(an except from the book “Finding Financial Fulfillment, for a Life Filled with Money and Meaning,” by Janet Tyler Johnson, CFP®)

There is a tremendous amount of information available today on how to manage your investments. I’ve worked in several areas of the financial services industry in my career and would like to acquaint you with some general truths. I’d also like to disclose that I have in the past, and still at present, manage assets for a fee for clients.

Let me say from the beginning here that there is no one “best” way to manage your assets. There are several “best” ways. I know that adds to the confusion for you, but you are a unique individual with unique goals and dreams.

The amount of risk you are willing to take, the amount of money you are saving, and your long-term objectives all play into the equation. I strongly urge you to work with a financial advisor, preferably a Certified Financial Planner® professional, who has been trained to look at your entire financial picture, not just your investments.

Fundamental #1:
Be Clear About Your Investment Goals

You must know what you are trying to accomplish with your money before you set out to invest it at all. For instance, is the money for your retirement? Or to help get your kinds through college? Or to fund a career change for yourself? What is the goal? What time frame are you looking at?

If you’re investing money in the stock market to try to make a killing in the next two years so you can quit your job and start a business, you are taking a very big risk. The stock market is not, in my opinion, for gamblers or short-term investors.

Fundament #2:
Diversify, Diversify, Diversify

Diversification is key. Have you ever heard the expression “don’t put all your eggs in one basket?” Betting everything you have on one stock, or even a few stocks, can be very risky. Owning just small company stocks, or stocks of only US companies, or just large company domestic stocks can also be a risk.

The secret to diversifying your investments is to slice up the investment world just like you would slice up a pie, with each piece of pie representing something different. For example, one piece could be international stocks, one piece could be domestic (US) small company stocks, and don’t forget mid size and large size US stocks, real estate, commodities corporate bonds, government bonds or municipal bonds (if you are in a high-income tax bracket), and cash-type investments such as CDs or money market funds.

Your investment allocation is very important. According to all the experts, how you allocate your investments (how much is in stocks, how much is in bonds, and how much is in cash) accounts for the vast majority of your overall investment return every year.

As you can see, there are a lot of things to think about when it comes to investing our money, which leads us to another topic that I think is paramount for you to consider.

Fundamental #3
Rebalance Your Portfolio

Another critical component to your overall investment success is rebalancing your allocations in your portfolio. By this I mean that if, when working with your financial planner, you agreed that your allocation should be 65% stocks, 30% bonds and 5% cash, and a year later, through market movement, your portfolio contains 75% stocks, 20% bonds and 5% cash, then you own more stocks than your original allocation called for and are taking on more risk than you agreed you would be comfortable with.

Conversely, if a year after that your portfolio has 55% stocks, 40% bonds and 5% cash, you are now invested more conservatively than you may need to be to meet your investment goals.

The markets move all the time, sometimes moving up or down quickly in very short periods of time. It is important that you keep your portfolio invested to your original allocation in order to increase your probability of investment success.

How often should a portfolio be rebalanced? There is no hard and fast rule on this topic, but from all the studies I’ve read over the years (and the academics look at this question in depth), I recommend to clients that we rebalance any asset class in the portfolio, i.e., international, small company, large company, real estate, bonds, etc., that is more that 25% above or below its target.

Setting up a parameter like this helps take the emotion out of investing. We, as human beings, have a hard time letting go of our winners. It’s easy to get greedy, or just hopeful that we’ll make even more money than we have. It’s also hard to purchase something when it’s losing value.

But remember, the one simple truth about making money in the stock market is to buy low and sell high. Since our human nature makes this difficult, setting a parameter of a 25% change in your allocation makes rebalancing easier to do.

Fundamental #4:
Know What It’s Costing You To Invest

How much is it costing you to invest your money? There is no free lunch out there, even though sometimes it appears that there is. Every type of investment has some form of cost attached to it. When you purchase a stock, you are charged a commission. When you purchase a bond, the broker buys the bond at one price, marks that price up, and then sells to you at the higher price (sort of like buying at wholesale and selling at retail price.)

All mutual funds, index funds, and exchange traded funds have charges called “expense ratios.” In addition, when buying exchange traded funds you also pay a commission. Some mutual funds carry sales charges in addition to their expense ratios. Investment advisors and investment managers charge fees to manage your portfolios for you.

To make things even more complicated, there is no one best way of investing for everyone. Stocks may be the appropriate choice for some investors, while index funds may make more sense for others.

Regardless of which type of investment is best for you, in my opinion, it is critical that you KNOW what your investments are costing you. I’ve seen investment portfolios where the cost of investing is in the 3% per year range. If you could reduce the cost by even one percent each year, you could be saving yourself hundreds of thousands of real investment dollars over a long period of time.

Whoever you are working with to handle your investments should be able to tell you exactly how much it is costing you to invest. If they won’t disclose this information to you, you may be better served by someone else. Reducing the costs of investing can mean far more money in your pocket, and that’s what counts!

Fundamental #5:
Don’t Forget Taxes

I always tell clients, it’s not what you earn on your money that’s important it’s what you keep. We’ve already discussed costs and how they can erode your returns. Well, taxes can also have a large impact on your overall investment success. The money you pay in taxes on your investment earnings is money you will never get back.

In taxable accounts where you save after-tax dollars, every year you are taxed on any profits that you have had to report. For example, if you sell a mutual fund that had a gain in it (a profit), the gain is taxed in the year of the sale. You may be eligible for capital gains treatment where the amount of tax may be lower than your ordinary income rate, but it’s still tax that has to be paid.

A good investment advisor or financial planner will do everything he can to offset taxes for you each and every year. Of course, you can never totally eliminate taxes, and reducing taxes should not be your number one priority if it means you would have to change your asset allocation to either take on more risk or reduce the amount of growth your portfolio is likely to achieve. But taxes are important.

If you do have to sell something that has had a gain that would be taxable, often times you can sell something else in your portfolio that has had a loss to offset that gain.

Of course, it is critical that you work with your tax advisor when trying to do this. I mention tax reduction as being important as I have seen many, many brokers and advisors over the years completely ignore the tax ramifications of making changes to a client’s portfolio. Again, it’s not what you earn that is important, it’s what you keep. And, you should always look at returns after all fees and taxes have been deducted. That tells you how your money is really growing.

Being diligent in this area can potentially mean thousands and thousands more dollars in your pocket. Make sure your investment advisor effectively tax manages your money.

Fundamental #6:
Is Your Investment Strategy in Alignment With You and Your Values?

I think most important of all is designing an investment strategy that is congruent with who you are and what you value. I’ve been helping people accumulate wealth for over 25 years, and I can tell you from first hand experience that accumulating money just for the sake of accumulating money doesn’t increase the fulfillment or happiness quotient in a person’s life.

So what is truly, truly important to you in life? For example, I know a great number of people who feel that it’s a parent’s responsibility, or expectation, that they should pay for their children’s college education. Somehow in this country we have gotten the message that “good” parents do this. Yet, all the studies show that children do better in school, and in life, if they pay at least a part of their education themselves. They have skin in the game, so to speak. They take their education more seriously. Yet many parents sacrifice their own retirement to make sure their kids get a free ride through school.

If putting your kids through college is really, really important to you, then that’s a worthy goal. But if you are paying for their education out of some sense of obligation, maybe you need to revisit this issue, especially if it may impact your own retirement. Your children can get student loans, but if you don’t’ have adequate funds for retirement, you risk being a burden to them in your later years.

In order to get a better handle on what is truly important to you, ask yourself this: if money was not an issue, what would you do differently in your life? Then ask: if you found out you only had five years left to live, what would you do differently in your life?

The answers to these questions can help you uncover what you truly value, and once you know that, you’ll have a much better idea of how much money you need in your life to create the life of your dreams.

Before you do anything else financially, give yourself the gift of dreaming again. What do you want to: be……, do.….., have.…..? What do you truly value? What would make your life be one of no regrets? What brings you the most joy in your life and how can you get more of that?

(Much more on Fundamental #6 in my book, “Finding Financial Fulfillment, for a Life Filled with Money and Meaning.” Go to http://www.jataj.com/lp-about/finding-financial-fulfillment.html to learn more or purchase a copy. It may be the best investment you ever make!)

Copyright © 2009 JATAJ. All rights reserved.

Author's Bio: 

Janet Tyler Johnson is author of the book "Finding Financial Fulfillment, for a Life Filled with Money and Meaning" and is a Certified Financial Planner(R) professional with over 25 years of experience in the financial services industry. Prior to opening her own fee-only financial planning and investment advisory firm in 2005 she was in charge of the financial planning and investment management division of the country's 12 largest CPA firm. You can learn more about Janet and the services she offers at http://www.jataj.com.

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