How to Invest and Diversify

If history repeats itself, over the long term investors should earn about 10% a year in stocks, over 5% in bonds and about 3% in safe money market securities (like T-bills) or savings in the bank. If you invest in stocks, bonds and the money market equally across the board you would average about 6% a year overall based on the above returns. You would also be diversified and have a conservative portfolio.

Based on the above average historical investment returns, an investment portfolio of 60% stocks and 40% bonds would produce average yearly earnings of 8% over the long term, at a higher, yet moderate level of risk.

If you squirrel all of your money away at 3% you have safety, but it takes more than 23 years to double your money. Put all of your money in stocks at 10% and you can double in 7 years, but your risk is heavy.

I suggest that most average investors shoot for an average yearly return of about 8% at a moderate level of risk. At this rate it takes 9 years to double your money. Now, the question is how to invest and how to diversify to accomplish this.

Mutual funds are the simplest way to diversify your investments, and they come in all 3 of the types you will need: stock funds, bond funds and money market funds. By holding a combination of all three, you can tailor an investment portfolio to fit your own personal risk profile.

In order to average 8% a year, stock funds should be your largest holding and amount to about 60% of your investment portfolio. The rest of your money is then split between bond funds and money market funds. If you want to lean toward the conservative side, invest about the same amount in each. If you want to be more aggressive favor bond funds over the high safety of money market funds.

If you include money market funds in your portfolio, how do you make up for the lower average earnings that they will likely contribute? You either accept a slightly lower overall rate of return, or you learn the ins and outs of how to invest.

Remember, 10% is what stocks have earned on AVERAGE per year over the long term. An investor who knows how to invest can do better than average. There are many varieties of stock funds to choose from. Get familiar with them. Examples include: growth funds, small-cap funds, international funds, and specialty funds like real estate and natural resources funds.

There is also a simple investment strategy you can use to help keep your risk moderate while boosting long term returns. REBALANCE your investment portfolio periodically. Example: you decide to go with 60% stock funds, 20% bond funds and 20% money market funds. Keep these figures in line by moving money from one area to another whenever the percentages change by more than a couple of points.

For example, after a couple of years you see that stock funds now account for 65% of your investment assets with bond funds at 20% and your money market fund at just 15%. To rebalance you simply move money from stock funds to your money market fund to get back to 60% ... 20% ... 20%.

Good money management requires a sound understanding of diversification and investment strategy. Putting it all together will require that you learn to invest in bonds, stocks and money market securities. The simplest way to do this is with mutual funds.

A retired financial planner, James Leitz has an MBA (finance) and 35 years of investing experience. For 20 years he advised individual investors, working directly with them helping them to reach their financial goals. Jim is the author of a complete investor guide, Invest Informed, designed for average investors or would-be investors of all levels of financial background and experience. To learn more about investments and investing and his new financial guide go to www.bank-credit-guru.blogspot.com