Investing 101 A crash course in building your personal portfolio

"For herein Fortune shows herself more kind than is hercustom; it is still her use To let wretched man outlive his wealthTo view with hollow eye and wrinkled brow An age ofpoverty."

In The Merchant of Venice, Shakespeare aptly describedone reason we invest-so we don't outlive our wealth. (Note thata person who is 65 today is expected to live to 84, if male, and88, if female.) Without an investment plan that's sensitive toboth immediate and long-term goals, as well as to the level of riskto be taken to achieve those goals, personal investment successbecomes difficult, if not impossible, to achieve.

Building wealth and protecting it from the effects of inflationand taxes are two major investment objectives common to almostevery investor. Some are more successful than others in achievingthese goals. If your wealth isn't growing because taxes andinflation are nibbling away at what you've accumulated, youneed to re-examine the ways you save and invest.

In "Money Wise" (November 1995), we told you how todetermine your level of risk tolerance. This month, we give you anoverview of some of the many investment options that can help youreach your goals.

Debt Securities

Even though past performance is no guarantee of future results,historically, investing in common stocks has proved to be the bestway to build and protect wealth over the long term. But manyAmericans, afraid of losing their principal, invest heavily inlower risk debt securities.

Bonds are debt securities issued by organizations to financevarious projects. All bonds have certain features in common,including coupon, maturity, face or par value, and credit qualityrating. When you buy a bond, the issuer promises to pay a certainrate of interest (called the coupon) for a certain period of time(until the bond matures). Interest is often paid semiannually. Theprincipal is also called the par or face value.

Two major rating services, Moody's and Standard &Poor's, assign letter ratings to bonds to give investors anidea of a bond issue's quality and the issuer's ability tomake timely payments of interest and principal. The highest ratingis AAA, then AA, A and so on down the line to D, the lowestrating.

If you're considering an investment in bonds, don't lookexclusively at the interest rate paid. Think of bonds as you woulda loan. Your brother-in-law may not be very good at paying backloans (if he were a bond, he'd get a lower quality rating), soif you were going to lend him $10,000 for five years, you'd askhim to pay more interest than if he had a great repayment history.And you probably wouldn't want to lend him money for 30 years.Bonds are the same: The longer the maturity or the lower therating, the more interest you should receive.

There are several categories of bonds: those issued bycorporations, the federal government and its agencies, state andlocal governments, and foreign governments.

1. Corporate bonds. There are several types ofcorporate bonds; they're classified based on the collateralthat backs the payment of interest and repayment of principal.Corporate bonds can be secured by real estate (mortgage bonds),equipment (equipment obligations), stocks and bonds (collateraltrust obligations), or the general credit of the issuing company(debentures).

Corporations can retire debt prior to maturity in several ways,including calling in their bonds and converting them into othersecurities. If your bonds are called or converted, you'llreceive your principal back and interest payments will cease orchange.

Corporations with lower quality ratings need to offer greaterincentives to investors in the form of high yields. Thesehigher-yield, lower-rated bonds are often called "junkbonds" because there is a greater likelihood investors'interest and principal will be at risk.

2. Federal government bonds. The federalgovernment, like corporations and state and local governments,borrows funds (through the sale of Treasury securities) to conductits business. Since Treasury securities are backed by the U.S.government, they have the highest safety rating. There are threekinds of Treasury securities: bills, notes and bonds.

Treasury bills are short-term securities with maturities of oneyear or less. They are issued at a discount from face value, andthey are issued in minimum denominations of $10,000, with $5,000increments available above $10,000.

Treasury notes are intermediate-term securities, with maturitiesranging from one to 10 years. Denominations range from $1,000 to $1million or more.

Treasury bonds are long-term investments, with maturities of 10years or longer, issued in minimums of $1,000.

You can buy Treasury securities directly from the U.S. Treasuryor from banks or brokerage firms.

Agencies of the U.S. government also issue securities; whilethese are not obligations of the Treasury, they have an inherentbacking by the federal government and are considered to be of thehighest credit quality. You may have heard of the "Mac"family-Ginnie, Fannie and Freddie Mac, otherwise known as theGovernment National Mortgage Association, Federal National MortgageAssociation and Federal Home Loan Mortgage Association. Thesesecurities are based on pools of mortgages and are called"pass-through securities" because the interest andprincipal paid monthly by homeowners is passed through toinvestors.

3. State and local government bonds. Home is wherethe heart is, and it's also where investors can findinterest-bearing investments free of state and federal incometaxes. If you purchase municipal bonds in your state, the interestpaid on these bonds is tax-free. Interest paid on bonds issued bythe Commonwealth of Puerto Rico is tax-free in all 50 states. (Forsome investors, this income may be subject to the federalalternative minimum tax, a flat tax applied to wealthy taxpayers toensure they pay at least some tax.)

4. Foreign government bonds. Foreign governmentsissue bonds to finance their projects, too; sometimes interestrates are higher than those of U.S. government bonds. But beforeyou invest, be sure you understand the inherent risks in foreignsecurities, including currency fluctuations and political andsocial instability.

Outrunning Inflation

If safety is your major concern, you may think your best bet isto invest in fixed-income securities, spreading your investmentamong several types of bonds or, if your most important goal issafety of principal, sticking with U.S. government securities. Butafter inflation is taken into account, this risk-free conceptbecomes questionable.

According to Chicago-based research firm Ibbotson Associates,over the long term, Treasury bills barely outperformed inflation,earning an annual 3.7 percent return while inflation increased at3.1 percent per year. In fact, after taxes and inflation, manyT-bill investors actually experienced a negative return.

Stocks, as represented by Standard & Poor's weightedindex of 500 stocks (which provides an indicator of pricemovement), have clearly outpaced inflation-and the taxman-with anaverage pretax total return, including reinvested dividends, of10.2 percent per year from 1926 to 1992, according to IbbotsonAssociates.

There's no guarantee this trend will continue, but considerthat the 66-year period between 1926 and 1992 includes times of warand peace, growth and decline, bull and bear markets, inflation anddeflation. Common stocks clearly give you the potential to fulfillyour objectives of building and preserving wealth.

Taking Stock

Buying stock in a company means buying part ownership in thatbusiness. As a shareholder, you receive capital appreciation (thedifference between your purchase price and the current marketvalue) and/or dividends (generally a quarterly payment thatrepresents a percentage of the company's earnings). Of course,stock prices and dividends can fall if the company doesn't dowell.

Stocks can be classified into several broad categories:

Blue chip stocks are the high-quality stocks of majorcompanies; they generally have long and unbroken records ofearnings and dividend payments.

Growth stock companies are those whose sales, earningsand market share are expanding faster than the industry average andthe economy in general. These companies usually retain most oftheir earnings to finance expansion and pay little, if any,dividends to shareholders.

Defensive stocks are from companies that providenecessary services, such as electricity and gas; essential goods,such as pharmaceuticals; or staples, such as food or soft drinks.Due to the constant demand of these products, the stocks provide adegree of stability during periods when the economy isdeclining.

Income stocks are generally attractive to people seekingimmediate income, particularly seniors and retirees. Income stocks,primarily public utilities, usually pay high dividends in relationto their market price, providing shareholders with greaterquarterly income.

Cyclical stocks are those of companies whose earnings aretied to the business cycle. When business conditions are good, thecompany is profitable and the common stock price usually rises.When conditions decline, the company's earnings and stockprices generally fall. Steel, cement, machine tools and automobilecompanies are considered cyclical stocks.

Seasonal stocks' performance fluctuates with theseasons. For example, retail companies' sales and profitsnormally increase at Christmas and the beginning of the schoolyear.

Avoiding The Pitfalls

Many investors who manage their own portfolios make commonmistakes that lead them to the false conclusion "It'simpossible to make any money in the stock market." Thesemistakes include:

• failure to establish clear objectives
• selecting securities that are not consistent with yourobjectives
• purchasing too many or too few securities
• taking profits too soon
• failing to minimize losses promptly
• buying a stock based on a "tip" rather thaninvestigating its merits
• not adjusting to changing market cycles
• not fully exploring alternative investments
• failing to follow a disciplined approach

Most investors don't have the time or expertise to searchthrough the thousands of investment possibilities to select aportfolio that suits their individual needs. Professionally managedportfolios make investing easier. Instead of selecting individualstocks or bonds, these investments let you pool your money withthat of other investors in a managed account. During the past 15years, mutual funds and other types of investment pools have gainedenormous popularity. These investments have several characteristicsin common-small initial investment, diversification, liquidity andprofessional management.

For a management fee and a sales charge, mutual fund managerspool investors' money and invest it in various securities.Whether you plan to invest a little or a lot, you'll findmutual funds in many varieties based on investment objectives andrisk tolerance. Here are the broad categories:

Income funds seek high current income by investing insecurities paying high dividends, such as government and corporatebonds, utilities and high-dividend stocks. Because of their highincome, these funds are somewhat insulated from some of the stockmarket's volatility, although they are sensitive to interestrate changes.

Growth funds, which seek capital appreciation byinvesting in large, well-established companies, are often called"blue chip" funds. Most pay dividends, although income isusually a secondary consideration.

Aggressive growth funds strive for maximum capitalappreciation and are often considered the riskiest of equity funds.They may concentrate on selecting small company growth stocks ormay use speculative techniques to obtain high profits. The greaterthe potential profit, the greater the risk.

Balanced funds strive to minimize risk by allocatingdollars to stocks, bonds and cash. They usually invest inhigher-grade securities and are appropriate for investors who wanta good return with lower risk.

International and global funds allow individuals toinvest in markets outside the United States and in foreignsecurities that trade on foreign exchanges. While global funds mayinvest in both U.S. and foreign securities, international fundsdeal exclusively in securities outside the United States. Bothtypes of funds increase in value when the dollar falls, allowinginvestors to benefit from changing trends abroad.

Total return funds seek long-term appreciation through acombination of dividends and capital gains. They often appear inlong-term retirement and education portfolios.

Bond funds have several different approaches and can bedivided into four classes: taxable, tax-free, high-quality andhigh-yield. They may include taxable, tax-free, U.S. government,foreign government, corporate or any combination of bonds. They mayalso vary in the maturities of bonds selected.

Bond fund share prices move in the opposite direction ofinterest rates. As with all bonds, when interest rates rise, shareprices fall. In addition, the longer the maturity of the issues ina bond fund, the more volatile the share price.

Money market funds invest in short-term IOUs fromindustry and government. Interest is usually accrued daily andoften credited monthly. Some allow you to write checks on thebalance of the account. These funds are designed to have no pricevolatility, but this is not guaranteed or insured by the U.S.government, and there can be no assurance that the fund will beable to maintain a stable net asset value.

Specialized or sector funds concentrate their investmentsin a particular industry or region, such as health care, utilities,precious metals, technology or the Pacific Rim. Since theyaren't diversified outside the particular area selected, thesefunds can be more volatile than diversified investments.

Regardless of the type of mutual fund selected, you shouldalways request a prospectus from the investment company to learnmore about the fund before investing. Mutual funds should beregarded as long-term investments, with a time frame of at leastthree to five years.

One final note on mutual funds: Many investors make the mistakeof chasing last year's hottest fund, and that's what itturns out to be-last year's best. Probably more important thanthe individual stocks, bonds or funds selected is the percentage ofyour portfolio dedicated to each asset class. This is when afinancial advisor comes in handy.

Best Advice

Last year's strong stock market lured speculators and saversalike to the offices of stockbrokers and financial planners. Butchoosing the right financial advisor is at least as important asselecting the investments themselves. A bit of preparation beforeyou meet with a potential advisor can save you a lot of headacheslater.

At the first meeting, be prepared to share some generalinformation about yourself, such as family status, financialresources and goals. The advisor should also ask you thesequestions:

1. What do you want your money to do? Do you seekhigh monthly income from your investments? Do you want them to grownow and pay later? Or would you like to achieve both goals?

2. What are your expectations for a return on yourinvestment? Almost any financial goal can be reached ifsufficient time is available and an appropriate level of risk isallowed.

3. What is your risk tolerance? Although the oldadage "No pain, no gain" is often true, don't letthis attitude prevail with your hard-earned money.

4. What time frame do you have in mind for achieving yourfinancial goals? Don't expect to double your money withno risk in six months. If someone tells you they can perform thisfeat or anything even remotely close, run for the door.

5. How much contact with me do you expect? If yourinvestments involve a group of highly rated mutual funds, asemiannual review might be sufficient. If you prefer stocks, yourcontact should be more frequent. Let the advisor know what youexpect, and be sure both of you are comfortable with thearrangement.

6. How much time do you want to devote to managing yourmoney? A hands-on approach is needed for a stock portfolio,even if you have a financial advisor. Mutual funds or professionalmoney management are far less time-consuming.

Some additional considerations:

1. Don't work with a financial advisor or broker whotells you that if you don't invest now, you'll never getanother opportunity. Stocks go down as well as up, and youmust feel comfortable with the situation before you invest.

2. Don't invest in anything you don'tunderstand. You should understand your advisor'srecommendations so well that you can clearly explain them tosomeone who understands even less than you do.

3. Don't be afraid to ask the price of advice.A client of mine confided I was the second broker she hadinterviewed. When she asked the first candidate what his servicescost, he replied, "If you have to ask, you can't affordit." He was right: No one can afford to work with a jerk!

4. Don't use an advisor without investigating his orher reputation. Call the National Association of SecuritiesDealers at (800) 289-9999. Their hotline can tell you if there havebeen customer complaints about or disciplinary action against aregistered representative.

No matter whom you decide to work with, be sure you feelcomfortable enough to ask questions. This may be all the moneyyou'll ever have, and the financial advisor you choose shouldbe as interested as you are in doing the best you can with it.

Top Software And Online Services For Investors

Quicken Deluxe5, $59.99 (Windows)

Intuit, (800) 816-8025

Quicken Deluxe 5, available on floppy disk or CD-ROM, addsinvestment management to Quicken's standard financialmanagement capabilities. Using a modem, Quicken Quotes lets userslook up prices for more than 100,000 stocks and mutual funds andupdate their portfolios automatically, while a Mutual Fund Finderhelps users choose funds that fit their financial profiles.

Managing Your Money Plus CD-ROM, $50 (Windows)

Meca Software, (800) 288-MECA, (203) 255-1441

CD-ROM-based Managing Your Money (MYM) Plus integratesbestselling financial management program Managing Your Money forWindows with additional financial information modules. It includesadvice from Andrew Tobias, one of the original creators of MYM, ontopics ranging from buying a home to investing in mutual funds.There's also a library of more than 150 personal financearticles.

MYM Plus includes software to access CompuServe's extensivefinancial resources. QuoteLink automatically downloads currentstock, bond and mutual fund prices from CompuServe and posts themto your portfolio.

WealthBuilder 4, $99.95 (Windows)

Reality Online, (800) 521-2475, (610) 277-7600

Reality Online's WealthBuilder takes you throughdata-gathering, goal-setting, decision-making and, finally,investing to help create a portfolio that will let you retire incomfort. After asking a series of questions, WealthBuilderdetermines your financial blueprint, then advises youaccordingly.

WealthBuilder's integration with Reuters Money Network givesusers access to this huge online financial database, andWealthBuilder and Reuters Money Network jointly track yourinvestment performance. (Reuters also works with Quicken andMicrosoft Money.)

CompuServe

(800) 848-8199

CompuServe has numerous sources for researching stocks, mutualfunds, bonds and commodities, and even gives users a chance to chatwith other investors in the Investors' Forum. An extensive listof newspapers and publications, such as Fitch InvestorsService's Bond Reader and IBM/Donoghue'sMoneyLetter, gives CompuServe users an edge in planningfinances.

In addition to getting the information needed to make informeddecisions, you can access discount brokers Quick & Reilly andE*Trade Securities 24 hours a day.

America Online

(703) 448-8700

For up-to-the-minute information on stock prices, AmericaOnline's (AOL) StockLink is an extensive, easy-to-use resource.Information on more than 30,000 securities can be downloaded totrack your investments.

Plenty of investment companies can be found on AOL, includingVanguard, a no-load mutual fund company, and Morningstar, whichprovides detailed information on more than 4,000 mutual funds. TheFidelity Investor Center includes a mutual fund library, brokerageservices, investment and retirement planning, and more. Fidelitycan also be found on the World Wide Web athttp://www.fid-inv.com.

Networth Galt Technologies

(412) 681-6100, http://networth.galt.com

Galt Technologies' Networth is the place to be for mutualfund information and financial newsletters. This World Wide Webpage is easy to use and has a great graphical interface.

After opening a free account on Networth, users can accessmutual fund profiles and performance reports from the Mutual FundMarket Manager, research articles from financial and businessnewsletters, find market analyses on mutual funds, and more. Thesystem protects you by withholding investment applications untilyou have read the fund's online prospectus. -CassandraCavanah

Contact Sources

Compuserve, 5000 Arlington Centre Blvd., P.O. Box 20212,Columbus, OH 43220;

Galt Technologies, 5001 Baum Blvd., #750, Pittsburgh, PA15213;

Ibbotson Associates, 225 N. Michigan Ave., #700, Chicago,IL 60601, (312) 616-1620;

Meca Software, 55 Walls Dr., Box 912, Fairfield, CT06430;

Reality Online, 2200 Renaissance Blvd., King of Prussia,PA 19406.