How to Invest For Greater Safety & Diversification

Most people don’t know how to invest effectively. At the same time they want to invest money to earn higher returns, but they want to avoid risk. Risk can not be avoided, but it can be reduced through diversification. Here’s your basic guide to investing with greater safety the easy way by investing in 4 different types of mutual funds.

Asset allocation is the key to true diversification (balance) in your investment portfolio. By holding investments in all 4 asset classes, you can earn higher returns at only a moderate level of risk over the long term. Very simply, losses in one investment can be offset by gains in another with proper asset allocation.

Professional money managers who manage billions of dollars invest in a variety of different investments to achieve growth and lower their overall investment risk. You can follow their lead by simply investing in the following mutual funds.

Stock investing produces excellent profits when the economy and the markets are favorable, which is most of the time. The easiest way for most folks to participate is to simply invest money in general diversified STOCK FUNDS.

Traditionally, smart investors have invested in bonds as well to offset possible stock investing losses and to increase their investment income. The easiest way for the average investor to hold a diversified portfolio of bonds: invest money in BOND FUNDS.

Money market securities are safe short-term investments that pay competitive interest rates. Professional investors hold them in their portfolios to increase safety and flexibility. You can invest money here by simply owning a MONEY MARKET FUND.

The fourth asset class is commonly referred to as “alternative investments”. Savvy investors invest in the likes of foreign investments, real estate, oil and other natural resources, and precious metals like gold and silver to add even more diversification to their total portfolio. Why?

When the going gets tough in the U.S. stock market it’s difficult to earn higher returns and to make your assets grow. Thus, they hold alternative investments in their portfolio to offset stock losses. When stock investing is a loser, oil prices can be climbing, gold can be soaring, and/or real estate might be thriving, and so on.

The question is how to invest in the above alternative investments. The simple answer is to just invest money in SPECIALTY MUTUAL FUNDS. Some funds specialize by investing in sectors like oil stocks, or gold stocks, or real estate stocks.

Asset allocation, more than anything else, is the key to investing success. By simply investing in all 4 of the above asset class with mutual funds you can achieve true diversification with greater safety.

Now it’s simply a matter of how to invest across these 4 mutual fund types … how much to invest in each fund type. This will depend on your personal risk profile, and is a topic for another article.

Stock Investing Vs Real Estate Investing Profits

Both stock investing and real estate investing have the same basic financial objectives. People invest money in both to make money from growth and/or income. Growth through price appreciation (increase in value or market price) is where you really make money, the big bucks. Here we compare the two investment options in terms of profitability and other factors.

Let’s talk about a $20,000 out-of-pocket 10-year investment in both investment options investing by traditional standards … like it has normally been done throughout the past 50 or so years. No unusual economic circumstances, no HEAVY leverage (borrowed money) involved. Now let’s look at both investment options.

Stock investing: The stock investment is $20,000 invested in a no-load S&P 500 Index fund which tracks the performance of the stock market. Over the long term the stock market has returned 10% a year. This is our assumed return, plain and simple.

Real estate investing: Here you buy a house in Middle America USA for $100,000, putting down $20,000, the traditional 20%. You average 3% a year in price appreciation. You rent it out to maintain an even cash flow. In other words, your rental income covers your mortgage payments, all repairs and maintenance, fees, taxes and so on. Plus, to keep it simple we assume that what you have paid off on your mortgage is absorbed by other expenses over the 10 years. So, if you were to sell after 10 years we will say that you still owe the bank $80,000. Sorry, this investment option is not so plain and simple to describe.

Let’s compare the profitability of these investment options.

Stock investing produced yearly average returns of 10%. Over 10 years $20,000 grows to $51,875 when compounded at 10%.

Real estate investing produced average yearly gains of 3% on $100,000. Growing at 3% a year the value of your house grows to $134,392 in 10 years. We are assuming that you still owe the bank $80,000, so the net value of your investment is $54,392. In reality you would owe less with a conventional mortgage. On the other hand this difference could easily be offset if extraordinary costs were incurred over the 10-year period.

You had $20,000 of your own money invested to make money. The score after 10 years: Stock investing grew your money to $51,875 and real estate got you to $54,392 under our traditional assumptions. In terms of profitability there wasn’t much difference.

But you and I both know that when you invest money to make money your success really depends on how well you know and play the game … no matter what arena you invest money in. For example, if you are good at selecting, improving, managing and financing real estate properties you can do much better than the above example.

You can also make over 10% a year in stock investing if you know how to invest in the stock market. The problem for most folks is that they don’t know how to invest in stocks, they are uninformed. Hence, stock investing for most folks is risky business.

On the other hand, TRADITIONALLY (not so in 2007-2009) many people are comfortable with real estate investing because they are familiar with real estate (they see it every day and likely grew up in a house). Real estate properties have historically gone up in value without many violent downswings. The stock market usually experiences a downturn (bear market) every few years.

Other basic differences in our two investment options follow.

Real estate properties require active management, and lack good liquidity as an investment. Selling a property can be costly and time consuming. On the other hand, real estate investing has traditionally been a good way to invest money and make it grow without taking much risk. Various investing techniques can be employed to enhance profits … financial leverage being among them.

Stocks offer high liquidity, meaning that you can sell a stock investment quickly and easily with low costs. No active management is involved; you just buy or sell over the phone or on your computer. On the other hand, you are inviting trouble if you try to make money here and haven’t spent time learning how to invest in stocks. Risk is always a factor when investing in stocks, especially if you are uninformed.

A Stock Investing Investment Strategy That Works

Stock investing without an investment strategy doesn’t work. The question is: how to invest in stocks with less risk while earning good returns. Here’s a proven investment strategy, a tool that works but only if used properly.

You can use a tool called DOLLAR COST AVERAGING to lower your risk and improve overall performance if you invest in stocks periodically over time (like in a 401k plan). You can also use this investment strategy when you have a lump sum of money you want to invest in stocks.

Here’s an example of how to invest in stocks using this tool with a general diversified stock fund as the stock investment. Why we use this as our stock investing vehicle will be explained later.

Picture that you have $50,000 you want to invest in stocks, perhaps sitting in your 401k plan. The stock market is getting volatile and you want to decrease the risk of investing at the wrong time.

Solution: Use dollar cost averaging by investing the same amount of money systematically at predetermined intervals. In this case our investment strategy will be to invest the $50,000 by investing $10,000 every three months, for 5 quarters, into a diversified stock fund. Watch what happens as we invest the same amount of money each time period as the fund price fluctuates over time.

1st stock investment: $10,000 at $20 buys 500 shares.

2nd investment: $10,000 at $15 buys 667 shares.

3rd investment: $10,000 at $10 buys 1000 shares.

4th investment: $10,000 at $15 buys 667 shares.

5th investment: $10,000 at $20 buys 500 shares.

Totals: $50,000 invested … 3334 shares purchased and owned.

Total value of stock fund investment: 3334 shares x $20 = $66,680.

Profit: $16,680.

The share price fell and then recovered to end at the same price it started at. The same amount of money was invested each time, with purchases ranging in price from $20 to $10. Had you invested $50,000 upfront in a lump sum at $20, you’d have had a rough ride and been happy to just break even a year later. Instead you made a profit of $16,680!

When you invest in stocks by dollar cost averaging be careful. Do not use this investment tool with an individual stock, especially with a speculative one. This is poor money management. Why?

When you continue to invest in stocks and buy more shares in a declining stock market you are making an assumption: that stock prices (in general) will eventually recover in the not too distant future. This is a reasonable assumption, since it has always happened throughout the history of the U.S. stock market.

On the other hand, every year a number of individual stocks decline and never recover. Even major stocks can go bust … for example, General Motors.

Make dollar cost averaging a part of your overall investment plan. It forces you to buy more and more shares as stock prices get cheaper and cheaper. This results in a lower average cost per share.

Make sure that your stock investment is a bet on the U.S. stock market in general vs. an individual stock that could drop off the face of the earth leaving you broke.

Learning how to invest in stocks with an investment strategy that smoothes out the level of risk is key to being comfortable with your stock investing.