Finance Quarterly #3

By Tiffany Rider - Senior Writer

January 17 - With the New Year upon us, 2012 provides an opportunity to revisit existing investment goals or to set up a new strategy for making money with the least amount of risk.

Once you’ve decided to invest, Lisa Petrie of The Petrie Group with UBS Financial says it is important to set short-term and long-term investment goals that best fit your personal situation. Ask yourself: Why do you want to invest? It may be for a project, a new business venture, a home or retirement. Investors should determine how much money he or she is willing to allocate based on how soon the returns are needed and the level of risk tolerance an investor is comfortable with.

“You [also] want to diversify those funds by spreading it around in several different areas,” Petrie said. “I would consider looking at stocks, bonds, real estate and commodities. Those are probably the main areas in which to invest. Of course, [each have different] risks associated with them.”

Next, determine how much you need to allocate for your emergency funds – maybe through your employer’s 401(k) and/or another type of savings plan. From there, learn what risks are involved with various investment types to be sure what best suits your situation. This is called developing your risk tolerance. “We don’t want people losing sleep at night because their portfolio has gone up or down a certain amount,” Petrie said. “So even though your goal may be that you’re not going to use this money for maybe 30 years . . . emotionally you have to decide if you’re comfortable watching market swings.”

It is also important, Petrie said, for investors to be educated about the default risk, credit risk and potential tax consequences of each asset allocation. Also, investments have headline risk, which means unforeseen events can devalue an investment. This is particularly true in the stock market where negative news can take down an individual stock or even an entire market. Investors must also consider liquidity risk, or how easily and quickly an investor can sell an investment when he or she wants or needs to. Petrie recommends reviewing investment goals with a trusted professional advisor.

Higher risk usually means higher returns, but not always, Petrie said. With bonds, maturity level factors into risk. In the short term, some investments may not perform as well. Petrie suggests longer-term is usually a lower risk strategy for both stocks and bonds.

According to Petrie, U.S. Treasury bonds are the most conservative bond investment, but have a much lower return than a more risky high-yield bond. High-yield bonds are typically a lower quality investment due to the higher risk associated with the issuing entity, whether corporate or municipal.

“Even though bonds as a whole did really well in 2011, high-yield bonds did very well [in particular], better than, say, a Treasury [bond], because interest rates did not go up,” Petrie said. “They actually went down for the year. The credit of the United States, the economy . . . as a whole improved, so those did even better. But [there was] a period a couple of years ago where if we had a company teetering on the brink of bankruptcy, with the whole economic outlook being bad, those [bonds] would not have done well at all.”

Bond values have an inverse relationship with interest rates: if interest rates increase, the value of the bond will go down and vice versa, although the yield stays the same for as long as an investor owns that individual bond.

Stocks basically go up as earnings go up, and earnings go up as companies grow and expand. Stocks tend to see the most fluctuation with changes in the market and the economy, but can produce the highest return depending on timing. Over very short periods of time, stocks do better in low inflation periods. “If we get 10 percent inflation overnight, stocks suffer in the short term,” Petrie said. However, she continued, stocks held for longer periods of time are basically not affected by inflation. “Those short-term spikes in the market even out, so stocks generally appreciate at a greater rate than inflation over time,” she said.