Execution is Everything

If you have followed my posts over the last two months, you will now have an idea of how to allocate your investments according to your assessment of future inflation rates and your own personal profile. Once your have decided how you want to divide up your funds, you must implement your plan. What’s the best way?

It depends on the value of your portfolio. If your portfolio is small, you should certainly consider mutual funds. Otherwise, with only limited amounts available to invest, you’ll probably find it difficult to achieve enough diversification within each asset category on your own.

For example, you may be able to purchase only four or five individual stocks with the Ghana Cedis or dollars you’ve allocated to shares or stocks. The probability that the total return from these few shares will be close to the market average is far less that the possibility that the return from forty or fifty shares in a mutual fund will approximate the average.
If you have a greater amount to invest, you may want to use a discount broker or retail broker to buy shares and bonds.

Again, to some degree how you invest – whether in individual securities or mutual funds – will vary according to your own attitude towards risk and the particular investment category. It’s hard to diversify adequately with fixed-income vehicles. For instance Institutions trade some bonds heavily, and commissions are steep on bonds purchases of less than GHc10,000 (Ghana) or $50,00 (US).

But with shares or common stocks, you may achieve enough diversification with GHc10,000 (Ghana) or $50,00 (US) or less – even if you make round lot purchases (that is, purchase of 100 shares or multiples of 100 shares). Mutual funds offer the opportunity to diversify with even less money.
If your portfolio is substantial, you may want to use an investment manager to manage your money. Most reputable money managers, however, will mange portfolios of only GHc50,000 (Ghana) or $250,00 (US) of more .

Firm Foundation
You know the basics of asset allocation. And you realize that this concept is the cornerstone of a sound financial plan. Moreover, you also have a good idea of how best to diversify your own portfolio. In the subsequent posts, you will see how to make specific choices with the broad asset – allocation categories that are right for your circumstances.

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Diversification – the Retiree

In my last two posts I looked at the personal cases of the Young Professional , the Rising Executive, the Manager and the Senior Executive and how they can diversify their resources across different resource. In this post, I will consider the case of the Retiree.

Retiree
Characteristics
Age: 60 plus Income: GHc 15,000 (Ghana) $100,000 (US)
Net Worth: GHc 225,000 (Ghana) $1.5million (US)
Risk tolerance:
Low Goals: Preserving capital

Assert Allocation
Cash and cash equivalents………….…………………..…..10% to 20%
Fixed-income vehicles……………………………………….40% to 50% Equities………………………………………………………..25% to 35%
Hard assets…………………………………………………... 5% to 15%

Financial Profile
Since you no longer take home a salary or pay cheque or expect to in the future – your tolerance for risk is low. For the same reason, your need for current income from your investments have increased.
And your planning time is shorter, so you can afford to reduce your inflation hedges. Also, you might find yourself needing some ready cash – for unexpected illnesses as an example.

Investment Strategies
You’re satisfied with a modest return on your cash, since you want to reduce the volatility of your portfolio and maintain readily accessible cash reserves.
You expect a lower return on you fixed-income investments than you’d get on shares or common stocks. But their lower volatility and higher current income make the trade-off worthwhile.

You still want to keep a significant portion of your portfolio in equities. You like the growth potential.
You also want to stay diversified in the event of a drop in the value of your fixed-income vehicles.

Since you’re more concerned about predictable income and your need for inflation hedges is low, you have few funds committed to hard assets.
Besides, most hard assets have low – or – no current income and liquidity, making them particularly unattractive for a retirement portfolio.

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Diversification – the Manager & Senior Executive

In my previous post I looked at the personal cases of the Young Professional and that of the Rising Executive and how they can diversify their resources across different resource. In this post, I will consider the cases of the Manager and Senior Executive

Manager
Characteristics
Age: 40s
Annual Income: GHc 10,000 (Ghana) $70,000 (US)
Net Worth: GHc 55,000 (Ghana) $300,000 (US)
Risk tolerance: Low to Medium
Goals: Educate children and planning for retirement

Assert Allocation
Cash and cash equivalents………….……………………..10% to 15%
Fixed-income vehicles……………………………………….30% to 40%
Equities………………………………………………………..35% to 45%
Hard assets…………………………………………………...5% to 20%

Financial Profile
Your allocation is more conservative and liquid than that of the rising executive. Granted, you’re the same age. And your concerns are also very similar. But you don’t expect your future earnings to be nearly as great. And you would be much worse off if you lost part of your principal.
Your focus is also more on such critical goals as retirement and you children’s educations. You're less concerned with discretionary goals, such as a second home or a deluxe vacation. So you may need less of an inflation hedge. The reason: you expect inflation for basic goods and services to lag behind the inflation you anticipate in the cost of discretionary, or luxury, items

Investment Strategies
To increase liquidity and boost your income, you allocate more to fixed-income vehicles and less to hard assets. Reducing your investment in hard assets also reflects your lesser need for an inflation hedge

Senior Executive
Characteristics
Age: 50s
Annual Income: GHc 30,000 (Ghana) $150,000 (US)
Net Worth: GHc 150,000 (Ghana) $1 million (US)
Risk tolerance: Low to Medium
Goals: Make gifts to children, grand children and charities; and plan for a comfortable retirement
Assert Allocation
Cash and cash equivalents………………………………….0% to 5%
Fixed-income vehicles……………………………………….30% to 40%
Equities………………………………………………………..35% to 45%
Hard assets…………………………………………………..15% to 30%

Financial Profile
Your cash flow is now quite healthy. Your earnings have increased considerably, and your expenses have decreased, since the children have all finished their costly colleague educations. Besides, you have now both just about everything you want and need.
But you do want to plan gifts for your children and grandchildren. And you’d like to make a generous bequest to you alma mater.
Most important: you need to feel secure that your retirement years will be comfortable.

Investment Strategies
Since you didn’t need much ready cash, you transfer some of your funds from cash equivalents to fixed-income instruments. You get a higher return from longer-term fixed-income instruments than from cash and cash equivalents. You still have a way to go until your retire, so you keep your inflation hedges – the hard assets – constant. Right now, it doesn’t bother you that these assets are illiquid and yield little.

In my next post, I will be considering the case of the Retiree

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Diversification – Young Professional & Rising Executive

In my previous post I completed the two part topic of how to diversify your resources among various resources ( Part 1 and Part 2). In this post and the subsequent two. I will touch on how five different individuals can diversify their resources based on their personalities. Specifically I will consider the cases of the following:

• Young Professional
• Rising Executive
• Manager
• Senior Executive
• Retiree

In this post, I will touch on the cases of the Young Professional and that of the Rising Executive.

Young Professional
Characteristics
Age: 30s
Annual Income: GHc 7,200 (Ghana) $50,000 (US
Net Worth: GHc 7,200 (Ghana) $50,000 (US)
Risk tolerance: High
Goals: Upgrade residence and personal property and begin planning for children’s education

Assert Allocation
Cash and cash equivalents………………………….……..5% to 10%
Fixed-income vehicles………………………………….….20% to 30%
Equities……………………………………….………….…..40% to 50%
Hard assets……………………………………...…………...15% to 30%

Financial Profile
You’re feeling optimistic about your life and career prospects. And you have a high tolerance for risk. After all, you reason, you can replace any principal you may lose, because your earnings are bound to spiral upward.
And since you have plenty of time for your investments to pay off, you can ride our any fluctuations in value common to growth stocks.
Moreover, you have little need for income other than your earnings, since your salary amply covers your living expenses.

You do, however want to protect your self against inflation over the long haul. So you invest in vehicles with a solid performance record over time
And you plan to make a down payment on a large house in the near future. So you want to keep a good portion of your holdings liquid.

Investment Strategies
Your portfolio is tilted quite heavily toward common stocks and real estates. The reason: although they fluctuate considerably in value, common stocks are historically, impressive performers over the long term. And they are very liquid.
Meanwhile, your hard assets – specifically your real-estate holdings – are an excellent hedge against inflation.

Rising Executive
Characteristics
Age: 40s
Annual Income: GHc 15,000 (Ghana) $100,000 (US)
Net Worth: GHc 75,000 (Ghana) $500,000 (US)
Risk tolerance: Medium to High
Goals: Educate children, buy a second home, begin planning for retirement and travel

Assert Allocation
Cash and cash equivalents………………………..………..5% to 10%
Fixed-income vehicles…………………………….………..25% to 35%
Equities…………………….………………………………....35% to 45%
Hard assets………………..……………………………….....15% to 30%
Compared with the young professional, the fixed income portion of your portfolio increases slightly while the percentage of common stocks decreases.

Financial Profile
You still have a long time for investment to pay off, but since you are beginning to consider retirement, you take a slightly more conservative posture than you did when you were younger. You still may replace any principal you lose with future earnings, but your time frame is shorter.
You are also less confident of you ability to slash money away, since your expenses are now higher than they were.

You have slightly less need for protection against inflation, because your investment planning period is shorter. But you may need additional income because of high living expenses.
And you still need to keep some holdings liquid. You want money for a sailboat and cash for a down payment on a second home.

Investment Strategies
By allocating less of your portfolio to common stocks and more to fixed – income vehicles, you reduce your overall risk and gain current income. Because you want ready access to your resources, you change the mix of your hard assets from natural resources, say to real estates.

In my next posts I will be considering the cases of the Manager ,the Senior Executive and the Retiree

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How to diversify your resources among various resources – Part 2

Diversification: the base case

This is the second part of the post I started last week. Last week I touched on Part 1 of how to diversify your resources among various resources, so by now you know which assets to include in your asset allocation or diversification plan and which to exclude. And you know the six different categories of investment assets you can choose from in diversifying your resources.

So how do you diversify?
Let’s ignore you personal circumstances for a moment and build an allocation model that assumes a moderate, stable level of inflation.
You might divide you assets equally among the six investment categories on the theory that equal investment provides equal protection against all kinds of risk – and particularly guards you against the ravages of inflation and deflation.

But since real estate, natural resources, and tangible assts usually move up or down in value together, it makes some sense to lump them into one category. Let’s call that category hard assets.
However, keep this point mind. Putting your money in real estate is usually less risky than putting your money in either natural resources or tangibles. The exceptions, if you have some special knowledge or experiences dealing with natural resources or tangible assets or have advice from a trusted expect

Now an equal division looks like this:
Cash and cash equivalents………………....………….25%
Fixed-income vehicles……………………….....………25%
Equities……………………………………………….....25%
Hard assets……………………………………………..25%
100%
But you really shouldn’t give cash equal treatment when it comes to allocating your resources. In most cases, an investment in cash is short term. Ghana cedis or dollars you have ‘parked’ in cash or cash – equivalent investment vehicles are cedis or dollars waiting to be invested more profitably.

So your cash investment actually represents your non commitment to some other investment category. It’s what’s left over after you’ve made your investment selection.
Reducing the percentage of assets you keep in cash results in this more realistic model for moderate inflation:
Cash and cash equivalents………………………..………..10%
Fixed-income vehicles…………………………....………….30%
Equities…………………………………………… ..........….30%
Hard assets…………………………………………........…..30%
100%

Now you’ve neutralize the potential impact of inflation. Cash is relatively unaffected by changes in inflation rates. But equities- investments, such as shares, that represent an ownership interest – are mixed bag. For example, whether or not a particular share moves in the direction of inflation depends on a variety of factors. Among them: the industry in which the company operates and the company itself.

Fixed-income securities

are a hedge against deflation. And hared assets are a hedge against inflation. (Remember, to make sure your hedges are truly effective, you must also diversify investment within your asset allocation categories)

Now suppose you expect inflation to be very low – or conversely very high. Here’s how our model might look in each of these situations:

Asset............................Moderate inflation..........Low inflation..........High inflation
Cash and cash equivalents............10%....................10%.................10%
Fixed-income vehicle.................... 30%....................45%.................15%
Equities ......................................30%.................... 30%.................30%
Hard assets .................................30% ....................15% ...............30%
Total............................................100% .................100% ..............100%

Diversification: the personal case
By now you should feel comfortable with the general principles of diversification. So let’s turn to the second part of our assets- allocation discussion: building a model that takes into account your own unique circumstance – the financial profile, goals, and objectives that you developed so far
To see how you might diversify your own resources, take a look at these sample asset allocations. There are six of them – I will be treating these in my next post beginning with the profile of a young professional.

Remember , there are no hard and fast allocation rules. But these models should give you a good idea of how to create your own diversified portfolio.

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How to diversify your resources among various resources – Part 1

So far we have considered what asset allocation is and why it is important to diversify your assets. In this post I will break down asset allocation into two parts. First, we will address the general principles of asset allocation (just a quick review). Then I will show you how you can apply these principles to your specific situation.

In thinking about asset allocation in general, two questions pop up. First, among what kinds of investments should I be allocating my resources?Well, if you read the ads you would think there were hundreds of kinds of investment vehicles – all of them tailored ‘just for you’.

The fact is, you can easily boil down all investment into only six categories:

• Cash and cash equivalent, such as money-market funds, treasury bills, current and savings account and short term certificates of deposit.
• Fixed-income vehicles, a grouped that includes tax-exempt bonds, corporate bonds, mortgages, and long-term certificates of deposit
  
• Equities, including both domestic and international stocks
  
• Real estate• Natural resources, including oil and gas
• Tangibles, such as gold and silver

Obviously there is a wide variation within these categories. Utility stocks / debentures, for instance, may behave at times like fixed income vehicles, because they yield such a steady rate of return. And some short-term, fixed – income vehicles may behave like cash. You must take these variations into account when you are ready to adopt specific investment strategies.

What to allocate

The second question that pops up: what resources should I be allocating among these six investment categories? There are some assets that you definitely want to exclude from your investment portfolio – your personal assets – and some that you definitely want to include – your investment assets.

The exclusions?

A cash reserve is a sure one. You should set aside some funds for emergencies in a secure, very liquid investment vehicle that does not fluctuate in market value. Examples include saving and current accounts.How much should you set aside? That depends. Many financial advisors suggest two or six months’ living expenses. But that advice does not apply to everyone.

You may, for example, be employed by a small company in a volatile industry. If that’s the case, you are more likely to face an extended period of unemployment than your neighbour who works for an established company in a secure industry. Or access to short –term credit such as credit cards may reduce your need fro cash on hand. However how much you eventually decide belongs in you emergency funds and should be excluded from founds you intend to invest.

What other assets to include?

You may want to consider as investment assets some items that you don’t ordinarily think of in this way. Among them:

• Insurance policy cash values
• IRA OR Keoghs (USA) SSNIT contributions (Ghana)
  
• Company – sponsored 401 K (USA) Provident fund (Ghana) and other savings plans
• Other Company defined – benefit plans

You should include these assets in you diversification plan because they are resource on which you will rely in the future and because they may be affected by market forces between now and the time you are ready to use them.

In my next post I will continue with this article and will show the diversification base case.

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Diversification – Balancing Return and Risk

In my last few post I have touch on two of the three parts of the basics of asset allocation – risk and return, In this post I cover the third part - Diversification . Diversification will help you see how to balance risks and returns into an intelligent strategy.

No one, alas, can eliminate all risk in investing. But by diversifying, you can at least minimize it. There are two ways to diversify.

Real Estate and Bonds
First, you can partially or completely offset your risk by investing in a number of different areas. Let’s say, for example, that you use some of your investment Ghana cedis or dollars to purchase a small apartment building. At the same time, you buy a high-grade cooperate bond.

Your real-estate investment provides a hedge against inflation. As prices rise, the value of your building rises, too. But its value could fall considerably during a prolonged deflationary period.
The value of your bond however, would respond in exactly the opposite way to either inflation or deflation. Inflation would lower the value of the principal you invested in the bond as well as the value of the interest the bond issuer promises to pay you. The effect of deflation, on the other hand, would be to raise both the price you could get for the bond and the value of the interest payments.
What’s important to note is that any change in the value of your building brought on by inflation or deflation probably will be offset by an opposite change in the value of your bond.

So, neither inflation nor deflation would prove disastrous. And if neither of these economic condition become a serious threat, both you building and your bond will still generate healthy returns. You’re braced against the harsh winds of economic change but positioned to profit in the calm of stability.

The second way of diversifying: spreading you holdings in anyone investment area- especially when buying real estate and common stocks, when you diversify by buying shares in a number of companies, say, or several parcels of real estates, your return is more likely to approach the average for that investment category rather than the return on any single investment.

Now that we’ve covered the basics of asset allocation – risk, return, diversification – its time to see how to balance these elements within an intelligent strategy. That’s what I will be touching on in my next post.



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Types of Risk

Investment risk falls into a number of categories. But bear in mind that any one investment can be subject to more than one type of risk.

Inflation Risk
Inflation risk refers to the loss of value in your investment caused by increasing depreciation of the currency. A constant rate of inflation, even if is high, is not risky. When you purchase a long-term bond, for instance, the price of the bond, and therefore its yield, already reflects the current inflation rate.
Rather, it is a rise in the inflation rate that is the source of risk. For example, you buy a long-term bond when inflation is low. If the inflation rate rises, both your bond’s resale value and the value of the interest you receive will decline. After all, the same Ghana Cedi or Dollar is worth less when inflation is high than when it is low.

Deflation Risk
Deflation risk is, not surprisingly, just the opposite of inflation risk. It is the risk that the value of our asset will decline when general prices levels fall during periods of severe recession or depression. Land that you buy during boom times, for instance, may lose value during a serious recession.

Business Risk
Business risk refers to the chance that some event might occur that reduces or destroys a particular investment’s return. For example, you might buy stock in a company that has perfected a pill to cure the common cold. Than a competitor develops a vaccine that prevents cold entirely. Your company’s product becomes obsolete.
Business risk can be more widespread – and more difficult to control. For example, changes in government policy, war, or erratic weather could suddenly wipe out the profits of the cruise ship company whose stock you just bought.

Interest Rate Risk
Interest rate risk is the decline in market value that occurs when the interest rate on new, similar investments rises. For example, you buy a five-year corporate bond paying 8 percent interest. The next year rates rise, and the same five-year bond fetches 10 percent interest. The value of your bond declines.

Market Risk
Market risks refer to the chance that an entire financial market may suffer a decline. Say you buy stock or shares in a prosperous company, but the entire stock market falls sharply in value as it did this year (2009) in Ghana, the US, UK and across the world. Your company is still doing well, but investors are wary of stocks and shares in general, so the price of stock or shares you bought drops.

Illiquidity risk
Illiquidity risk refers to the loss you might have if you’re forced to sell an investment before you had panned. Perhaps you have an unexpected medical expense and much sell some real estates in a hurry to raise the cash. You’ll have to take what the market will give you for your property, because you can’t wait for a better price.

The question, now that you know what the different risks are, is what you can do about them. The answer, in a word: diversify! – Diversification will be the focus on my next post

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What You Need to Know About Asset Allocation

To many people, investing means giving a broker the green light to buy a certain share or stock. But buying share or stock – or any other specific investment vehicle – is really one of the last steps in investing. And – believe it or not- it is among the least important ones.

Before you invest – and long before you think about which product you want to buy- you much decide how to allocate your resources among the different categories of investment.

Why allocate?
Why is allocation so important? Here's the reason. More that 94% of the total return on your investment cedis or dollars is a result of the way you allocate your resources. Only 6% depends on the specific assets you buy.

You can see why asset allocation is the single most important aspect of a successful investment strategy. And asset allocation is really a simple concept. It just refers to the way you divide your investment cedis or dollars among different types of investment vehicles – cash, bonds, shares, real estates and so on.

Before I show you how asset allocation can work for you, I'm going to spend some time explaining the issues involved in assess allocation. I guarantee you, it will be time well spent.

Where Does the Money Go?
Lets' assume that you've managed to accumulate Ghc10,000 or $ 10,000 in savings. Naturally you want to invest it to your best advantage.
So you do your homework. You quiz your friends, your co-workers, your sister-in-law, even the guy you meet on the bus.
They all have advice (as usual) and it comes down to these choices:
· Leave the money in the bank
· Buy shares in a small high-technology or financial company
· Buy shares in a well-known, diversified multinational company
· Buy corporate bond
· Buy government treasury bills
· Invest in real-estate limited partnership
· Buy shares in a mutual fund

So what do you do? One of them? All of them? Some combination? Which combination? If you hesitate before answering, you're on the right track.

The fact is you can't make a sensible choice without more information. And you need to evaluate and consider the following:
· The relationship of risk and return
· The forms of returns
· The relationship of the form of return to risk
· The types of risk
· The need for diversification

My subsequent posts will run through each of these issues.


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Investing 101: Portfolio&Diversification - Part 6

It's good to clarify how securities are different from each other, but it's even more important to understand how their different characteristics can work together to accomplish an objective.

The Portfolio
A portfolio is a combination of different investment assets mixed and matched for the purpose of achieving an investor's goal(s). Items that are considered a part of your portfolio can include any asset you own - from real items such as art and real estate, to equities, fixed-income instruments and their cash and equivalents. For the purpose of this section, I will focus on the most liquid asset types: equities, fixed-income securities and cash and equivalents. An easy way to think of a portfolio is to imagine a pie chart, whose portions each represent a type of vehicle to which you have allocated a certain portion of your whole investment. The asset mix you choose according to your aims and strategy will determine the risk and expected return of your portfolio.

Basic Types of Portfolios
In general, aggressive investment strategies - those that shoot for the highest possible return - are most appropriate for investors who, for the sake of this potential high return, have a high risk tolerance (can stomach wide fluctuations in value) and a longer time horizon. Aggressive portfolios generally have a higher investment in equities.

The conservative investment strategies, which put safety at a high priority, are most appropriate for investors who are risk averse and have a shorter time horizon. Conservative portfolios will generally consist mainly of cash and cash equivalents, or high-quality fixed-income instruments. To demonstrate the types of allocations that are suitable for these strategies, we'll look at samples of both a conservative and a moderately aggressive portfolio.

Note that the terms cash and the money market refer to any short-term, fixed-income investment. Money in a savings account and a certificate of deposit (CD), which pays a bit higher interest, are examples. The main goal of a conservative portfolio strategy is to maintain the real value of the portfolio, or to protect the value of the portfolio against inflation.

The portfolio (picture on the top right) you see would yield a high amount of current income from the bonds and would also yield long-term capital growth potential from the investment in high quality equities.

The moderately aggressive portfolio (picture on the top left) is meant for individuals with a longer time horizon and an average risk tolerance. Investors who find these types of portfolios attractive are seeking to balance the amount of risk and return contained within the fund. The portfolio would consist of approximately 50-55% equities, 35-40% bonds, 5-10% cash and equivalents.

You can further break down the above asset classes into subclasses, which also have different risks and potential returns. For example, an investor might divide the equity portion between large companies, small companies and international firms. The bond portion might be allocated between those that are short-term and long-term, government versus corporate debt, and so forth. More advanced investors might also have some of the alternative assets such as options and futures in the mix. As you can see, the number of possible asset allocations is practically unlimited.

Why Portfolios?
It all centers around diversification. Different securities perform differently at any point in time, so with a mix of asset types, your entire portfolio does not suffer the impact of a decline of any one security. When your stocks go down, you may still have the stability of the bonds in your portfolio.

There have been all sorts of academic studies and formulas that demonstrate why diversification is important, but it's really just the simple practice of "not putting all your eggs in one basket." If you spread your investments across various types of assets and markets, you'll reduce the risk of catastrophic financial losses.

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Investing 101: Introduction - Part 1

Have you ever wondered how the rich got their wealth and then kept it growing? Do you dream of retiring early (or of being able to retire at all)? Do you know that you should invest, but don't know where to start?

If you answered "yes" to any of the above questions, you've come to the right place. In this tutorial we will cover the practice of investing from the ground up. The world of finance can be extremely intimidating, but we firmly believe that the stock market and greater financial world won't seem so complicated once you learn some of the lingo and major concepts.

We should emphasize, however, that investing isn't a get-rich-quick scheme. Taking control of your personal finances will take work, and, yes, there will be a learning curve. But the rewards will far outweigh the required effort. Contrary to popular belief, you don't have to allow banks, bosses or investment professionals to push your money in directions that you don't understand. After all, no one is in a better position than you are to know what is best for you and your money.


Regardless of your personality type, lifestyle or interests, this tutorial will help you to understand what investing is, what it means and how time earns money through compounding. But it doesn't stop there. This tutorial will also teach you about the building blocks of the investing world and the markets, give you some insight into techniques and strategies and help you think about which investing strategies suit you best. So do yourself a lifelong favor and keep reading. Each day,over the next seven days, i will be writing a series of articles on the following:

1) Investing 101: What Is Investing?
2) Investing 101: The Concept Of Compounding
3) Investing 101: Knowing Yourself
4) Investing 101: Preparing For Contradictions
5) Investing 101: Types Of Investments
6) Investing 101: Portfolios And Diversification
7) Investing 101: Conclusion



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