Some ideas for investing those savings safely

Milton Kiang
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Personal finance Funds should be divided into three pools

Do you hate the fact that your money could be earning more than the meagre interest rates from your savings account or in government T-bills? Getting a handle on your savings is no easy task, one which requires careful thought, planning, and finally, action. It doesn't come overnight and there are no easy formulas to apply.

You can find hundreds of books on this subject at your local library, but the problem is sorting through all that information, and more importantly, identifying the information that addresses your needs.

Do you hate the fact that your money could be earning more than the meagre interest rates from your savings account or in government T-bills? Getting a handle on your savings is no easy task, one which requires careful thought, planning, and finally, action. It doesn't come overnight and there are no easy formulas to apply.

You can find hundreds of books on this subject at your local library, but the problem is sorting through all that information, and more importantly, identifying the information that addresses your needs.

Assessing your needs

The first step is to assess your investment needs: Are you investing simply to stay ahead of inflation? How much risk can you tolerate? Are you investing for your future retirement?

You should be dividing your savings into three pools: The first is cash that you may suddenly need, covering living expenses for three to six months in case of emergencies. The second pool is your nest egg, what you need for your retirement or down payment on your future home. The third is for medium- to high-risk investments, money you can risk in return for higher yields.

First pool

The first pool should be placed into an investment that is safe, such as a Guaranteed Investment Certificate (GIC) or a Government of Canada Treasury Bill.

Although your money will earn low interest rates (currently lower than the rate of inflation), it isn't subject to the volatility of the market, and you always get your money back plus interest.

At the time of this writing, a three-month GIC earns you about 1.8 per cent at most Canadian banks.

A good choice would be a short-term GIC renewable upon expiry. On top of the GIC, it is advisable to keep one to three months of cash in your savings account to tide you over until your GIC matures.

Second pool

The second pool represents funds put into low-risk investments. This pool represents your future retirement fund, or the future down payment on your home, and therefore most people cannot afford losses when there is a downturn in the market and the investment money is urgently needed.

A person's RRSP funds commonly represent the second pool and can be invested into mutual funds, stocks, fixed income securities, GICs, T-bills, and mortgages.

A popular choice is a balanced mutual fund that is invested in a combination of equities and fixed-income securities.

A mutual fund is considered to be less risky because the fund is diversified into a large basket of stocks and bonds, and so a sudden drop in a few of these will not greatly affect the fund's overall price.

You may also consider stocks that are considered "safe plays": Large-cap blue-chip stocks that pay handsome dividend rates (three to six per cent) and enjoy steady capital growth over the long-term. The risk is that stocks, like any other investments, can go up and down, but generally the volatility with established blue-chip companies is less compared to smaller-cap stocks.

You must study the company in which you are investing: What is the company's niche in the marketplace? How has their stock price traded during the last three to five years? How consistent are their dividend payments? What were the company's earnings (profits) during the last three to five years?

If you intend to invest in stocks (not "play" the stocks, there's a difference), then you must study a company's annual report. There's a lot of information in the library or on the web that explains the basics of making stock investments.

Real estate is a favourite investment for many, providing steady capital gains over the long-term, subject to less volatility than stocks or even mutual funds.

Many would prefer allocating their rent toward equity in their own home rather than into a landlord's pocket.

The downside to real estate is the length of time it takes to accumulate the down payment.

Second, while it's true that your rent goes toward your investment, for the initial period, all or most of it goes to paying your bank's interest on the mortgage. So investments in real estate make sense in a market when property values are trending up.

When property values go down, you may find yourself in a "negative equity" situation, where you end up owing more to the bank than what your property is actually worth in the market.

In the U.S. and U.K. today, many homeowners are in a negative equity situation due to falling housing prices caused by the subprime credit crisis.

Thus, in an environment where there are falling housing prices, you should put your cash elsewhere until property prices stabilize.

Third pool

The third pool represents funds that you can risk in return for higher rates of return.

The portion you allocate to this pool depends on many factors, such as your age, monthly income, or your retirement plans.

For example, if you're still young with many working years ahead, you may apportion more money into this pool than into the second.

In deciding on how to invest these funds, I find investment newsletters invaluable. Today, there are numerous investment newsletters available for subscription between $99 and $300 per year.

For example, The Motley Fool (www.fool.com) recommends in its monthly newsletter, The Stock Advisor, two stocks a month, complete with a detailed analysis of the company: earnings; market niche; cash flow and balance sheet; management profile; and why the stock will outperform the market in the long-term.

The newsletter also contains a performance chart of all its recommended stocks: How they are faring in comparison to the S&P 500, and which ones are being maintained as "hold" and which ones ought to be sold.

(The newsletter issues an "alert" via e-mail when it's time to sell a stock.)

The Complete Investor (www.completeinvestor.com) is another favourite of mine, where several stocks are recommended each month, each stock representing "High Growth," "Income Growth," "Small Cap" and other categories geared to your investment preferences and risk tolerance.

China Strategy (www.chinaprofitstrategy.com) recommends companies that profit from China's explosive economic growth. Recommended stocks consist of Chinese companies as well as U.S. and multinational firms, each of which currently or potentially dominate various segments of the Chinese market.

DIY?

If you have no time to handle your own investments, you may choose to outsource this responsibility to a financial planner.

Of course, the success of your portfolio depends on the skills and acumen of your planner, but what could be more important than getting a handle on your own investments?

There are some who spend lots of time researching the pros and cons of the latest flat-screen TV, yet have no time to handle their own investments.

If you do engage a financial planner to invest all or part of your money, be sure to ask them why they are making each investment, what are the pros and cons of those choices, and the time horizons.

Organizations: Government of Canada Treasury Bill, The Motley Fool, S&P

Geographic location: U.S., U.K., China

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  • Mr
    July 02, 2010 - 13:30

    Real estate is a favourite investment for many, providing steady capital gains over the long-term, subject to less volatility than stocks or even mutual funds.

    Hello!?! The value of property can go down as well as up...have you not noticed what happened south of the border (and will happen here to a lesser degree over the coming 18 months)?

  • Mr
    July 01, 2010 - 20:18

    Real estate is a favourite investment for many, providing steady capital gains over the long-term, subject to less volatility than stocks or even mutual funds.

    Hello!?! The value of property can go down as well as up...have you not noticed what happened south of the border (and will happen here to a lesser degree over the coming 18 months)?