Tips on How to Map ’92 Investment Plan
Now’s a good time to start planning your investment strategy for the year ahead, and that means drawing up a plan if you haven’t.
Most do-it-yourself mutual fund investors have probably never put pen to paper to map a strategy of attack. Many wind up buying and selling funds in a hodgepodge manner.
“As human beings, we want to go with the winners--such as last year’s hot-performing funds,” says Victoria Felton-Collins of Keller, Coad & Collins Investment Counsel in Irvine. “People who don’t develop a plan follow their impulses.”
For mutual fund investors, there’s nothing especially difficult about drawing up a plan; you can make it as simple or complex as you want. However, the exercise should involve serious thinking about your risk tolerance, objectives and other factors. Here are some questions professional money managers and financial planners ask new clients:
* What do you intend to do with the money you compile, and when will you need it? If you’re investing for a specific purpose, such as retirement or a child’s education, you might be able to make a reasonable estimate of how much cash you will need to amass by a future date. “Work backward--that’s the key,” says Lori Holman of Holman Capital Management in Oakland.
Once you have established a future financial target, you will have a better idea of how much cash you need to invest now and what sort of annual returns you will have to reap over the years. Keep in mind that long-term financial planning is an inexact science--variables such as inflation, taxes and your own circumstances may alter your plan, but at least you’ll have a lighthouse to tack for through the fog.
* What sort of mutual funds will help you achieve your goals? Although many types of investments move in a random fashion, especially over the short term, certain asset categories have fairly consistent, well-documented long-term records that help shed light on future performance. If you keep these historic returns in mind, you will be in a better position to choose mutual funds appropriate for your situation.
For example, if you need long-term growth of 10% a year, stick with equity funds. The stock market has achieved average compounded gains of about 10% a year stretching back to 1926, reports Ibbotson Associates, a Chicago research outfit. That compares to just 5% or so on corporate bonds and less than 4% on cash instruments such as Treasury bills.
“Even retirees need to keep at least 20% of their investments in growth stock funds,” suggests William F. Walton, a financial consultant in Rancho Santa Fe.
Put another way, the more time you stick with an equity fund, the less likely you are to suffer losses. There’s about a 30% chance of losing money in the stock market in any given year based on historic results, Holman says, but only about a 6% chance for people who stay put for five years.
* What’s your appetite for risk? A critical element of any investment plan is determining how much volatility you can accept. A portfolio of three or four solid stock funds might promise superior long-term results, but these selections won’t do much good if you can’t stomach the bumps along the way.
Before you can gauge your risk tolerance, you may need to do some reflection. What’s more important, higher rewards or consistent returns? Would you rather outperform the market or suffer no down years? Are you less comfortable holding cash when the market’s going up or stocks when the market’s going down? These are the kinds of questions Walton asks new clients before offering recommendations.
Once you have a good idea of your objectives, time horizon, risk tolerance and asset preferences, you can turn your attention to buying specific mutual funds. How many do you need? Some experts recommend a fairly small list of perhaps three to eight for a person with $50,000 to $100,000 or so to invest. Additional funds will result in more paperwork and, possibly, extra fees, without providing much else in the way of diversification.
If you don’t want to put together your own mutual fund portfolio, you will probably have to pay a professional do it.
Stockbrokers and other commissioned salespeople typically will recommend “load” mutual funds--those with a sales charge attached. Or you can do business with a fee-based financial planner or money manager, such as Holman Walton and Felton-Collins. These professionals typically recommend no-load funds and are compensated by charging a flat yearly fee, such as 1% of the amount you invest through them. Unfortunately for smaller investors, most require accounts with at least $50,000 to $100,000.
Fee-only advisers say that they, unlike commissioned salespeople, are free to recommend any mutual funds, including no-loads, thus avoiding a potential conflict of interest. “We’re sitting on the same side of the table with clients,” Felton-Collins says. “We make money when the client does and lose when the client does.”
Whether you need professional help in drawing up and implementing a mutual fund plan depends largely on the amount of time and energy you can commit to investing, as well as your confidence in dealing with financial matters. A good professional will lead you through the process one step at a time, providing ample explanations of how mutual funds work.
“A key part of the process is education,” Holman says. “We explain all the elements of risk and return, and help people come up with realistic investment expectations.”
Shopping for an Adviser
Many financial planners, stockbrokers and money managers can help you draw up an investment plan focusing on mutual funds. Fees and services vary, however, so it’s wise to shop. Ask these questions of each professional you interview:
* How are you compensated? Some advisers earn a commission on each trade, while others charge a flat fee. Fee-based consultants say they are free to select only the best mutual funds in any category, unlike commissioned salespeople.
* What’s your investment philosophy? Find an adviser who shares your temperament--conservative, aggressive or whatever.
* What types of investments do you consider appropriate for someone like me? The answer here should help you determine whether the adviser’s approach is too risky for you.
* What is your investment performance? Look for consistent results, and give more credence to results verified by an independent evaluation service. Find out if the numbers reflect all of the adviser’s accounts or just a top-performing one.
Be sure to ask for references, including those from third-party referrals such as accountants. Also, request both parts of Form ADV, a document advisers must file with the Securities and Exchange Commission. It lists the person’s background, years in business and other information.
A good source for fee-only consultants is “The Charles Schwab Guide to Selecting a Financial Advisor,” available free at Schwab branch offices.
