A Practical Guide for RANDOM WALKers and other Investors
Exercise 1: cover Thyself with Protection
Two categories of life insurance
– High-premium policies that combine an insurance scheme with a type of savings plan. They do have some advantages. Earnings on the part of the insurance premiums that go into the savings plan accumulate tax-free. But they entail high sales charges.
– Low premium term insurance that provides death benefits only, with no buildup of cash value
buy term insurance for protection – invest the difference yourself. To buy renewable term insurance. You can keep renewing your policy without the need for a physical examination. So-called decreasing term insurance, renewable for progressively lower amounts, should suit many families best, because as time passes, the need for protection usually diminishes.
Exercise 2: Know your investment Objectives
Find your risk-tolerant level
– It is critical that you understand yourself before choosing specific securities for investment
Identify your tax bracket and income needs
Exercise 3: Let the Yield on your cash reserve keep pace with inflation
Four short-term investment instruments that can at least help you stand up to inflation.
1.Money-market mutual funds
2.Money-market deposit accounts
4.Tax-exempt money-market funds
Exercise 5: Renting leads to flabby investment muscles
The long-run returns on residential real estate have been quite generous.
Interest payments on your mortgage and property taxes – are fully deductible;
Realized gains in the value of your house up to substantial amounts are taxexempt.Own your own home if you can possibly afford it.
Exercise 6: Beef up with real estate investment trusts (REITs)
Ownership of real estate has produced comparable rates of return to common stocks over the past 30 years.
Real estate is probably a more dependable hedge against inflation than come stocks in general.
Common stocks should form the cornerstone of most portfolios. High returns can be achieved only through higher risk-taking.The amount of risk you can tolerate is partly determined by your sleeping point. Risk is also significantly influenced by your age and by the sources and dependability of your non-investment income.
Long-run equity return = Initial dividend yield + Growth rate
A life-Cycle Guide to Investing
The most important investment decision you will probably ever make concerns the balancing of asset categories (stocks, bonds, real estate, money-market securities, etc.) at different stage of your life.
I.Four Asset – allocation principles
– History shows that risk and return are positively related
– The risk of investing in common stocks and bonds depends on the length of time the investments are held. The longer an investor’s holding period, the lower the risk.
– The longer an individual’s investment horizon, the more likely it is that stocks will outperform bonds.
– investing the same fixed amount of money in, for example, the shares of some mutual funds at regular intervals,
say, every month, over a long period of time.
– distinguish between your attitude toward and your capacity for risk.
II. Three guidelines to tailoring a life-cycle investment plan
– A specific need must be funded with specific assets dedicated to that need: if you expect to need a $30,000 down payment to buy a house in one year. That $30,000 to meet a specific need should be invested in a safe security, maturing when the money is required, such as a one-year certificate of deposit.
– Recognize your tolerance for risk
– Persistent saving in regular amounts, no matter how small, pays off.
III. The life-cycle investment guide
– [Age 20-30] A very aggressive investment portfolio is recommended.
– As investors age, they should start cutting back on riskier investments and start increasing the proportion of the portfolio committed to bonds and stocks that pay generous dividends such as REITs.
– By the age of 55, investors should start thinking about the transition to retirement and moving the portfolio toward income production
– In retirement, a portfolio heavily weighted in a variety of bonds is recommended.
– For most people, I recommend broad-based total stock-market index funds rather than individual stocks for portfolio formation
The do-it-yourself step: potentially useful stock-picking rules
Rule 1: Confine stock purchases to companies that appear able to sustain above-average earnings growth for at least five years.
Rule 2: Never pay more for a stock than can reasonably be justified by a firm foundation of value.
I do feel that you can roughly gauge when a stock seems to be reasonably prices. The market price-earnings multiple is a good place to start: you should buy stocks selling at multiples in line with,or not very much above, this ratio. My strategy, then, is to look for growth situations that the market has not already recognized by bidding the stock’s multiple to a large premium. Some people call this a GARP (growth at a reasonable price) strategy. Buy stocks whose P/E’s are low relative to their growth prospects.
Rule 3: it helps to buy stocks with the kinds of stories of anticipated growth on which investors can build castles in the air.
Rule 4: Trade as little as possible. My own philosophy leads me to minimize trading as much as possible.