As I sit down with clients and prospects I always ask them “What is your experience with your finances?” As straight-forward and awkward as it may seem, it’s a pretty loaded question. Some immediately think of budgeting, balancing the some times delicate act of paycheck and bills, and saving. For my younger clients, it has been “I don’t really know, that’s why I’m talking to you.” For those more experienced clients with “investment” experience, they talk about past advisors and what they were told. I say “investments” because I’ve seen some strange things called “investments.” If you give a person money and don’t understand how the “investment” works, it’s not an “investment” it can be a scam.
I would like to just discuss risk tolerance and outline some common investments.
Risk Tolerance
Investing is a roller coaster ride and your risk tolerance is your willingness to get on different roller coasters.
Higher Risk tolerances means you’re ready for big ups and downs and want that adrenaline at the end of the ride. You like riding Drop Zone or the Hulk. You risk big in hopes of higher rewards. The good thing about high risk/high return is the possible high return, just don’t forget there are a lot of valleys in the way, and if you can handle some dips throughout your time frame the pay off can be big. If you have a higher risk tolerance you’re more aggressive. Just remember that if you are an aggressive investor that you need to have plenty of time to recoup the money if there is a dip before you need it. Young people saving little bits for retirement now typically can be more aggressive now for retirement, because they have time to recoup.
The lower the risk tolerance the more likely you’re going to go on the Dr. Seuss ride (which is still awesome by the way). You don’t want ups and downs you want a steady ride. You’re more conservative. What you lack in dips and peaks you make up for in steady returns, typically small. If you have a small time frame, you want to be more conservative, because you have little to no time to make up the difference.
For those that are in the middle, you’re moderate. Maybe more of a Spiderman ride, with some twist and turns but not as much up and down motion. Some aggressive investors will go moderate on shorter term investing because they can’t really commit to being conservative and some conservative investors may invest moderately because they have a longer time frame but can’t commit to being aggressive.
Whatever your tolerance, you should discuss all investing options with a professional to validate your thought process as well as the options available to you given your situation.
Now on to Investments
Easy stuff: Stocks & Bonds
Stocks – I’m sure you’ve at least seen the S&P 500 channel surfing. A stock is an ownership of the company. What many people don’t realize is that the S&P 500 is a second hand market meaning the stocks traded are not coming directly from that company, but from another entity or person. The price rise and decrease doesn’t increase or decrease the company’s bottom line because they sold more higher priced stock. Most stocks are held not by individuals but investment companies to put in their products such as mutual funds (discussed later). The ups and downs are very volatile depending on many factors. As nice as it would be to have a formula to predict how it trends, it is impossible because of too many uncontrollable factors (war, weather, politics, etc).
Bonds – You don’t own the company but the company/government OWES you money, you’re the debtor. Bonds are rated on an alphabetical scale from Aaa/AAA being the best to Ba/BB+ & below to be “non-investment” grade, meaning (surprise!) you don’t really want to invest with those. Government bonds are rated on the same scale and are Aaa/AAA. There are no guarantees in investing, but government bonds have the lowest risk tolerance out there.
Step up your game: Mutual Funds
Mutual funds are a package of domestic stocks, international stocks, corporate & government bonds, cash, and other assets (such as gold). Individual mutual funds have an investment approach and a fund manager. The investment approach tells you what the fund’s goal is and how it invests. It’s the fund manager’s job to make sure what he/she picks is in alignment with that approach. For example, if you have a Science & Tech fund, the manager will invest in companies that are developing more technology (like Apple, Google, etc.) and the sciences (like new uses for corn) but would not likely invest in paper. Each fund tries to maximize its return on investment, but that doesn’t mean every mutual fund will get a 12% return. Many funds will get 3-5% because their investment approach is more conservative.The nice thing about mutual funds is that it, in itself, is typically diverse. Diversity helps you control the risk. For every higher risk investment you can have an equal and opposite lower risk investment. The mutual fund manager typically will control how risky the fund is based on the investment approach. If you’re investing in government bonds it will be conservative. If you’re investing in science and technology it is more aggressive.
To some people I understand this is common knowledge, to others though I hope I have shed some light on a few things for you. If you talk to a financial person, whether it’s at your bank or at an investment office, make sure they can explain to you completely and understandably what you’re investing in. If they can’t, find someone who can. I’m always open to answer any questions you might have.
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