What's Your Bag?
Q: I've been investing for a long time and have most of my investments in equities of one form or another. After the stock market's correction last October, I've become a lot more interested in asset allocation. What is it, and can it help protect my portfolio?
A: Asset allocation is the process of divvying up your assets into different categories, including stocks, bonds and cash. It is widely believed that a large part of an investor's return on investment is related to his or her mix of asset classes.
Think about it: If you invest all your money in stocks, in a bull market your investments will probably outperform those of your mother-in-law who divides her investments equally among stocks, bonds and cash. Of course, if the Bears return to Wall Street, a portfolio that is 100 percent invested in equities could take more of a beating than a more diversified one. The thing to remember is not how your investment performs for you in the short term but what kind of risk you can tolerate over the long haul. Asset allocation is for long-term investors, not those who try to time the market.
Q: I am a member of a new investment club and have never invested before. I have read about technical and fundamental analysis, but after 10 years of therapy, I don't want to spend any more time on anyone's couch. What are these techniques and are they for me?
A: That's a good question. Here's the answer: Fundamental analysts study such things as a company's sales, earnings per share, profits, management style and competitive environment to discern whether its stock price will rise or fall. They usually consider a company's annual report an important tool.
Technical analysts concern themselves with charts of the historic movements of a stock's price, looking for patterns that could help them predict its next direction. These analysts study such tools as advance decline lines, and look for "support" and "resistance" levels. Many investors combine styles--sort of like using both psychoanalysis and Gestalt therapy.
Q: I recently purchased a computer and have found a whole new source of information and advice about stocks and investing. What with chat rooms, online investment information services and online brokers galore, I'm unable to absorb it all. So much advice is available that I don't know which way to turn. What should I do?
A: Another good--and timely--question. Sources of information are appearing more rapidly than the ability of regulators to govern them, so the best thing to do is research any idea before you invest. After all, what may be good for some investors may not suit you. Before deciding, check to be sure the investment fits your needs for growth or income, risk and reward, and short or long time-frame.
During the October 1997 market correction, some investors who depended on online brokers were disappointed by their inability to access their site or input trades and receive timely executions. Many online services have since upgraded their sites, but unlike full-service firms, most online services didn't compensate subscribers for order delays. Basically, you get what you pay for. Still, some inexpensive executions may be worth a little inconvenience.
Q: Although I'm familiar with many aspects of investing, my 10-year-old recently stumped me when he asked what the Dow Jones Industrial Average (DJIA), the Nasdaq and the Russell 2000 were. I could kind of fake the first two, but I'd never heard of the last one. It's a registry of small terriers, isn't it? Please help!
A: First, the Russell 2000 has nothing to do with dogs, at least not the barking kind, but let's take it from the top.
The Dow Jones Industrial Average is a registered trademark of Dow Jones Inc. and is a weighted average of 30 large-company stocks. Some of the companies that are part of the Dow include McDonald's, Texaco, Chevron, Philip Morris and IBM. The Dow comprises about 15 percent of the dollar amount of all U.S. stocks.
Nasdaq stands for the National Association of Securities Dealer's Automated Quotation system; it is sometimes referred to as the "over the counter" market. There are about 5,500 stocks in the Nasdaq market, accounting for about 18 percent of all U.S. stocks.
The Russell 3000 index is comprised of the 3,000 largest U.S. stocks, making up about 98 percent of all stocks, while the Russell 2000 is the bottom two-thirds of this index. The latter is considered the proxy for small stocks.
Q: With the new tax law, there's now a traditional IRA, a Roth IRA and an Education IRA. Can I put $2,000 in each one and take a $6,000 deduction on my taxes for 1998?
A: No, no and no. The most you can put in an IRA is $2,000, no matter how you cut it. That's the combined limit for both the Roth and the traditional IRAs. The Education IRA has a separate $500 per year/per child limit, not subject to the $2,000 contribution limit applicable to the other IRAs. The Roth and Education IRAs begin with the 1998 tax year.
Q: I plan to sell my condo in Manhattan soon, and since it's my primary residence, I heard that my wife and I can exclude the gain on this property up to $500,000. Is this a once-in-a-lifetime exclusion? If the real estate market in New York City's Upper West Side crashes with the stock market, can I realize a loss on it instead?
A: This exclusion is not a once-in-a-lifetime offer. If New York City real estate keeps appreciating, you may get another chance because you can take this exclusion more than once, provided you use the home as a primary residence for at least two out of the five years before the sale.
Single taxpayers may exclude a gain of $250,000 on the sale of a primary residence, while married taxpayers filing jointly may exclude up to $500,000. The exclusion may be used only once in any two-year period. Unfortunately, you can't take a capital loss on the sale of your principal residence, so get thee to the closing--and to a tax advisor as soon as possible.
Q: In high school, I read George Orwell's book "1984," but I thought all those people were paranoid.
Recently, though, I read a court case about a murderer who was caught because police disproved his alibi by checking the use of his EZ Pass [an electronic toll system available throughout New York]. I don't want to get away with murder, but I do want to protect my privacy and avoid credit fraud. How can I prevent "little brother" from getting his hands on information about my finances?
A: Here are some simple ways to protect yourself:
- Don't fill in personal and financial information when you return warranty and product registration cards. Many companies sell this information to list brokers who then sell it to other companies and viola! junk mail.
- Never carry your Social Security card in your wallet. If it is stolen, someone can use it, your license and your credit cards to "steal your identity," i.e., open credit card accounts and charge thousands of dollars worth of merchandise to you without your knowledge.
- To make sure your credit is safe, order a copy of your credit report annually from one of the three major credit bureaus and check anything that looks suspicious.
- If you make purchases over the Internet, be sure your information is encrypted so it will be inaccessible to hackers, and never ever give anyone your Social Security number over the Internet.
Of course, if you want to be totally safe, you could always pay cash for everything . . .
Lorayne Fiorillo is a financial advisor at Prudential Securities Inc. in Charlotte, North Carolina. For more information, write to her in care of Entrepreneur, 2445 McCabe Way, Irvine, CA 92614. Past performance is no guarantee of future returns.