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STEP ONE: Figuring Out How Muchto Invest in Stock Funds and How Much to Invest in Bond Funds
My easy steps to successful investing really are easy. Each step requires some thought, but I'm here to help you along the way. Investing successfully is crucial to your financial future, so spend some time now going through the four steps so that you can invest your hard-earned savings well enough to achieve your financial dreams. There is no magic here, just a lot of common sense applied to techniques that have been used by successful investors for centuries.
A lot of people are frightened about investing. They have been led to believe that investing is complicated and the average Joe and Jane are simply incapable of making sensible investment decisions. Well, you'll soon find out how straightforward successful investing will be. It won't take long.
To make life a little easier, I'm going to introduce the four steps by using mutual funds exclusively. Most investors start out with mutual fund investments, and even experienced investors and investors with large portfolios should make generous use of mutual funds. Once I've introduced the four easy steps to successful investing in the first four chapters, I will then show you in Part II how to fit individual stocks and bonds into your portfolio. But the guidelines that are presented in this and the following chapter apply to all of your investments-mutual funds as well as individual stocks and bonds,
A Simple Calculation: The following step involves a simple calculation that will help you determine your allocation between stocks and bonds- inother words, of the total money you have available to invest how much should be invested in stocks and how much in bonds? These are the two most frequently used investment categories. There are two other categories-shortterm investments and real estate, which are discussed in Chapters 17 and 14, respectively-but I'm not including them here for reasons I'll discuss in those chapters. For the time being, we'll stick with stocks and bonds, or at this stage, stock mutual funds and bond mutual funds.
Three different overall investment allocations are presented in the following discussion. The one you select is up to you, depending on how comfortable you are taking risks. There are risks in stocks and bonds, but stocks are the riskier. If you are comfortable with investment risk, then you will probably opt for the aggressive investment allocation. On the other hand, if you are a bit uncomfortable with taking risk, the conservative allocation may be for you. For those who are somewhere in between, like me, there is a moderate investment allocation as well.
Are you unfamiliar with some of the terms I've been using so far, such as stocks, bonds, mutual funds, and risk? If you are relatively new to investing or want a quick refresher course, Appendix A explains the basics of investing and what the various kinds of investments are and do.
Aggressive Portfolio Allocation
If you are willing to accept risk in your investments in exchange for the possibility of earning high long-term investment returns, here is the formula for calculating an aggressive investment allocation:
Subtract your age from 120. The resulting amount is the approximate percentage of the money you have available for long-term investment that you should invest in stocks. The rest should be invested in bonds.
EXAMPLE: A forty-year-old investor is quite comfortable with risk and therefore wants an aggressive portfolio allocation. She would, according to the above formula, invest about 80 percent of her money in stock funds (120 - 40 = 80) and the rest, about 20 percent, in bond funds.
Moderate Portfolio Allocation
I'm most comfortable with a moderate portfolio allocation, which still includes a fairly heavy weighting of stocks in the portfolio. To determine a moderate portfolio allocation, use the following formula:
Subtract your age from 110. The resulting amount is the approximate percentage of the money you have available for long-term investment that you should invest in stocks. The rest should be invested in bonds.
EXAMPLE: A sixty-five-year-old investor wisely realizes that he needs to continue investing for growth as well as income during retirement. He feels a moderate portfolio allocation would fit the bill. According to the above formula, this investor would put about 45 percent of his money in stock funds (110 - 65 = 45) and the rest, about 55 percent, in bond funds.
Conservative Portfolio Allocation
If you are less comfortable with the ups and downs of the stock market, a conservative portfolio allocation may be your cup of tea. A conservative allocation will still allow for stock funds in your portfolio, which are essential if your portfolio is going to grow over the years, but the proportion of stocks will be somewhat lower than the aggressive and moderate portfolios. To determine a conservative portfolio allocation, use the following formula:
Subtract your age from 100. The resulting amount is the approximate percentage of the money you have available for long-term investment that you should invest in stocks. The rest should be invested in bonds.
EXAMPLE: A fifty-three-year-old investor is a bit skittish about the stock market. She realizes that stocks are crucial to her longterm investment success, but she will feel most comfortable with a conservative portfolio allocation. According to the conservative investment allocation formula, she would invest about 47 percent of her money in stock funds (100 - 53 = 47) and the rest, about 53 percent, in bond funds.
Please Take Note
If you are new to stock investing or have previously been uncomfortable with stocks, you may be surprised at the high proportion of stocks that would be in your portfolio based on the above formulas.But stocks have pretty consistently been the best long-term investment compared with bonds and short-term investments like Treasury bills. Yes, stocks do decline periodically-sometimes a lot-but as the following table of annual rates of return by decade for various types of investments shows, stocks are clearly the winners. While stocks didn't always outpace other investments, they did beat bonds and Treasury bills over most of the periods surveyed-and usually by a wide margin.
All three investment allocation formulas are based on your age, so as your age increases (alas, there's nothing you or any of us can do about that), you will gradually invest more money in bonds and less in stocks. In fact, the formula will change each year. But that doesn't mean you need to change your investment allocation every year. These formulas should be...Your Financial Futue
4 Easy steps to Sucessful Investing. Copyright © by Jonathan Pond. Reprinted by permission of HarperCollins Publishers, Inc. All rights reserved. Available now wherever books are sold.