Page 183 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Personal Financial Planning

Notes
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Caution Regardless of what type of investments you choose to buy - whether they are
stocks, bonds, or real estate - don’t bet your retirement on one single asset.

As you contribute savings to your retirement fund month after month, year after year, the last
thing you want is for all your savings to be wiped out by the next Enron. And if there’s anything
we have learned from the Enrons and Worldcoms of the world, it’s that even the best financial
analysts can’t predict each and every financial problem.

Given this reality, you absolutely must diversify your investments. Doing so isn’t really that
difficult, and the financial markets have developed many ways to achieve diversification, even
if you have only a small amount of money to invest.

10.2.3 Active vs. Passive Management

Consider buying mutual funds or exchange-traded funds (ETFs), if you are starting out with a
small amount of capital, or if you aren’t comfortable with picking your own investments. Both
types of investments work on the same principle - many investors’ funds are pooled together
and the fund managers invest all the money in a diversified basket of investments.
This can be really useful if you have only a small amount of money to start investing with. It’s
not really possible to take ` 1,00,000, for example, and buy a diversified basket of 20 stocks, since
the commission fees for the 20 buy and 20 sell orders would ruin your returns. But with a mutual
fund or ETF, you can simply contribute a small amount of money and own a tiny piece of each
of the stocks owned by the fund. In this way, you can achieve a good level of diversification with
very little cost.
There are many different types of mutual funds and ETFs, but there are two basic avenues you
can choose: active management and passive management. Active management refers to fund
managers actively picking stocks and making buy and sell decisions in attempt to reap the
highest returns possible.
Passive management, on the other hand, simply invests in an index that measures the overall
stock market, such as the S&P 500. In this arrangement, stocks are only bought when they are
added to the index and sold when they are removed from the index. In this way, passively
managed index funds mirror the index they are based on, and since indexes such as the S&P 500
essentially are the overall stock market, you can invest in the overall stock market over the long
term by simply buying and holding shares in an index fund.

If you do have a sizable amount of money with which to begin your retirement fund and are
comfortable picking your own investments, you could realistically build your own diversified
portfolio. For example, if you wanted to invest your retirement fund in stocks, you could buy
about 20 stocks, a few from each economic sector. Provided none of the companies in your
portfolio are related, you should have a good level of diversification.
The bottom line is, no matter how you choose to diversify your retirement holdings, make sure
that they are properly diversified. There is no exact consensus on what number of stocks in a
portfolio is required for adequate diversification, but the number is most likely greater than 10,
and going to 20 or even a bit higher isn’t going to hurt you.

10.2.4 Troubleshooting

As you build your retirement fund, you’ll likely experience some bumps in the road along the
way. One of the most common problems you’ll encounter is an inability to make your monthly

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