Financial Reference

Investments are where we put our money to make more money. It sounds so simple, but the large number of investment options and opinions make this subject one of the most complicated areas in finance.

The complications involve a dizzying array of products: stocks, bonds, cash, commodities, mutual funds, and annuities to name a few. Within these classes, there are a ridiculously large number of individual options. And every time you open the paper or an investing magazine, there is a different advisor recommending a different individual product.

There are two right ways to deal with the complications. One is to put your investments on autopilot; the other is to actively manage your investments for maximum gain. Let me be completely clear: by actively manage I do not mean you should trade often; I mean you should learn enough about investments to get higher returns over the long run.

The first right way, putting your investments on autopilot, can be accomplished in a couple of ways. One way is to seek the services of a knowledgeable fee-only financial planner. This opens up a whole new hornet’s nest of issues which I will discuss later. Another way to put your investments on autopilot is to maintain a certain percentage of your investments in different asset class and rebalance when necessary.

The second way is to learn enough about investing to take advantage of inefficiencies in the market. For example, stocks return more than bonds, even after adjusting for the higher risk. This is commonly referred to as the equity risk premium. Another example is using consumer debt when the interest rate asked is below market value.

The first investment decision to make is what kind of investor you want to be. Do you want to put a lot of work into trying to beat the market or do you want to put only a little work into your investments and get close to market returns? Despite the popularity of the strategy, it usually is not a good strategy to try to beat the market using only a little effort. Usually that leads to trading too much and sub par returns.

After you decide what kind of investor you want to be, then you can move on to the next step of designing a portfolio to meet your individual needs.