Frequently Asked Questions
The investment process is comprised of several steps that enable you to select a portfolio appropriate to your risk tolerance and desired return. The primary steps in this process are:
- Determine your desired return and risk tolerance
- Develop an asset allocation plan
- Select diversified investments within each asset class
- Monitor your investments
Q: How are risk and return related?
A: Risk and return are positively correlated. The higher the risk of an investment, the higher a return it must offer in order to compensate for the risk. Risks come in many forms such as the volatility of the market, inflation risk, interest rate risk, and business risk. You must determine the degree of risk that you are willing to tolerate. Your investment professional can assist you in this process.
Select the level of risk that permits you to sleep at night. If you have a long investment horizon, then focus on your desired return. Year to year fluctuations should not be a concern. Over the long term, stocks have generated annual returns of about 10 to 11 percent and have had the highest level of risk while long-term government bonds have had long-term returns of 5 to 6 percent and have had the lowest level of risk. The more risk you can tolerate or the higher your desired rate of return, the higher the portion of your portfolio invested in stocks should be.
Q: What is an asset allocation plan?
A: Asset allocation is the distribution of investments among asset classes. Asset classes include different types of stocks, bonds, and mutual funds. It is a significant factor in determining your investment return relative to risk. Proper asset allocation maximizes returns and minimizes risk. This is because different classes of assets react differently to economic upswings or downswings. Allocation differs from diversification in that it balances a portfolio among different classes of assets, for example, growth stocks, long bonds, and large-company stocks, while diversification focuses on variety within an asset class. Generally, allocation among six or seven asset classes is recommended.
Q: What is diversification?
A: Diversification is the selection of multiple investments within a portfolio. For example, investing in a portfolio of 30 stocks rather than in just a few. By maintaining a diversified, varied portfolio, you are minimizing risk. You’re less likely to make that “big killing,” but when individual investments take a nose-dive, you won’t take a big hit.
Q: How can I best monitor my investments?
A: Examine carefully and promptly any written confirmations of trades that you receive from your broker, as well as all periodic account statements. Make sure that each trade was completed in accordance with your instructions. Check to see how much commission you were charged, to make sure it is in line with what you were led to believe you would pay. If commission rates have increased or will increase in the immediate future, or if charges such as custodial fees are to be imposed, then you should be informed in advance.
If securities are held for you in street name (where the customer’s securities and assets are held under the name of the brokerage firm instead of the name of the individual who purchased the security or asset), you may request that dividends or interest payments be forwarded to you or put into an interest-bearing account, if available, as soon as they are received, rather than at the end of the month or after some other lengthy period of time.
Set up a file where you can store information relating to your investment activities, such as confirmation slips and monthly statements sent by your broker. Keep notes of any specific instructions given to your account executive or brokerage firm. Good records regarding your investments are important for tax purposes, and also in the event of a dispute about a specific transaction.
Periodically, ask yourself the following questions about your investment:
- Is this investment performing as I was told it would?
- How much money will I get if I sell it today?
- How much am I paying in commissions or fees?
- Have my investment goals changed? If so, is the investment still suitable?
- Have I decided what contingencies need to happen for me to sell the investment (i.e., a certain percentage decrease in value)?
What types of risks are involved in investing?
Nobody invests to lose money. However, investments always entail some degree of risk. Be aware that:
- The higher the expected rate of return, the greater the risk. Depending on market developments, you could lose some or all of your initial investment or a greater amount.
- Some investments cannot easily be sold or converted to cash. Check to see if there is any penalty or charge if you must sell an investment quickly or before its maturity date.
- Investments in securities issued by a company with little or no operating history or published information may involve greater risk.
- Securities investments, including mutual funds, are not federally insured against a loss in market value.
- Securities you own may be subject to tender offers, mergers, reorganizations, or third party actions that can affect the value of your ownership interest. Pay careful attention to public announcements and information sent to you about such transactions. They involve complex investment decisions. Be sure you fully understand the terms of any offer to exchange or sell your shares before you act. In some cases, such as partial or two-tier tender offers, failure to act can have detrimental effects on your investment.
- The past success of a particular investment is no guarantee of future performance.
What steps can I take to avoid unnecessary risks?
1. Never give in to high pressure. A high-pressure sales pitch can mean trouble. Be suspicious of anyone who tells you, “Invest quickly or you will miss out on a once in a lifetime opportunity.”
2. Never send money to purchase an investment based simply on a telephone sales pitch.
3. Never make a check out to a sales representative.
4. Never send checks to an address different from the business address of the brokerage firm or a designated address listed in the prospectus.
If your broker asks you to do any of these things, contact the branch manager or compliance officer of the brokerage firm.
5. Never allow your transaction confirmations and account statements to be delivered or mailed to your sales representative as a substitute for receiving them yourself. These documents are your official record of the date, time, amount, and price of each security purchased or sold. Verify that the information in these statements is correct.
What questions should I ask before making any investment?
Have this list of questions with you the next time you talk to your broker. Write down the answers you get and the action you decide to take. Your notes may come in handy later if there is a dispute or a problem. A good broker will be happy to answer your questions and will be impressed with your seriousness and professionalism.
- Is this investment registered with the SEC and a state securities agency?
- Does the investment match my investment goals?
- How will the investment make money for me (dividends, interest, capital gains)?
- What set of circumstances have to occur for the value of the investment to go up? To go down? (e.g., must interest rates rise?)
- What fees do I have to pay to buy, maintain, and sell the investment? After fees, how much does the value have to increase by before I make a profit?
- How easy is it for me to unload this investment in a hurry, should I need the money?
- What are the specific risks associated with this investment, for example what is the risk that rising interest rates will devalue your investment or the risk that an economic recession could decrease its value?
- Is the company experienced at what it is doing? How long has it been in business? What is their track record? Who are their competitors?
- Can I get more information: a prospectus, the latest SEC filings, or the latest annual report?
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