Has the seemingly ageless advice for buying stocks of “buy and hold” a thing of the past?
In many cases, it does seem that may be the case.
Like anything related to investments, there really is no single right answer that covers all possible scenarios. But the “buy and hold” philosophy with stock investments, historically, was the most common method for consistently positive returns.
While we don’t advocate “day trading”, it does appear that a “buy and hold for a short time”, in many cases, is the method most advantageous to “recession-era” investors.
What’s the best approach to take during rocky economic times when it comes to investing?
Many times the best answer is “hold steady”.
Now, of course, everyone will have to look at their own specific financial goals, risk tolerance, and age, among other considerations. But, it is true that the largest percentage of investors should still continue along the course they had previously plotted.
It would be prudent to take a closer look at those previous decisions however. Given the changes in the economic landscape, almost every investment strategy will have room for some tweaking.
Most working adults in the United States take advantage of their employer’s 401K retirement account program, if one is offered. And many contribute the maximum amount allowed by the plan, or at least the maximum amount matched by their employer.
However, your involvement shouldn’t stop there.
Evaluate your 401K at least once a year. Are your investments performing as expected? Are you still on track to meet your goals? Can you contribute more?
These are all questions that need to be answered on an individual basis, since we all have different needs and expectations.
However, one word of caution – Be wary of evaluating your 401K too often. Don’t try to follow the market trends. Instead, set your goals, and allow time to determine if those goals are going to be realized or not.
If you are new to investing perhaps you are not familiar with bonds. Before you get started, you need to understand some of the risks associated with bond investing. Most people assume that all interest-bearing securities are completely risk free, but this is not the case. Even if you know a lot about investing, you may not be aware of some of the risk characteristics associated with bonds.
The most important thing to take into account is the interest rate. The Federal Reserve (also known as the Fed) meets every 6-8 weeks to evaluate the health of the economy. At each meeting, the Fed renders a decision regarding interest rates.
If inflation is rising, the Fed will need to raise interest rates to tighten the money supply. If inflation is moderate or contained, the Fed will likely leave rates unchanged. However, if the economy is slowing down and there is very little inflation or maybe even deflation, then the Fed might decide to reduce interest rates to create a stimulus for economic growth.
The reason why you need to consider present and future interest rate levels is because as interest rates increase, bond prices go down, and vice versa. If you are able to hold your bond until maturity, then interest rate movements do not really matter, because you will redeem the principal upon redemption. But often, investors have to cash out their bonds well before the maturity date. If interest rates have moved up since you purchased the bond, and you sell it prior to maturity, then the bond will be worth less than your initial investment.
You should also be aware of the claim status of the bond you are buying. Claim status refers to your ability to liquidate your investment in the event the bond issuer goes bankrupt. If you are buying a government bond, such as a Treasury Bill, claim status is irrelevant, because the odds of the Federal Government going bankrupt are slim and none.
If you are buying a corporate bond, however, there is always a chance that the issuer could go out of business. In the event of liquidation, bondholders are given priority over stockholders. However, there are often different classes of bondholders. Senior note holders can often claim against certain kinds of physical collateral in the event of bankruptcy, such as equipment (computers, machines, etc.). Regular bondholders can not always claim against physically collateral, and are next in line after the senior note holders.
Next, you should always check the three main features of the bond you are buying; the coupon rate, the maturity date, and the call provisions. The coupon rate is the interest rate. Most bonds pay an interest rate semiannually or annually.
The maturity date is the date that the bond will be redeemed by the issuer; simply put, the maturity date is when the company must pay back to you the principal you loaned to them. The call provisions are the rights of the issuer to buy back your bond prior to maturity. Some bonds are non-callable, while others are callable, meaning that the company can buy your bond back before maturity, usually at a higher price than what you paid.
Finally, you should also understand that if economic conditions become more favorable after you a buy a bond, and interest rates start to go down again, the issuer will likely issue a lot more bonds to take advantage of the low interest rates, and will use the proceeds to try to buy back any callable bonds it issued previously. So, when interest rates go down, there is an increasing likelihood that your bond will be redeemed prior to maturity, if in fact the bond is callable.
You should invest in bonds. However, you should also take into account the risk factors we have covered. Your portfolio should contain a mix of corporate, federal, municipal, and even junk bonds (there is always a default risk associated with junk bonds, but they pay a huge interest rate). Talk to your broker about diversifying the kinds of bonds in your portfolio and you will reduce your overall risk and maximize your return.
Most of us are quite comfortable with investing in cash deposits, government bonds, and stocks for conservative risk-averse investors. We hear these products discussed widely in the financial media. But rarely do we hear commodities discussed as an investment alternative. After all, what do commodities have to offer that stocks haven’t already provided?
Here are reasons why commodities can be a good investment:
- By diversifying your portfolio, the risk can be reduced, especially during recessionary periods such as bear markets where stocks tend to decline and lose value. Commodities tend to rise and this would counter the loss of portfolio value.
- Commodities trend better than stocks, not only on individual or also stock sectors and stock indexes. As such they are a better long-term investment vehicle. Trends tend to last short term such as a few months to a few years. When the trend begins, it is very unlikely there will be sharp reversals or unpleasant surprise.
- Commodity markets have large liquidity. Not all stocks are liquid even if they look very attractive earnings-wise, but exiting can be a painful process. In commodities, all commodities traded are highly liquid.
- Commodities have been trading for more than a century. More than 90% of stocks come and go. None are changed any way so there is more reliability in back-testing (review your strategy on past historical data) than others instruments such as futures and stocks where premiums change from one expiring contract to a new one, or stock-splits.
- At tax time, profits from commodities pay lower taxes than profits from stocks. In addition, there is no need to itemize all the transactions line by line where all stock transactions must be itemized. Long term or short term capital gains do not apply in commodities.
- Due to leverage, the gains can be spectacular, possibly many multiples of the original equity. For a small sum in the account, it is possible to more than double the account equity in a very short period of time.
- If the financial objective of the person is aggressive where he has high tolerance for risk, then commodities may fit is personal tolerance for risk. With a small equity, he can use for high-growth part of the entire diversified portfolio.
Here are some reasons against the investing in commodities:
- Daily Price Limit can prevent the investor from exiting a position if prices have reaches the day’s maximum price rise or decline allowed. This is especially difficult when his position is in a loss. Many times, margin calls will automatically exit the position. However, the account can be in the negative where the investor must fund additional money to the account to get back in black.
- There is lack of research materials covered in the media or in print compared to those covering stocks. The most popular financial books mainly use stocks as examples. Most brokerages and investment banks whose analysts cover industries and stocks. Investors like to see easily available and up-to-the-minute information which can be made available but not in a wide variety.
- The leverage is high, so small losses can make a big impact on the equity. This is a common scenario where the uninitiated and unprepared will see the account being wiped out.
- Future contracts constantly expire. If it’s a long-term holding, contracts must be managed properly changing to forward contracts. This can be tricky because premiums change from one forward contract to the next. Acute attention must be given in doing so.
If the investor is risk-averse in which he is content with small return year to year, then commodities might not be the right investment.
This list should not be considered final for any person to decide if he or she should trade commodities.
There are many other factors and priorities, such as financial situation, time and preparation of each person to commit before deciding. To effectively profit from any market, due diligence and preparedness is the method to obtain the desired objectives. Weigh each pro and con carefully and verify the arguments for oneself before committing hard-earned money to waste.
If you are anxious to get your investments started, it may be prudent to walk before you attempt to run. You could start by being a conservative investor with a low risk tolerance. This will give you a way to making your money grow while you learn more about investing.
Start with an interest bearing savings account. You may already have one. If you don’t, it would be a good idea to open one. A savings account can be opened at the same bank that you do your checking at – or at any other bank. A savings account should pay 2 – 4% on the money that you have in the account. It’s not a lot of money – unless you have millions in the account – but it is a start, and it is money making money.
Next, invest in money market funds. This can often be done through your bank. These funds have higher interest payouts than typical savings accounts, but they work much the same way. These are short term investments, so your money won’t be tied up for a long period of time – but again, it is money making money.
Certificates of Deposit are also sound investments with no risk. The interest rates on CD’s are typically higher than those of savings accounts or Money Market Funds.
You can select the duration of your investment, and interest is paid regularly until the CD reaches maturity. CD’s can be purchased at your bank, and your bank will insure them against loss. When the CD reaches maturity, you receive your original investment, plus the interest that the CD has earned.
If you are just starting out, one or all of these three types of investments is the best starting point. Again, this will allow your money to start making money for you while you learn more about investing in other places.
For many people, the next logical step would be to consider investing in stocks. Some first time stock investors think that they should invest all of their savings. This isn’t a sensible strategy. To determine how much money you should invest, you must first determine how much you actually can afford to invest, and what your financial goals are.
First, let’s take a look at how much money you can currently afford to invest in stocks. Do you have savings that you can use? If so, great! However, you don’t want to cut yourself short when you tie your money up in an investment. What were your savings originally for?
It is important to keep three to six months of living expenses in a readily accessible savings account – don’t invest that money! And don’t invest any money that you may need to lay your hands on in a hurry in the future.
So, begin by determining how much of your savings should remain in your savings account, and how much can be used for stock investments. Unless you have funds from another source, such as an inheritance that you’ve recently received, this will probably be all that you currently have to invest.
Next, determine how much you can add to your investments in the future. If you are employed, you will continue to receive an income, and you can plan to use a portion of that income to build your stock investment portfolio over time. Speak with a qualified financial planner to set up a budget and determine how much of your future income you will be able to invest.
With the help of a financial planner, you can be sure that you are not investing more than you should – or less than you should in order to reach your investment goals.
Golden rules to follow include never borrow money to invest in the stock market, and never use money that you have not set aside for investing!