Seeking Security

Chapter 4

Suitable Recommendations

 

 

 

  Many consumers have investment vehicles that are a haphazard maze. They tend to be based on whoever last knocked on their door. While this may produce positive results, it may just as well leave the individual short on funds in retirement. While any retirement planning is better than none, when investments are not well thought out the investor might not be as prepared as he or she intended.

 

  Once goals are established, procedures must be in place to ensure those goals are reached. While investing can be complicated, it does not have to be. Investing can be fairly simple as long as logic is used. Although the consumer must always make the final decision, when logical, affordable, and appropriate recommendations are made by agents and other financial planners the end result is more likely to be the one expected.

 

  The first investment each adult makes is typically a simple savings account. Few people consider this an ‘investment,’ but any type of financial savings comes under that heading. The savings account can be for any reason, but basically it establishes the emergency fund that every family needs to have. Additionally, and perhaps more importantly, it gets the consumer into the habit of putting money aside. Emergency funds are generally located nearby at the bank used for their checking account and is easily accessible. This accessibility can be both bad and good: it is bad in that the savings can be spent too easily but it is good because it is nearby and available during an emergency.

 

  A money market account is an excellent vehicle to use for short-term or emergency savings. Many consumers end up with a "put-and-take" account. They put money in a savings account and then take it right back out again. If this becomes a continual cycle nothing is accomplished. Establishing an emergency savings account must be a goal that is taken seriously. Once the money is deposited into the account, these funds must be considered spent and unavailable. As long as a savings account is considered available, saving money will continue to be difficult.

 

  Once the emergency account is established and growing, the consumer can look to the next goal: perhaps an IRA. IRAs may be located in a variety of vehicles, including annuities issued by insurance companies. Annuities are considered competitive investment vehicles and have guarantees through insurers that are not necessarily available elsewhere.

 

  Deciding where to invest can be one of the most important elements of financial planning. Roughly 85 percent of investment returns result from how investments are chosen. The remaining 15 percent come from specific assets that are purchased. In other words, where assets are placed (asset allocation) is a basic concept. It refers to how the individual divides their investment dollars among the various financial vehicles available. This includes annuities, cash value policies, cash accounts (like the emergency fund), Certificates of Deposit, stocks, and sometimes even real estate. Virtually any type of financial vehicle could be included in this list.

 

  Another way of explaining asset allocation is that it is an investment strategy whose goal is to balance risk and return by apportioning a portfolio’s assets according to the investor’s goals, risk tolerance and time horizon (how soon the money will be needed). An annuity, for example, is seldom used for short-term investing since the return just would not do as well as other types of vehicles. The exception to this are immediate annuities since they immediately begin paying out income. However, they require a large sum be deposited in order to make the return worthwhile.

 

  There are three primary asset classifications: equities, fixed-income, and cash and equivalents. Each has a different level of risk and return so each will perform differently over a period of time. Each investor must find the types of investments that work well for him or her; there is no simple formula for the perfect asset allocation. However, most financial planners feel that asset allocation is one of the most important decisions an investor will make. Some say asset allocation is ultimately more important than the actual investments made.

 

  The old saying “Don’t put all your eggs in one basket” refers to asset allocation. It is likely that each type of investment will have ups and downs in performance. Having a proper mix is the key to preventing large losses at any particular point in time. No matter how good the investment is, variety is the key to success.

 

  Having proper asset allocation even applies to annuities since the differences between fixed-rate, equity-indexed and variable annuities is very important. Appropriate balance is the key to satisfied customers not losing sleep due to performance worry. Over short periods of time, the stock market is more volatile than other types of investments so investors with less risk tolerance should probably not invest in this area, or at least not in large measure compared to other types of investments. As we know, some types of annuities guarantee the principal so they would be more appropriate for older-age investors.

 

  Younger investors can tolerate higher risk than older-age investors because younger investors have time on their side; if unexpected losses occur, they can theoretically make them up over time. This length of time is referred to as the investing horizon. Risk tolerance always plays a role (or should at least) in the types of investments chosen.

 

  A primary goal in investing is diversification, whether that is among various types of annuities or various types of stocks. Investing usually utilizes many types of investments so insurance producers should not expect to place all available funds in a single type of annuity. Long-term investing typically has the ultimate goal of retiring in financial comfort. The investment choices made along the way can affect the final goal.

 

  Insurance producers will not only have clients that are uncertain about what type of life insurance to buy; they will also be uncertain about how much should be invested where. Insurance producers and other investment professionals must know the products personally in order to make the best recommendations for their clients.

 

  In many cases it is more productive to concentrate on product volatility and the client’s risk tolerance capabilities. Many clients would not be comfortable with variable annuities for example. Even though they might be outperforming fixed-rate products, if the client is not certain that the variable annuity product is right for them, then it is not.

 

  One of the greatest investment risks is doing nothing at all. Inaction means nothing is being saved and retirement will bring about very meager income; in some cases, only Social Security is available at retirement. It is always better to invest somewhere than nowhere. For those who cannot deal with risk or have trouble dealing with any type of uncertainty, fixed-rate annuities might be the best course of action even though their rate of return is low. Something is always better than nothing.

 

  In some cases, low return fixed rate annuities are a proper and appropriate choice. For someone retiring in fifteen years or less risk is the enemy. These individuals have little time to make up for losses. Certainly, they should avoid high risk in their investment choices, although some medium risk investments might be prudent.

 

  Individuals facing retirement within five years have a big problem. While low risk is advisable there is not likely to be sufficient returns. Therefore, the investor must set aside much larger amounts in order to have sufficient retirement funding. Few people multiply their current income times the number of years they are likely to live in retirement. Consequently, they greatly underestimate how much money must be set aside for retirement.

 

  Those with more than fifteen years until retirement can venture into higher risk vehicles but the amount invested should be balanced between various risk-level vehicles.

 

  A surprising number of people do not have any idea of how many assets they have in relation to their debt. Those who enter retirement with large credit card debt, for example, will soon find their income does not match their out-go.

 

  Before any investing begins at any age, it is important to know what the bottom line is: what is owned and what is owed. If some investment already exists, it is important to also know how much of the investment is owned; in other words what could it be liquidated for? Annuities carry early surrender penalties so anyone who is not certain they will leave the funds there should avoid them. Either that or learn to save and keep it saved.

 

  Many insurance producers say they often find that their new clients have no idea where their money is. They might have mutual funds, but not know exactly what they are worth. They might have previously bought annuities but not remember what company issued them. In other words, their investments are not organized in any manner that allows the investor to follow how well they are doing. As a result, they do not know if they are on track to a financially secure retirement or not.

 

  It is this inability to organize their own portfolio that often leads consumers to qualified financial advisers. He or she will keep their portfolios organized.

 

The Self-Taught Investor

  Some individuals seem able to make their money grow no matter what financial vehicle they select. These individuals appear gifted when it comes to money management. In reality, these individuals probably understand money more than the average person. Much investing has to do with a simple understanding of the possible avenues available in money management. This understanding of investment or asset allocation works in their favor. Of course, they also follow through with their objectives. There is no reason all consumers could not do the same thing. It simply takes the initiation of a logical financial plan that is followed day in, day out, week in, week out, year in, year out. In other words, the investor is seriously laying out a financial future.

 

Making Decisions

  Jack inherited $100,000 when his father died. Jack had little experience in money management or asset allocation; what he earned, he spent. Jack was not an extravagant person, but he never seemed to save anything. Having come into this money, Jack was determined to put it to good use. He began by asking everyone he knew where his money should be invested. He asked his siblings what they intended to do with their inheritance. He asked his friends at work what they have invested in. He even asked the stranger at the newspaper stand about investments (he was reading the financial section). Jack got many varied answers.

 

  Jack reviewed the following suggestions:

·         Put the money into the local bank using a Certificate of Deposit or money market account.

·         Buy stock in either a small high-technology company or a well-known diversified corporation.

·         Buy corporate or municipal bonds.

·         Purchase rental property or other types of real estate.

·         Purchase mutual funds.

·         Invest through an insurance company using an annuity.

·         Loan the money to someone who needs it (from the stranger reading the financial section and also from his cousin Earl).

 

  While each suggestion sounded reasonable, Jack was unsure which investment vehicle would be best for him. Actually, no decision should be made without additional detailed information. Too many consumers jump into investments with little or no knowledge of the vehicle they have chosen. This is often because a salesperson knocked on their door and presented some type of plan to them. Because the general consumer is not educated in money or asset management, they go with whatever sounds good at the time. This is not necessarily bad since most consumers would not invest at all if left to themselves. However, for the person who wants to plan their future, this is not the best way to invest.

 

  Since Jack is not likely to have additional money come his way, how he invests this $100,000 inheritance is very important. The initial deposit and resulting interest may be his only nest egg at retirement. His past performance indicates that he is not disciplined in his spending habits. If this inheritance is too handy, it will likely be spent. Therefore, in Jack's case, it is best for him to invest in a way that makes it difficult to withdraw funds prior to retirement.

 

  Jack may want to diversify to some extent. For example, if he opens an IRA perhaps he will continue to contribute to it in future years. If he does, the initial deposit will be “seed money” helping him to develop a savings routine that did not previously exist. An insurance agent would be helping Jack if he or she set up such an account and took it one step further. By putting Jack on an automatic bank draft, Jack would consider the contribution a bill rather than a savings account. In this way, Jack would continue to deposit regularly into the account directly from his checking account or, if available, through his employer. Deposits would not depend upon Jack physically making them since his bank or employer would be doing it for him. This works well for many people.

 

  The remaining inheritance still needs to be deposited into some type of financial vehicle. Once Jack's friends realize he has spare money he will suddenly have more so-called friends than ever before. Therefore, Jack needs to make some decisions early on. Jack may want to place his money somewhere temporarily until he knows precisely where he wants to invest. A 6-month Certificate of Deposit would be a good choice.

 

  As Jack investigates his various options, he should be looking at the factors that guide investment options rather than the actual investments themselves. For example, rather than look at a specific annuity, Jack would want to look at annuities as a whole. If he decided to utilize an annuity, then he would begin to look at them individually.

 

  In Jack's particular case, an annuity is an excellent option since he has not been able to put aside any dollars in the past. Since an annuity is not a liquid investment Jack will not be tempted to repeatedly make withdrawals as friends deliver sad stories or he is motivated to spend foolishly in other ways.

  There are several things to consider in a financial investment. They include, but may not be limited to:

·         The amount of risk involved;

·         The rate of return that can be expected over time;

·         How return is realized (maturity dates, for example);

·         In the event of Jack's death, how the investment will transfer to beneficiaries; and

·         Tax implications.

 

  There may be more considerations beyond those listed. Some types of investments have their own concerns that are unique to them.

 

Risk and Return

  Few consumers understand the relationship of risk to return. Simply put, the higher the risk, the higher the possibility of return should be. It would be foolish to invest in a vehicle that yields a low interest rate yet has a high chance of loss. This concept is generally understood. Beyond understanding this statement, relatively few people know how to determine the probability of loss and the relationship it has with risk. Greater risk does not necessarily mean greater return; it is always a gamble or uncertainty.

 

  High risk investments are not always a poor choice, but it is vital for the investor to realize they might lose principal as well as interest. Therefore, no person should invest in high-risk ventures unless he or she can tolerate the loss that might occur. In Jack's case, he does not want to lose the inheritance since he is unlikely to have any money set aside for retirement beyond that $100,000.

 

  Most investments have some type of investment history that can be researched. It must be understood that average returns are never a guarantee of future returns. Investments have fluctuations in their yields. Although high risk ventures hope to bring about high returns, low returns are just as possible and everywhere in the middle. There are never any guarantees. Generally speaking, however, an investor does expect higher returns with higher risks. In many cases this tends to be the end result, but investors must realize that no promises are made when it comes to investing.

 

  There are two types of returns: current income and appreciation. Current income is the amount of return that the investor receives on a regular basis. It could be received monthly or quarterly or at any regular interval. There are several types of investments that provide regular income, including annuities, if set up to do so. Some types of investments, such as stocks, generate income in the form of dividends. Real estate may generate income in the form of rent.

 

  Appreciation is what we hope our homes will acquire (appreciation and equity are not the same). Appreciation is the increased value of an asset between the time an individual purchased it and today’s current value. Luckily, most homes do appreciate in value, but that is not always the case. If a home is located in a neighborhood that has deteriorated, the asset can actually lose value. Potential buyers try to "size up" the neighborhood at the time of purchase as well as the home itself. That is why appraisals seek out three like homes that have recently been sold in the immediate neighborhood. It tells the appraiser what factors may increase or decrease the property's value. When a property decreases in value, it is referred to as depreciation. This is not the same thing as depreciation used in tax and accounting forms. Current income, appreciation and depreciation closely relate to the degree of the investment's risk.

 

  Investments relying more on appreciation than current income can be risky. Therefore, using this formula, real estate is a riskier investment than annuities. That is because real estate relies on appreciation. Annuities deal with income. It is always more difficult calculating future growth.

 

  Let us say that Jack's brother, Arthur, used his $100,000 inheritance to buy rental property. Because he had only the $100,000 inheritance to work with and wanted a low mortgage payment, he purchased a home located in an old neighborhood that had seen better days. Many of the homes were vacant. The majority of homes were used as rental properties. Therefore, the people in the area were in constant rotation. While some renters are very responsible, when tenants are constantly changing there is the chance that they will not care for the homes. They may, in fact, even damage them beyond the normal wear and tear. Over the next five years, Arthur saw his rental house damaged repeatedly. Twice he had to replace flooring that was ruined by animals and careless cigarette smokers. He had regular maintenance costs and sometimes had to fix damage to the home beyond normal expectations. Often tenants left without paying their rent, yet Arthur had to pay the mortgage. Over the five-year period, Arthur lost money. The home also depreciated because the neighborhood became infested with gangs, violence, and general disrepair. Although Arthur would be able to claim losses on his income taxes, his purpose had been to increase his investment; not decrease it. In this particular example, the investment failed.

 

 

  Had Arthur placed his money in an investment that paid income on a regular basis, his chance for gain would have been much smaller than the real estate, but it would also have been less risky. An investment that pays current income will usually be based on conservative investments made by those controlling the vehicle. In the case of annuities, for instance, there will probably have been a guaranteed interest rate while actually paying a higher return based on the investments made by those managing the asset.

 

  There are degrees of risk in everything. Even the bank's Christmas club account has risk if the interest earned is less than inflation. The most notable risk is loss by inflation. If the Christmas account is only paying 3 percent and inflation is at 5 percent, the account has lost 2 percent of its value (5 percent – 3 percent = 2 percent). Some stocks are less risky than other stocks. There are degrees of risk in everything.

 

 

Types of Risk

 

  As we have stated, there are degrees of risk in everything. Life itself is a risk. We may step off the corner at a busy intersection and be struck by an automobile and killed. Our house could burn down. We could be downsized out of a job.

 

  Just as there are degrees of risk there are also varying types of risk. Each financial vehicle could be exposed to more than one type.

 

 

Inflation: The Silent Reducer

 

  Inflation is overlooked so often when considering investments that it has become known as the "silent reducer." Even though it is often talked about on the evening news and in newspapers, few people pay it much attention. Inflation reduces our investments simply by depreciation of our currency. It is a loss of investment value.

 

 

  If the rate of inflation remains constant, it may not seem to be a risk. That is because we can figure its effect on the funds we set aside. That is true even if inflation is relatively high. When inflation fluctuates or rises it becomes difficult to assess the investments value at the time of retirement.  It affects our investments if we have not accounted for a rise. When an investment is purchased, it already reflects current values. It is when those values change that our investments are affected. When inflation decreases our investments benefit. It is probably a safe bet, however, that over twenty or thirty years, inflation will rise rather than fall. Therefore, there will be a decrease in our buying power (currency), which will lower the value of our investments. If an investment is purchased at a low inflation point, the depreciation of our currency (inflation) that follows can greatly harm our investments. On the other hand, if the investment is purchased during an unusually high period of inflation, when it lowers to a normal point, our investments will be helped. Simply put, our dollars are worth more when inflation is low and less when inflation is high.

 

Deflation

 

  Deflation is the opposite of inflation. Deflation is the risk that the value of a particular investment or asset will decline when general price levels decline during periods of recession or even a depression. This is similar to what happened to Arthur's rental house except that this type of risk usually happens because the overall economy is experiencing problems rather than a small-defined area (the house's neighborhood).

 

 

  People who lived through the great depression fully understand deflation risk. They saw it all around them because it affected nearly everyone to some degree. Since the great depression, we have not seen deflation risk to that degree. Even so, it does occur to a lesser degree. This has especially been true when property values were inflated. When the values dropped to a more realistic level, deflation devalued the investments.

 

 

Business Risk

 

  Most insurance agents are self-employed. They own their own business. If the agent is the only person running the business, his family depends upon him to continue earning the income that keeps the business afloat. Should that agent die or become unable to sell policies, the business would fold. That is the risk businesses run. For most of our clients, business risk includes more than this. For them, business risk involves any of their assets tied to the continuation of a business or form of industry.

 

  Business risk can be tied to many things. Perhaps the investment is in the stock of a company that becomes obsolete. Perhaps changes in the government’s environmental policy (such as logging) force the closure of businesses. Even war, or the lack of it, can cause business risk if the business is engaged in providing military inventory. Weather conditions can also affect business risk, particularly in industries relating to food production.

 

  Business risk is very hard to control. In many ways, it relates to supply and demand. If the business provides goods that are in demand, it will make money for its investors. If that demand stops, there will be an over-supply and the business may face difficult times; so will the stockholders and investors.

 

 

Interest Rate Risk

 

  Insurance agents are well acquainted with the ups and downs of interest rates. We deal with it every day as we market our insurance products. The insurance industry has been basically level in interest rate risk, but that is not true for many other types of investments.

 

  We see this type of risk in investments that "set" their interest yield for the long term. Short-term maturities will gain the current value and are less likely to be hit with this risk. Say, for example, that an investment is set at six percent interest for a ten-year period. If the general interest rates fall to five percent, the investor will feel he or she is lucky to have been locked in to six percent. If, however, the rates rise to eight percent he or she will not feel lucky. In this case, they have experienced a loss of return. They have experienced interest rate risk.

 

 

Market Risk

 

  Market risk is a type of risk that more people are aware of because it is so often presented in the news. It refers to the chance that the entire financial market might rise or fall. Of course, it is the declines about which we are concerned. Even when a company is doing well, if the stock market falls, the business is affected because investors will be afraid to buy their stock (any stock, for that matter). During a market decline, investors are wary of stocks in general.

 

 

Illiquidity Risk

 

  The general American population needs to be educated on this type of risk. That is because the American population is becoming less and less liquid in their financial affairs. We are bombarded with the opportunity to go into debt through the use of credit cards. That can happen to businesses as well as to individuals. Usually when businesses have no liquidity it is due to expansion, exploration, over investment or any number of other situations. It can be due to simple hard times: not enough buyers for their product.

 

 

  For investors, the risk of illiquidity comes into play if they must produce cash by selling an investment or cashing in an investment before its maturity date. Even real estate has a maturity date. It just is not as obvious. Real estate needs time to gain equity. This is often referred to as "ripening." Using agricultural terms, it means turning from a green investment to a ripe investment. Since land was originally used primarily for farming, this term has developed from that context. When an investor is forced to sell real estate before equity has developed (or so quickly that the equity cannot be realized) the investment can suffer a loss. This might especially be true if the investor must take whatever is offered quickly simply to obtain cash.

 

  This type of loss does not only apply to real estate. Annuities are often cashed in before their maturity date when cash is needed. As a result, the investor suffers a loss in the form of surrender penalties. Even cash value life insurance policies are borrowed against in times of need. Eventually, this can harm the policyholder.

 

 

Minimizing Risk

 

  Risks are always present in investments. Even so, there are ways to minimize them. One way that is well known to professional investors is diversification. Our grandparents used the saying: "Don't put all of your eggs in one basket." There are multiple ways to diversify. Even if a person only wants to invest in annuities, they can diversify among several companies. However, most diversification means using several different types of investments. For example, Jack could put $2,000 into an IRA, $25,000 into an annuity and the balance into a mutual fund.

 

  Some types of investments react differently to investment conditions. Real estate tends to rise in value as inflation rises. Bonds would react in the opposite manner. By diversifying correctly, neither inflation nor deflation would have a disastrous overall effect on the investment portfolio. The point of using various investments is to minimize the possibility that one large event could financially ruin the investor.

 

 

  Some investors are not comfortable using financial vehicles unless they are personally acquainted with them. Diversification is still possible, but the choices will be limited to those the investor is familiar with. There is nothing wrong with investing in products the investor knows and understands as long as he or she is willing to investigate other types of products and continually broaden their knowledge.

 

  Most investors look towards professionals for investing advice. This is, after all, their area of expertise. For this reason, only a very foolish agent will represent him or herself as being more educated than is actually true. It is smarter to seek out necessary education than to misrepresent oneself. The first question a potential investor is likely to ask is "What kind of investments should I put my money in?" Consumers receive so much advertising in the mail that they may believe there are literally hundreds of different types of investment vehicles. While there are many subcategories, there are only six basic types of investments. These include:

1. Cash accounts, such as Certificates of Deposit
2. Fixed-income investments, such as mortgages or corporate bonds
3. Equities, such as domestic and international stocks
4. Natural resources, such as oil
5. Tangibles, such as gold, and
6. Real estate investments

 

  As we said, there are numerous subcategories. Some of the subcategories will belong simultaneously under more than one of the six main categories.

 

  Many investors are concerned they may invest too much money into a single financial vehicle. This would especially be true if the investment vehicle contained a large degree of risk. Some assets should never be invested. It would be unwise to invest the value of anything that would cause distress if a loss occurred. For example, investing the value of one’s home does not usually make sense. The personal home will gain in value on its own in most circumstances. The equity in it should not be put at risk through other investments. Not all salespeople may agree with this or at least that is what they may say to the consumers. If, however, the consumer has no other assets to invest with it is a foolish insurance agent or investment counselor that will advise removing the equity to invest elsewhere. If the consumer has no assets to invest, that consumer needs to start at the beginning by learning to put aside and save money for later investing; not begin by depleting their sole asset.

 

 

  A house is not always a home. If the house is a rental, it would not be the owner’s home. Even when it is their personal home, is it an asset? If the consumer plans to keep their home (and live in it) for several years, the home is a personal asset rather than an investment asset. Even when the home is sold, if another is purchased with the proceeds for the purpose of living in it for a length of time, it remains a personal asset. Whether the home’s immediate value goes up or down will not be a concern at that time since the consumer's standard of living will not be affected.

 

  Even when the home is a personal asset, it is typically included in the list of investment assets. The amount of equity in their home may determine the other types of investments they wish to make. While housing equity is often considered low risk that is not always the case; it would depend on the housing market in their immediate area. Recently we have seen some areas in the United States drop dramatically in their housing values. In some cases, homeowners owe more than their house is actually worth. If the payment is affordable, it may be worthwhile to ride it out until values rise again; on the other hand, if a variable mortgage rate is held, payments may not be affordable. These homes often end up in mortgage default.

 

  Besides the investor's personal home, there are other things that should not be invested. Every investor must keep an emergency cash fund. This cash fund should never be invested. Emergency funds should be kept in a secure, liquid vehicle that will not fluctuate greatly in market value. Money market funds are generally recommended. The amount of the fund must be tailored to the individual, but generally it is recommended that six months living expenses be kept in this account. For some career industries that might be too little.

 

  Many people do consider the cash value in their life insurance policies as an investment asset. In other words, they take the cash out and invest it elsewhere. Even if the cash value is left in the policies, they would still be considered an investment asset because they are aimed at the investor's future needs. This is also true of IRAs, Keogh plans, 401(k) plans, and company sponsored defined-benefit plans. All of these are resources that will be utilized in the future. By that definition, they are certainly investments! In addition, these assets may be affected by market forces between today and retirement tomorrow.

 

  Exactly how the investor decides to diversify will depend upon their personal preference. The agent is there to make suggestions and explain why he or she thinks the suggestions are relevant. However, the final decision should always be the consumers. Pushing a consumer into one investment or another is never a good idea. If the consumer is uncomfortable with the investment, he or she is unlikely to remain in it long term.

 

  Some types of assets tend to move up and down financially at about the same time. Therefore, it is good to diversify among those that react differently to the market forces. When one is down, in other words, other investments will be up. This will average out the risks involved. Real estate, natural resources, and tangible assets tend to move together, whether that happens to be up or down. These types of assets are often referred to as hard assets. They are sometimes put together by analysts rather than itemized out as we did. We itemized them out because most investors see them as different types of investments. For instance, most investors probably own a home, but they do not necessarily have gold or oil reserves. In fact, it is certainly less risky to invest in real estate than it is to invest in either natural resources or tangibles. For a few years, gold was said to be the "in" investment. Many investors lost a great deal in this market. To the average investor they are different types of investments and rightfully so. Even so, it is necessary for the agent to understand that they may be lumped together under the heading of hard assets.

 

 

  If the consumer wants to diversify among the remaining four categories (cash, fixed-income, equities, and hard assets), it is likely that they will want to assign one fourth of their investment funds to each type. This is not necessarily the best way to do their investing. Cash investments tend to be short term and therefore tend to earn a lower interest rate. That is one reason banks so often recommend to their clients that they move their money from Certificates of Deposit over to the bank-sponsored annuities. Money kept in cash investments should be minimized unless the investor believes he or she may have a need for cash in the near future. For example, if the investment is marked as a college fund and that time is approaching, then it makes sense to keep it in something like a Certificate of Deposit. If, however, there is no immediate intention to use the money, it should be invested in something more profitable.

 

  The reason investing in insurance products is becoming so popular is not hard to understand. Stocks, while possessing the ability to make great profits, can also bring about big losses. Equities, which are what stocks are considered to be, represent an ownership interest. The ups and downs of equities, such as stocks, depend upon many factors, including inflation, the industry involved and even the company itself.

 

  Fixed-income securities are generally considered to be a hedge against deflation. Hard assets are a hedge against inflation. Therefore, the two seem to work well together. However, to be truly effective, the investor must also diversify within each category. Just as the investor might want to spread their annuity money among different insurance companies, so too might he or she want to spread their fixed-income investments and hard asset investments among different sources.

 

 

  Diversification is always a personal decision. Individual factors will affect how the consumer wants to spread out their money. These factors will include objectives and goals, both short and long term. Remember that these objectives and goals should have already been mapped out before actual investing began. There are no real investment rules, although some authorities lecture otherwise. As we mentioned, in past years there was a lot of money made selling books on how to invest in gold and other precious metals. Many investors read these so-called authorities and lost their investment funds as a result. Only the authors made any money.

 

  Investing is a personal matter, bringing in all the hopes and fears the individual has grown up with. Often how a person invests will directly relate to their educational background and current age. The younger a person is, the more he or she can tolerate risk. That is because the younger person has more time to recover financial losses. The older a person, the less time he or she has to re-earn the money that was lost in a bad investment. It is often younger investors that put higher percentages of their investment income into stocks. Hopefully, they diversify between the various types to prevent excessive risks.

 

  When a person is young, it is likely that their earning power has not yet peaked. Because this individual will continue to earn ever-higher wages, a loss of principal in an investment can be recovered through future earnings. This also enables them to ride out the bad times, allowing their investments to recover on their own. Growth stocks commonly have fluctuations in their value. With time on the young person's side, those fluctuations will not bring the stress that might be present for someone nearing retirement.

 

  It is easiest for a person to invest if they do not need any income from their investments. Often, this translates into younger people who are living on the income from their salaries. When investments are allowed to re-invest their earnings, they are more likely to grow at a faster pace. These investments should still try to protect against inflation, of course.

 

  As the investor ages, he or she will become more conservative since they have less time to make up losses. It must be remembered that there is risk in every investment, if only to inflation. Therefore, the investor must always realize that there is the potential for loss. That is why older investors tend to use those vehicles that have a lower level of risk involved. Older investors are more likely to look towards insurance companies for their investments. The guarantees tend to be good, and, with the newer products, return is also likely to be good.

 

  For most investors, the type of employment they have has a great deal to do with how they invest. Two men may be the same age, but with very different future prospects. The first one, Dan, is a salesperson. He knows he can always get work selling something, but his income may be erratic and uncertain. The other man, Jeff, is employed at an hourly wage, but his long-term employment is less certain. His industry experiences shutdowns and downsizing from year to year. He has no way of knowing if he will be employed five years from now.

 

  Each man is the same age, earning approximately the same annual amount, yet their circumstances are different. Because the differences exist, how they invest will be different. Dan, the salesperson, is not worried about obtaining work, but he is uncertain about his income level. Even staying at the same sales job, he knows his income directly relates to the number of sales made. Jeff knows his annual income will remain steady and fairly level, with occasional increases, but he does not have any confidence in his long-term employment. If his industry continues to downsize, Jeff realizes that he may find himself looking for work in a field that is uncertain.

 

  Dan is likely to be less conservative in his investment strategy. He knows he needs to invest whenever the funds are available. When funds are not available, he simply ceases to invest, saving only as funds allow. Jeff, on the other hand, wants to keep much of his money liquid. If a long layoff occurs, he must be able to meet his obligations. His investment funds may need to meet this situation. Jeff may also be considering putting money aside to attend college or trade school. He knows he may need to change careers. Jeff will be less concerned with luxury goals, such as a vacation home. He knows he must concentrate on critical goals, such as schooling, an emergency fund and retirement. Dan, who has always been comfortable with change in his life, will focus more on luxury goals, as well as retirement. In fact, Dan really does not see himself retired like Jeff does. Dan's job is not physically difficult, and he plans to work well into his seventies.

 

  Each investor has individualized objectives and goals. Each investor views the future differently. As a result, each investor will choose different paths. Unless the insurance agent recognizes these differences, he or she will be unlikely to be part of Dan's or Jeff's investing.

 

  By the time one reaches fifty, investing should be well established. Even though individual goals will differ, the habit of investing should be set. Usually by this age, cash flow is quite healthy, unless an unforeseen job change has occurred. Most people are well established in their career, and they are anticipating retirement. Children are raised and have children of their own. Material things have been purchased. Only luxury items may still be part of the individual’s objectives.

 

  At this age, since the need for cash has decreased, some of the cash investments can be moved to something less available, such as an annuity. Any type of investment that is longer term will probably yield better results. At this age, illiquidity is not a concern. Risk is a concern. The investor no longer wants to risk the loss of their principal. Even though the investor's accumulated assets (net worth) may be relatively high, the loss of any asset would affect their retirement possibilities.

 

  Once the investor reaches his or her sixties, conservatism is an important factor. Potential income becomes a consideration. Understanding the programs offered through the employer becomes more important.

 

 

  Once retirement occurs, high risk becomes unacceptable. Even moderate risk may be avoided. Since the investor no longer brings home a paycheck, loss cannot be replaced. Spending needs also change. Those costs associated with a job disappear (certain types of clothing, for example). Other expenses develop. For example, if the investor had his or her health care covered previously through their employer, they may find themselves paying for it now. Never having paid for health insurance before, they may be shocked at the cost of it. Even so, it is an expense that is very necessary.

 

  Between the ages of 60 and 64 the investor should also look into purchasing a long-term nursing home policy. Once age 65 arrives, premium costs for such a policy go up dramatically.

 

  At retirement, some of the investments may not be tapped, but others will be. Income will be the focus of each investment at some point.

 

  No matter what the age of the investor, the first step is always the habit of putting something aside. Investing seldom works if the individual is not disciplined. It is much easier, of course, to sit back and hope the government or rich Uncle Harold will manage one's financial future. This seldom happens. When retirement arrives, if no plans were made and carried out, the individual may find themselves in a very bleak situation.

 

  Implementing one's objectives and goals is critical. No matter how good the planning is, if it is not carried out, the plan is worthless. How does one implement a plan? Often by starting small. When we are raising our children, buying a home, and establishing a career, it is hard to save any money. Only by starting small will one get started at all. A few dollars saved each week will grow into much more. Not only will the interest earnings increase it, but also it will become easier to save larger amounts. As the saying goes, "the longest journey begins with a single step."

 

 

End of Chapter 4