Asset Allocation Tips

Asset allocation. It sounds like a dry subject, but the reality is this topic will make or break almost every financial decision of your lifetime so pull up a chair and sharpen your pencil.

Life stage planning is exactly what it sounds like; if you are a retiree or boomer nearing retirement then your financial planning will consist of one of the following:

1. Preservation. Assuming you have a tidy nest egg then your emphasis will be on maintaining the purchasing power of your investments despite inflation.
2. Go For Broke. If you are like the unfortunate majority of retirees or near retirees with minimal to no savings or investments then you might take a "go for broke" approach to investing. What do you have to lose right? Not so fast. The reality is inflation is likely to eat away what little you expect to receive from Social Security or a pension so having even a few hundred dollars extra each month might make a very big difference in your standard of living. Don't assume your only option is to bust the bank and speculate on one big win.

Life stage planning for the younger generation has an entirely different set of issues. First, forget Social Security. Everyone admits it is broken and once the current Boomer generation gets into full swing there won't be enough money to fund their retirement much less yours. As for pensions, they are quickly becoming extinct. Even if you are fortunate enough to have a company sponsored pension, don't put all your eggs in one basket...look at Enron to see how quickly that can turn sour. Instead, you need a long term strategy that incorporates growth combined with security.

The good news is that time is on your side. Growth investments will predominate your portfolio but always set aside a low to no-risk secure investment area for the worst case scenario" to assure you have something to start-over with or at least fund a subsistence existence in your old age.

There isn't a one size fits all approach to asset allocation but keep these tips in mind:

• Diversify Investments to make sure you are never "wiped out".
• Don't risk what you cannot afford to lose. Even if you are young, the first objective is to have a safety net in place. Government Savings Bonds, CD's and other low risk investments are the first tier. Once those are established then move on to higher risk investments.
• Real Estate or REIT's provide another level of diversification especially when inflation is a risk.
• Commodities including precious metals might benefit your portfolio but are highly volatile.

	Book: Getting Started in Asset Allocation
	Book: Understanding Asset Allocation: An Intuitive Approach To Maximizing Your Portfolio
	Book: The Art of Asset Allocation
	Book: Asset Allocation Essentials: Simple Steps to Winning Portfolios

Bonds are essentially I.O.Us used to lend money to whatever entity you are purchasing the bond from including the federal government, state and local municipalities, corporations, mortgage- and asset -based securities and foreign government bonds. In exchange for the use of your money, they agree to pay a given interest rate. It sounds simple, but there is a lot to learn about making the most of your bond investment. Begin by using the following checklist when researching your purchase:

1. Is the bond convertible or "straight."
2. What is the rating? A bond is only as good as the underlying financials of the issuing entity.
3. What - if any - special features are in play? Pay attention to call risk and don't count your profits before maturity.
4. What is the yield, maturity date, coupon rate and tax status?
5. Consider the "call risk". The call risk is when a bond issuer "calls" the bond and then creates a new issue at a lower rate. This is of particular importance when interest rates are falling.

Every portfolio has a place for bonds. Don't automatically assume they are less risky than stocks, or that their rate of return is less. The bond market is highly volatile and capable of bringing as much - or as little - stability versus risk as desired. Bonds are simply another form of investing and diversification. Keep in mind there are different types of bonds as well. For example, convertible bonds are those that can be converted into a specified amount of equity in the company at specific times of the lifecycle. Because they are bonds that have the option of being converted into stock, they tend to trade at a lower rate of return.

	Book: Bonds: The Unbeaten Path To Secure Investment Growth
	Book: All About Bonds and Bond Mutual Funds: The Easy Way to Get Started
	Book: Inflation-Indexed Securities: Bonds, Swaps and other Derivatives

A CD or Certificate of Deposit is one of the safest and liquid forms of investment available. Insured by the FDIC (Federal Deposit Insurance Corporation), CDs are a type of interest earning deposit account. Unlike savings accounts, a CD requires a fixed sum of money for a fixed period of time ranging from six months to several years.

CDs are attractive to investors because they typically pay a higher rate of interest than a traditional savings account and have FDIC insurance up to $100,000. Don't expect to get rich from investing in CDs but they are a valuable addition to any portfolio to assist in providing liquidity. Use these quick tips to get started in purchasing and investing in CD's:

1. Use a ladder approach to purchasing certificates of deposit. By using a ladder approach you spread out the interest rates and redemption times. Should you need to cash in a CD you will have more options available and lose the least amount of potential interest.
2. If investing more than $100,000 spread it between two or more banks or brokers. Remember, FDIC insurance only covers up to $100,000 per entity.
3. Confirm the maturity date - see it in writing before signing or finalizing the purchase. CDs can mature in as little as six months or as long as twenty years.
4. Confirm the interest rate and yield. Is the interest rate fixed or variable?
5. Understand penalties and early withdrawals. Pre-payment penalties, early withdrawal fees and other related items can dramatically impact yield.

The Fosback Index, created by Normal Fosback, has fallen out of favor in recent years, but it is a quick and easy tool that belongs in every mutual fund investor's toolbox. For those young investors who have never heard of the Fosback Index, here is a quick tutorial.

The Fosback Index measures the cash holdings or liquidity of mutual funds against the normal levels.
Zero = Neutral
Positive = Extra cash. The more positive the more bullish.
Negative = Deficit cash. The more negative the more bearish.

By estimating how much cash the mutual funds should have -- compared to how much they are actually holding -- based upon current interest rates, positive or negative number is derived to represent the bullish or bearish market forces at play in the mutual fund market.

Worried about inflation? Fear the current spending on the war, Social Security, Medicaid and Medicare will create the perfect inflation storm? Want to hedge your bet that the general stock market will drop as Baby Boomers begin to retire and withdraw their investment dollars into long term, more stable instruments? Whatever the reason, there are a steps you can take to diversify investments and create an inflation adjusted asset allocation strategy. Here are a few areas to explore. Invest in

• Energy
• Foreign currency
• Precious metals
• Explore TIPS or Treasury Inflation Protected Securities rather than fixed rate bonds
• I-Bonds over traditional savings bonds

China is expected to grow at 8 percent annually between 2006 and 2010.

India is expected to grow at nearly 9 percent annually.

International stocks sound more and more appealing with double digit growth rates projected for several years to come in emerging markets such as these. On the other hand, the media spares no expense in reporting corruption, infrastructure delays and a host of irregularities that make foreign investment seem truly foreign in more ways than one.

How can you invest in international stocks without acquiring more risk than necessary? It might be easier than you think:

1. Explore ETFs or Exchange Traded Funds. They trade like stocks, but with the added benefit of built-in diversity.
2. ADRs or American Depository Receipts act as a proxy for foreign stock shares, but are issued in dollar value.
3. Closed end funds are like a cross between mutual funds and ETFs which trade like stocks but are a collection of stocks from one country. For example, IFN is a closed end fund for India and CAF is a closed end fund for China. Both invest invest 100% in their countries but are managed by an American investment company and trade on the NYSE.

Book: The Top 100 International Growth Stocks

True or False - You can control investment risk?

If you are a newbie investor than you probably tried to give a "yes" or "no" response, but veteran investors would immediately ask "what type of risk?"

There are different types of investment risk to contend with. A wise investor knows the different types of investment risk and how to minimize each in their favor.

1. Inflation. Without a doubt inflation is one of the most frequently overlooked types of investment risk. In fact, it can turn a seemly "safe" investment into a downright "risky" investment. Let's use a very simplistic example: you take $1,000 and put it into a piggy bank at home. It earns nothing. For ease of numbers, let's assume inflation is averaging .05 percent annually (inflation typically runs about .03 percent annually but has reached double digit levels in the late 70s and early 80s). At the end of one year, your piggy bank still has $1,000, but it can only purchase $950 worth of goods. Several years of that and your money isn't worth much. All investments must earn at least the rate of inflation or you are actually losing money each year.
2. The Economy. The economy can radically alter both the purchase price and volume of stocks, bonds, real estate and other investments. Remember, price and volume work hand-in-hand. You must have someone who is able and willing to purchase what you are selling whether it is real estate, bonds, or stocks. Credit can tighten, supply and demand changes the availability and other economic data can have a long-term impact on your investments.
3. The Business. Business risk is inherent. Competition, management issues, supply issues, major lawsuits, government regulation and other issues can alter the profitability of a company with little warning. Some industries are subject to greater risk than others so it is important to closely monitor the industry and individual companies.
4. Valuation Risk. Even if the company is strong and the economy is doing great, it is still possible that a company presents too much risk due to valuation risk. Price must be in accordance to the potential long term benefit of the market or industry as a whole. Even if a company is a good investment, it may not be the right price.
5. Individual Risk. Always have a contingency plan in place. If you are investing with a specific time line that you must sell then you are personally increasing your own risk. Never invest money you cannot afford to lose or which is needed for other necessary debt repayment. If you are forced to sell during a downturn then it could result in long term losses. Many investments turn sour in the short term only later to recover. Make sure you have staying power and choices in order to reduce your personal investment risk.

What is the difference between a money market mutual fund and a money market account? If you are like most Americans, many of which actually have one or both of these types of investments, you really aren't all that sure.

Here is a quick tip: Figure it out so you don't embarrass yourself.

A money market account is similar to a savings account. In fact, depending on where you bank you may have your money parked in a MMA. Interest is paid on the deposits and they are federally insured. The difference between MMAs and traditional savings accounts is most notable in a higher interest rate, minimum balance requirement and some limitations on transfers or withdrawals.

Money market mutual funds are completely different. These funds are not federally insured, which means your money is at risk should a loss take place (although rare, it is theoretically possible) and mature in 13 months or less. Money market funds take combined funds and then purchase investments ranging from very safe (for example, government only Treasury funds) to corporate securities.

When purchasing money market funds, be sure you understand the yield after annual account fees and other charges.

Remember the story about the tortoise and the hare? The slow but sure sometimes wins the race, but will that really work when it comes to investing? Surprisingly, the answer is often "yes."

1. A slow but sure strategy will usually diversify investments thereby reducing risk. Critics correctly point out that diversifying risk frequently results in minimizing the payout, but a slow steady gain is better than no gain.
2. Fewer fees. The average consumer doesn't really understand money. They purchase a home based upon monthly mortgage payments, shop sales using high interest credit cards and then hold the bulk of their investments in situations that require high transaction fees. The combined effect of transaction fees, penalties and other small charges dramatically change the ROI or Return on Investment. Many slow but sure investors tend to charge less and invest for the long-term which results in dramatically lower fees and therefore higher real rates of return.
3. Inflation adjusted alternatives like government TIPS and I-bonds provide a method of investing in nearly risk-free government-backed securities while taking inflation into account. It is important to notice, government backed TIPS or I-bonds use the official CPI or Consumer Price Index to measure inflation rather than the types of consumer costs most people think of when considering inflation. The official inflation measure is very different than your personal inflation rate.

Real estate can be a wise investment but beyond purchasing a home of your own, what is the best way to invest in real estate without getting your hands dirty and spending your spare time chasing tenants for rent?

A REIT or Real Estate Investment Trust may be the perfect investment vehicle. REITs own, and often operate, real estate but are publicly traded like stock. Profit is paid as dividend to stock owners.

To invest in a REIT, it is imperative that you do your homework. Real estate is a tangible asset, but there are major holding costs including maintenance, taxes and insurance. Local market conditions change dramatically and can take years to recuperate.

Before investing in REITs research the following:

1. Is the REIT registered with the SEC and publicly traded? Use caution before investing in an REIT that isn't registered or publicly traded.
2. Determine the type of REIT: equity, mortgage, hybrid?
3. What type of property does the REIT invest in? What is the economic forecast related to that industry?
4. Who is on the board and management team? What is their experience?
5. How will it impact your taxes? Most REIT distributions are taxed as ordinary income.

Small cap stock investing is volatile. That is one of first things you should know and understand. So, why risk your money by investing in what is typically considered risky business? First and foremost - increased risk equals increased potential reward. However, there is another way to look at it. Investing in risk can actually decrease the total risk of your portfolio.

Here is how it works. By diversifying your portfolio to include high volatility, moderate and minimum risk instruments the overall return tends to be greater thereby actually eliminating risk by increasing volatility.

Small cap stock are defined as those companies with a market cap of less than $1 billion (calculate market cap by multiplying share price by number of outstanding shares). Size matters when it comes to small cap stock investing. Just ask yourself, what is easier to do - double your money from $1 to $2 or double $1 million to $2 million. It's a no-brainer. The same applies to corporations. Growth becomes more difficult as the company grows beyond a certain point, but the rewards for finding the right company in the early growth stage can lead to the type of returns every investor dreams of.

Use these quick tips when searching for small cap stocks:

1. Understand the market. Yes - we are saying it again for a reason. The fundamentals never go out of style and there are few places this is more true than investing in small cap stocks.
2. Don't believe the better mouse-trap theory. You know the old adage "build a better mouse-trap and they will come." The reality is closer to "imitation is the best form of flattery." Before you bet the farm on the next new and improved technology, remember how much money is required to bring it to market.
3. Stay involved with the company. Read and understand the company information itself. Who is at the helm? What is their prior experience? The best plans fall apart without proper guidance.

Not sure what to look for when purchasing small cap stock? Use this small cap stock selection checklist to make sure you cover the basics:

• Earnings. Look for a rise in current and annual earnings. Some investors will use a 25 percent increase in current earnings per share, but that is heavily contingent upon prevailing market conditions and the industry averages.
• Volume. Trading volume is critical especially when dealing with small cap stocks. Remember, to make a profit you need someone willing and able to buy what you are selling.
• Institutional sponsorship. Look for investment by mutual funds and other large institutional buyers.
• Growth. Read analyst reports for growth forecasts of 15 percent and up.
• Revenue. Look for revenue or sales growth of at least 15 percent change above year over year rate.