Investors with discipline and patience to weather the economic collapse of 2008 have been rewarded with a stock market that has gained more than 135 percent between its March 9, 2009 low and May 28, 2013 record close.
Unfortunately many people sit on the sidelines and wait for the best time to begin. The adage “buy low, sell high” typically becomes “buy high, sell low” for inexperienced investors. A balanced approach to savings and investing, reserving a certain percentage toward less risky positions and putting a percentage toward higher risk, higher yielding vehicles, will improve your performance.
A Primer on Investments and Savings
It is important to understand basic concepts associated with investing and savings in order to determine how your money should work for you. One of those concepts relate to time and its impact on returns. The longer it takes for you to invest your money, the harder it needs to work for you.
Using two strategies, dollar cost averaging and portfolio rebalancing, you can see how determining a portfolio based on their risk profile and maintaining a disciplined approach through a process of rebalancing assets to achieve a desired return should result in the achievement of your financial goals.
Understanding Risk/Reward Tradeoff
Some investment and savings vehicles have a greater risk profile than others. Their risk, however, corresponds to the amount of return on your money that you should expect. The more passive or guaranteed an investment or savings vehicle is, the less it will yield versus those investment and savings vehicles that are more aggressive and not guaranteed.
The tradeoff between risk and reward is typically represented in a pyramid. The higher you go on the pyramid, the higher the risk (that the vehicle may lose all of its value), but the higher the potential return. Stocks tend to be at the top of the pyramid while guaranteed investments like certificates of deposit (CDs) and money market accounts are at the bottom.
An economist by the name of Harry Markowitz in 1952 discovered what is known to professional investors as the efficient frontier, as part of the Modern Portfolio Theory or MPT. The MPT shows a set of portfolios that consist of a mix of portfolios blended with different assets. Along the frontier, a varying percentage of those assets will move them closer to a desired return. An over concentration of any one asset (e.g., higher percentage of stocks or savings vehicles like CDs) may result in the portfolio moving away from your desired return.
Planning your Investments
You should plan your investment and savings strategy by first prioritizing your needs and time horizon for investing. As an example, if you are looking to buy a house in five years, tying your money up in a guaranteed fixed annuity would not be advisable because of the fees and penalties associated with accessing the money in such a short time frame. If you plan to retire in five years, putting all of your money in an aggressive growth fund may prove disastrous as short term swings in the market will result in a loss of your principal before retirement begins.
This article was contributed by Mark Cunningham, entrepreneur, small business supporter and casual day trader. Mark writers on behalf of Ashley D. Adams, PLC, who specializes in securities litigation, helping those who have fallen victim to fraud and white collar crimes.
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