Understanding Financial Concepts

As we move forward into the New Year, many of us are in the process of reviewing our financial plans. During this process we are often faced with new concepts and terms that some of us may not be familiar with. As your financial advisors here at Continuum II, we have compiled a list of concepts that we feel are essential to understand when building and effective financial plan.

Diversification: In financial terms, diversification means that you invest in a variety of assets to reduce risk, in other words diversification promotes not putting all of your eggs in one basket. One may even compare it to the following; remember the Atkins diet, high in protein and low in carbohydrates? It promises fast weight loss, but stick to it too long and you may end up with high cholesterol and kidney problems. Basically, too much of a good thing can be bad for you!  Now compare that to the Weight Watchers diet by eating from diversified food groups in moderation you will reach your weight goals, be healthier and the results will last. So to better reach your financial goal, keep your investments diversified to include Cash, Fixed Income, Canadian Equities, and U.S Equities and for a little spice some Global Equities. Your financial planner at Continuum II can help you select the right mix to meet your individual goals.

Chasing Returns: Chasing returns is the act of switching from a poorly performing investment, to one that has recent return success. It is comparable to waiting until after Lance Armstrong has won all 7 Tour de France titles to place a bet on his winning the next one. However, much like Lance, buying into last year’s top fund(s) is never a guarantee and it is unlikely to stay on top. In respect to your finances, it is better to choose a fund with at least a 5-year history of stability and decent returns. Added tip, if it looks too good to be true, it probably is.

The concept of Buy low and Sell high: Think back to grade 5 math.  You buy a bushel of tomatoes from your local farmer in August. The bushel weighs 65lbs and costs $10.00. In December you go to Whole Foods and buy 1 pound of tomatoes at $2.99 a pound. How much would a bushel cost? (65x $2.99 = $194.35). Based on these figures, the time to buy tomatoes is in August. The time to sell tomatoes is in December. The same type of formula applies to your investments. It is all about figuring out when the time is right, and when you will receive the biggest, or best possible, return. This is what your fund manager does, so you don’t have to.

Dollar Cost Averaging: Dollar cost averaging is an important concept for everyone to understand. The idea behind dollar cost averaging is that by averaging costs over a specific period, it may lessen the risk of investing a large amount in a single investment at the wrong time. Stocks aside, dollar cost averaging is a concept that can be applied in your day-to-day lives. For example: Take the mundane investment of filling your car up with gas. Every week, on Monday you buy $50 of gas for your car. Some weeks you fill your tank, other weeks it’s a little less than full. With the cost of gas constantly fluctuating it makes it hard to decide on how much you want to invest (put into your car) at any given time. So what should you do?  Why buy gas every Monday of course! Think about it like this. In January you have no idea what the price of gas will be during the year and you cannot buy a years worth of gas all at once. By buying gas every week, the average price of gas for the year is $1.24. Treat your savings the same way, invest regularly and your average cost will lower, you will surely avoid buying a years worth of investments at the years high.

Compound Interest: Compound interest is the idea that any added interest that you may accumulate produces such benefits that it to may also collect interest going forward. Think of it like this. You buy a plant from your local garden center. The plant begins to blossom beautiful flowers-these flowers are what can be considered the interest on your investment. Eventually, those flowers begin to spread seeds, and before you know it you have a garden full of flowers. In other words, your original investment provided you with interest, which then spread to provide even more interest. When working with your investment advisor look for stocks that have the potential to snowball and get the most out of your money. Happy investing!

Credentials are important: When choosing a family Doctor it is reasonable to look for and expect to see MD after their name. When choosing a financial planner it only makes sense to look for, and expect, your financial planner to have the Certified Financial Planner (CFP) designation after their name. The CFP designation is one of the most rigorous and well-respected designations, signifying competence and high ethics. Insist on it!

If you have any further questions regarding any of these concepts, or others, contact your financial advisor at Continuum II today.