The Balancing Act of Growth and Value

Question of the week:I've always invested in growth mutual funds because they seemed to do so well. But the last year or so, the value funds are performing much better than growth funds. I'm thinking of switching all my money to value. What do you think about that? --Wobbling Dear Wobbling, It seems that the upswing in value funds has caught the attention of other investors, too, and that quite a few of them have the same idea you do. According to the Financial Research Corporation, a consulting firm that tracks these things, value-style funds brought in far more in new investments in the first quarter of this year than did growth funds. When we asked the Armchair Millionaire community how they are reacting to the upswing in value and drop in growth, we got a range of responses: Ignore the swings. "Have a diverse portfolio and stick with it. Ride out the highs and lows of the market and over time you will make money." --Joe G. Move a little with the swings. "I have shifted somewhat more into value funds. I do think it's worthwhile to adjust your portfolio mix depending on the market." --Mike F. Leverage swings to the fullest. "I've looked at the market swings as opportunity to invest in stocks that are undervalued with an expectation for growth. --Linda I'd caution you against falling into the classic trap of making drastic changes in your portfolio in order to chase performance. After all, who's to say that as soon as you switch to the value funds that we won't see an upswing again in growth? My quick guide will help you understand what growth and value investing is all about and how to wisely balance the two. The Armchair Millionaire Guide to Understanding Growth and Value What is value investing? Value investors are the bargain shoppers of the stock market, on the lookout for stocks that, for one reason or another, look inexpensive. It could be that the company is in an industry that has fallen on hard times or it may have recently had disappointing earnings reports. The trick to value investing is in determining which companies are fundamentally strong but has gone unrecognized by the stock market. Once they are discovered (or often re-discovered), the value investor is set to profit. What is growth investing? In contrast to thrifty value investors, growth managers are happy to pay full price (or even a premium) for stocks that have shown good growth in earnings in the recent past and that they believe will continue to show strong growth in the future. Typically, these companies offer much-in-demand products or services, a solid business plan and management team, and an overall healthy financial picture. What works when? Because the two styles are so different, it's unusual that they both work well at the same time. When the economy is growing, growth usually reaps the highest rewards. But during times of economic slowdown, investing in stocks that are still a real value can pay off nicely. What are the risks? Both styles carry their own kind of risk. Simply because they have further to fall, the prices of growth stocks can take a bigger hit during bear markets than value stocks. On the other hand, the risk in value stocks is that they simply may never achieve their hoped-for value. Which is right for you? If you're looking to build a well-rounded, long-term portfolio, the answer is "Both." By investing in at least one fund managed for growth, and one managed for value (or a single index fund, which will cover both), you'll be positioned to capture the advantages of each, regardless of what the economy may bring. At the same time, the diversification you'll achieve will help reduce the risks of each. THE BOTTOM LINE: There's always some part of the market in vogue, and another part in the doghouse. But since you can't accurately predict the next darling of Wall Street, stick with a diverse portfolio that covers all of the market.

Raising Money-Savvy Kids

Question of the week:I'm the father of two young children and I want to do everything I can to make sure they know how to make good financial decisions when they grow up. What should I be doing to teach them about money? --Denver Dad

Dear Denver,

Your kids are lucky to have a parent thinking about teaching good money skills. When we polled Armchair Millionaire community members about how much their parents had taught them about money and investing, a resounding 79 percent said, "Nothing." We also asked them to tell us how they are teaching their own kids, and got a range of good ideas:

Model good behavior. "Let your actions speak for themselves. Young people are going to emulate the people around them so if your kids see you being reckless with money, there's a good chance they'll follow suit." --Marcus

Let them in on the family finances. "I made an enlarged copy of a check that I had written to American Express in the amount of $1,107.48. I showed it to my nine year old and his eyes got as big as quarters! Now he knows that plastic credit cards are not actually endless sources of money." --Tammy S.

Start young. "As soon as kids are old enough to ask for cookies, comic books, and/or cash, they are old enough for their first of many financial awareness discussions." --Perry

These days, when our paychecks are deposited automatically and our cash is spit out of ATM machines, it can be challenging to teach kids the real value of money. The key is to set them up to succeed while grounding your lessons in real life. Lectures about saving and investing will mean little if your kids don't have the opportunities to experience their own achievements and failures with money. My checklist provides some ideas on raising financially literate youngsters.

The Armchair Millionaire's Checklist for Raising Money-Wise Children

• Entice them to save. Help your child set up a savings account and get them going with a $50 or $100 deposit. Offer to match some portion of every dollar they save, and be sure to review their account statements with them so they understand the contribution that interest is making to their grubstake.

• Teach smart spending. Let's not forget the other side of the coin-spending. If kids don't learn about living within their means, all your good advice about saving and investing will add up to naught. Help them make a realistic budget and stick with it.

• Show how much debt really costs. If your child asks for a loan, help them out, but charge a realistic rate of interest--and insist they pay it. They'll quickly learn how expensive it can be to use other people's money.

• Start them in stocks. Investing will stop being an abstract concept the moment your kids have some stock of their own. You can start them out with a gift of one or two shares of a well-known company (check out gift stock brokerages like, www.oneshare.com) and follow it with them weekly in the newspaper or online. As they get older, help them buy stock themselves through a dividend reinvestment plan. Offered by many blue-chip companies, these plans allow small stock purchases of a single share or even fractions of shares. Most have low initial minimum requirements and many allow regular additional monthly investments of as low as $25. You can find complete information on these plans at www.netstockdirect.com.

THE BOTTOM LINE: The financial lessons and habits learned in childhood can last a lifetime. To help your child grow to an adult who wisely handles money and investments be a good role model for them and teach them through real-life learning opportunities whenever possible.

Outlasting the Bear

Question of the week:I started investing for retirement in 1999 when everything seemed rosy. Now everything's going downhill and I have less than when I started! What should I do? --Susan G.

Dear Susan,

No doubt about it, this is the kind of market that tests an investor's mettle. It's tough to see your portfolio lose value, especially after the banner bull market years of the late 1990s.

We asked other members of the Armchair Millionaire community how they were holding up in the down market. The response was nearly unanimous: Stay the course.

Here are a couple of examples:

"I'm using the same techniques now that I used during the bull market: Keep making monthly investments into a broadly diversified portfolio of stocks and keep a long-term outlook." --Jerry

"I have made no changes in the way I invest over the past two years. If you start with a good solid plan, there is no reason to change it." --Bryan J.

We know that the market goes up and down from one day and one year to the next, sometimes with big, stomach-wrenching swings. But over longer periods of time, it only goes one direction: up.

Let's take a look back at how the market has performed historically.

Since 1926, the worst single year for large U.S. companies as measured by the S & P 500 was 1931, when it lost about 43 percent. Its best year was 1933, when it gained over 54 percent. Talk about volatility!

But step back a bit and look at 25-year periods between 1926 and 1999. During these periods, average annual returns ranged between 5.9 percent and 14.9 percent. And if you look at the entire period from 1926 to 1999, the S&P 500 returned an average of 11.3 every year.

Even if you keep a long-term perspective, it can still be difficult to prepare psychologically for the years when the market drops. Use my checklist of common sense steps to help ensure that your portfolio stays on track.

The Armchair Millionaire Checklist for Riding Out Market Downturns

Resist the impulse to sell. Selling into a down market will guarantee that you'll miss out on the inevitable market recovery. Do your homework--choose stocks or funds that are fundamentally sound and watch them to make sure they continue to match your goals and risk tolerance, then just hang on tight.

Maintain a diversified portfolio. There's more to the stock market than the Dow Jones Industrial Index and the NASDAQ. If you have a broadly diversified portfolio that includes large, medium and small cap stocks representing both international and U.S. companies, you'll minimize short-term volatility. For easy diversification, I'm a big fan of using index mutual funds.

Dollar cost average. This simply means investing the same amount of money on a regular basis (like monthly or quarterly), regardless of how the market is behaving. When the market's up, your money buys fewer shares. When it's down, it buys more. Over time, your average price per share will tend to be lower than if you had bought in large lump sums. (This technique works best with no-load, no transaction fee mutual funds.)

Tune out the noise. For every pundit forecasting the next great bull market, you'll hear another who is sure that we're in for continued doldrums. The truth of the matter is that no one can consistently predict the short-term direction of the market with 100 percent accuracy. Ignore the talking heads.

THE BOTTOM LINE: History teaches us that the best way for investors with long- term horizons to make money is to simply stay invested in stocks. Don't let emotion scare you into making moves that will derail your long-term investment success.

Hands Off That 401(k) Cash

Question of the week:I'm 28 years old and have about $18,000 in my 401(k). I'm leaving my job for a new one next month and I'm thinking of cashing out my 401(k) to pay some bills and old college debts. What do you think? --Milwaukee Job Hopper Dear Job Hopper, You're certainly not alone in your temptation to use that money for something other than retirement. According to a study by global management consulting firm Hewitt Associates, 68 percent of 401(k) plan participants choose to take their money as a lump sum when changing jobs. But just because so many people do it certainly doesn't make it a good idea. I strongly urge you to think twice and carefully consider just exactly what the real cost of cashing out your 401(k) will be. Let's look at that $18,000. First, you'll have to pay a ten percent early withdrawal penalty to the IRS, along with regular income taxes on the money. Assuming that you pay 27 percent federal tax and five percent state tax, you'll wind up with just $10,440 after you pay the penalty and tax. Next, assume that you were to leave that $18,000 alone to continue its tax-deferred growth until you reach age 60-another 32 years. At an average annual return of 10 percent, it would grow to over $380,000. So cashing out that 401(k) really leaves you with just over half of what you had in your account and ultimately, $380,000 less for retirement. If the math alone doesn't convince you, take a look at some of the real-world experience of members of the Armchair Millionaire community who cashed out 401(k)s: "I cashed out and it was the worst financial mistake of my life. I used it to pay off credit cards, but it wasn't worth it. If I'd had a better understanding of the penalty and taxes that I ended up paying, I'd never have done it." --Suze G.T. "I had been laid off from my first real job and money was tight. I cashed it out, paid the tax and used the money for a down payment on my first home. Who knows what it would be worth now if I had only rolled it over …" --D. My checklist will give you the details on alternatives to cashing out that 401(k). The Armchair Millionaire's Checklist of 401(k) Choices for Job Changers Roll it over into a traditional IRA. This means simply moving your money from your 401(k) to an IRA. Any mutual fund company or brokerage will be able to supply you with information for setting up a rollover IRA and making the transfer. (By the way, be sure to do a direct rollover, where the money is sent directly from your 401(k) to your IRA. If you take the cash and then deposit it yourself into the IRA, you'll be subject to a 20 percent backup withholding tax.) Keep it with your old employer. As long as you have at least $5,000 in your account, you can leave it in your former employer's plan. You might opt to do this if you especially like the investment choices it offers or if you just need more time to decide what to do. If you have between $1,000 and $5,000 in the account, however, your employer may choose to roll it over to an IRA on your behalf. Roll it over to your new employer's 401(k) plan. Most plans allow you to do this. Your human resources department will be able to give you information on eligibility and the forms you need to arrange the rollover. THE BOTTOM LINE: If you're changing jobs and faced with the decision of what to do with the money in your 401(k), think carefully. It might be tempting to walk away with a handful of cash, but it will end up costing far more than you may think.