Business of Investing - 3
By Saghir Aslam
(The following information is provided solely to educate the Muslim community about investing and financial planning. It is hoped that the ummah will benefit from this effort through greater financial empowerment, enabling the community to live in security and dignity and fulfill their religious and moral obligations towards charitable activities)
Risk and Reward: Mutual Funds
Mutual funds pool the money of many investors and invest in diversified portfolios of stocks and/or bonds to help manage the risk of single investments. Funds provide professional investment management, research and record-keeping. If you are considering a mutual fund, request the fund's prospectus and its Statement of Additional Information, and read these materials carefully before making a decision. Study the fund's performance record over the last ten years, and compare it with the performance of other funds of the same type.
If the fund has been successful, see whether the senior managers responsible for its success are still there. Make sure the fund's investment objectives and philosophy are compatible with your own. Keep in mind that past performance is not a guarantee of future results.
Making Interest-Rate Fluctuations Work for You
Changes in inflation and interest rates have major effects on both stock and bond prices. Predictions about their movements are a major focus of market analysis and business journalism, but are not always reliable. One way to make interest-rate and price changes work for you is through time diversification.
For stocks, time diversification can take the form of dollar-cost averaging. This means investing the same number of dollars in the chosen security at regular intervals, without regard to current prices. The result is that you buy more shares when prices are low, fewer shares when prices are high. Over time, the average purchase price of your shares is lower than if you had bought an equal number of shares at each interval. You're protected against the risk of buying the entire investment at the top of the stock's price range. (Of course, you also give up the chance of buying the entire investment at the bottom of the price range.)
Dollar-cost averaging, though a beneficial strategy for many investors, does not guarantee a profit and does not protect against a loss in declining markets. Such a strategy involves continuous investment -- so before starting a program, consider your ability to continue purchases through periods of low price levels.
For bonds, time diversification can take the form of a bond ladder. If new money becomes available each year, this works much like dollar-cost averaging for stocks, as you can invest roughly the same number of dollars in new bonds at current interest rates.
But even without new money, you can diversify over time by staggering the maturities of your bonds. As a portion of your portfolio matures each year, the face value is reinvested in new bonds at current interest rates.
In a five-year ladder, for example, the portfolio is divided evenly among bonds maturing in each of the next five years. As each year's bonds mature, the proceeds are invested in new five-year bonds. The strategy depends on a normal interest-rate environment, one in which short-term issues have lower coupons than longer-term issues.
All these forms of time diversification can help you smooth out the effects that interest-rate and market fluctuations have on your portfolio.
For more information, or for assistance managing personal or business finances, talk with your Financial Advisor.
(Saghir A. Aslam only explains strategies and formulas that he has been using. He is merely providing information, and NO ADVICE is given. Mr. Aslam does not endorse or recommend any broker, brokerage firm, or any investment at all, or does he suggest that anyone will earn a profit when or if they purchase stocks, bonds or any other investments. All stocks or investment vehicles mentioned are for illustrative purposes only. Mr. Aslam is not an attorney, accountant, real estate broker, stockbroker, investment advisor, or certified financial planner. Mr. Aslam does not have anything for sale.)