The above is a simple chart of Investment
categories by risk and reward. It is in the shape of a pyramid.
With Investments at the top of the pyramid an individual can expect
the greatest returns but because of the risk associated with these
investments an individual can also experience the greatest risk
of loss. Volatility is the key. If you knew exactly when to invest
in high risk areas and exactly when to sell, then you should experience
the highest returns. Consequently, with the investments at the bottom
of the pyramid you would expect low returns with little risk of
loss of investment. The placement of investment vehicles on the
pyramid is subjective and opinions as to their placement could vary.
More aggressive portfolios (more
stock) are usually recommended for those younger and/or single while
more conservative (more bond) investments are generally recommended
for retirees. This is not cast in
stone and depends on many variables. Before you invest at any level
you should first address a budget and your current and future needs.
The essence of this exercise is to
emphasize the basic risk/reward parameters. You should not invest
in the more risky ventures until/unless you have covered the less
risky areas first. It should be clear, therefore, that one does
not utilize gold, precious metals, uncovered option writing or the
use of single issue securities until the more conservative issues
have been addressed- such as having enough insurance for your family.
Fixed Annuities, Whole or Universal life insurance
These policies earn income on a tax
deferred basis (possibly tax free with insurance policy loans) and
are essentially risk free as regards to the guarantee which is based
on claims paying ability of Insurer.
By definition, mutual funds are diversified
(at least 13 stocks).
Diversified Individual stock and bond portfolios
The use of individual stocks and
bonds is more risky if one attempts to do it themselves. These portfolios
MUST be actively monitored.
Variable annuities are annuity contracts
that shift investment risk to the the contract holder. The contract
owner can select from among a number of separate investment accounts.
Variable products are subject to mortality and expense charges and
administrative fees not typically found with other investments.
Variable Life Insurance
Variable life insurance is a life insurance policy
that has fixed premiums and a minimum guaranteed death benefit.
Investment risk is shifted to the policyowner. The policyowner is
able to direct funds backing the policy into one or more of a group
of segregated investment accounts made available by the life insurance
company. Variable products are subject to mortality and expense
charges and administrative fees not typically found with other investments.
Covered Option Writing
Security options - puts and calls
- are negotiable instruments issued in bearer form that allow the
holder to buy or sell a specified amount of a specified security
at a specified price within a certain time period. The buyers of
puts and calls are willing to invest their capital in return for
the right to participate in the future performance of the underlying
security, and to do so at low unit cost and limited exposure. Some
consevative investors use options to increase their income or insure
against losses on shares purchased. It is important to note that
options are not suitable for all investors. There is limited upside
potential when writing a covered call. For example, if the underlying
security's price rises above the exercise price, the buyer will
typically excercise the option and the writer will be forced to
sell the underlying security. To obtain current Option Disclosure
Documents simply call or mail us. You can obtain our phone number
and address by clicking the "contact us" section of our
Non diversified portfolios of stock or bonds
These generate a significant amount
of unsystematic risk since the movement of a single stock can seriously
erode the entire holdings.
Rental real estate
Singular ownership of real estate
has provided many past investors substantial returns. However, investors
must recognize the personal management involved in running such
operations. Real estate is a non liquid asset and with inflation
probably staying low for many years, investors cannot depend on
the high appreciation of the 80's and must calculate their potential
return with a much longer holding periods.
Closed End funds
These are similar to open ended managed
mutual funds but are issued with a fixed capitalization. They are
bought in the same method as stock. They tend to be sold at a discount
to Net Asset Value. Unless their track history is considered, many
investors may purchase these with incomplete knowledge.
Sector mutual funds
These must have at least 25% of their
portfolios invested in a particular area- health, communications,
etc. And when too much is placed in a risk area, it usually is not
ultimately beneficial to the investor who does not understand the
Prior to the tax law change of 1986,
many partnerships did very well. The purchase of LIMITED amounts
of partnerships was generally considered acceptable for middle income
wage earners. However, with the recessionary economy many went into
default. Some partnerships do continue to work and are even viable
today, but the risk limits their use.
General partnerships, precious metals, etc.
These require a sophistication far
in excess of the normal middle income wage earner. Far too much
risk and far too much to go wrong. Individuals using such investments
must have considerable wealth and a thorough understanding of risk,
or be advised by a knowledgeable adviser.