Ralph Bovitz, CPA, PFS

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Investing - Some Fundamentals

By Ralph Bovitz, CPA, PFS

     Lawyers generally know little about investment planning, even the ones who spent their undergraduate years majoring in business administration, economics or finance. Aspiring attorneys who majored in history, political science or sociology probably received even less exposure to it. As a result, you may view the capital markets, meaning stocks and bonds, with some distrust or even dismay. This is understandable. When things look good, the market goes down and when things look bad the market goes up, which doesn’t make sense. Yet the money you are making needs to be invested in something that pays better than a savings account or certificate of deposit if you want to cope with inflation and see your money grow.

     A lesson in fundamentals may be all that is necessary to feel comfortable investing your money in stocks and bonds, and still focus on your law practice.

     Bonds are interest-generating investments. Interest-generating investments are promises by a company or the government to repay you the amount you lend them on a specific future date; until then, the company or government will pay you interest for allowing it to use your money. You will receive the money that you loaned them unless the company or government goes bankrupt.

     Although bonds generally incurs a lesser risk than stocks, the negative for such an investment is inflation. With a 3.1 percent inflation rate, $1,000 loaned today will have a buying power of $737 in 10 years, when you are repaid. So bonds are best used for short-term investments, generally less than five years. Then the impact of inflation is not as serious.

     Stocks, on the other hand, are equity investments. These represent direct ownership of a company, unlike a bond that is just a loan to a company or the government. Stocks have a potential for greater growth and, yes, loss. Unless you are buying high-risk, speculative stocks, however, your potential for total loss is possible but not likely.

     The downside to investing in stocks is euphemistically called "volatility." Said another way, when the share price zooms up and then just as suddenly and dramatically zooms down, you are experiencing volatility. Generally, you are compensated for that zooming and possible loss by a bigger return than you would receive from a bond. Because of this volatility, investment in stocks should be undertaken when the need for the money is many years away, usually more than five years. Historically, as the years pass, the zooming smoothes out, accompanied by a general upward growth to your investment. The goal for stock investments is typically retirement or a child’s education.

     To achieve adequate diversification in order to lessen your risk of loss, many stocks should be owned. To get the best break on the transaction cost of buying stocks, purchases should be made in lots of 100 shares.

     It is generally easier and cheaper for busy attorneys to buy stocks through a mutual fund, where with a modest investment in the neighborhood of $1,000, you can buy mutual fund shares that individually represent pieces of hundreds of different companies. The stocks that a mutual fund buys normally display similar characteristics, based upon the investment policy the fund adopts. For instance, a mutual fund may declare it will only buy very large companies, very small companies, companies in-between or foreign companies.

     It is considered important for mutual fund stocks to remain "pure" because certain categories or types of stocks behave differently than other types at the same point in time. For example, when large company stocks are falling in value, small company stocks may be increasing in value or not falling as much. A mutual fund describing itself as a foreign stock investment that adds a significant domestic presence will be diluting the foreign exposure you are seeking for your portfolio.

     Another good way to diversify is to select different categories of mutual funds. Categories that may be included in your portfolio are small, large and foreign company stocks. To that mix add foreign and domestic corporate, municipal and U.S. Treasury bonds. Asset allocation is the moniker applied to the selection of different categories of stocks and bonds.  Over time, asset allocation has shown itself to be the most successful way to achieve the best return, consistent with an acceptable amount of volatility and risk.

 

 

 

 

 

 

 

 

 

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