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To decrease the odds of your investments getting clobbered at the same time, you need to put your money in different type of investments such as cash, bonds, stocks and real estate. Because different types of investments tend to move at different times--one investment may be moving up in value when another is moving down. You might want to consider investing in a mutual fund, which are diversified portfolios of securities such as stocks and/or bonds. You buy into the mutual fund, which in turn pools your money with that of many others to invest in a vast array of stocks and/or bonds (More information on Mutual Funds...). Diversification reduces the volatility in the value of your whole portfolio (all of your investments). Diversification, however, reduces your overall return, as does any strategy that reduces risk. For example, a portfolio of stocks have gained about 11 percent annually on average, whereas a portfolio that is half stocks and half government bonds returned around 8.5 percent. In terms of total wealth over a long period, that difference is substantial. Invest $10,000 at 8.5 percent and leave it alone for thirty five years, and you'll have $193,853. Invest the same amount at 11 percent and you'll have more than twice as much: $461,760, to be exact. So the real trick to diversification is doing just enough to allow yourself to sleep and meet near-term goals, without doing so much that you rob your self of generous long-term returns. Diversification is not an ironclad guarantee against loss though. No matter how much diversification you employ, investing involves taking on some sort of risk.
Don' Put All Your Eggs In One Basket: In the investment world, this same advice rings true. When someone says "Don't put all of your eggs in one basket," they're trying to tell you to diversify your financial portfolio because the risk of holding everything in the same place is huge compared to the profit you may or may not make. If you buy stock in individual companies, you should keep no more than 10 to 15 percent of your total assets in any one company. So if your assets (excluding your home) are worth $100,000 you should keep no more than $10,000 to $15,000 in the stock of any one company. If that company's stock goes up significantly, you'll should rebalance you portfolio by selling some of the stock in that company. If you only have a few thousands dollars, you should buy stock mutual funds instead (index funds are best). If you purchase mutual funds, you're already diversifying your basket of eggs because traditional mutual funds never hold more than 5 percent of their assets in any single stock, and may actually hold positions in as many as 500 companies (S&P 500 index fund, for example). In investing, keeping all your investments in one basket is similar to playing the lottery. If you win, you win big. But the odds of winning are huge. And if you lose, you might lose it all (when the company goes bankrupt).
Asset Allocation:
The main principle of asset allocation is that the older you get, the less
risk you should face. Although stocks and real estate offer you
attractive returns, they can and do declines in value from time to time. Money
market and bond investments are good places to keep money that you need to use
sooner. Bonds can also be useful for some longer term investing for
diversification. Determining the proper mix of investments in your portfolio
is extremely important. Deciding what percentage of your portfolio you should
put into stocks, mutual funds, and low risk instruments like bonds and
treasuries isn’t simple, particularly for those reaching retirement age. But a
useful rule of thumb for dividing or allocating money between stocks and bonds
is to take 100% and subtract your age. The resulting percentage is the amount
you invest in stocks, the rest you invest in bonds. If you want to be
aggressive and can stand the risk, use 110% and if you want to be conservative
use 80%.
What is Dollar
Cost Averaging (DCA) ?
Dollar cost averaging is a process in which you invest your money
in equal amount on a regular basis, such as once a month,
regardless of the share price. For example, if your have $20,000
to invest, you can invest $2,000 a month until it's all invested.
More shares are purchased when prices are low, and fewer shares
are purchased when prices are high. The cost per share over time
eventually averages out. This reduces the risk of investing a
large amount in a single investment at the wrong time. There is a
saying in investment world "buy low, sell high". It's easier said
than done because buying low and selling at the peak is impossible
(unless you can tell the future, I know I can't).
DCA is also good for investors who doesn't have a lot of money at
the start, but can invest small amounts regularly. This way
you can contribute as little as $50-100 a month to an very low
cost investment like an index fund. Keep in mind that dollar cost
averaging doesn't prevent a loss in a steadily declining market.
DCA can also cause headaches with your taxes when its time to sell
(except retirement accounts). When you buy an investment at many
different times and prices, then when you sell blocks of the
investment, it gets confusing and complicated. Next ==>>
Questions you need to ask before investing Table of Contents |
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