Monday, July 11, 2011

How to find your investing sweetspot - Reuters (blog)

Dan Greenshields, CFA, is President of ING DIRECT Investing, a subsidiary of ING Bank, fsb. The opinions expressed here are his own.

In baseball, good hitters don’t chase pitches in the dirt. They wait to swing on a ball in their sweetspot — that small space over the plate at which they can maximize the power and accuracy of their bat. Good hitters are patient and make a point to play to their strengths.

The same is true for good investors. Chasing speculative, non-liquid or unusual investments can lead to heavy losses. But waiting and putting dollars into a financial sweetspot could bring maximum returns.

Here are three tips for how to find the sweetspot for your investments.

First, don’t drive your financial strategy with a tax strategy.

Some investments do indeed afford unique and substantial tax advantages. But if that’s the sole selling point for a particular investment, wait before handing over your money. The time to try to minimize taxes is only after you have fully reviewed your risk and liquidity needs.

However, when the time comes, the tax angle can be worked in a number of different ways.

If an investment has yielded a large gain, you may want to hold it for at least a year. For most investors the maximum long-term capital gains rate is 15 percent — and that rate was extended by President Obama into 2012. And that level is substantially lower than the 25-35 percent tax most Americans have to pay on regular income.

The money generated by cashing out a short-term investment immediately would likely qualify as income and be subjected to the higher tax rate. But by being patient and waiting, you allow that gain to grow into a larger, tax-reduced harvest.

Also, when it comes to employing tax benefits for investments, maximize the amount of money you put into tax-privileged retirement vehicles.

Individual Retirement Accounts (IRA), for instance, are a great way to shield your money. Total annual contributions to an IRA are capped, however, at $5,000 for people under 50 and $6,000 those over 50.

There is a 10 percent tax penalty for withdrawing IRA funds before you hit 59.5 years old. So be sure to save up separately for shorter-term expenses like a mortgage and a child’s college education.

The second key to finding your financial sweet spot is to remember that circumstances often change. Avoid putting yourself into an investment position which locks you out of your money when you need it.

While some investment vehicles can have attractive returns, always look at the flipside in case you need get out tomorrow. Long-term CDs, annuities and insurance contracts typically have high surrender charges and limited exit or rollover provisions.

Many who invest in real estate, hedge funds or venture capital do so through partnerships that entail claims on future commitments of capital under certain circumstance.  During the financial crisis many hedge funds froze or severely limited withdrawals. Make sure you understand the length of the commitment and the total funds committed before you invest.

The third key to finding your financial sweetspot is keeping three to six months of liquid living expenses.

A paper published just this May by the National Bureau of Economic Research found that nearly half of Americans couldn’t come up with $2,000 in 30 days. A huge number of families are economically fragile and could be thrown into ruin by even a small financial emergency.

The way to avoid that fate is to maintain three to six months in living expenses in cash or liquid investments. Think of liquidity as how long it takes to convert an asset to cash. A house, for instance, it highly illiquid — it takes months or even years to turn a home into dollars.

A rule of thumb to live by is that you’re in a good liquidity position if 50 percent of your assets take less than 100 days to convert to cash. And until you have at least a three- to six-month cushion, shy away from investments with long horizons, high risk or tough restrictions on cashing out.

Sweetspots aren’t just for athletes. Average investors have them, too. By following these three rules, you can maximize the return on your investments while helping maintain short-term financial security for you and your loved ones.

View the original article here

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