GMR 96: Rules of Investing Part 1
Episode 96
The world of investing is shrouded in mystery, full of difficult to understand words and rules. No wonder so many people feel lost, and so few dare to invest. In this episode of GMR, we demystify the rules of investing to give you the foundational knowledge you need to be confident and bold in your investing.
SHOW NOTES
“Earlier today I was using the rule of 72 to calculate the number of years it would take for me to be able to live on my investment income using the 4% rule. Of course, I’m hoping this bull market will continue and my strategy of Dollar Cost Averaging & Rebalancing will help smooth out the ride. I’ve been trying to find an advisor who will execute my market price trades in a fiduciary fashion, I’m hoping to avoid the next bear market with a few Stop Limit pricing strategies for the sale of my diverse portfolio of assets. I want the best investments for me, not just something that seems suitable to some salesman.”
Rules and Terms of Investing
Rebalancing
When something gets out of balance, you have to reset it, like the tires on your car. This is called rebalancing, and it’s a similar principle of investing in the stock market.
Some of your investments will go up, and some will go down. Your original investment philosophy is to have a balance of multiple investments that give you good diversification. When you have some investments that have gone way up and others that didn’t grow as much, it’s a good idea to rebalance them to your original intent.
Usually, people rebalance across investment types: Stocks, Bonds, Real-Estate, Gold
50% stocks -> 80% stocks
50% bonds -> 20% bonds …. Time to rebalance back to 50/50
It also can rebalance across your mutual fund types.
25% Large Cap
25% Medium Cap
25% Small Cap
25% International
While there is no required schedule for rebalancing a portfolio, most recommendations are to examine allocations at least once a year. It is possible to go without rebalancing a portfolio, though this would generally be ill-advised. Rebalancing gives investors the opportunity to sell high and buy low, taking the gains from high-performing investments and reinvesting them in areas that have not yet experienced such notable growth.
Fiduciary vs Suitability standards:
There are Investment advisers and there are investment brokers, both tailor their investment advice to individuals and institutional clients.
Brokers work for broker-dealers and they are not governed by the same standards. Investment advisers work directly for clients and must place clients' interests ahead of their own, according to the Investment Advisers Act of 1940. Brokers, however, serve the broker-dealers they work for and must only believe that recommendations are suitable for clients.
Advisor’s designations to look for:
CFP - Certified Financial Planner - To become a CFP, a professional must complete a set of courses, then pass a seven-hour test. The test is administered by the CFP Board. The pass rate is below 70%. If you work with financial planners with a CFP, you know they know their stuff!
CFA - Certified Financial Analyst, is an expert in investments and securities. The program for becoming a CFA requires candidates to master 10 investment topics and also pass three levels of rigorous exams. Working with a CFA is an excellent choice if you are looking for an investment manager.
Questions to ask:
Are you a fiduciary? A direct question deserves a direct answer. Pay attention to how the advisor responds. If your advisor has told you that he or she is acting as a fiduciary, ask them to show that to you in writing.
Do you receive any type of compensation in addition to what I’m paying you? Some advisors receive commissions or other product-based compensation when they steer clients into particular investment products (such as mutual funds, annuities, and variable annuities). This is a clear conflict of interest and can indicate that the advisor is not, in fact, a fiduciary. Make sure your advisor is providing unbiased advice and not simply selling you investment products.
Are you “dual-registered”? Some advisors are registered as both investment advisors and broker-dealers. Often, a broker-dealer is acting in the role of a salesperson. If your advisor is also a broker-dealer, make sure you understand which hat they are wearing when providing advice to you.
Dollar-Cost Averaging
Dollar-cost averaging is a tool any investor can use to build savings and wealth over a long period.
It is also a way for an investor to neutralize short-term volatility in the broader stock market. A perfect example of dollar cost averaging is how it works in a 401(k) plan. This also works outside 401(k) plans, such as mutual funds and index funds in an IRA (individual retirement arrangement).
In a 401(k) regular purchases are made regularly, regardless of the price of any given mutual fund within that account.
An employee selects a pre-determined amount of their salary (10%) that they wish to invest in several mutual or index funds.
When an employee receives their pay, the amount the employee has chosen to contribute to the 401(k) is invested in their investment choices.
Example of Dollar-Cost Averaging:
Mike works at XYC Corp. and has a 401(k) plan. He receives a paycheck of $2,000 every two weeks. He decides to allocate 10% or $200 of his pay to his employer’s plan. He chooses to contribute 50% of his allocation to a Large Cap Mutual Fund and 50% to an S&P 500 Index Fund. Every two weeks 10%, or $200, of Mike’s pre-tax pay will buy $100 worth of each of these two funds regardless of the fund's price.
The per-share cost of the mutual fund fluctuates up and down over time.
Sometimes, the price is higher and Mike’s purchase costs him more.
Other times the price is lower and Mike’s purchase costs less, buying him more shares with the same $100 from every paycheck.
This allows Mike’s overall cost to be averaged over a period of time.
This also reduces volatility and prevents Mike from buying shares at one time which might be when the price is at the highest. By regularly buying the shares as the price fluctuates both up and down, Mike is able to get a lower average cost and avoid mistakes.
Rule of 72
Rule of 72 is a shortcut to estimate the number of years required to double your money at a given annual rate of return.
Anyone can do 72 ÷ 8 (interest rate) = 9 (years).
If it takes 9 years to double a $1,000 investment, then the investment will grow to $2,000 in Year 9.
$4,000 in Year 18.
$8,000 in Year 27, and so on.
Example: 72/10% = 7 years - $100,000 invested at 10% (11.3% average for the past 100 years) for 30 years (35-65 Yrs) is:
$100,000 - start
$200,000 - 7
$400,000 - 14
$800,000 - 21
$1,600,000 - 28
This is without any additional investment, which if purchased, could result in significantly more wealth.
RESOURCES
Budgeting and Debt Elimination Tools
Jesus on Money by David Thompson - stewardshippastors.com