Cents and Sensibility
Cents and Sensibility
Remember the old saying, "Don't put all your eggs in one basket?" Today, "gathering eggs" typically consists of stopping by the store to pick up a dozen Grade A's. However, the wisdom of the sentiment still applies, especially when it comes to investing. An Easter message
about diversificationIn yesteryear, this sage advice was meant to protect you (and your eggs) should some unfortunate mishap befall you between the house and the chicken coop. Today, when applied to investing, these words of wisdom are intended to help protect you and your investments against mishaps. Here's how:
Unlike eggs, which all basically look and taste alike, each investment is unique, and each is designed to fill a certain need. Income objective investments -- such as certificates of deposit, bonds, income mutual funds and fixed annuities -- are designed to provide a regular stream of income to help meet monthly expenses. Growth objective investments -- such as individual stocks, equity mutual funds and variable annuities -- are designed to let your investment grow in value and, thus, stay ahead of inflation's erosive powers. Growth-and-income objective investments offer both income and growth. All three types of investments are included in a well-balanced portfolio.
When you choose a variety of investments, it's called diversification. One of the greatest benefits of diversification is the protection it helps to provide. No investment performs well under all conditions. In fact, certain investments practically "counterbalance" one another. For examples, bonds typically perform well when the stock market declines, while stocks typically perform strongly when the bond market declines. Owning both helps cushion you against the market's ups and downs.
Of course, knowing you should diversify your investments and actually diversifying them are two different things. Often, investors fall into the habit of relying on such "old faithfuls" as CD's and bonds. Unfortunately, limiting yourself to income investments can undermine your money's long-term purchasing power. Just look at how inflation has affected the price of a stamp.
In 1950, a stamp cost 3 cents. By 1970, the cost of a stamp had doubled to 6 cents. By 1990, the cost of a stamp rose to 25 cents. Today, a stamp costs 34 cents. That's what's meant by the loss of purchasing power.
Although there is comfort in knowing how much your investment will earn each year and return in principal at maturity, what you don't know is how much purchasing power that money will retain. That's why it's important to place a portion of your investment dollars in growth objective investments, which typically outpace inflation, so you can not only keep up with the cost of living, you have the potential to keep ahead of it.
When diversifying, it's important to remember that not only should you diversify in different types of investments, you should also diversify within each type of investment.
For example, when choosing stocks for growth potential, don't limit yourself to one stock or even one type of stock, such as consumer goods or utilities. Instead, spread your dollars among a number of stocks.
The same holds true for income objective investments. Choose bonds with short-, intermediate- and long-term maturities. This practice, called laddering maturities, helps position you to take advantage of changing interest rates. When interest rates fall, you have money locked in at higher rates. When interest rates rise, you'll soon have money available to invest at those higher rates.
Which mix of investments is right for you? Which investment should you choose? That depends on your needs and goals. Unfortunately, there is no "one size fits all" investment plan.
Proper diversification requires serious thought and takes time to implement. If you need help determining which investments are best-suited to your needs, seek the help of an investment professional. He or she can explain what types of investments are available and how they would fit in your portfolio.
Aside from next week's Easter egg hunts, we may no longer gather eggs in baskets, but there's still a wealth of wisdom in the simple caution: "Don't put all your eggs in one basket."
Guy Steele is a financial planner and head
of the Pali Palms office of Edward Jones. Send
planning and investing questions to him at 970
N. Kalaheo Ave., Suite C-210, Kailua, HI, 96734,
or by email at: gsteele2@pixi.com