Number One: Diversify Your InvestmentsThe important idea here is to spread your risk of making a bad decision. Risk is your enemy, so your need to minimize it. Even a brilliant investor makes mistakes, so we need for those mistakes to have minor impact.
My grandfather Tom had savings accounts at all six major banks in his city. He did this because he had lost money in the Great Depression due to bank failures. This was his diversification strategy in case another depression occurred.
As a practical example, here is how I have increased diversification in the GeoDon Fund (the portfolio I inherited from my grandfather George):
· Increased the number of stocks from 20 to 27.
· Diversified within the energy sector of the fund by having stocks in petroleum, natural gas, propane, uranium and a utility.
· Put an investment dollar limit on any new stock added to the fund, just in case I pick a dog.
When investing in mutual funds:
· Make sure your mutual funds aren’t investing in the same type of securities. For example, if you own three “large-cap” funds, you really aren’t diversified.
· Your 401-K should be divided among at least three different mutual funds. If your program doesn’t have three good funds, it is time to utilize a self-directed option.
And regarding minimizing mistakes: My worst investment of 2008 was buying bonds from the Bank of Greece (You can start laughing now). Why did I do this? The bonds were paying a whopping 9% and of course a country like Greece was not going to go broke! (You can laugh even harder now). The important thing is that I bought three other more stable bonds at the time, so my Greek bond investment was small and of course it was soon to get much smaller. But diversification limited the loss in my big, Greek, investment screw up.
Number Two: Review Your Investments Periodically
Three years ago I worked with my financial advisor to restructure my wife’s IRA. We selected seven strong mutual funds that were consistent with the strategy for the account. I did not have time to review this account since then because of all the other financial decisions I had to make. I realized there was a problem in January when the account showed 0% growth for 2011. Based on the investments, the account should have grown in the 3-6% range.
These were good funds three years ago, but not now. Most of the funds had new managers who were not as skilled as the previous ones. The account was diversified, but it was diversified among a group of lousy funds. I moved the money to better mutual funds and it was like feeding a starving man. The account immediately jumped to life and is now showing much improved results.
It is always a red flag when a strong performing mutual fund changes managers. The investment firm will tell you that the fund strategy and philosophy will not change and they expect the fund to continue to produce excellent results blah, blah, blah. But if you are not careful, your fund could end up being managed by Curtis Painter.
Who is Curtis Painter? He is the guy who replaced Peyton Manning as the quarterback of the Indianapolis Colts last season. Curtis wore the same uniform, played in the same stadium, ran the same plays, but somehow did not achieve the same results as Peyton. The chances of the new fund manager being as good as the previous fund manager of a very successful mutual fund are very low. You should watch these funds closely and be ready to bail at the first sign of trouble.
Number Three: Manage Your Risk and ReturnEveryone complains about the low interest rates paid on current certificates of deposits. It is hardly worth tying up your money to receive a rate under 1%. I believe the rules of risk and return still apply, but the problem is that the world has become a much more risky place.
Therefore to gain a larger return, you will need to assume more risk. To get the same 3-6% returns that you previously got with CD’s, you can invest is short-term bond funds. Of course there is more risk because your principle is not insured. Some good funds in this category are FGCIX, WBRRX, LALDX. I do not own these funds, but I do own BAGSX and PSTCX which should provide slightly higher returns, with of course higher risk. However to my knowledge, none of these funds has investments in the Bank of Greece.