The following list are some of the more basic investment and portfolio management tips/concepts that you should find helpful in becoming a better and more informed investor. I am a believer in the basics and consistency. Before we dive into these, remember that learning to become a better investor takes time and effort, but the good news is that it is not rocket science.
By understanding the basics, you will know your way around the investing landscape. Becoming a better investor is about learning and developing a set of habits and rules you live by that eventually support you in reaching your financial goals. To do this, you should prepare and be willing to break through any self-imposed mental barriers like this: “Investing is too hard.” ”I let my broker handle that stuff.” ”I was never any good at math.” Those are all just lazy excuses to avoid the effort required to learn.
Let’s take a look at 10 Simple and Useful Investment Tips and Concepts.
These are the some of the initial tips and concepts that I would want to know if I was starting from scratch.
1. Rate of Return – If an investment compounds at 5% for 5 years, multiply the investment by 1.05 five times in a row to figure out the rate of return. If it compounds at 8% for 10 years multiply the investment by 1.08 ten times in a row. There are calculators that do this for you and figure out the compounded rate of return. By “seeing the math” you should better understand rates of return and the power behind compounding.
2. The Rule of 72 – This is one of my favorites. The rule of 72 tells you how long it takes to double your money at a given rate of return (We will use 8% for this example). Just divide “72″ by the rate of return. So, using our example, if we wanted to know how long it will take to double our money at 8%, we see that it takes 9 years. (72 divided by 8=9). With me so far? Not hard at all and now you are as smart as half of Wall Street, once you buy a dart board!
3. Duration – Straight out of my “Please be careful tool box” I urge you to take this term seriously. A bond’s duration measures its volatility to changes in interest rates. This is an important concept to learn if you own bonds today. This is largely because interest rates are at 30 year lows and at the end of a long term cycle that saw rates tick down for decades and bond prices rise. Rule of thumb: When rates rise, bond prices decline. We are headed into a long term rate rising environment and you will want to understand this now versus when the train pulls out of the station.
If you own bonds in your portfolio, please take some time to understand what the average maturity of those holdings are. Also, understand that in a rising interest rate environment you want to look at things like laddering your bond portfolio and other investment alternatives. Rates will eventually rise; we just don’t know when.
4. Modern Portfolio Theory - Most of the readers of The Wise Buck are people investing in 401k plans and IRAs. Modern Portfolio Theory is the framework most institutions build their education models from and where the “Don’t put all your eggs in one basket comes from.” But remember this: MPT is just a theory. Usually well thought theories work most of the time but they are not fail safe. See 2008. This is why I take certain precautions and make safe investments that match my risk profile. (I hate to lose money.)
In Modern Portfolio Theory, the optimal portfolio is the one that has the most return for a given amount of risk. MPT also says that time horizon, age and asset allocation are more important factors in determining long term investment performance versus the skill of the portfolio manager or the choice of investments.
5. Growth Stocks trade at a higher price to earnings ratio than value stocks and are by nature more volatile. Hence, investing in growth type investments requires a higher risk tolerance.
6. Value stocks are generally cheaper, lower price to earnings ratios, stocks. This is where you find higher dividends and less volatility. The trade off is that you give up the growth potential found in growth stocks for the certainty of a regular dividend.
7. A market is considered “secular” when it has moved in the same general direction (up or down) for a long period of time. Within secular markets there are “cyclical” short term moves or swings.
8. The more popular and tracked domestic stock market indices are:
Dow Jones Industrial Average – tracks 30 large cap industrial stocks
S & P 500 – tracks the overall US market. This gives you a barometer for the US stock market
S & P 400 – tracks mid cap stocks
Russell 2000 – tracks small cap stocks
We will end with 2 general tips from me.
9. Get Educated - Your personal savings took your hard work and effort. Doesn’t it make sense to watch after your savings so that they watch after you? Don’t ever let laziness get in the way of your financial success. We all have to start somewhere. Begin with learning from others. Begin by taking an active role and learn more about investing. Read The Wise Buck. Read other top personal finance blogs . Once you get the basics, you see how things work and doors open up, light bulbs come on and you’re at ease.
10. Finally, Take Ownership and Stop Making Excuses – Once I really understood this, my life changed in so many ways. It’s so easy to blow this stuff off and just take whatever comes your way. But is that really any way to go through life? Average?? I didn’t think so. No one is going to just drop things in your lap. Whether it’s at work, your personal life or learning how to invest, you are the only person that stands in your way for the most part.
Things don’t get done by someone else; you either do it or end up second – last of what you could have done or become. That’s where most people fall into the bitter and complaining phase and become cynical. Amidst all the “noise” and negativity in the world today, I have truly never been more optimistic and forward looking. Mostly because I learned this one concept about personal responsibility. So, stop making excuses and go out and create a remarkable life!
Happy 4th of July. Enjoy your freedom! Personal Wealth is Freedom.
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Good tips. To expand on the duration number consider that the duration of AGG ( the exchange traded fund that tracks the overall U.S. bond market) is 4.2 years and its yield to maturity is 3.68%.
If rates rise by 1% ( i.e. the 10 year Treasury today is 2.95%) over the next year – for example the yield on the 10 year Treasury rises to 3.95% the average price of the bonds in AGG will fall by 4.2! This is what duration tells you. The total return then will be approximately +3.68% from yield -4.2% from price change or in total -.52%, If rates go up by 2% , i.e. 10 year Treasury yield rises to 4.95% then total return would be approximately -4.72%!
Morningstar is a good place to get durations for exchange traded funds
Hi Robert, thanks for posting the example on duration. This is a concept fixed investors need to become familiar with, especially today and into the future, as the prospect of rising rates increases.