When the recession deepened, many contracting businesses depleted liquidity. As markets recover, now is an appropriate time to review investment strategies for rebuilding lost wealth. This month, we take a look at a common investment vehicle and one system for selecting products.
The most common investment
The most common individual investment choice is the mutual fund, which is a professionally managed investment that combines individual shareholders’ money to purchase stocks, bonds and money-market products, such as bank certificates of deposit and U.S. Treasury bills. More specific niche funds also have appeared, and your investments can be coordinated with your ethics and belief systems. For example, your chosen fund might select products based on sensitivity to environmental impact or emerging markets in developing countries.
The advantages of putting your money in mutual funds include relatively low-risk, fairly lucrative returns and professional management. Individual investors almost never generate equivalent returns by purchasing or selling individual stocks, and “timing the market” (cashing out and reinvesting based on market swings) is equally unrewarding. In contrast to the amateur player, a professional mutual funds manager works full-time to research and monitor individual products, seeking the optimal mix to maintain the highest possible return over time, regardless of market conditions.
It is well-documented that stocks performed at twice the rate of bonds over the last century, although when stocks produce, bonds typically perform poorly, and vice versa. Currently, banks offer extremely low rates on CDs and savings accounts, and only their debtors derive comfort from lower loan interest rates. During these expected cycles, timing is critical to maximizing returns and minimizing risks. For most investors, mutual funds still offer a reasonable choice over the long run.
Selecting a mutual fund requires some effort. While no-load funds do not charge commission on individual trades, management or administrative fees can vary considerably. Also, the historical pattern of returns will vary, and wide variances will be more important if you are nearing retirement.
The 10-10-10 system
One system you might use to choose a mutual fund is the 10-10-10 method, which is based on several criteria. First, the fund has existed for at least 10 years. Second, the same manager has made the investment decisions for at least 10 years. Finally, the average return (which includes increases in the value of the invested money plus any dividends earned) must be at least 10 percent for at least 10 years.
Although it will be harder to find mutual funds that meet such criteria in this economic environment, it is still a sensible and conservative approach. You are measuring consistency of management decision-making and a very attractive average return over a period of time that minimizes the impact of short-term shifts in values.
Degree of risk
The patterns of variance over time also affect investment returns. If there are two mutual funds producing the same overall results, ensure you look at the growth patterns over the past decade. If one fund shows steady growth with few large spikes or dips, while the other has a wildly varying wave pattern, your return may be drastically reduced if you invest at a peak time and withdraw your money when the fund has hit a severe low. To minimize such risks, mutual fund managers work to produce steady returns over time.
Returns are related to degree of risk and timing. As a contractor, you should expect substantial returns on your investment in your own company (about 20–30 percent), since the construction industry is a high-risk environment. If you are building your wealth to ensure a comfortable, secure retirement, the longer your funds are able to grow, the more likely you will reach your goal. Advisers suggest that you invest in lower risk vehicles if you are nearing retirement, while the 20-something investor can afford higher risk levels to generate higher possible return, with decades to reverse any errors. Automatic investment programs, authorizing a monthly withdrawal from your checking account, minimize the attention you need to devote to your investments. The more you invest, the more compounding builds your wealth.
There is always risk, of course. Successful investors have great timing and a special talent for predicting trends in politics, economics, or other factors affecting the stock market. Ultimately, investment is always a form of gambling, and a certain degree of luck is always present. Over the long term, if you choose a well-managed vehicle with a reasonable risk level, you should experience growth. If you have a low risk tolerance and expect ever-increasing growth with no losses, have someone else open your statements, and hope for good luck.
Next month, we’ll look at picking stocks, hedge funds and arbitrage.
NORBERG-JOHNSON is a former subcontractor and past president of two national construction associations. She may be reached at firstname.lastname@example.org.