it is taken off the market (de-listed). All you can expect is a write-off on your taxes for your losses.

Is this unethical and illegal? Yes it is. However, there isn’t very much you can do because it happens frequently. “An ounce of prevention is worth a pound of cure” and the best way you can prevent this is to do your homework on every stock you purchase.

The first question you should ask is, “Does this stock earn money?” Earnings are a major measure of value in the stock market. Four times a year, each stock trading on an exchange is required to report earnings. This is the single most watched number on Wall Street. Each quarter, analysts give their estimate of how they feel a company will do for that quarter. The estimates are averaged, and that average becomes the “consensus” estimate. If the company does worse than this estimate, their stock price almost certainly falls in the following trading sessions.
Earnings estimates are an example of “fundamental analysis.”

Fundamental Analysis
Fundamental analyses are basic factors such as earnings, balance sheet variables, and management quality. This type of analysis attempts to determine the true value of a security. If the market price of the stock deviates from this value, one can take advantage of the difference by acquiring or selling the stock. Fundamental analysis may involve investigating a firm’s financial statements, visiting its managers, or examining how a particular industry is affected by changes in the economy.

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There are many ways of running a fundamental analysis on a stock. Some of the basic methods are described below. Keep in mind that these ratios mean nothing by themselves. In order to use them effectively, they must each be compared against an industry average, particularly the industry in which the stock being analyzed exists.

Price to Earnings Ratio (P/E) = (Market Value per Share)/ (Earnings per Share) – This ratio compares the current price with earnings to see if a stock is over or under valued. If the Starbucks PE ratio is 54.71, but the “Specialty Eateries” industry (the industry in which Starbucks is grouped) has a PE ratio of 30.4, this could signal that Starbucks is overvalued and should be sold.

Return on Equity (ROE) = (Net Income)/ (Shareholder’s Equity) – This ratio measures the level of return the company’s management is able to get on the owner’s investment. On the day this article was written Starbucks had an ROE of 23.88%. The Specialties Eateries industry had a ratio of 21.7%. This means that for the time period measured, the management of Starbucks did a better job of getting a better return on shareholder investment than the industry.

You can learn more about fundamental analysis at www.investopedia.com.

Technical Analysis
You can also do “Technical Analysis” on a stock. It’s a method that involves analyzing patterns and statistics created through market activity such as past prices and volume. In no way is it an attempt to measure a stock’s intrinsic value, as is done through fundamental analysis, but instead technical analysis uses charts to identify patterns that might suggest future activity.
The use of technical analysis only takes historical performance into account. For example, take a stock that trades at $6 per share, one year later it appreciates to $10 per share in value, and then one year later it goes back to $6. If using technical analysis you might purchase the stock thinking that because of past performance it has formed a trend and will hit $10 the following year.

Once you do the research on the stock and decide to purchase it, you must then commit to a regular investment strategy such as dollar-cost averaging. You could purchase many shares at one time, but in the next section, you will read why it is more beneficial to spread your purchases out in regular intervals using this strategy.

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Both governments and corporations need to raise capital to operate. Salaries, suppliers,and facilities are all examples of expenses that a corporation incurs on a consistent basis. Welfare, social security, Medicaid, public schools, and the Iraq war are all examples of programs and events that require a significant amount of funding from the government. One of the ways to pay for expenses and programming is to borrow from individuals by issuing bonds. If you purchase a bond, you are essentially lending that entity money and they are promising to return the funds borrowed PLUS interest.

If someone asked you to borrow money, and you were in the process of contemplating other more valuable uses of your funds than to let them use it, you would not allow them to borrow the funds because you wouldn’t want to miss out on a potentially prolific investment opportunity. So in order for them to entice you, they would have to make it worth your while by giving you a rate of return. This is why there is always an interest rate attached to bonds. This is how the bond market works. The riskier the investment, the more likely the issuer is offering a higher interest rate. Treasury Bonds are the safest type of bonds because they are backed by the full faith of the U.S. Government. When you start looking at corporate bonds, which are issued by companies looking to raise capital and municipal bonds which are issued by states, counties, cities, towns, state authorities or agencies, then you have to do more research to find out how likely you are to be paid back in full. You also want to make sure the interest they are offering is acceptable for the amount of risk you are taking.

Bonds should be an integral part of every portfolio. However, the amount of bonds that you have in your portfolio is determined by your age and amount of risk you are able to bear.

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Gold and other precious metals are great hedges for investors because they are not heavily influenced by systematic risk. As a result, when the market goes down, these investments are considered “safe havens.” Furthermore,when you’re concerned about the strength of the US dollar, gold and other precious metals can be hedges against inflation.

Here are a few ways you can invest in gold:

1. Direct Ownership – Our currency, the dollar, is nothing more than an IOU or a promissory note that is not backed up with any tangible value. It is called “fiat” money that only has value because the government has declared it to have value. If the dollar falls in value, those who have tangible goods such as resources and precious metals will benefit. Gold cannot be changed or controlled by the government and will not change based upon what the Fed Chairman decides to do with interest rates or dollars in circulation. Only the natural laws of supply and demand come into effect. However, a direct purchase can be risky because when you purchase gold you buy at retail and sell at wholesale,so a big jump in price will be needed just to break even making the necessity to have a long term perspective more important. The easiest way to purchase gold is through minted coins such as American Eagles or Canadian Maple Leafs.

2. Exchange Traded Funds – These are funds that are designed to trade according to how an entire index trades. We like SPDR Gold Shares. This fund and other gold ETFs trade on a stock exchange like an ordinary stock. The portfolio of all ETFs is fixed in value and does not change. GLD holds gold bullion as their one and only asset. This is a more practical way of investing in gold as opposed to direct ownership.

3. Gold Mutual Funds – These funds hold companies that might mine for gold. The one problem about this investment strategy is that the price also depends upon management, administration, and profit of the company. You want to research these funds the same way that you do any other fund as outlined in, “How Do I Pick the Right Mutual Fund.”

4. Gold Options and Futures –There are many commercials that play the advantages of options and futures trading. If you are not willing to commit the time to become a full time professional trader, then we would highly caution you against this option because the risk and volatility in this market is extremely high. It’s really only for the experienced investor who wants to speculate the price of gold.

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Real estate has been a proven profitable investment strategy that can generate millions or even billions of dollars in wealth IF done properly. The perks can be tremendous, the wealth accumulation astounding, and the revenue streams are almost endless but you must be properly prepared. To make sure that you are not among the hundreds of people who become broke trying to play the real estate game review these important steps.

Step One: What you don’t know can bankrupt you!
If you are thinking about entering to this market, you must read more and commit to a positive attitude.
• Go to Amazon.com and read as many books as possible to make sure that you are getting different perspectives of how to invest in real estate.
• Look for real estate investing classes or seminars offered through your local church, non-profit, or community center.
• Tap your network for anyone who might practice real estate investing to see if they would be willing to become your mentor.
• Consider getting a mortgage brokers or real estate agents license to gain a tremendous amount of knowledge about the ins and outs of the industry.

Step Two: What is your plan?
Once you have obtained the knowledge, now you must lay out a plan/strategy for investing in real estate. The plan that you lay out should include the following:

• The type of properties that you’re going to invest in.
• The geographic area(s) that will be your focus.
• The best strategy to invest in those property types and area(s).

Step Three: Take your time, don’t overload yourself!
Your first property should be as unrushed and methodical as possible. You should only be doing one deal at a time if this is your first investment property.

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Step Four: Plan for the worst but expect the best.
You should have more than one exit strategy and be prepared for all worse case scenarios.

• What if the renter in your property moves out? Do you have enough to pay at least 6 months of the mortgage?
• What happens if it’s a renter’s market and you can’t get enough to cover your entire mortgage? Do you have enough money to cover the difference indefinitely?
• What would you do if there is a fire in the property? Do you have enough to pay for homeowner’s insurance?

Step Five: Be wise!
Make sure that you are being as prudent as possible when you purchase real estate. There are three “Dont’s” to remember:

1. Don’t become that investor that puts 100% of their capital into real estate. There are other investments that we have discussed here that you should always consider

2. Don’t forget that the best deals usually don’t have any competition, so don’t be afraid to be unique and do plenty of research.

3. Don’t chase the market! Many people are guilty of looking for the hottest markets and thinking those are the best places to invest. “Buy low…sell high” also applies in the stock market and it also applies in the real estate market. If you were going shopping and saw a shirt that was marked UP 200% would you buy it? Of course you wouldn’t-you would rather it be marked DOWN 50%. So if you wouldn’t want to purchase a shirt that is marked up, why would you want to make a multi-thousand or million-dollar investment that is marked up? If you ever hear someone say this statement, “Why would you ever want to invest property there?” This is your cue to start looking for a good piece of property in that area to buy.

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Researching individual stocks, bonds, real estate and entrepreneurial opportunities can be a very complex and involved process. It is easy for portfolio managers with $500 million in capital to set rules to limit the total percentage value of each stock to 5 – 10% of the total value of the portfolio. However, for you the individual investor who may have $1,000 to $5,000 in cash to invest, it may be hard to establish and maintain a properly allocated and diversified portfolio by investing in each individual investment.

Mutual funds are securities that give smaller investors access to a well-diversified portfolio of equities, bonds and other securities. Each shareholder participates in the gain or loss of the fund. Shares are issued and can be redeemed as needed.

Each mutual fund is managed by a qualified portfolio manager, ideally, whose sole job is to get those who invest in his mutual fund a solid return. There are thousands of mutual funds with thousands of managers whose styles and strategies are extremely different. It is your job as an investor to make sure that you select the mutual fund that is most appropriate for your needs and preferences. However, with such a wide variety of mutual funds, how do you select the best one for you? There are many ways to distinguish one mutual fund from another, and the following will touch upon a few key areas of focus when selecting one.
Picking the Right Mutual Fund
Mutual funds should be selected based on five criteria: expenses, management tenure, Morningstar rating, risk rating and performance measurement. Most of this research information can be found either through Morningstar.com or directly from the mutual fund’s website and/or prospectus (a booklet of past performance, financial statements and other fund-related information).

Expenses -No-load mutual funds are sold directly to customers at net asset value without a sales commission. Commissions can erode the long-term return of a portfolio. Hence The Money Movement suggests individuals invest in “no-load” mutual funds as part of their portfolio. Many investment advisors will suggest that you select “loaded” mutual funds, or funds that are bought and sold that generate a commission. For every loaded fund, you can find five no-load mutual funds that can give you an equivalent or better performance. You can’t control market performance but you can certainly control the fees and expenses.

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Management Tenure-It is important that the manager of the mutual fund has significant experience in directing the investments of the mutual fund. You want to determine the success a particular manager has had with managing the mutual fund. If you see that a mutual fund has a five-year history of averaging 20% return per year, see if that performance was generated by a previous manager or the current manager. In addition, it is usually best to ensure that the management has directed the returns of the mutual fund for at least a five year period.

Morningstar Rating – Morningstar is a well-known and respected analyst service. They rate funds based upon performance against the rest of their peers – one star being the lowest and five being the highest rating. Generally speaking it is best to select funds with the minimum rating of four stars. The Morningstar rating should not be your sole reason for selecting a fund. Some of our A-Listers have built portfolios by selecting only five-star funds, and later learned that you can have all five-star funds and still not beat a portfolio of three, four and five star funds.

Risk Rating-In order for you to be able to sleep at night, you should select funds that don’t have excessive risk. Selection of high risk funds means that the manager’s investment strategy or the investments that he selects are often very volatile. We usually suggest that a fund’s rating be from low to average risk compared to its peers. If you suggest a high risk fund, make sure the historical returns have kept up with the risk.

Performance Measurement-Performance measurement is the return percentage a money manager is able to achieve over a stated time interval. As one year is not a sufficient amount of time, it is common practice to measure the return over the past three, five, AND ten years of the life of the fund. It is common to assess the return by comparing it to a benchmark over the same interval. One commonly used benchmark is the S&P 500. If a mutual fund has outperformed the benchmark during ALL THREE time intervals (by the same manger), this is a good indication of a quality investing strategy displayed by the manager of which you may want to invest in. Here is a hypothetical example:

VWXYZ, a mutual fund, has achieved a return of:

• 36% for the past three years vs. an S&P 500 return of 34% for the past three years
• 25% for the past five years vs. an S&P return of 21% for the past five years
• 90% for the past ten years vs. an S&P return of 88% for the past ten years

In the above example, the mutual fund identified as VWXYZ has outperformed the S&P 500 in each time interval.

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Another type of investment to consider are exchange traded funds. In order to achieve ultimate diversification, one would have to purchase a share of every stock in the market. This sounds farfetched, but it isn’t entirely impossible. There are funds that are designed to trade according to how an entire index trades, just as if you purchased every stock in the stated index. If you are just starting out and don’t have much money to invest, it may be wise for you to simplify your portfolio even further beyond mutual funds. One of the best portfolios to select for beginning investors is comprised of an “Exchange Traded Fund” or an ETF.

Exchange traded funds are securities that track an index and represent a basket of stocks like an index fund, but trade like a stock on an exchange, thus experiencing price changes throughout the day as it is bought and sold.

The advantages of owning an ETF over a mutual fund or a stock are:

• You receive the diversification of an entire index.
• Due to the fact that the trades are computer generated, the expense ratios are lower than the average mutual fund.

For the investor looking to start a portfolio from scratch, exchange funds are an easy way to obtain broad diversification with low expenses.

Didn’t find what you were looking for in Money Guide:Investing? Send us an email at info@moneymovement.org and one of our experts will get back to you.

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