by Larry Wiener
Larry sent in this helpful article on investing just before the end of the year, and although we're already a week into the new year, I think you will enjoy it!
* * *
As I write this we are just a few days away from the end of the year. Soon we will hear about the year’s losses in all three of the major stock indices (Dow, NASDAQ, and S&P). As many of us get our year end statement from brokerage houses and mutual fund companies, we will see our own losses and many of us won’t be happy.
For those of us who are diversified in good funds and companies and who have a relatively long horizon for our investments, we’ll probably be fine. This too will pass, though who knows when.
Quite a few of us, however, got sucked into a la-la land during the 90's when stocks kept going up and up and up. I used the stock market to save for a car. Fortunately, I took the money out to buy the car before the market went down too much. Don’t plan on doing that again.
I’ve been doing quite a few reality checks lately to make sure I don’t get sucked into the la-la land of believing that the 90's are coming back again. Here are a few things I’ve learned from those checks:
Keep a Reserve That Is Not in the Market
Every better budgeter knows that a family should have a reserve. This is even more important now that the economy is kind of iffy. We’ve always known that reserve money should not be in the market because the water heater may not be kind enough to blow at a time when stocks were up. Quite a few of us cheated on the size of our reserve and put some of it in the market figuring it would make money before we needed it.
Often that happened in the 90's. Ain’t gonna necessarily happen again. During the 90's if we needed money during a temporary turnaround, we could sometimes wait a short time until the market picked up again. If your water heater blows now and you wait for the market, you might be in for a long period of cold showers.
Don’t Use the Market for Short or Medium Term Savings Goals
During the 90's if your purchase of a car or new furniture was two or three years away, you could put money into good quality stocks or stock mutual funds and usually make out well. That’s not necessarily true anymore. You can’t count on the market going up even over a two or three year period from any one day to a day two or three years from then.
With CD rates so low now, I-bonds look good for these medium term investment goals. These totally safe bonds usually pay a relatively good rate of interest, especially if you keep them for five years or more. You can buy them online.
But Don’t Be Afraid of the Market for Long Term Goals
Historically, stocks still perform better than any other asset class. The events of the past year might make you afraid of stocks, but that’s not good either. The fundamental economy is still relatively sound even if it is at a low point right now.
You’ll probably need to be more discriminating in your selection of stocks now as not everything will go up. Look at the P/E ratio, the quality of the management, and other factors. Look closely at leaders in industries.
You won’t be able to buy and hold and hold and hold and expect the same stock to serve you will for 20 years. If you aren’t willing or able to give your stocks that attention, find a good quality mutual fund. Expense ratios have gone down considerably in the past several years and they are especially low on index funds, so you don’t save as much in costs anymore by doing it yourself. Consider folios, which are kind of make your own mutual fund kits, if you do want to pay closer attention to your stocks (check www. foliofn.com for one company offering folios).
Also, as so many Enron employees can tell us, diversification is important. Companies come and go in and out of favor. The old adage of not putting all your eggs in one basket is back in vogue because some baskets, well, don’t hold up as well as others.
If you are using stocks to save for retirement, as you get closer to that time, consider adding some bonds to your portfolio as a safety net.
And, as always, dollar cost averaging makes sense. A method I use is what I called modified dollar cost averaging. If I have not bought my allotment for the month for my Roth IRA, I look for a three or four day period when the market is going down. I then call my mutual fund company and buy that month’s allotment. I find this gives me a little edge over buying the same day each month.
Hope you enjoyed the 90's and benefitted from the stock surge. I did, though I took a few losses.
By the way, if you have some cash left over from the 90's or from anywhere else, this is a great time to buy things you need for your home and family. The retailers had a rather non-wonderful Christmas and might be willing to part with some of their excess inventory for a little less cash than usual.
Now it’s time to get used to a new paradigm, though, and use the stock market a little differently from the way some of us did in the 90's.
* * *
Return to Budgeting Article Index
Copyright © 2001 by Larry Wiener. All rights reserved.
