The saying “Don’t put all your eggs in one basket” applies to investments, because concentration increases risk. Whether you invest your money yourself or work with a professional, never put all your assets in the same basket—the same kind of stock, bond, mutual fund, or other investment. In addition to avoiding concentration, diversification is key to improving investment results. Various asset classes, or types of investments, tend to perform differently under certain market conditions. Some perform better, and some perform worse, depending on what is going on with the economy and financial markets. The best investment strategy is to have a diverse portfolio that includes a mixture of stocks, bonds, and international investments. Diversification across asset classes helps reduce risk; correlation illustrates this benefit. Correlation measures how things, such as investment returns, move in relation to each other. Some asset class returns are more correlated than others. Say you invest in a…
Making Tax Prep Less Stressful
Due to COVID-19, the federal tax filing deadline has been extended. Even with additional time, preparing your taxes is not a fun task. It can be significantly less unpleasant if you are organized. Your taxes involve a lot of documents, and you must keep good records. In addition to your W-2 (or 1099-Misc forms, if you are a contractor), you will need supporting documentation related to your savings and investment accounts. A 1099 is a statement that details the dividends, interest, and capital gains earned during the year. Some investments are structured as partnerships and provide a year-end, or annual, K-1 instead of a 1099. A K-1 shows an investor’s share of partnership income for a given year. Transactions that you need to document at tax time occur throughout the year. Therefore, I strongly recommend that you keep a Current Year Taxes folder. As you receive tax-related documents in the…
Paying Yourself First
When you are just starting out, make a goal of saving and investing a fixed dollar amount every month. The amount you save is not as important as getting in the habit of putting money aside consistently. Automatic savings plans, which you can use to build an emergency reserve or save for a down payment, graduate school, or retirement, are a relatively painless way to save. You can set up an automatic transfer from your bank on the day you get paid, a practice known as “paying yourself first.” Investing a fixed-dollar amount at set intervals is called dollar-cost averaging. An advantage of these automatic plans is that you invest the same dollar amount every time. When markets are weak, or asset values have fallen, the same dollar amount will allow you to buy more shares of a mutual fund or a stock than when markets are strong and investable assets have appreciated. In this example,…
Needs vs. Wants
To develop a realistic budget, you must start with an analysis of how you are currently spending money. If budgets are unrealistic or unattainable, they will not work. Analyzing your monthly outlays by type and category is a great place to start. Look at each of your monthly expenses as a percentage of your take-home pay. Assign each expense or outlay to one of three categories: Essentials: things such as rent, transportation, groceries, utilities, insurance, and the like Savings and debts: establishing an emergency fund, saving for retirement, and paying off debts Everything else: travel, entertainment, shopping, gifts Totaling each category – essentials, savings and debts, and everything else – is an excellent diagnostic tool. It shows how you are spending your money and where you can make changes to improve your situation. Take a close look at your nonessential expenses. These are often tied to lifestyle choices and are…
Different Types of Risk
Risk is the variability, or volatility, of expected outcomes. The weather is a good illustration. A forecast gives an average, or expected, temperature for a city on a certain day of the year. In some regions, such as Southern California, there is less variability, or volatility, in temperature for a given day of the year. In other areas, such as Chicago, there is much more variability, or volatility, in temperature for a particular day of the year. Standard deviation is a measure of volatility that looks at how far an actual outcome might be from the average or expected outcome. The standard deviation in weather for a particular day of the year is larger in Chicago than it is in Southern California. Likewise, for investments, the greater the standard deviation of outcomes or returns, the greater the risk. Investors should be compensated for taking risk and will demand a higher return. In other words,…
Emergency Reserve and Liquidity
Experts recommend that you have an emergency fund sufficient to cover three-to-six months of living expenses. Your emergency fund should be a safe, stable reserve such as a savings account or money market fund. If you are new to the workforce, it may take time to build up an adequate reserve. The easiest way is to transfer a portion of your paycheck every pay period directly into an account. If you dip into your emergency fund, replenish it as soon as possible. In addition to an emergency reserve, you need to think about liquidity. Liquidity is a term from economics that indicates how easily an asset can be converted to cash. Some asset classes are more liquid than others. Cash and money market funds are the most liquid assets. Stocks and bonds are usually liquid. During periods of financial turmoil, however, you may not want to convert these assets to…
Focus on Your Net Worth
Managing your financial life involves making a lot of decisions. When the dollars involved are material, you should always think about the repercussions for your net worth. This practice will have a profound impact on your long-term financial well-being. In Accounting 101, you learn about a balance sheet. A balance sheet is a financial statement that lists your assets, your debts, and your net worth. Your assets are anything you have of value, such as your home, bank account, investments, 401(k), and car. Debts include any outstanding liabilities or obligations such as a mortgage, student loans, car loans or leases, and credit card debts. Your net worth is the difference between your assets and your debts. In other words, your net worth is an outcome, and you can think of the formula: Assets – Debts = Net Worth If the total value of your assets is higher than the total…
Take Advantage of Retirement Plan Matches
When it comes to planning and saving for retirement, you must be consistent and save and invest every year. You also must be disciplined. Once you invest the money, you cannot touch it. Because of the power of compounding investment returns, contributing to your retirement every year and allowing it to grow are the keys to building your nest egg. It is easier to put money away when you are young than when you have a mortgage or a family. Many of those that are just starting out in the workforce, however, face substantial headwinds: hefty student loan payments and high—and in some cases sky-high—housing costs. Even with a tight budget, saving for the future must be a priority. Start saving for retirement through your employer as soon as possible and take advantage of corporate matches. Corporate matches are free money that helps boost your savings every year. Make sure…
What is Your Time Horizon?
Life transitions, such as college graduation, are a good time to think about financial goals. Different goals have different time horizons. Some are short term—such as establishing an emergency fund—and some are long term, like retirement. Tackling all your savings goals at once is unrealistic, so you should prioritize. The most immediate savings goal is your emergency fund. Experts recommend that you have an emergency fund sufficient to cover six months living expenses. Assets in the emergency fund should be very liquid such as cash in a savings account or in a money market fund. If you are new to the workforce, it may take time to build up an adequate reserve. The easiest way is to transfer a portion of your paycheck every pay period directly into an account. You may need a bigger emergency fund in some circumstances. You may face hurdles when looking for a new job,…
Financial Jargon – You Asked…
Question: What is the VIX that I keeping hearing about in the financial news? Answer: The Chicago Board Options Exchange, or CBOE, created the VIX® to measure expected volatility for the US stock market. It is calculated based on the prices of put and call options for the S&P 500® index over a rolling 30-day period and is the global standard for measuring volatility. The VIX® is also known as the Fear Index. It spikes when markets are turbulent, as has been the case in the past two weeks.