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Chapter 3: Becoming An Investor
An Introduction To Compounding or How To Get Rich Over Long Time Periods

Beyond The Basics: How to Invest Your Money, Now That You Know a Thing or Two

Beyond The Basics:

How to Invest Your Money, Now That You Know a Thing or Two

By Mary Farrell

Beyond The Basics emphasizes investing early and letting the power of long-term compounding work for you. Saving and time are the keys to investment success.

Farrell strongly believes in investing in equities over bonds, but the book has a solid chapter about bond investing. This chapter discusses the capital gains bond investors of the early 1980's received because the investors bought bonds when inflation and interest rates were high (and, hence, bonds had high yields). Then, of course, inflation was tamed, and bonds increased significantly in value, especially, longer-term, noncallable bonds.

Farrell writes, "Bonds provided annual returns of only about 3.1 percent between 1926 and 1981, but produced returns of 14.2 percent annually between 1982 and 1998."

Most of this bond revaluation was due to the control of inflation, and Farrell expects real returns of only 2% to 3% on bonds in the future. Investors shouldn't expect large capital gains from buying bonds today, she writes, because interest rates are low and under control.

Farrell wisely suggests matching bond maturity to the time when you will need the money. For example, if you need money to send your son or daughter to college in five years, Farrell says to consider bonds of a duration of five years. Zero coupon bonds are also discussed. While bonds serve a good source of income in the short-to-near-term, for investment horizons approaching ten years, Farrell favors stocks. But, if you're buying bonds, Farrell says be willing to buy callable bonds, because today there is little value in locking up the current yields and you might get slightly greater returns.

Beyond The Basics has a good section about tax-free, municipal bonds and bond insurance. There is also a comparison of real returns on tax-free versus taxable bonds. The relation is (1 - tax rate)(taxable yield)=(after tax yield). But, I assume most serious investors already know this.

Beyond The Basics discusses Farrell's concept of "thematic investing." Thematic investing involves making a top-down decision about what's happening in the world and how an investor might benefit from it. For example, two themes Farrell discusses are 1) the aging of the baby boomers and the likely benefit to the health care industry and 2) the growth of technology.

Health Care, especially pharmaceuticals, and technology are strong and profitable growth industries. Farrell likes buying growth stocks. Farrell also believes larger company stocks should do well, partially, because they have more exposure to foreign markets and more resources for innovation.

In addition, Beyond The Basics discusses mutual funds. I especially like Farrell's use of specialized sector funds to round out a portfolio. For example, if you want to favor the medical industry, you could invest in a specialized medical fund. This allows individual investors to make top-down investment decisions just like many professional investors do. However, the investor doesn't need to spend time studying individual companies.

Similarly, Farrell recommends mutual funds for investments in foreign countries. This is solid advice. However, she also briefly mentions that you could buy a mutual fund with a load. Ah, no thanks! If you are "beyond the basics," you probably aren't into buying mutual funds with loads! But, because Farrell is Managing Director of PaineWebber, a brokerage firm, we can understand that she can't just come out and say, "Don't ever pay a front end sales load because there is absolutely no correlation between fund performance and loads." I can say it. She briefly mentions annual expense ratios and suggests keeping them low, which is good advice.

"Rethinking Retirement Planning" is my favorite chapter in Beyond The Basics. Farrell does a great job of summarizing retirement planning. As in all of the chapters, Farrell uses abundant graphs and charts to illustrate her points. We learn that in 1945 there were 41.9 workers employed for each Social Security recipient. In 1995, there were only 3.3 employed workers for every recipient. The point is clear. Retirees shouldn't count only upon Social Security.

The book shows the power of tax-deferred compounding via 401(k)'s and explains why aggressive saving is necessary for retirement planning. Earlier retirement and increased longevity, combined with inflation, demand far more wealth for a comfortable retirement than many realize.

People view retirement far differently today, the author notes. Back in the 50's, for example, when pension plans were more common and more people worked in factory jobs, retirement was viewed as a deserved reward for past working years. Today, many people view work and retirement differently. Only 15% of people surveyed in a PaineWebber study planned a conventional retirement, while most planned to continue working. Today, people tended to view work as an integral part of their lives.

Beyond The Basics contains special chapters about "Investing For Your Children" and "Women And Investing." Overall, there is much good information and insight in this book, but it tends to focus more upon the general stock market than it does upon buying individual stocks. Beyond The Basics reads quickly and enjoyably for both new and intermediate level investors and is a good addition to the investor's bookshelf.

Beyond The Basics: How to Invest Your Money, Now That You Know a Thing or Two
Beyond The Basics

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