Tips on Low-Risk Investing: Regain Optimism-Personal Finance

Tips on Low-Risk Investing: Regain Optimism

Regain Optimism

Mike Monthei says he felt the change in November. Donna, his wife, insists it was October when they began to feel optimistic again about their finances. "We were no longer afraid to open our retirement and college savings statements," says Mike, a 38-year-old marketing manager in Austin, Texas.

With the economy projected to grow 4% or more this year and the stock market expected to rise 8% -- as it has on average in Presidential election years since 1888 -- people are feeling bullish for the first time in years.

But the stock market plunge of 2000, the corporate accounting shockers that followed, and the recent mutual fund scandals still haunt many investors. "We want our portfolio to experience any growth that occurs, but we don't want our investments to become road kill again," says Mike.

With investor confidence up but risk sensitivity remaining, here are five financial moves to consider:

Talk to a Portfolio Pro
"If your annual household income is under $70,000, a fee-only planner who charges by the hour is probably all you need," says Zvi Bodie, a finance professor at Boston University and author of Worry Free Investing. "You don't need someone charging you large sums each year."

The Montheis knew they needed advice before the market's recent turnaround. "After the crash in March 2000, we didn't know how to fix our portfolio, so we let it ride," says Mike. By early 2003, the Montheis' portfolio had dropped 70%. "We needed someone we could trust and afford," says his wife, Donna, 39, a registered dietitian and mother of two children.

So last May they turned to Eric Rabbanian, a fee-only financial planner in Austin. Rabbanian is part of a new breed of advisors who charge by the hour instead of a percentage of assets managed. Fee-only advisors can bill between $150 and $250 an hour, and a 401(k) or college savings plan can take two to six hours to develop.

Like all fee-only planners, Rabbanian doesn't sell financial products or collect commissions. You pay as you go. For Mike's 401(k) plan and the couple's IRAs, Rabbanian and the couple discussed how much money they would need by retirement, when they would need it, and their risk tolerance level. Then Rabbanian reviewed the full range of choices in Mike's 401(k) plan and recommended how best to adjust the couple's asset allocation.

For help, Bodie suggests starting with the National Association of Personal Financial Advisors (NAPFA.org), which represents fee-only planners, as well as the Financial Planning Association (FPAnet.org).

Bodie also recommends the advisor be a "certified financial planner," someone who's passed a comprehensive exam and agreed to a code of ethics. Once you have located a few candidates, ask if they work with clients in your income bracket and whether they do planning on an "as needed" basis, he says. Then speak with a few of their clients who are about your age and have the same size family and financial standing. Discuss the awkward topics, such as whether the planner answers e-mails and telephone calls -- and whether you'll be charged every time she does.

"A good planner should be a tutor, answering questions, telling you what they think and providing a narrow range of choices you fully understand," Bodie says. And if you eventually want to handle your finances independently, make the planner educate you -- for example, walking you through available online tools.

Get a lifecycle Fund
Your 401(k) plan is probably your most valuable possession after your Home. Yet many participants aren't sure how to invest among the array of fund choices. In 2002, a year of tumbling stock values, only one in six employees shifted 401(k) assets, says Lori Lucas of Hewitt Associates, an employee benefits consulting firm. "Most people haven't adjusted their plans, though the market may have changed their portfolio. They're also likely in a new place in their lives and can't tolerate as much risk," she says.

Even though more companies are making 401(k) advice available to employees, the average investor feels it's all too complicated and still too easy to make mistakes, says Lucas.

Enter the "lifecycle" fund. This fund type invests your money in a mix of stocks, bonds and cash, appropriate for your current age and risk tolerance. Then each year, the fund shifts the mix to reflect your age, becoming less risk-oriented as retirement draws closer. According to Hewitt Associates, 55% of 401(k) plans now offer this and other lifestyle funds, compared with 35% in 2001.

"The lifecycle fund is the automatic transmission of investing," says Jill Gianola, a fee-only planner in Columbus, Ohio, and author of The Young Couple's Guide to Growing Rich Together. Anyone at any age can invest in these funds, she adds. They can be used in any type of account, and the expense ratio is typically less than 1%. Because of its one-stop nature, a lifecycle fund is designed to hold most or all of your assets. "It shouldn't be used for 50% of your allocation with the other half spread among other funds," Gianola says. "That will water down its value. I suggest investing 80% or more in the lifecycle fund, with the other 20% split between a small-cap and international fund."

Climb the Financial Ladder

Climb a CD Ladder
Reiner Lomb, 47, of Fort Collins, Colo., has always socked away some of his money in certificates of deposit. "It's where I like to keep my just-in-case money," says the computer industry manager. But about a year ago, with CD rates low, he wondered whether there was a better way to capture a slightly higher rate of return without tying up his money.

When Lomb asked Colleen Miller, a fee-only financial planner in nearby Windsor, Colo., she suggested a "CD ladder." "Instead of putting all your safe money in a five-year CD or a one-year CD, you invest in a series of short-term CDs that continuously come due," she says. "This provides a higher rate of return and the option of using the money, if you need it, penalty free."

Miller's plan: Say you have $10,000. In March, you invest $2,500 in a one-year CD, then $2,500 the same way in June, September and December.

As a result, you'll have $2,500 plus interest coming in every three months in 2005, which you can roll into new CDs (thereby also reducing the temptation to spend it). "I have the option of investing more in a CD when it matures or taking out some cash and reinvesting the old sum," says Lomb.

Another strategy invests in longer term CDs and makes assets available annually. Shop for CDs at local banks or at Bankrate.com, which lists the best CD rates from banks nationwide. There are no fees when you buy a CD, but the penalty for removing money prior to maturity can be up to six months' interest.

Favor ETFs Over Individual Stocks
One of the big lessons individual investors learned over the past four years is that sinking sums in individual stocks is risky. Companies can fold, taking your money with them.

"To create a portfolio that's sufficiently diversified, you'd have to own at least 20 to 30 stocks in a range of industries," says Michael Joyce, a fee-only planner in Richmond, Va., and chairman of NAPFA. "That's impossible for most investors, and it's the reason mutual funds were invented."

But mutual funds have drawbacks. One of the biggest is that no matter when you sell shares, you receive the end-of-day price. So, if you sell 100 shares at 10 a.m. and they drop from $100 a share to $95 by 4:00, you're out $500.

For the diversity of a mutual fund and trading flexibility of an individual stock, consider exchange-traded funds (ETFs), says Joyce. Introduced in 1993, ETFs are indexed -- meaning each of the 135 ETFs available owns the same stocks in the index it tracks. Because ETFs trade like stocks on the major exchanges, shares can be bought or sold anytime during market hours. When you sell, the trade is executed almost immediately.

How do ETFs stack up against the stock index mutual funds you may already own? "An ETF tends to be more flexible and less costly, especially when it comes to management fees," says Joyce. "But I wouldn't recommend selling your index mutual funds just to invest the assets in ETF equivalents."

Rather, Joyce recommends using ETFs to gain index exposure in specific industries. "Instead of buying the stock of a company, buy the industry ETF and you own the entire index," he says. "For example, my parents have about 6% of their IRA split between an energy ETF and a health care ETF, and my dad is a retired mailman."

A full list of ETFs can be found at www.Morningstar.com. ETFs are purchased through a broker or discount broker. Most of them are listed on the American Stock Exchange, and Fidelity and Vanguard are starting to offer their own ETFs.

Catch the Bond-Fund Wave
Interest rates are at historic lows. That's good for people who borrow money to finance Homes and cars, but bad for those who lend money -- which is what you're doing when you invest in bonds. You're lending the government or a company money, and they're paying you interest.

When interest rates are low, bond rates are generally low too. But as the economy improves, more investors buy stocks instead of bonds, causing bond prices to fall and issuers to offer higher rates to attract investment.

"That's why you want to invest now in bonds that mature in short periods of time," says David Yeske, a fee-only financial planner in San Francisco and chairman of the FPA. "If you buy a bond that matures in, say, ten years, you'll be stuck with that low rate just as similar bonds offer better rates. If you sell, you'll sell at a loss."

Yeske recommends investing 40% of your bond allocation in a fund that invests in bonds maturing in 6 to 12 months. "As rates rise, the fund will buy new bonds with higher rates, and its yield will rise over time," he says.

The remaining 60% can go in an intermediate-term bond fund that invests in both the United States and abroad. This will capture the current high rates abroad, Yeske says. "But you want a fund that invests in bonds that mature in no more than five years."

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