INSTRUCTOR: Richard Kilmer
Everyone faces various types of financial risks which must be identified, understood, and where possible, managed. Financial risks are those which involve items that are "payable" to you becoming less valuable or worthless. An example would be a debt owed to you by a person who became unable to repay the money he owes you.
Interest Rate Risk is inherent in any purchase of bonds. When you purchase a bond (or bond fund) the value of the fund will fluctuate according to the current interest rates. If you purchase a 30 year bond when interest rates are high, and then find interest rates going down, the value of your bond will go up, as buyers will now be willing to pay a premium to obtain the higher return. Conversely, if you purchase a bond (or bond fund) and interest rates subsequently rise, the underlying value of your bond will decline. The longer the term of the bond, the more the value is subject to fluctuation in the event of interest rate changes. Therefore the best way to reduce interest rate risk is to purchase shorter term debt instruments.
Market Risk is something we're all familiar with -- as sentiment swings from the extremes of euphoria and fear, the market price of stocks will fluctuate up and down significantly. History has shown that over longer periods of time, the result of stock investments has been very positive, but for funds which may be required in six years or less, the stock market is not an appropriate place to invest.
Another form of risk is "Purchasing Power Risk" -- which is simply another word for inflation. To the extent inflation causes the value of dollars to decline, you're going to need more dollars in future years to maintain your present lifestyle. Any financial planning for individuals requires a realistic assessment of the future impact of inflation.
Given the fact that all financial planning involves various elements of risk, it's important to manage that risk using proven techniques:
Diversification is one technique. It's simply a take off on the old maximum about not putting all your eggs in one basket. Investment categories such as stocks, bonds, and real estate typically don't all go up and down together. By having your investments in different asset categories, you can reduce your overall risk. Note that even within asset categories, diversification is desirable. Thus U.S. stocks can be diversified by industry; and one's overall stock portfolio can be diversified between U.S. stocks and international stocks and funds.
Dollar cost averaging is a technique for averaging into the market rather than dumping into it. This opportunity arises when one has a lump sum distribution, and wants to invest it. If it's all invested at the same time, the result is likely to be less rewarding than if a fixed sum is invested on a periodic basis. This results in buying more shares (in the case of stock or mutual funds) when the market is low; and fewer shares when the market is high.
Periodic asset reallocation: This risk management tool assumes that you will periodically rebalance your portfolio among the basic asset categories: Domestic Stock, Foreign Stocks, Gold, Bonds. Using this technique ensures that you will "buy low and sell high".
Recommended reading: "The Great Boom Ahead", by Harry Dent. This book demonstrates the effect of baby boomers on the overall stock market. The correlation is both surprising and significant. Generally when we're 45-50 we spend less money. The kids are gone, and we don't need such a big house anymore. And we're getting closer to retirement -- so we (finally!) need to get serious about salting $$ away. What's coming? A huge population of new 50s. To the extent this is a valid yardstick, it would suggest that equity markets have another 5 years to go. Generation Xers are smarter, and invest more.
Mutual Funds -- There are more mutual funds than stocks on the NY stock exchange.. The benefit is that for what is usually a very small fee, you've purchased professional management of your assets. The downside to mutual funds is that they distribute all income & capital gains, so you lose a little control over tax consequences. However, this can be can minimized by careful mutual fund selection. Recommends the Janus Worldwide Fund.
Financial Management for Full Timers: There is a unique problem for RVers who spend all or a significant portion of their time "on the road". Banking and investment become more challenging. Probably the most important tool to help manage banking and investment activities is the use of online services, which are offered by many, many banks and brokerage firms. On the investment side, he recommends Charles Schwab, which offers both StreetSmart software (Mac and PC) for managing your investments remotely; and also access to your accout, trading, etc., through their Internet site. The challenge here, as RVers have already discovered, is getting more RV parks to become "Modem Friendly". [This of course is one of the key objectives of RVers Online]
Note: Richard Kilmer's firm specializes in financial planning for RVers.