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If you have participated in the recent roller coaster ride of the Nasdaq or Dow Jones Industrial Average, you see that market volatility can be very unsettling. This is especially true if you are in your 20s or 30s, have only experienced our current long-term bull market, and have never known a down market. Or perhaps your checkbook is finally in the black after paying for those essentials like shelter, food, clothing and your share of the Hampton’s summerhouse and you have a few dollars to invest. You might be wondering when is a good time to “get in” the market. Under either of the above scenarios, a refresher on the basics of investing may prove to be helpful. As with life, investing in the market is about risk and reward. The decision to invest in the stock or bond market presents the investor with considerably more risk than putting their money in a certificate of deposit at a local bank. However, the reward for taking such risks is greater return on investments. It is well documented that over a long period of time, “safe” investments such as bank accounts perform slightly above inflation, creating little real asset growth for the investor, while investing in equities yields a rate of return in excess of inflation, increasing an investor’s wealth. Along with this greater rate of return however, comes risk. Risk can come in the form of market volatility. Both the stock and bond markets have ups and downs, possibly making an investor’s paper gains or wealth disappear in a matter of weeks (or hours) as we saw in last month’s Nasdaq and Dow gyrations. Even with the ups and downs of the market, historical analysis has shown that the equities market has out-performed other types of investments in the long run. Keep in mind, however, historical rates of return are no guarantee of future performance. After deciding to commit funds to the stock or bond market, an additional element of risk comes into play when an investor asks, “what particular security should I buy?” Many individuals are of the opinion that choosing the right stock is similar to going to Las Vegas and playing blackjack. There are many success stories of individuals who have invested in Wal-Mart or Cisco Systems when it was a start-up, and a several thousand-dollar investment turned into a million dollars. There are a greater number of stories of individuals who have invested in companies that have gone bankrupt, wiping out their entire investment. What makes choosing the right security even more difficult is that a security’s price is not necessarily a reflection of the underlying fundamental value inherent in a company. Instead, many outside factors influence what a security is valued at. All of these factors add to the elements of risk when investing in securities. GAUGE RISK TOLERANCE So, what should one do? First, an individual must realistically gauge their tolerance for risk. Riskier investments usually provide the opportunity for greater reward. Unfortunately, they also provide the opportunity for greater loss. If you are the type of individual who is risk-averse and are going to get an ulcer every time your portfolio goes down in value, risky investing is not for you. You have enough to worry about with the happenings of your career and home life. In most situations, a successful career in law will be your meal ticket, not the managing of your portfolio. This type of investor should invest conservatively. If you are a risk taker however, and do not mind seeing fluctuations in your portfolio, risky aggressive investments usually produce greater reward in the long run. One must also consider risk and volatility in light of their investment time horizon. A longer period of time to invest allows the ups and downs of the market to even out. A younger investor with a longer time horizon can ride through several business cycles and look for long-term appreciation and should therefore be less concerned with short-term volatility. An older investor, nearing retirement, may have a need to cash in investments sooner and should be more conservative in their investment style. Individuals should plan their current asset mix based on their investment time horizon and risk tolerance. Studies have been performed to determine the optimal mix of assets and investments for individuals at various stages of their life. The right asset mix can help minimize overall risk and maximize return. For instance, younger investors should have a majority of their assets in more risky investments such as stock with better long-term appreciation potential and less of a percentage of their assets in conservative investments such as bonds or certificates of deposit. Individual investing styles can also vary. Some investors follow a buy and hold approach, purchasing securities and not following their day-to-day price fluctuations. This can create great long-term appreciation. However, buy and hold investors must be sensitive to overall changes in the fundamentals of the companies they invest in or changes in a particular industry. For example, tobacco stocks were a sound investment a number of years ago, but because of changes in the industry due to litigation risk, they are less appealing today. Some investors engage in value investing, looking for undervalued stock with long-term appreciation potential. Others can be labeled momentum investors, following the current hot market. Examples of momentum investing can be seen in recent explosion (and subsequent implosion) of dot-coms, tech, new media and bio-tech sectors of the stock market. Whichever investment philosophy suits you, experts generally recommend you stick to that philosophy over the long-term. RESEARCH TOOLS No matter what type of investor you are, many great tools previously reserved for the market pros now exist which provide current information to help you make sound investment decisions. Remember, if you are going to do your own investing, invest wisely and be sure to do your homework on those companies you consider investing in. Another good rule of thumb is never to invest more than you can afford to lose. Borrowing to invest, known as buying on margin, is a very dangerous proposition. For those interested in investing but who do not have the time, inclination or experience to manage a portfolio, consider investing through a mutual fund. If your asset base is large enough, you can also consider using a professional money manager. Although you pay a fee to the fund manager, having a quality investment manager to make your buying and selling decisions for you can save time and anxiety. Not all funds are created equal, so before investing be sure to examine the fund management, prior historical performance, fund investment philosophy and fees charged. Rating systems exist which can help an investor choose the mutual fund that will best suit their needs. Clarence G. Kehoe, CPA, is a tax partner and the director of Anchin, Block & Anchin LLP’s pension and employee benefit plans practice, as well as a member of the firm’s Law Firm Services Group.

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