This page has general interest financial information with links to useful sites for more details. Note that links are opened in a secondary window.
There are lots of ways to deal with the cost of a college education. One important advantage of saving and investing is that it puts your money to work on the problem.
Estate planners provide you with advice on estate taxes or other estate planning issues and put together a strategy to manage your assets at the time of your death. While attorneys, accountants, financial planners, insurance agents or trust bankers may all provide estate planning services, you should seek an attorney to prepare legal documents such as wills, trusts and powers of attorney. Many estate planners hold the Accredited Estate Planner (AEP) designation.
“In common law legal systems, a trust is an arrangement whereby money or property is owned and managed by one person (or persons, or organizations) for the benefit of another. A trust is created … ” (more)
A well-crafted living trust can be useful in some circumstances but could be pricier than creating a will. What’s the difference between a will and a trust? This AARP article helps sort it out.
“Knowing how to secure your financial well-being is one of the most important things you’ll ever need to know in life. You don’t have to be a genius to do it. You just need to know how to get started. No matter how much or little money you have, the important thing … ” (more)
Here’s an Introduction to Mutual Funds from the Securities and Exchange Commission.
Market fluctuations that give one person a fitful night’s sleep make another wake up energized and eager. And while a return 10% above the market could make an investor skip and sing tra-la, that same investor might have a fit of street rage at a portfolio that underperformed the major indexes by half that amount. Risk is more complicated than standard deviations and guaranteed principal, and part of what makes it so is what each of us brings to it.
Whether risk terrifies you or excites you, however, you should expect to be compensated for it. In other words, what makes the market work is the notion that risk and return ought to be directly related. Of course, “nothing ventured, nothing gained” doesn’t necessarily mean “something ventured, something gained,” but there are ways to reduce uncompensated risk in a portfolio.
What is risk, and how do we know when we have enough? Intuitively, financial risk is the chance of losing money. Although this is often construed as loss of principal, it would be better to think of it as reduced financial well-being. If the world at large gets a substantially higher return than you, your material standard of living will suffer, even though you lost no principal. Here’s a list of risk categories that covers most of the ways financial well-being can deteriorate:
- Market risk is the chance of a broad market decline, or the perception among investors of diminished prospects for a particular security, market segment, or the market in general. Think 1929 – or 1973 or 1987 or 2000.
- Business risk is the likelihood of a decline in a company’s fortunes due to deteriorating fundamentals such as diminished sales, increasing expenses or lousy management decisions.
- Interest rate risk affects bonds and other fixed income investments, and is the chance that rising interest rates will reduce the market value of the investment.
- Inflation risk is the chance that inflation will outstrip the return on your investment.
- Liquidity risk addresses the real possibility that circumstances – the need for cash; force a sale when the market is down.
- Currency exchange risk affects dollar investments in foreign securities such that adverse changes in currency exchange rates reduce gains and exacerbate losses.
In the financial community, the widely accepted measure of risk is the standard deviation of total annual returns. It is a measure of how the returns have varied over time to produce the average return – how good the good years have been and, more important to the question of risk, how bad the down years have been. It also measures the frequency of good and bad years. Over time, what it means is that two-thirds of historical returns have been within one standard deviation (plus or minus) of the average return. What it implies is a level of predictability about future returns and volatility, that is, the likelihood of future good and bad years and how good or bad they will be.
If, for example, an investment has an average total annual return of 10% and a standard deviation of 11% then it returned between -1% and 21% four years out of six. Further, one year in six had a return less than -1%, just as one year in six had a return in excess of 21%. Finally, remember that all the ups and downs together produced an average return of 10% over the measurement period, the same as an investment with an average return of 10% and a standard deviation of 0%.
Is this a reliable predictor? Well, yes, as predictors go, but don’t bank on it. Both the average and the standard deviation will change over time. In the long run it will be true but we won’t know the truth of it until it is past and we can calculate it. And, as Keynes said, in the long run we’re all dead. So what’s a body to do? Since we can’t choose to wait forever, we have to find a way to mitigate the risks, to balance a portfolio with a mix of investments that will tend to offset each other; we have to diversify.
Asset Allocation and Diversification
A diversified portfolio is one invested in assets of various risks and returns, and with various correlations between their returns as well. The aim of diversification is to reduce risk. We have to keep in mind, however, that just as a rising tide lifts all boats so a falling tide lowers them. In other words, a severe bear market will probably lower the returns of all the equities in your portfolio even though the statistical correlations might suggest otherwise.
Asset allocation is spreading your assets across asset classes. The purpose of a particular asset allocation plan is either to maximize return for a given level of risk, or to minimize risk for a given return. Of course, this is not perfectly predictable. What was optimum over the past five years may prove to be disastrous for the next five. What we want to do is settle on a reasonable plan for the long term and rebalance periodically to account for different returns in the various classes.
How much will you need? A rough estimate can help you get started.
Defined Benefit Pensions
You have a retirement pension plan funded by your employer. What does that mean?
Defined Contribution Plans – 401(k)
Your employer provides a plan for you to fund your own retirement. How does it work?
“An annuity is a contract between you and an insurance company, under which you make a lump-sum payment or series of payments. In return …” (more)
“Variable annuities have become a part of the retirement and investment plans of many
Americans. Before you buy a variable annuity, you should know some of the basics – and be prepared to ask your insurance agent, broker, financial planner, or other
financial professional lots of questions about …” (more)