Saturday, September 7, 2013

The First Step is Always the Hardest

I hate to be repetitive, but it seems that I need to return to the same subjects again and again. The most important step is the first step. Unfortunately, many people are afraid they will make a mistake, so they never take the first step. Don’t be that person. There is only one way to become an investor; invest. Don’t worry about making a mistake. It is a certainty, you will make mistakes.

For most of my readers, the first step is a 401-K or equivalent tax deferred retirement account offered by their employer. Go ahead, start making contributions to that account—start today! How much? Start small so you will not stop the first time you find that you need some extra money. Try to contribute enough to snag all the matching money as soon as possible. If your employer offers a dollar for dollar match up to some level (usually 3%) grab the money and run. You simply can not beat a 100% instantaneous tax free return on your investment. What funds does your employer offer? Most offer a mix of bond funds and index funds. Put at least your age minus 15% in bonds (for example 30 years old – 15% = 15% in bonds) buy a bit of a fund that buys treasury bills and a bit of something that mimics one of the major bond indices. Put 2/3 of the balance in a S&P 500 index fund. Then split what is left between a small cap fund and a foreign stock fund.

If all that sounds too complicated just put your 401-K money into your age appropriate lifecycle fund. These funds decide how to distribute your money according to your age. I don’t like them because I am something of a control freak, but if you are too frightened to make your own decisions, you won’t go wrong starting with something simple.

Automate the savings process. Money that is taken from your paycheck before it is taxed is money you are not likely to miss. Every time you get a raise or a bonus make certain that some portion of this new money finds its way into your 401-K. Over time you will watch a 2% contribution become a 15% contribution. If you move slowly, letting the natural course of your career increase your contribution level you will never miss the money. Then one day you will wake up with a $300,000 tax deferred nest egg waiting for your retirement.

Really, it is that easy. In essence you are practicing what is termed dollar cost averaging. Every pay period you are buying shares in a variety of funds. You will buy more shares when the price is low. You will be buying fewer shares when the prices are high. Combine this practice with periodic rebalancing (maybe once a year unless the market goes crazy) and you will be OK. Periodic rebalancing forces you to buy more shares when the market tanks and sell some shares when the market is high. Buying cheap and selling dear is exactly what you want to do.

While you have no control over the terms and conditions of your employer’s 401-K avoid funds with sales loads, high fees, and high rates of turnover. Anyone who sells you anything with a 12b-1 fee is not your friend. Run away. As you move beyond your 401-K into the marketplace think low cost index fund. Think Vanguard. Really, Vanguard is no longer the only game in town. Fidelity, Schwab, and others offer competitive low cost funds, but always check out the Vanguard offering before making your decision.

Diversify, diversify, diversify. Let me say it again, diversify. Gradually, over time, move into different sectors and different capitalization sizes. Yahoo divides the market up into basic materials, conglomerates, consumer goods, financial, healthcare, industrials, services, technology, and utilities. That is not the only such list. The American market is divided into Large Cap and Small Cap shares. Some fund providers add Mid Cap. Large cap companies lumber along paying a decent dividend. Small cap companies tend to rocket up and down with the economy. Mid caps do a bit of both. Foreign markets are divided into Canada, Europe, the Asian tigers (Japan, Korea, Singapore), and the developing markets (Brazil, Russia, China, India). Understand that this paragraph is a gross simplification of what is available. By the time you are making these decisions you will not need to be reading this introductory blog post. I have more advanced articles I could share with you on these subjects.

Finally, after building a diversified base of low cost index funds, begin to move into single stocks. If you are a bit of a gambler (like me) you can buy shares in a single company sooner rather than later. Don’t put more than 3% of your liquid net worth into a single holding. Don’t put more than 10% of your liquid net worth into any sector. You will be OK. When the dotcom crash hits, you will lose 50% of the 10% in your technology sector holdings. You can live with that kind of a loss. If you lost 50% of 3% in something like the British Petroleum platform fire, life goes on. If you had 50% of your retirement savings invested in the Bank of America, I hope you enjoy living with your children or learning new ways to prepare Alpo. I actually saw this happen in the 2008-2009 melt down. Don’t let it happen to you.

Buy what you believe in. Buy what you understand. If you like McDonalds burgers, if you like their business model, if you like their real estate holdings, buy McDonalds (MCD). If you are a vegetarian or a union organizer, put your money somewhere else. Start small, never buy too much of any one thing or too much at any one time. Piece by piece; step by step; build your portfolio.

Then one day you will wake up to discover you are free. After all, isn’t that what this is all about?

OK People! Let’s be careful out there today.

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