By Mickey Welcher
Investing can be overwhelming to most people. There are so many things to know and when you learn one thing, you will always find more things you need to know. Here’s a quick introduction to six of the most important things every investor should know.
It’s the most important part of an investing portfolio. Asset Allocation is the “framework” of your portfolio. Risk tolerance, investor age, time frame and goals are the start of this process. Once those questions are known, the portfolio is set with a percentage going to equities and bonds. A young investor might have an allocation of 80/20 (80 percent equities/20 percent bonds), while an older investor might be at 40/60 (40 percent equities/60 percent bonds). Studies have shown that 90 percent of portfolio performance is based on asset allocation.
Once allocation is set up, you need to build a diversified portfolio. This is what helps reduce risk in your portfolio. Using the asset allocation percentage, different asset classes are used to fill in the portfolio. On the equity side you could use large-, mid- and small-cap values as well as international or different sectors to fill those percentages. Bonds can be municipals, corporate, treasuries or other types.
To the new investor, diversification can be frustrating because when the market is going up, you will have asset classes that are not performing as well as others. That’s okay, though, because when the market goes down, you won’t take as much of a hit as others. This is where diversification works best.
Understanding your risk tolerance is the third thing you should know. This refers to how well you can handle losing money in the market. Many investors get caught up when the market is going up and over-estimate their tolerance. When the market turns, they lose much more than anticipated because of not truly understanding their tolerance. You need to be very realistic when determining what yours is; it will be used to set your asset allocation.
Portfolio Management Fees
Every investment in your portfolio has a fee or cost. If you buy individual stocks, you pay a commission. Mutual funds come in different classes. You pay an upfront fee, or “load,” for A-shares,
but a higher ongoing fee for “no load” C-shares. The A-shares have ongoing fees that are lower than the C-shares. Annuities also have fees as do alternative investments. You need to know and understand the fees you are paying for an investment.
What’s more, financial advisors managing all of these assets also get paid, in one of three ways. The most common is the adviser charges the client a fee to manage the account. On average this fee is about 1.25 percent. If you only buy and sell stocks, the advisor could charge for commissions only. The third way is being paid by the mutual fund companies.
If an adviser puts you in a fund, they could receive fees or “trailers” from the fund company, which can be around 1 percent. Most advisers will either charge a straight fee or take the fee from the mutual fund companies. It’s important to know how your adviser gets paid and what happens to the mutual fund fees. The impact to your portfolio could be substantial.
Individual Stocks Are Very Risky
Most investors like to buy stocks and watch them go higher. This can be very exciting, but it can also be very hazardous to your portfolio. Buying individual stocks can cause your portfolio to not be diversified and thus very volatile. That’s because stocks will move very quickly — down as well as up — as news hits the market instantly. Most investors are not prepared or understand how to handle this volatility, causing them to panic and sell at the wrong time. Use exchange traded funds or index funds in your portfolio instead of individual stocks.
Technology Has Changed The Stock Market
Computers have been the biggest change for the stock market as any investor can now buy and sell stocks right from his or her home computer. Also, information is instant, which causes more market volatility. Computers have brought the market high frequency trading, which is done at ultra-high speed, causing even more market volatility. Developers are continuously building faster and better computer programs to buy and sell stocks, which will continue to add market volatility.
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