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By Barbara O’Neill, Ph.D., CFP®, Rutgers Cooperative Extension, [email protected]

In a prior post, five key action steps related to investing were presented: Address the prerequisites, Set SMART investment goals, Understand risk-reward relationships, Understand and accept specific investment risks, and Assess your risk tolerance. This blog post continues the conversation about investing with nine more concepts that investors need to know:

  1. Investment Characteristics- Different investments have different strengths. Common stock rates high for potential growth, bonds and preferred stock for income, and government bonds for safety.
  2. Historical Returns– Stocks have historically outperformed bonds and cash equivalent securities over the long term. From 1926 to 2017, the compound annual return of different types of assets was as follows: small company stocks: 12.1%, large company stocks: 10.2%, government bonds: 5.5%, and Treasury bills: 3.4%.
  3. Loanership Versus Ownership– With loanership investments, such as corporate and government bonds, investors lend money to a company or government entity (e.g., city, county, or state). Investors receive a pre-set interest rate and the promise of a return of their principal. With ownership assets (e.g., stock and real estate), investors purchase all or part of an asset. Investment returns and asset values fluctuate.
  4. Real Rate of Return- To achieve long-term investment growth, investors must earn a higher after-tax return on all of their investments, combined, than inflation. Otherwise, they are losing purchasing power.
  5. Asset Allocation- Asset allocation is the weighting of various types of assets in an investor’s portfolio. For example, 50% stock, 30% bonds, and 20% cash. Investors need to periodically rebalance their portfolio to maintain its original asset allocation weights. Rebalancing can be done by selling securities in an overweighted asset (e.g., stock growth after a bull market) and/or putting new investment deposits in an underweighted asset (e.g., bonds and cash assets after a bull market).
  6. Taxable Equivalent Yield Formula– This formula is used to compare the return on tax-exempt and taxable bonds. The taxable equivalent yield is calculated by dividing the tax-exempt yield (e.g., the return on municipal bonds) by 1 minus an investor’s marginal tax bracket. For example, the taxable equivalent yield of a 4% municipal bond for an investor in the 22% marginal tax bracket is .04 ÷ 1- .22 (.78) = 5.12%.
  7. Dollar-Cost Averaging- This is the practice of investing regular amounts at regular time intervals, such as $100 on the 5th day of every month. Many investors practice dollar-cost averaging automatically through deposits into their employer retirement savings plan or a mutual fund automatic investment plan.
  8. Rule of 72- This mathematical calculation tells how long it will take, or what interest rate is required, to double a sum of money. To solve for the time period, divide a known or assumed interest rate into 72. To solve for the interest rate, divide the desired time frame to double your money into 72.
  9. Investment Record-Keeping- Keep tax returns for up to six years after filing and retirement plan records (e.g., deposits, loans, rollovers, and beneficiary designations) for as long as these accounts are open. Also, save annual account statements from mutual funds and brokerage firms and records of investment sales.

For additional information about the basics of investing, review the OneOp on-demand webinar: Fundamentals of Mutual Funds.

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