Today, Brian and Bo tackle the risk that you take by sitting on the investment sidelines. They have been fielding a number of questions over the past few months covering this very topic. The moral of this episode is to get started doing something sooner rather than later so that you do not miss out on what the market has to offer.
Brian shared an interesting piece of data that showed if you invested $10,000 a year for 25 years during the period from September 1, 1929 to September 1, 1954 (the Great Depression), while the DOW only increased 2 points in overall value (381 to 383), your dollar-cost-averaged investment would be worth $1.5 million. This shows that during a period where the market did not really appreciate at all, there was still value in investing your money in the market. That equates to an annualized return of 11.7%.
So, with that information, there are a few factors that need to be considered:
- Do you have enough cash to cover your emergencies? You should maintain enough cash reserves to replace at least 3 to 6 months of your income.
- What is your monetary needs timeline? If a big purchase is on the agenda, it may be necessary to hold that money in cash to avoid losing substantial amounts of the principle (down payment on a house 3 to 4 years from now).
- Make sure that the cash you are holding in the bank does not exceed the FDIC insured amount of $250,000.
- Measure your risk profile:
- Risk vs. Reward: How much risk are you willing to take for your desired level of returns?
- Risk Tolerance: Correlates with your risk vs. reward by measuring how much risk you can handle for a given amount of reward (or loss).
- Risk Capacity: How capable is your portfolio of taking loss given your investment timeline?
Risk of Not Taking Risk:
Inflation risk: Inflation could be a factor in the near future, is your portfolio giving you the required appreciation to maintain your purchasing power? Ask yourself what one dollar today will buy for you in 10 years.
Outliving your money: If you and your spouse reach the age 65, there is a 50% chance that one of you will live past age 90.
Multi-Generational Housing: Beware of running out of money and having to move in with your children (not because you want to, but, because you have to). Make sure your army of dollars is working for you!
Strategies to combat the fear of uncertainty:
- Have ample cash reserves worth 3-6 months of salary.
- Diversify your allocations: cuts volatility, use alternatives to outweigh individual sector risk, it has psychological value.
- Dollar cost averaging: This is something we preach! Spread your purchases out over time to help mitigate risk.
Things to consider when entering the market:
- When do you want to retire?
- How much money do you want every year in retirement?
- Do you want to leave a legacy?
Interesting Facts:
- If inflation averaged 3% per year over a 25 year period it would cut your purchasing power in half!
- Current S&P 500 dividend yield is greater than a 10 year treasury bond.
When investing in mutual funds, you normally choose between Class A, Class B or Class C. The main difference in these options is the fees that you will be charged and how they are charged. A good way to understand how these fees work is to look at the funds one by one and determine which plan is best for you financially.
We used “360 degrees of Financial Literacy” as a reference for explaining the difference between the classes.
Class A – This class of funds is a good choice for investors wanting to invest a large number of shares for a long-term investment. The commission is taken on the front end, meaning, 3-5% is paid to the advisor and 95-97% then goes into the investment. There is also another component to mutual funds, called internal expense. These expenses pay for the manager or the investment team that manages the assets.
Class B – This class is best for those who don’t want the front end loads. The load is taken on the back end. The entire amount is invested up front, but, on the back end, you pay a fee based on what the fund is worth when you leave that investment. The commissions are paid to the advisor by the mutual fund company through much higher internal expenses.
Class C – This is the new and improved version of the B shares and has become the most popular. The internal expense is not as high as the B shares and they don’t charge a front end expense. This is kind of a hybrid between the A and B shares.
When trying to determine which type investment is best, consider this: research shows that an A share is a better investment than a C share after about 9 years. This is because the front end commission puts the investor at a disadvantage to the C share, and it takes about 9 years to overcome the front end load fees.
No-loads are designed for two types of investors, those who want to do it themselves and those who what to hire an investment planner. Most people can manage their own assets up to about $250,000. Over that, you need the help of a professional who can make the most of your portfolio. It’s like shopping at Sam’s or Costco, the professionals have access to better deals on the investments than just an individual can get.
Just remember, watch your taxes, fees, and asset allocation, and you cannot help but be a successful investor.
