April 12, 2007


Greed and fear – commonly characterized as the most prevalent factors that drive investment activities … I recently read material published by the FPA (Financial Planning Association) offering 20 keys/steps to rein in greed and ease investing fears. It is not offered to turn you into an investment pro, or enable you to accurately predict the future of the stock market. It will provide information to help you use time-tested principles and techniques [helping you learn from the failures as well as successes of the past] so that despite the inevitable ups and downs of the markets, you can realistically achieve your financial goals.

  1. Understand the difference between saving and investing. Saving is for short-term goals/needs (family vacation, emergencies, car, etc.); investing is for goals that are 5+ years away. Savings can be met with CDs, high yield savings accounts, etc. Although investing carries more risk (losing your principal, not earning as much as you’d planned, etc.), wise investing will also provide a greater opportunity for earning significantly higher returns in the long run [relative to savings vehicles].
  2. Put the rest of your financial house in order first. Before investing, you may want to tackle other financial issues: creating a budget to enable you to invest more on a regular basis, developing an emergency fund, make sure you have adequate insurance in place, and paying off high interest rate debt to name a few.
  3. Clarify your goals. Invest with a specific purpose. Doing so will make it easier for you to stick to your plan. Goals should be realistic, specific, and provide a timeline for accomplishing them.
  4. Don’t just grab for the highest return. With reasonable, specific goals, you can make informed, realistic investment decisions to accomplish your financial goals without taking unnecessary risk. The tortoise wins the race every time I read the book.
  5. Understand your own tolerance risk. Risk tolerance is a function of several factors – your investment goals, how much time you have to invest, other resources you have, and your “personal fear factor.” Investments that keep you up at night [although they may make the most sense ‘financially’ may not be right for you]. Gauging that can be tricky – people obviously tend to feel more risk tolerant when the market is doing well …
  6. Educate yourself about investments and investing. Even if you work with a financial planner or advisor, you should understand how investments work, their risks, and how they fit into your financial plan. Many people understand the risks associated with stocks or real estate, but fail to realize that bonds and other investments also carry risk.
  7. Hold realistic market expectations. One downfall of the market boom of the late ‘90s was the belief that high double digit returns for stocks were normal. Historical information reveals otherwise. I have a chart on my wall (Ibbotson chart) that shows that between 1926 and 2001, small company stocks returned an average of 12.5% per year; large company stocks 10.7%; and long-term government bonds 5.3%. These historical returns don’t guarantee anything (I can earn more or less than that any given year), but they allow me a benchmark/ perspective for comparison when things are going very well [or very poorly].
  8. Follow a detailed written plan. Use this like a road map to keep you focused and on-track; it is easy to lose focus when things don’t go as planned. Obviously, this plan should change as “life happens” – marriage, job/career changes, family, as well as changes in objectives.
  9. Allocate investments according to goals and needs. The shorter the timeline, the more conservative your allocation should be. Will you have other resources at retirement? Depending on your circumstances, you may feel more [or less] comfortable with an aggressive portfolio.
  10. Diversify your investments. Spread your dollars across several investment classes (stocks, bonds, large/small companies, international, etc.). Research has shown that diversification will reduce risk while at the same time maintaining [or even improving] portfolio performance.
  11. Don’t overload on company stock. Financial planners typically recommend limiting company stock to no more than 10-15% of the account value. One word speaks volumes … Enron!
  12. Don’t chase ‘hot’ performance. Today’s hot investments are often tomorrow’s cold turkeys. Technology stocks, represented by the Nasdaq 100 Index returned an amazing 85.6% in 1999, but fell nearly 40% the next year and another 21% the next …
  13. Don’t ignore ‘cool’ performance. The opposite of chasing ‘hot’ performance. The easiest way to avoid these two problems is to stay diversified and stick to the game plan that you spelled out in your investment plan.
  14. Stay in the market. Don’t try to “time” when to get in and get out of the market. Nervous investors often want to wait on the sideline until a downturn in the market is over … a study by SEI Investments reviewed 12 bear markets (market downturns) since World War II. Those who stayed in the market saw the S&P 500 gain an average of 32.5% (not counting dividends) during the first year of the market recovery. Those who missed the first week of that recovery earned 24.3%; those who waited three months to get in gained only 14.8%.
  15. Start investing early. The most powerful weapon on your side is time. The earlier start, the more financial leverage you gain.
  16. Invest regularly and automatically. Those issues of greed and fear tempt us to try to time the market. Financial professionals commonly recommend instead investing on a regular basis regardless of what the market is doing. This will help you keep your eyes on your long-term objectives. Funding investments not only makes this easier to do, but in many instances will allow you to start without having a large initial investment.
  17. Pay attention to investment expenses. You can’t control the market – you can control your expenses. Investing with an eye toward lowering your investment costs can significantly improve your returns over many years.
  18. Don’t let taxes dictate. Yes, it is smart to invest with an eye on tax-saving strategies. Taxes shouldn’t be the ultimate deciding factor, however. If it makes sense for you to sell an investment, you should sell the investment.
  19. Rebalance your portfolio. It is inevitable that over time the asset mix you originally assign to your portfolio will become unbalanced over time as different asset classes perform differently. If, for example, the stock market does very well this year, the stock portion of your allocation will become ‘heavier’ than your desired allocation. This means that you will now have more risk in your portfolio because you have a heavier weighting in stocks. How often you rebalance is a personal question – many suggest doing it about once a year.
  20. Monitor and revise your investment plan. As with any financial plan, you’ll want to review your investment plan at least once a year to make sure you’re still on target, that it is still accommodating your needs, etc. Whether you turn your investments over to a professional or manage them yourselves, ultimately, it is you that is responsible for the results!