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Articles from the tag of 401k
Investment Strategy - what's that?
Posted by: Joseph E Poff, CPA CITP from Auburn Software, Inc. on Friday July 2, 2010 at 4:08 PM   (-07 GMT) | Comments (0)
Tags | 401k, | Investing, | IRA | Categories: | Accounting - 401ks, | Financial Markets - Mutual Funds, | Accounting - Retirement Valuations

Do you have an investment strategy? Do you even know what that is? Does it consist of a 401k voluntary deduction each pay period that goes into some fund but you can't really remember which one? Well, don't feel alone - that's the approach of a lot of people I've worked with through the years.

It's ok to have a hands free investment approach to some degree but you don't want it to be totally hands free. If you're driving a car, a boat or flying a plane - all will go pretty much on their own - but you do have to steer occasionally and sometimes stop for gas. Once in awhile you also need to have an inspection of your means of transportation and make repairs. The same is true with your investments.

First - which fund(s) get your money? Funds are often very specialized now with exotic titles such as "The Fund of the Penny" whose stated objective is 'To corner the market on the 1963 US penny and then drive the price up and sell taking a capital gain on the increase in value". Ok - ok - I'm kidding, but there are some very very specialized funds you can invest in. Would the one I listed make sense? No. Do you know that you haven't already invested in it and don't know it? Well it is a fictitious fund ( I think) - but you see the point - you don't know if you don't spend a few minutes looking at it.

I'm constantly amazed that I'll see individuals spend hours - days - months arguing with the phone company over an extra $3 charge but won't spend any time looking at their 'very very large' retirement portfolio. Why? Usually it's because they have trouble understanding it and feel better leaving it in the hands of someone else. This is the 'close my eyes and hope for the best' approach and lots of times that works out ok. It's dangerous to do this though.

I can understand individuals not understanding investing and shying away from it. Working on that phone bill is easier because it's easier to understand. However, investing isn't so complicated - it's just that a lot of people haven't been exposed to it. Learning a little bit about it seems 'very complicated' because the terms are unfamiliar and they come fast and furious especially if someone is selling you something. No one wants to feel like an idiot and show that they don't understand. But you know - that's 'wrong'.

It's just like anything new - boating, flying, bee keeping, rocket building - all are hard in the beginning, but once you pick up on the 'lingo' - which will come quickly - you'll start making a lot of progress. It is hard in the beginning - that's for sure - especially the rocket building - ha ha - but soon the terms make sense and everything starts to fall into place.

In investing terms such as mutual funds, money market funds, T Bills, contract buy downs, reverse mortgages - all of these are terms (and lots of others) most people have heard of but may not be really familiar with them.  And to invest wisely, you don't need to know how to put together your own mutual fund - but broad stroke concepts are good things to know. This was one of the reasons I designed and developed Economics 411 - to expose individuals to some of the different types of investments and to illustrate things such as the dollar impact over say 10 years of investing in a passbook savings account versus 10 years with a money market account or CD. I think that seeing that in black and white in the game will resonate with them. They'll go - wow - I never understood that but do now.

Staying with mutual funds - you need to know how to value them. This is easier in recent years, but there are two parts to a mutual fund. One is that the mutual fund passes out earnings. The other part is the per share value of the fund.

Let's say you have a fund - we'll call it "The Fund of the Penny" - and the value per share at the end of the year was $27.40. Earnings for the year were $.75 a share and the value of the fund at the beginning of the year was $28.65. You have 1,214 shares. How did you do for the year? Should you invest more?

Well, let's look at that.

Beginning of the year value $28.95 per share
Earnings $    .75
End of year value should be if the market value held steady $29.70
End of year value is $28.65
Loss $  1.05

So, you didn't do too good on this - it lost $1.05 a share or 3.6% of it's value.

Now suppose the fund had paid out $2.00 a share during the year - what then? Well, that would mean you actually made $.95 a share. So, as you can see you need to really look at your investments to track how they are doing and if you need to change to a different fund.
With your retirement funds - not just mutual funds - you don't necessarily just want to look at just one year or some isolated period. I remember one time at a client's company retirement plan meeting (Profit Sharing Plan) - there was my client, his investment person, myself and about 30 employees. The investment person had prepared statements for the overall performance of the fund. He showed me his handouts prior to the meeting and they showed that from August to December the retirement funds had increased something like 25% - in just those 4 months. Pretty impressive.

What he 'hadn't' shown was that from January to August the fund has lost 50% ( I can't remember the numbers exactly). In any event the year ended up being a 25% loss (if my math' s correct) for the year - something I told him I'd have to point out in the meeting when I gave my report. Sure enough - the crowd was all pumped up from him and his 25% increase since August. Following him reminded me of when I went to one of the local schools for career day and watched the fireman come in with his fire truck, hoses and gear; the veterinarian with his cages and the animals he brought in; and me - with my mechanical accounting pencil. The crowd was ready to go and I was about to give them a downer. At least then I was able to tell the kids that we had a rock band they'd know as a client.

So, I followed the gentleman and gave out my report which shortly generated questions regarding why my report showed a 25% loss for the year and the broker's show a 25% gain? I had to explain that while his was 'technically correct' - it was limited to that time period - August through December. My report covered the whole year which also encompassed the drop in the market that occurred in early August of that year (some of you will remember the time I'm talking about).

My dad often said - 'figures don't lie but liars figure' so there you go. You can often distort numbers to your needs so make sure of what you are comparing - be consistent. Ask questions of your advisors. Never be embarrassed that you don't know something. Fire your advisor if they can't or won't answer your questions - or seems disinterested. Only doctors are allowed to not pay attention to you!! (Ha ha - just kidding Dr's that are clients.) Don't take that from your advisors.

I'd often tell my older clients that it took them all their life to accumulate their wealth - and in all likelihood if they lost it now there won't be enough time left in their lifetime to rebuild it. So, one of the keys is principal preservation. As you get older, you generally want to start picking a little more safe investments rather than worrying about getting an extra bit of interest. Sometimes it's not worth the risk - but of course you have to review your overall portfolio. Which brings up a good point - diversification - that will be in an upcoming article.

Invest safe and wisely and have fun!wisely and have fun!

Joseph E Poff, CPA
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