What will do you when your investment nest egg is empty?

The 2009 recession has delivered a heavy blow to investors. Before you think about reinvesting, first decide how much money you are willing to risk. You might be able to save $2,500 a year, but are you prepared to risk all of it on a single investment?

To anyone who is new to investing, or to seasoned professionals, I strongly suggest you consider the principle of diversification. This simply is the art of investing portions of your money in different things so that, if one of them goes south and bottoms out, you will not lose the entire portfolio of wealth. This is also a good way to reduce your risk.

However, you must also give careful thought to how widely you wish to diversify what proportion of your funds you want to dedicate to various investments. The real reason this should be a concern is that if you divide your money into smaller amounts, you reduce the number of investment alternatives available for each portion of your portfolio.

For example, let’s say you set a limit of $1,000 for any particular investment, you restrict your choice of bonds, CDs, stocks worth $10 a share or less. And yes, since stocks are usually traded in round lots of 100 shares, gold coins, and a couple of other instruments are available for consideration.

Another example — you increase your investment to $5,000, you can also consider small real estate properties, such as rental houses and duplexes, and stocks up to $50 a share. With a $10,000 limit per investment, you can include on your list of possibilities small commercial real estate properties, such as small apartment buildings, T-Bills, and stocks worth $100 a share or less.

The good thing is the larger amount you are willing to commit to any one investment, the broader the range of choices open to you. But, keep in mind too that the greater amount you commit as an investor, the more your whole financial standing will be affected by the success or failure of the ventures into which you have place your money.

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When people borrow money in today’s financially burdened society they are faced with leverage obstacles never before seen since the depression. People use what they have got to get more, and use both to earn higher investment income in hopes to generate larger capital growth. Not only is this technique effective, it’s also reinforced by government tax policy.

But, what does all this mean?

Basically, if you are going to borrow money, either you a) want to strategically borrow using other people’s money as part of your wealth building program, or b) you need money to pay unexpected costs. These are the only two good reasons to borrow money. Flexibility and choice, however, raises a question you must ask yourself: Which is the better strategy? The answer lies in a list of cautions when using leverage.

If an investment seems to have good potential returns, after taking interest payments and taxes into consideration, you can afford to carry the loan, then borrowing to invest is a reasonable risk.

Wherever you look in the world of investing, it is unlikely you will find something for nothing. The greater the risk you are willing to take, the greater your chance for large profits. When you look at it another way, lending your money, or invest in debt, you expect to receive some benefit in the form of interest. And, you expect to get all your money back at some point.

Simply put, your money is in a savings account, and you are saying to the bank, “I want to lend my money in the form of deposit, but I make no commitment as to how much or how little I will lend, or how long I will leave it with you. I also want you to guarantee to pay me back all the money I put into deposit.” Although the probability that you will get all your money back is very high, your level of risk and return on investment is very low.

On the other side of the coin, for example, if you invest in equity by buying shares of a venture, you are accepting a much higher risk. There is no guarantee of growth, and you could lose your entire investment. Most investments, whether they are in debt or in equity, fall in between two extremes. Only you can decide how much risk you want to take and what kind of risk it will be.

One of the most important things to remember when borrowing money, even if you don’t need the money, is to establish a credit rating. You then repay the loan promptly. The argument is that this will establish you as a good credit risk and will enable you to borrow more easily in the future if you need money for an emergency.

A simple analysis will give you a better idea whether you are in the position to borrow money. Enter the following:

The figure on line 8 is the amount of additional repayment which experts say you could afford each month. It’s based on the commonly used criteria that no more than 35 percent of household gross pay should be earmarked for debt repayment. This is the absolute maximum you should commit to debt repayment. You can try 25 or 30 percent conservatively, if you feel this will not leave you strapped or compromise your lifestyle.

Well managed borrowing can be an immensely powerful way to build your wealth, or take care of unexpected expenses.

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The patterns of any particular investment will detail the relative risks and rewards undertaken with each investment. Risks can be defined as “the chance or possibility of injury, damage or loss.” Risk focuses on the future and our ability to forecast that future. In turn, the ability to predict the future is largely dependent on what you’ve learned from the past. The best you can do is to study the record and draw on experience – your own and that of others.

On the surface, the relationship between risk and return  seems straight forward. In general, you will find that risk and return move in the same direction. In other words, if you accept a higher risk, it is possible to achieve higher returns. High-risk investments invariably promise a high
return.

But equally important, where it is possible to win big, you can lose big. And the odds are always with the “house” (the provider of the risk-return). If all it took to create instant wealth was as suming high risks, then you could assure yourself of millionaire status simply by attending the race track every day and betting all your money on the long shots!

Avoiding Risky Investments

No other advice on investing is complete without a few important warnings. The investment industry has its share of unscrupulous people who, at best, will mismanage your investment, and at worst, steal you blind.

They’ll come at you with Ponzi schemes, pyramid deals, real estate that’s never been any good and never will, and telephone offers or email offers of stock or funds or oil leases or gems or precious metals, etc., that offer large and easy returns with no risk.

These salespeople play on a universal desire to “get something for nothing” and to “get rich quick.” Most of us are not immune to a good pitch. However, by just taking the simple precaution of thoroughly investigating an investment offer yourself or through a trusted accountant, lawyer, financial adviser, etc., you’ll greatly minimize the risk. The best caveat to bear in mind is: “if it sounds too good to be true, it probably is.”

Watch out for the Ponzi and Pyramid.

In their eagerness to make a lot of money quickly, many people and millions of dollars every year are sucked into Ponzi schemes and pyramid deals. In the former, expect to lose your money, and in the latter there’s a very high probability that you’re wasting time and money.

In the 1920s Charles Ponzi invented a simple, alluring investment fraud that’s still practiced today. In its simplest form, a swift-talking promoter will ask you to give them, say $5,000 to invest in a spectacular, usually secret, investment to which the promoter has access. They promise a spectacular return of, say 20 percent in three months.

At the end of the three months, they offer to deliver $6,000 (your investment plus your return) but suggests that you let it all “ride” for an even better return in another three months to six months. What you don’t know is that there is no investment. The promoter is simply gathering as much as they can from as many suckers as they can convince. Then they have to pay Peter, it comes from Paul. Eventually, the promoter disappears with the bulk of the investment money.

A Pyramid scheme is an illegal type of multilevel sales except usually there is no product sold. You are asked to pay ($500, $1,000, $10,000 etc.) to become part of the pyramid. The amount of your payment to the promoter determines your position level in the pyramid and “allows” you to promote the pyramid to others. The more people you bring into the pyramid, the higher you rise and the closer you get to the big payoff.

Financial Risk

For most investors, financial risk is the most immediate one. It centers on the simple question, “If I put my money into this investment, will I at least get my money back?”

Your best protection against financial risk is to explore any investment to the point where you understand the factors that risk and/or secure your principle. When you buy a common stock, for example, the financial risk is tied to the credit and operating histories of the company issuing the stock.

So you analyze the firm’s financial capacity (ability to generate income). A firm that can’t pay its debts or has a low financial capacity and a comparatively high financial risk. A company with earnings high enough to pay fixed costs many times over is thought to pose a lower financial risk.

Generally, such vehicles as certificates of deposit, commercial short-term paper, federal savings bonds and Treasury securities are considered of low financial risk. Whenever you evaluate the risk inherent in a given investment, ask yourself:

1. What kind of risk is involved?

2. What is the extent of this risk?

3. Is the potential return worth this risk?

By first learning a set of criteria with which you can evaluate an investment, and then considering those objectives in light of your personal factors, you’ve begun acting like an investor.

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