Posted Sep 01, 2008 01:10 pm CDT
• Establish a money market account in an amount equal to (a) at least six months of your expenses (to cover emergencies) plus (b) planned major purchases within five years (such as a new car). This ensures that short-term drops in the value of your stocks (from market declines) or bonds (from interest rate increases) will not affect your short-term financial security.
• Only invest in stocks and bonds with money that you won’t need for at least five years (such as your retirement), allocating your investment between stocks and bonds in a manner that matches your age and risk profile. Generally, with each decade closer to retirement, decrease your stock allocation and increase your bond allocation.
For example, if you’re risk averse, determine the percentage of assets that should be in stocks by simply subtracting your age from 100. Under this formula, a 40-year-old would invest 60 percent of a portfolio in stocks and 40 percent in bonds.
• Diversify. When retirement is at least five years away, a balanced investment portfolio should include large, medium and small-cap stocks; value and growth stocks; and domestic and international stocks.
Bond investments should include both corporate and government securities, with an average duration of no longer than six years (to avoid excessive interest-rate risk).
And remember, given the current state of the mortgage industry, research is necessary to determine whether a bond offering has invested in mortgage-backed securities that have questionable value.
• Consider investing in a few no-load, low-expense index mutual funds to obtain a maximum level of diversification. While healthy blue-chip companies that produce food, metal, gas and other needed commodities traditionally do well during inflationary periods, in the long term, few people are able to pick stocks that outperform aggregate stock market returns, such as the returns of the S&P 500 or Wilshire 5000 indexes.
To keep it simple, limit your investments to three broadly diversified index funds: (a) a domestic stock index fund (such as Vanguard VTSMX or Fidelity FSTMX), (b) an international stock index fund (such as Vanguard VGTSX or Fidelity FSIIX) and (c) a bond market index fund (such as Vanguard VBMFX or Fidelity FBIDX).
• Be disciplined. Panic is a normal reaction when economists mention the R-word (recession), but do not let short-term swings in stock prices, interest rates or leading economic indicators change long-term investment plans.
The most common mistake investors make is to emotionally react to short-term market drops. Short sales lose money, create negative tax consequences and rack up trading fees.
• Budget wisely so you can continue to max out your retirement contributions. Buying more shares of stocks at lower prices can lead to bigger benefits when markets upturn.
• If you don’t know how much you need for retirement, promptly consult a financial adviser, or calculate it at SmartMoney.com’s retirement planning site.
But delaying retirement or reducing expenses are the only options if you’re currently over 60 without sufficient funds. If you’re in this predicament and can emotionally stomach risk, consider maintaining 50 percent of your portfolio in stocks to outpace inflation.