Investments
How and where you invest your hard-earned money is an important decision. However, fully understanding your investments can require a crash course in terminology. The following definitions for a few key terms can help increase your understanding of the investment process and enable you to make better decisions:
Investment types
The most common terms that are related to different types of investments:
Bond: A debt instrument, a bond is essentially a loan that you are giving to the government or an institution in exchange for a pre-set interest rate paid regularly for a specified term. The bond pays interest (a coupon payment) while it's active and expires on a specific date, at which point the total face value of the bond is paid to the investor. If you buy the bond when it is first issued, the face or par value you receive when the bond matures will be the amount of money you paid for it when you made the purchase. In this case, the return you receive from the bond is the coupon, or interest payment. If you purchase or sell a bond between the time it is issued and the time it matures, you may experience losses or gains on the price of the bond itself.
Stock: A type of investment that gives you partial ownership of a publicly traded company.
Mutual fund: An investment vehicle that allows you to invest your money in a professionally-managed portfolio of assets that, depending on the specific fund, could contain a variety of stocks, bonds, market-related indexes, and other investment opportunities.
Money market account: A type of savings account that offers a competitive rate of interest (real rate) in exchange for larger-than-normal deposits.
Exchange-Traded Fund (ETF): ETFs are funds – sometimes referred to as baskets or portfolios of securities – that trade like stocks on an exchange. When you purchase an ETF, you are purchasing shares of the overall fund rather than actual shares of the individual underlying investments.
Know Your Client
A standard form in the investment industry that ensures investment advisors know detailed information about their clients' risk tolerance, investment knowledge and financial position.
KYC forms protect both clients and investment advisors. Clients are protected by having their investment advisor know what investments best suit their personal situations. Investment advisors are protected by knowing what they can and can not include in their client's portfolio.
Investment Strategies
Growth Investing • This approach involves picking companies that keep all their earnings to invest in growing their business. The stock may be expensive today, but growth investors believe that the company’s future growth will help the stock continue to go up in price.
Index investing • This approach involves investing in a group of stocks that behave like a particular market index. You can make your own picks, or simply buy units of an Exchange Traded Fund (ETF). An ETF lets you invest in a group of stocks that behave like a particular market index.
Top-down investing • With this approach, you start looking at the overall economy first, to find out where there are strengths and opportunities. Then you pick the industries or sectors that will most likely perform well, choosing stocks with the greatest growth potential within that industry.
Bottom-up investing • This approach is the opposite of top-down investing, because it doesn’t focus on economic trends. It involves using assorted financial ratios and other indicators to pick stocks based on a company’s basic strengths, including its management team. Bottom-up investors believe a stock can perform well even in an industry that is not doing well.
Socially Responsible Investing • This approach involves choosing companies that show a high level of care for the environment and social well-being. Some indexes are now available for these companies, such as the Dow Jones Sustainability Indexes, and the FTSE4Good Index.
Asset Allocation
Establishing an appropriate asset mix is a dynamic process, and it plays a key role in determining your portfolio's overall risk and return. As such, your portfolio's asset mix should reflect your goals at any point in time. Here we outline some different strategies of establishing asset allocations and examine their basic management approaches.
Age Allocation • The rule of thumb used to be that you should subtract your age from 100 - and that's the percentage of your portfolio that you should keep in stocks. For example, if you're 30, you should keep 70% of your portfolio in stocks. If you're 70, you should keep 30% of your portfolio in stocks.
Strategic Asset Allocation • This method establishes and adheres to a "base policy mix" - a proportional combination of assets based on expected rates of return for each asset class. For example, if stocks have historically returned 10% per year and bonds have returned 5% per year, a mix of 50% stocks and 50% bonds would be expected to return 7.5% per year.
Constant-Weighting Asset Allocation • Strategic asset allocation generally implies a buy-and-hold strategy, even as the shift in values of assets causes a drift from the initially established policy mix. For this reason, you may choose to adopt a constant-weighting approach to asset allocation. With this approach, you continually rebalance your portfolio. For example, if one asset is declining in value, you would purchase more of that asset; and if that asset value is increasing, you would sell it.
There are no hard-and-fast rules for timing portfolio rebalancing under strategic or constant-weighting asset allocation. However, a common rule of thumb is that the portfolio should be rebalanced to its original mix when any given asset class moves more than 5% from its original value.
Tactical Asset Allocation • Over the long run, a strategic asset allocation strategy may seem relatively rigid. Therefore, you may find it necessary to occasionally engage in short-term, tactical deviations from the mix to capitalize on unusual or exceptional investment opportunities. This flexibility adds a market timing component to the portfolio, allowing you to participate in economic conditions more favorable for one asset class than for others.
Tactical asset allocation can be described as a moderately active strategy, since the overall strategic asset mix is returned to when desired short-term profits are achieved. This strategy demands some discipline, as you must first be able to recognize when short-term opportunities have run their course, and then rebalance the portfolio to the long-term asset position.
Dynamic Asset Allocation • Another active asset allocation strategy is dynamic asset allocation, with which you constantly adjust the mix of assets as markets rise and fall, and as the economy strengthens and weakens. With this strategy you sell assets that are declining and purchase assets that are increasing, making dynamic asset allocation the polar opposite of a constant-weighting strategy. For example, if the stock market is showing weakness, you sell stocks in anticipation of further decreases; and if the market is strong, you purchase stocks in anticipation of continued market gains.
Insured Asset Allocation • With an insured asset allocation strategy, you establish a base portfolio value under which the portfolio should not be allowed to drop. As long as the portfolio achieves a return above its base, you exercise active management to try to increase the portfolio value as much as possible. If, however, the portfolio should ever drop to the base value, you invest in risk-free assets so that the base value becomes fixed. At such time, you would consult with your advisor on re-allocating assets, perhaps even changing your investment strategy entirely.
Insured asset allocation may be suitable for risk-averse investors who desire a certain level of active portfolio management but appreciate the security of establishing a guaranteed floor below which the portfolio is not allowed to decline. For example, an investor who wishes to establish a minimum standard of living during retirement might find an insured asset allocation strategy ideally suited to his or her management goals.
Integrated Asset Allocation • With integrated asset allocation, you consider both your economic expectations and your risk in establishing an asset mix. While all of the above-mentioned strategies take into account expectations for future market returns, not all of the strategies account for investment risk tolerance. Integrated asset allocation, on the other hand, includes aspects of all strategies, accounting not only for expectations but also actual changes in capital markets and your risk tolerance. Integrated asset allocation is a broader asset allocation strategy, albeit allowing only either dynamic or constant-weighting allocation. Obviously, an investor would not wish to implement two strategies that compete with one another.
Conclusion • Asset allocation can be an active process to varying degrees or strictly passive in nature. Whether an investor chooses a precise asset allocation strategy or a combination of different strategies depends on that investor's goals, age, market expectations and risk tolerance.
Keep in mind, however, that this article gives only general guidelines on how investors may use asset allocation as a part of their core strategies. Be aware that allocation approaches that involve anticipating and reacting to market movements require a great deal of expertise and talent in using particular tools for timing these movements. Some would say that accurately timing the market is next to impossible, so make sure your strategy isn't too vulnerable to unforeseeable errors.
Start Investing With Small Amounts of Money
I have had the pleasure of helping people from various walks of life and investing situations while they were trying to invest in the stock market. I got to see the full range of individuals from those just who were learning to invest to some who were sitting on very expansive and lucrative investment portfolios. It was those who we’re wanting to invest in the stock market with little money I enjoyed helping most as they largely were just starting out in terms of growing their wealth. The challenge they often faced though was the belief they couldn't afford to get started investing.
A common misconception among many is that they need to have thousands upon thousands of dollars to invest in the stock market. While more is certainly better, big bucks is not a requirement in order to invest.
Many start out with a minimum opening balance of as little as $250, or nothing at all, which is tough to beat. While investing in mutual funds is usually not the best option, as many involve a minimum to get started, you can start investing in stocks with little money. Granted it may not be many shares to start with, but at the very least it allows you to invest in the stock market and not sit on the sidelines.
AUTOMATION CAN BE YOUR BEST FRIEND
Automation can be such a huge asset to those just starting out and those who have been investing for years alike. If you set up an automatic electronic transfer between your investment account and your bank account, after a few transfers, you will not notice the $50-100 per pay check. Using this feature allows you to build a pile of cash that you can invest in the stock market. Unless you’re transferring a large amount over, try to avoid buying stocks with each transfer as it’ll only cause you to spend more money in fees and commission.
A QUANTIFIABLE GOAL CAN BE YOUR BEST FRIEND
Have something to work towards to help with incentive pushes you to reach your goal. Whenever I wanted to give up or not work to get a bigger bonus I’d look at the picture and I’d be motivated to start working for it again because I wanted it. If you’re struggling to invest in the stock market because a lack of funds, look for ways to not only motivate yourself but push yourself to find ways to find the cash to invest.
DON’T GIVE INTO THE EXCUSE OF LACK OF FUNDS
Many were professionals, making a very decent salary but choosing to not make investing in the stock market a priority. Worse yet, they were using the belief that they had no money to spare as an excuse to not invest in the stock market.
Ultimately, it comes down generally to a lack of priorities and not thinking about the future and instead only thinking of the present. If you’re in this situation, I ask you to look at your spending habits and look for ways to cut your expenses. I’ll spare the list, as it has been rehashed here many times before, but look for ways you can trim the fat from your spending and put that money to work for you as opposed to being enslaved to it.
It may seem like a small amount, but finding something as simple as even $40-50 per month to invest in the stock market will do you wonders in the long run. If you’re wanting or needing help to locate those areas to trim, my favourite tracking tool is Personal Capital. Not only is Personal Capital free, but it also allows you to track your expenses, offers a free portfolio review and so much more in order to stay on top of your finances.
Whatever your situation is, please take action to get started today as you don’t want to look back years from now wishing you would've started earlier.