Benefits of Diversification
“Don’t put all your eggs in one basket” is a common expression that most people have heard in their lifetime. It means don’t risk losing everything by putting all your hard work or money into any one place.To practice this in the context of investing means diversification—the strategy of holding more than one type of investment, such as stocks, bonds, or cash, in a portfolio to reduce the risk. In addition, an investor can diversify among their stock holdings by buying a combination of large, small, or international stocks, and among their bond holdings by buying short-term and long-term bonds, government bonds, or high- and low-quality bonds.
A diversification strategy reduces risk because stocks, bonds, and cash generally do not react identically in changing economic or market conditions. Diversification does not eliminate the risk of experiencing investment losses; however, by investing in a mix of these investments, investors may be able to insulate their portfolios from major downswings in any one investment.
Over the long run, it is common for a more risky investment (such as stocks) to outperform a less risky diversified portfolio of stocks, bonds, and cash. However, one of the main advantages of diversification is reducing risk, not necessarily increasing return. The benefits of diversification become more apparent over a shorter time period, such as the 2007–2009 banking and credit crisis. Investors who had portfolios composed only of stocks suffered large losses, while those who had bonds or cash in their portfolios experienced less severe fluctuations in value.
Source: Morningstar, Inc.
A Quick Guide to Home Equity Loans
If you as a consumer need an additional line of credit, a home equity loan, also known as a second mortgage where your home serves as collateral, is one of several options that you can choose from. There are two major advantages of home equity loans. First, the interest rate on home equity loans is usually lower than credit cards and other consumer loans. Second, you can usually deduct the interest on home equity loans, unlike other loans. There are two types of home equity loans — fixed-rate loans and lines of credit.A fixed-rate loan provides a single, lump-sum payment to the borrower, and is repaid over a fixed period of time at a pre-determined interest rate. This is useful if you know how much you would need and when you would be able to pay off the loan.
A home equity line of credit (HELOC) is a variable rate loan that works like a credit card. Borrowers are pre-approved for a specific spending limit and can withdraw money when needed via a credit card or special checks. Similar to a fixed-rate loan, the outstanding loan amount must be repaid in full at the end of the term. However, unlike a fixed-rate loan, HELOC interest rates float up or down, generally adjusted based on the current prime rate. A HELOC is a convenient way to cover short-term, recurring costs, such as quarterly tuition for a four-year college degree.
Although home equity loans do provide attractive rates of financing, we caution consumers to think twice about the reasons why one would need an additional line of credit. If you are thinking about using a home equity loan for day-to-day expenses, one should examine whether you are overspending and possibly sinking deeper into debt. If you end up taking out more money than your house is worth, the interest paid on the loan above the value of the home is not tax deductible.
Source: Morningstar, Inc.
Common Investing Mistakes
Almost all of us have made investing mistakes. The key is not to make the same mistake twice. These mistakes can directly affect whether or not you achieve your desired goals. By repeating even just one mistake, individual investors can quickly become their own worst enemy. Below are some common mistakes that many fall prey to and some suggestions on how to sidestep them.Starting Too Late
The first mistake a large number of investors make is waiting too long to initiate a long-term investment plan. The earlier you can start the investment process, the more likely it is that the plan will succeed. For example, let’s consider two investors—Bill and Tim. Bill began investing $5,000 per year 30 years ago. Tim began investing $10,000 per year 20 years ago. Assuming a hypothetical return of 10% per year, Bill’s ending wealth value was $822,470 compared to $572,750 for Tim. Thanks to the power of compounding, a small amount of money, wisely invested early on, can turn into a large sum over time. Avoid procrastinating; start investing today.
Lack of Diversification
By investing all of your money into just one asset class, industry, or company, you are placing all of your eggs into one basket—and this can be extremely risky. It is better to combine a variety of investments, such as stocks, bonds, and cash, which are unlikely to move in the same direction. Your risk exposure should be lessened as a result.
Chasing Past Performance
Yesterday’s hot stocks or mutual funds may not be today’s best investments. A good number of investors purchase assets when they have already reached their peak, only to watch their performance subsequently suffer. It may be a good idea to choose investments with a history of good performance as well as quality management.
Lack of Research
No matter what type of investment you plan to make, be sure to conduct the proper research. It is unwise to allocate your money to an investment you do not understand. There are a number of helpful resources that you can explore—ranging from public information to professional advice. Take advantage of these when possible.
Unrealistic Expectations
Many investments require time to grow. Investors often become frustrated with the early performance of their investments, decide to sell too quickly, and move the proceeds into other investments. This will result in too much trading, which is not only expensive, but also usually unnecessary. It is important to maintain a long-term view and to not be distracted by short-term results.
Overconfidence
Confidence is a good thing, but overconfidence can cause investors to improperly select investments. Too much assurance in one’s knowledge and ability can lead investors to focus on the upside and deemphasize the potential downside of investments. Instead, a solid financial plan constructed by a professional can go a long way.
Source: Morningstar, Inc.
RJ Capital’s new blog
Welcome to RJ Capital's new blog, RJ Capital Insights. Here we will post regularly about current events in and around the financial markets as well as critical information for the smart investor.Please check back often for updates by making this page one of your favorites or bookmarks. You can also subscribe via email or RSS by using the menu on the right side of this page.
Thanks for visiting!
IRS Audits 80% More Rich Taxpayers
Robert Frank at the WSJ looked at the latest audit statistics in the IRS Data Book and discovered that the IRS audited more than 18% of returns with income of at least $10 million. This is an increase of 80% from 2009, when only 10% were audited. Audit rates increased for other income groups as well, though most sharply for the higher brackets. (more…)
Hard Work + Smart Investing + Frugality = $1,000,000
CNN Money has a slideshow called “Meet the Millionaires” in which they share infographic-type statistics about millionaires. (more…)
Why Smaller Stocks Are Still Worth a Look
Small and midsize stocks have been beating the big boys where it counts, and many analysts still like their prospects. Thanks to the ability to borrow money cheaply — and the huge piles of cash now sitting in corporate coffers — many big companies are finding themselves in a buying frame of mind. Purchasing the right midsize firm can have an appreciable impact on an acquirer’s sales and profits, and yet at the same time, be relatively easy to integrate with the buyer’s business operations. Read the full article in Smart Money…
Smart Investing in the $2.7 Trillion Healthcare Sector
Love him or hate him, President Barack Obama has done one thing that will change healthcare in the United States forever. And it’s actually a good thing.