Tuesday, April 14, 2015

Investment Diversification cont'd - Cash

In previous weeks we talked about the various ways to diversify your money among stocks and bonds. A third component of spreading your money is CASH. It is important to keep a percentage of cash on hand for various reasons:

- safety - the value stays reasonably consistent,

- liquidity - it's available with no hassle when you need it,

- opportunity - when a time to enhance your portfolio comes along the money is available to buy more stocks or bonds,

- emergency - with an ample cash cushion you won't run up credit card debt incurring huge interest charges.

Other than stuffing the cash into your mattress or hiding it in a coffee can in your closet here are a few places to keep your cash:

- plain old-fashioned bank savings account (FDIC insured),

- short-term bank CD (certificate of deposit) (also FDIC insured) where you have immediate access if you are willing to incur the penalty and lose the interest but in this low-interest environment, you won't be sacrificing much,

- money market, which is actually a money mutual fund of a variety of very short term investments ( may be FDIC insured if at a bank) and usually pays a higher return than a savings account,

- short-term bond fund, which is a grouping of bonds that mature soon and frequently. These are definitely not FDIC insured and will go up and down as the bond market reacts to various events. Because these funds hold very short-term investments, they are not very volatile, reasonably safe and offer a higher return.

Be $ Smart - find a good home where you earn some interest on your "safe" cash investments.

Investment Diversification cont'd - Bonds

When you talk about diversification you hope to spread your money into a variety of investments. By doing so, you are given the opportunity to create the potential for your money to grow while you reduce the risk.

Last week we addressed stocks. This week we'll review the many facets of bonds.

Bonds come in many varieties - both taxable and tax exempt.
With a bond, you are lending your money; it may be to a corporation, a country or a municipality.

Corporate bonds are issued by companies, of all sizes. High grade corporate bonds from major corporations carry high ratings and the interest earned and distributed is taxable. Most high rated bonds are backed by collateral, e.g. inventory, buildings, property, machinery, etc. Because of their relative safety, they will pay a lower interest rate.

High yield corporate bonds pay a higher return because they may be less safe. The company may be having some financial difficulty and the bonds may be backed by a "promise to pay", not real collateral.

Governments issue bonds for many reasons to run their country. Our own U.S. Treasury offers several types of bonds. Sovereign bonds issued by governments outside the U.S. offer international diversification. Because of the solvency of each country, the risk and yield (return) will vary. You will pay taxes on the interest you earn on these bonds.

Municipalities like cities, states, counties, towns all have the ability to borrow money and issue bonds. Again, the solvency of the region will determine how safe your money may be and the interest each will pay. There are several agencies that rate these bonds. AAA is the highest all the way on down to NR, not rated. The U.S. government does not tax the income from these bonds - they are considered tax-exempt.
A bond issued by New York city would be triple tax-exempt to a resident of NYC. He would pay no city, state or federal tax on that bond.

For diversification you would want some taxable and tax exempt bonds.
You would use bonds of different countries as well as different municipalities.

Be $ Smart - use several different types of bonds when building a portfolio.

Bonds can be quite complex. This is a simplified overview.

Diversification in Investing

In any given day or any given year we have no idea which part of the market will perform well or under perform. The purpose of diversification (not putting all your eggs in one basket) is to have some money in several different areas to take advantage of an upward move and to protect against a downward move.

Asset allocation allows you to divide your money into:
Cash and

And, within each of those categories are several smaller subcategories.
Stocks may include:
- large companies - large cap,
- mid-size companies,
- small companies.

Stocks may be bought in different "sectors" such as:
- Drugs (pharmaceuticals) & health care,
- Transportation,
- Consumer Products,
- Utilities - gas, electricity, telephone,
- Advertising, marketing, social media,
- Financials - banks, brokerage houses,
- Real Estate - office building, malls, apartment buildings.

Stocks may also cover different geographic areas:
- Domestic, meaning only U.S. companies,
- Foreign or international - outside the U.S.,
- Developed countries - in U.S., Europe, South America or Asia,
- Emerging markets, may be found in Africa, Indonesia.

And you may purchase mutual funds that include combinations of all those listed.

A diversified portfolio means holding some of these many choices so you have the exposure to both grow and protect your money. How do you know which ones to buy? It can be quite a challenge! Do the research yourself or find an advisor whom you trust to make the task easier but you still must play an active role of asking questions and reading statements.

Be $ Smart - plan a diversified portfolio for both opportunity and protection.