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Mastering the World of Investing

September 24, 2007

Basic Definitions 

Diversification: The idea of spreading out your money across many different types of investments. Choosing to diversify your investment holdings reduces your risk tremendously.

Risk Tolerance: An investor’s ability to withstand losses caused by one or more of the different types of risk. This ability can be limited by your temperament as well as your time frame and financial circumstances. For example, someone who is investing for a goal 10 to 20 years or more in the future generally has a higher risk tolerance and may feel more comfortable with riskier investments than a person whose investment goal is only 5 years away or less.

Bull Market: A prolonged period of time when prices are rising in a financial market faster than their historical average. Bull markets can happen as a result of an economic recovery, an economic boom, or investor psychology.

Bear Market: A prolonged period of time when prices are falling. It is usually marked by a price decline of 20% or more in a key stock market index from a recent peak over at least a two-month period. Bear markets usually occur when the economy is in a recession and unemployment is high, or when inflation is rising quickly.

Market Correction: A drop of at least 10%, but not more than 20%. A correction is often considered beneficial for the long-term health of the market, in that the prices had risen too quickly and the drop put them back to more realistic levels.

Basic Goal Planning:

Short-Term = Anything less than 5-7 years. If you need the money in the next 3-5 years, do not invest the money into conventional investment areas like bonds, stocks, or real estate. Stick to cash and equivalents. Money market accounts yield around 4-5% annually and good ones will not charge any fees and there are no minimums (Check out www.emigrantdirect.com as an example).

Long- Term = Anything greater than a 7-year holding period.

Now that you have been primed. Let’s talk about Investment Options

Stocks: Stocks represent shares of ownership in a public company.

Bonds: Bonds are basically a chance for you to lend your money to the government or a company. You receive interest and your principle back over a predetermined amount of time.

Mutual Funds: A mutual fund is simply a financial instrument that allows a group of investors to pool their money together with a predetermined investment objective.  The mutual fund will have a fund manager who is responsible for investing the pooled money into specific securities. By pooling money together in a mutual fund, investors can purchase stocks or bonds with much lower trading costs than if they tried to do it on their own.

Exchange Traded Funds (ETFs) = A fund that tracks an index, but can be traded like a stock. Because ETFs are traded on stock exchanges, they can be bought and sold at any time during the day (unlike typical open mutual funds). Their price will fluctuate from moment to moment just any other stock’s price and you will have to pay a ticket or transaction charge to purchase the holding. They are typically more tax efficient than normal mutual funds, and they have very low operating and transaction cost associated with them.  The first ETF created was the Standard and Poor’s Deposit Receipt (SPDR) in 1993.

ETF’s are:

* Great for large single investments of large cap or sector holdings
* Great for year end buying
* Not great for dollar cost averaging because of transaction costs

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Dirty Secrets of Investing

1. The S&P 500 Index usually outperforms 2/3rds of the actively managed stock funds

2. The average US stock mutual fund’s expense ratio hovers around 1.5% of assets, not including commissions and sales charges.

3. The front-end load (commission) for the average equity fund is over 5%

Good Advice Does Not Need to Be Complex. Review these simple investing guidelines…

* Stay away from 1 or 2 year HOT funds

* Look at the Long-Term Performance (5-7 years)

* Don’t buy what is being talked about

* Research the fund manager/investment advisor to ensure that he/she has a history of success, and is not learning the ropes with your money.

* Consider buying No-Load (no commissions) mutual funds

* Look at the mutual funds internal expenses (the lower the better)

* Use Index Funds for Large US Companies (i.e. S&P 500 Companies)

* I know that it is boring, but a Buy & Hold investment plan works much better than emotional trading

* Diversify your Investments

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