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The Five Criteria for Every Investment

A recent reader question is from Alex L, who is a member of my Super Sports Roadster club, a “collaborator-friend,” and big help in getting the Miller’s Money Forever project started:

“Dennis, you started actively managing your portfolio when your CDs got called in and you were sitting on cash. What do you suggest for people who already have a portfolio but might want to rearrange it a bit?”

It’s a good question, and one that I’ve been asked frequently. Let me reinforce one critical point. Do not do what I did and start reading newsletters and buying into investments because they sound like winners. There is a good chance you’ll just compound any problems in your portfolio. (I have an article from my Miller’s Money Weekly service titled “Getting the Most from Your Investment Newsletters” that explains how to use investment research from investment newsletters and make sure it fits into your strategy.)

A major component of my business career was consulting for small businesses. This was usually a three-step endeavor. First, the client recognized they had a problem and usually had a pretty good idea of what they needed to do to solve it. Second, they asked for help because they didn’t know how to implement their solution. And that’s where I stepped in: putting the solution into action.

Alex L’s question presents a nearly identical situation. Many investors are uncomfortable with their portfolio balance, and most realize that the solution is rebalancing things in order to meet their goals, but they need outside help to rebalance.

Before you make any trades, start with the process. Take each and every investment you have and build your personal investment pyramid. The Money Forever portfolio is only a starting point. Each investor has to determine his own personal allocations. After you have done that, you’ll find the holes that need to be filled, and where you’re over-allocated.

There are five criteria which should be looked at for every investment:

1. Is it a solid company or investment vehicle?

2. Does it provide income?

3. Is there a good opportunity for appreciation?

4. Does it protect against inflation?

5. Is it easily reversible?

Look at each investment you currently own and see how it stacks up. Safety is a major concern for two reasons. First, retirees and people approaching retirement cannot afford to take a major portion of their life savings and gamble on a Facebook IPO going through the roof. The risk is simply too high.

Second, there is a grey cloud on the horizon called “inflation.” The Treasury Department reports that on February 28, 2006, our government debt ceiling was $8.2 trillion. On January 31, 2012, Congress approved a debt ceiling of $16.4 trillion, essentially doubling our debt in six years (because you know every time they raise it they just spend up to it again).

We did not double our national debt by selling debt instruments to foreign governments and investors. A major portion of the increase was sold to the Federal Reserve. In essence, the money was printed or created by accounting entry. That’s why combating inflation is vital. (Over the years there’s been a lot of buzz about Treasury Inflation Protected Securities, or TIPS. Many retirees are finding TIPS are not all they’re cracked up to be. Check out my recent article on why TIPS might actually be one worst investments you could make.)

The inflation problem is masked for many investors. In today’s climate, if you have a high-quality bond or CD, collect the interest and then pay the tax on that interest, your net yield could be 1% or less. With the Fed printing plenty of money, a 5% inflation rate is not completely unforeseeable in the near future. In round numbers, over a five-year period, your principal around such an inflation rate would buy 82% of what it did five years earlier when you purchased it.

While I’m approximating to make the point, if you had a $10,000 CD at the end of a five-year period, your $10,000 would buy what $8,200 bought five years before. On the other hand, you would need $12,200 to buy what $10,000 bought five years earlier. Your goal is to keep up with and stay ahead of inflation, not to lose ground along the way.

Using these criteria, look at each investment in your current portfolio and see how they stack up. Hopefully most do very well. If not, you’ll know where you might want to begin to liquidate and rebalance.

By: Dennis Miller

Find out more about how to apply these criteria to your investments using my new book, Retirement Reboot; get your copy here.

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