Armchair Millionaire

Turning Down the Noise

Question of the week:I want to learn to become a better investor, but I'm kind of overwhelmed by the amount of investing information out there. Can you recommend the best expert or publication? I'm especially interested in finding out which direction the market will be going. --K.R., Dallas Dear K.R., Given the incredible deluge of financial information on the Internet, television and the newsstand, you can hardly help but be overwhelmed. But you need to realize that the media needs to sell headlines to stay in business, and that nothing sells headlines better than "investing noise"--claims about where the market is headed in the near term and which investments your must buy (or avoid). This noise creates uncertainty, even fear, in some investors, prompting many of them to try to constantly chase a better return or find a better fund manager. This is the exact opposite of how a successful long-term investor behaves. When we asked members of the Armchair Millionaire community about where they got their investing information and how they used it, we heard some nuggets of wisdom: "Variety of sources, such as CNNfn, CNBC, CBS, ABC, Prudent Bear, newspaper, magazines, weekly finance publications, etc. Each has a perspective, and some have an axe to grind." --Alan and Kay "I read a lot and subscribe to Business Week, Kiplinger's, and Fortune. I skim for ideas and seldom bite. My portfolio turnover is of the order of 5 percent a decade ... These sources are useful, with a lot of filtering." --Duke I was at a recent investing seminar and the speaker, whose job it was to "wow" the crowd, said it best: "Don't accept forecasts. No one knows the future. Use only historically-proven investing methods." The theme here? These smart investors recognize that there are many sources for investing ideas but no substitutes for using common sense. If someone tells you they know something that's going to happen in the future, you would do best to regard them with skepticism. Rather than being a "noise investor," focus on becoming an "information investor"--someone who knows how the financial markets work, who uses a common sense, long-term investment strategy, and who doesn't chase the latest hot investment. My guide will help you filter out the noise as you journey towards becoming an information investor. The Armchair Millionaire's Guide to Tuning Out the Noise Focus on quality, not quantity. More is not always better when it comes to financial information. Choose one or two quality publications or programs that address a wide range of investing and personal finance topics, and that focus on education to help you be a better investor. Consider the source. Who is making a particular recommendation? Is it an analyst that is mainly concerned with the short-term direction of a stock? If so, such a recommendation offers little for an investor building a portfolio for the long term. Resist any calls to immediate action. Be wary of headlines that scream, "Sell Stocks Now!" Sudden about-faces have no place in any well-considered, long-range investment plan. Beware of anyone making forecasts. No one has a crystal ball. For every pundit who says the market or a particular stock is heading one direction, you can find another who swears it's going in the other direction. What we do know for sure is that the market goes up and down from one day and year to the next, and that over longer periods of time it goes up. Stick with the enduring rules. No matter which direction the market is heading, there are timeless investing principles that will see you through. Save a portion of each paycheck. Invest regularly to take advantage of dollar cost averaging. Take advantage of all tax-advantaged investing opportunities, like your 401(k) or IRA. Buy and hold low-cost investments that track the stock market, such as index funds. THE BOTTOM LINE: The reality is that there is no single expert or publication that will consistently provide you with an advantage when it comes to choosing particular investments or deciding when to invest. But the good news is that you don't need this kind of advantage to be a successful investor.

Ready to Dump Your Funds

Question of the week:With all the news lately about improper practices in the mutual funds industry, I'm about ready to dump my funds completely. Do you have any suggestions for a good alternative place to put my money? --S.C.

Dear S.C,

Given that Americans have $7 trillion invested in mutual funds, and a steady stream of troubling news from the industry watchdogs, I'm sure there are many other investors out there who are having the same response. When we asked members of the Armchair Millionaire community for their reactions to the mutual funds mess, we heard a range of opinions. Here are just three:

Voting with his feet. "Although I only have a money market account with Strong, and was not affected by Dick Strong's market timing of his own company's funds, I am going to close the account and put the money with a company that is more ethical. I also closed a Janus account for the same reason. If more investors voted with their feet, fund companies would soon get the message." --John R.

Wait and see. "So far I am hanging on to good quality mutual funds, but I am watching and listening ..." --Les

Sticking with funds. "I have left my mutual funds alone, intact and where they were for the most part. I think this is just a 'bump in the road' and that fund investing will continue as always. --Alana F.

In terms of alternatives to mutual funds, there is one choice that offers the easy, instant diversification that makes mutual funds so attractive. Exchange-traded funds (or ETFs, for short) look like an index fund, tracking the securities of a particular equity or bond index. However, they trade just like stocks, so you need to buy them through a broker. Perhaps the best known ETFs include SPDRs (often called "spiders"), which track the S&P 500, and DIAMONDS, which track the Dow Jones Industrials.

My guide gives you a look at the most important differences between ETFs and mutual funds in the key areas you should consider.

The Armchair Millionaire's Guide to Mutual Funds vs. ETFs

• Expenses. The annual expense ratios for mutual funds can range from a low of about .2 percent for the best index funds on up to 2 percent or even higher for some actively managed funds. ETFs are generally much more cost-efficient, with expense ratios ranging from about .1 percent up to just .6 percent.
• Trading costs. If, like me, you're a big believer in the value of investing small amounts on a regular basis (called "dollar cost averaging"), ETFs are problematic. While no-load funds let you buy shares as often as you wish without paying a sales commission, you do have to pay a brokerage commission every time you buy ETF shares. These trading costs could easily wipe out the advantages of the low expenses of ETFs.
• Selection. With the thousands of mutual funds available, there's one to suit virtually every investor's taste, from the broadest index funds to specialty funds investing in just a single industry or country. But there are all kinds of ETFs, too. There are ETFs that track all the major stock indexes, including large, mid- and small cap indexes, growth and value indexes, global indexes and bond indexes.
• Flexibility. Mutual funds usually require a minimum initial investment (typically ranging from $500 on up to $3,000 or more), but make it easy to automatically make subsequent investments. You can invest in funds through a financial advisor, broker or directly from many fund companies. ETFs, like stocks, are bought and sold throughout each trading day, and can be sold short or bought on margin. There is no minimum investment, but you will need to have a brokerage account set up to buy ETFs.
• Taxes. Because of the turnover of investments held by mutual funds, you may often have to pay taxes on capital gains, even if you don't sell any shares. ETFs, on the other hand, are extremely tax-efficient, though you will have to pay taxes on capital gains if you sell your ETF shares for a profit, just like you would with any stock.

THE BOTTOM LINE: It's certainly not reassuring to hear about big names in the fund industry being investigated for possible wrongdoing. However, you should not simply react and pull your fund investments altogether. By being aware of your alternatives, you can try them out and come up with your best solution.

Investing According to Your Values

Question of the week:I'm just starting to invest and I really want to do it according to my religious values. I've never seen much information on how to do this. What are your suggestions for how to go about it? --M.T.

Dear M.T.,

Even though you don't hear much about it, there are actually plenty of people who pay a good deal of attention to their faith when they make financial decisions.

According to a recent study by MMA Praxis Mutual Funds, 80 percent of investors surveyed consider themselves to be religious or spiritual. Of these, two-thirds would consider changing investments based on their values and beliefs. And the survey also found that the five most important concerns of these investors are the operation of sweatshops, product safety records, high executive compensation, environmental records and adult entertainment.

When we asked members of the Armchair Millionaire community about religion and their money, we certainly heard all kinds of responses. Here are just two:

Values beat fundamentals. "I consider it my responsibility to manage my God-given resources wisely. When considering investing vehicles, I do reject those companies that contradict my moral values--regardless of how great their fundamentals are." --A. Rodriguez

Don't need to be religious to tithe. "Although I don't formally practice any religion, I do give 10 percent of my income to my favorite charities and non-profit organizations." --Mysticaltyger

Whether you would like to avoid investing in companies whose practices you dislike, or use your investments to influence the way companies do business, you have a number of different ways to invest according to your faith. My guide provides the basics.

The Armchair Millionaire's Guide to Faith-Based Investing

• Choose stocks that match your values. Like companies that donate back to the community, that support your favorite cause, or that produce goods and services you believe in? Help ensure their success by investing in them.
• Choose funds that match your values. If you'd rather invest in mutual funds than bother with individual stocks, there are a number of different ones available that invest in accordance with defined religious, social and/or environmental guidelines. You can find more information on these faith-based and socially responsible mutual funds at www.socialfunds.com.
• Engage in shareholder activism. Some investors choose to try to influence company policy by submitting and voting on corporate proxy resolutions. There are a number of organizations devoted to changing the way companies do business from the inside out. One is the Interfaith Center on Corporate Responsibility (www.iccr.org), a coalition of 275 faith-based institutional investors. Another is the Shareholder Action Network (www.shareholderaction.org), which serves as a clearinghouse of information for faith-based groups, and social and environmental organizations involved in shareholder activism.
• Get like-minded advice. Some financial advisors specialize in helping their clients choose investments that are aligned with their values. You can locate one through the directory located at www.socialfunds.com.

THE BOTTOM LINE: Even if you think that money is the root of all evil, that doesn't mean you can't use it to do some good while reflecting your deepest values.

Portfolio Design 101

Question of the week:I'm just starting to save for retirement and am doing a lot of research to find the best possible mutual funds. What are your recommendations? --G.B.

Dear G.B.,

Your enthusiasm is commendable, but you're really putting the cart before the horse here. Choosing your mutual funds before you've designed your portfolio is like building a house and shopping for the wallpaper before you even have the blueprints.

The important question is actually not which mutual funds you should buy, but what kind of portfolio you want to build. Once you know that, it will be easy to choose the right funds.

You see, contrary to popular wisdom, most of your investment returns over the long run actually have little to do with your individual investment choices. Instead, academic studies tell us that most investment returns are largely determined by your asset allocation--the different types of investments and the proportion of each investment type in your portfolio.

In other words, a portfolio consisting of 100 percent stocks will perform very differently from a portfolio made up of 80 percent bonds and 20 percent cash. This makes your asset allocation much more important to your long-term investing success than the specific funds you choose.

We recently asked members of the Armchair Millionaire community about how they build their portfolios, and heard several detailed descriptions. Here's one:

"My portfolio is in stocks, heavily weighted toward small caps. My Roth IRA is entirely in small caps, while my brokerage account is mixed … and my 401(k) is 20 percent large cap value, 20 percent large cap growth, 30 percent small caps, 20 percent international and 10 percent employer stock." --Doug

While Doug has obviously done a lot of thinking about his portfolio design, your own does not need to be so complicated, particularly since you're just getting started. My guide will give you a basic overview of using asset allocation to build the best possible portfolio for your needs.

The Armchair Millionaire Guide to Designing a Great Portfolio

• Step 1. Choose your asset classes. An asset class is a set of investments that share the same broad risk and return characteristics. The three we think of most commonly are stocks, bonds (also called fixed income) and cash (which includes money you keep in CDs, a money market account, or in U.S. Treasury bills). Most people who are investing for a goal that is many years away--such as for retirement--will generally want to invest primarily in stocks because they offer the best returns over time. For shorter-term goals, you can mix in bonds and cash, which generally give you a lower return, but also less risk.
• Step 2. Choose your sub-asset classes. Sub-asset classes are groups within each asset class that share a narrower set of risk and return characteristics. The most important sub-asset classes within the stocks asset class include U.S. large cap stocks, U.S. small cap stocks and international stocks. It's important to diversify across all three of these sub-asset classes in order to get the highest returns while minimizing your risk. The allocation I've chosen for my own portfolio is one-third for each of the three.
• Step 3. Choose your funds. Now you're ready to pick the mutual funds that will fit into the asset allocation that you've chosen. I highly recommend using index funds, which track the stocks of sub-asset classes. An S&P 500 index fund, for example, is composed of U.S. large cap stocks. A Russell 2000 fund is composed of U.S. small cap stocks. Because you always know which sub-asset classes index funds invest in, they make it very easy to stick with your chosen asset allocation.
• Step 4. Put it into action. Once you know the funds you want to buy, the rest is easy. Simply contact a broker or consult with a financial advisor to open an account and purchase the funds. Or, you can usually buy your funds directly from the fund company.

THE BOTTOM LINE: Wall Street would love us to think that the key to investing success is simply buying the latest hot mutual fund. But what it really takes is using asset allocation to design a portfolio that makes sense for you, and then buying--and holding--the mutual funds that are right for that portfolio.

Should Men and Women Invest Differently?

Question of the week:My husband and I have an ongoing disagreement about whether men and women should invest differently. I say they do; he says they don't. Who do you agree with? --Happily Married in Boston

Dear Boston,

I'm definitely not taking sides on this one. Lucky for me, I get to say that you're both right--sort of.

I believe that the rules of good investing are gender-neutral. At the same time, I recognize that real-world circumstances (most notably, on average they live longer than men and earn less) often mean that women have to be even more diligent in following those rules to achieve the same results as men. So women should invest the same, only better.

We asked members of the Armchair Millionaire community for their thoughts on this thorny topic. Folks were generally in agreement that while there shouldn't be any difference between the sexes when it comes to investing, it does make sense to take into account the different needs of women:

Less means more. "Women have less money and have to make it stretch further. I think that the same rules of good investing apply to everyone. It's just that women have less margin for error." --Chris in California

Less aggressive approach. "Men and women should not invest differently. I would give the same investing advice to both my son and daughter. However, my daughter needs to recognize her natural tendency will be to be less aggressive in her investing, but because she will most likely live longer, she needs to be at least as aggressive as my son with her investments." --Mattchiavo

My guide highlights the unique challenges that many women face and how to overcome them.

The Armchair Millionaire Guide to Overcoming Women's Financial Challenges

• Secure your retirement. Women on average still earn about only about 75 percent of what men earn, and spend many more years outside of the work force, primarily to care for children or parents. This adds up to significantly less retirement savings for women. The solution? Be super-diligent in maximizing every opportunity to stash away retirement funds. This means your employer's 401(k), your own IRA and a taxable investment account.
• Get adequate life insurance. The average age of widowhood in the U.S. is just 56. And widows on average widow experience a 38 percent drop in their household income. The solution? If you're dependent on a husband's or partner's earnings, make sure you really have enough life insurance to meet your needs.
• Get adequate long-term care insurance. Women on average live seven years longer than men and are more likely to need long-term nursing home care. The solution? Prepare yourself for this possibility by obtaining adequate long-term care insurance.
• Empower yourself. Studies show that women tend to be less confident, more conservative investors. The solution? If you haven't already, let go of the old stale myth that a man will be there to take care of your finances. Empower yourself with education. Bookstores are chock-full of publications that will teach you how to ensure your financial future, and the Internet is packed with resources, as well. (My favorite sites for women include www.wfn.com and www.womenandco.com.) If you want help from a real person, attend an investing seminar--there are plenty available, many of them designed especially for women.

THE BOTTOM LINE: It's true that most women encounter certain financial obstacles that most men don't. But those obstacles are certainly not insurmountable. With an educated, common sense approach, both men and women can achieve the financial security they deserve.

Cashing in on Collectables

Question of the week:I just found a stock certificate from 1970 for one share of Ringling Bros. and Barnum & Bailey Circus. It's very pretty--a colorful piece of paper with pictures of animals and the like. How can I find out how much it is worth today? --Caitlin C. Dear Caitlin, Despite what you might think from watching the Antiques Roadshow, making serious money on items you might find in the attic is actually quite rare. While many collectables--everything from coins and stamps to comic books and baseball cards--do increase in value over time, actually profiting from these items on a consistent basis takes deep know-how about your genre. When we asked the Armchair Millionaire community about their views on investing in collectables, we heard two comments that went right to the heart of what makes it so challenging to make money at it: Value is in the eye of the beholder. "The values of collectables are purely subjective. There is the prospect of great profit only if you can find the right buyer who is emotionally involved in the product." --Erik The usual rules don't apply. "Illiquid assets such as collectables are a game in which the rules are considerably less standardized than the securities markets." --Doug If you're just dabbling with collectables, the first place to turn for information will likely be the Internet. In the case of your old stock certificate, you want information on scripophily--the hobby of collecting old stock and bond certificates. You can visit www.scripophily.com to get an idea of the value of your stock certificate. But if you really want to try to make money buying and selling collectables, you'll need to get much more serious. My guide will get you started with the basics. The Armchair Millionaire Guide to Investing in Collectables Risk. Collectables are among the riskiest of all investments. While they can go up in value, they can also drop. If you buy at the peak of a collectable's popularity (remember Beanie Babies?), it will probably end up being worth less than you paid for it. Lack of liquidity. Unlike more traditional investing--where you can always sell your stocks or mutual fund shares--there are no guarantees that you'll ever be able to find a buyer for your collectable willing to pay your price. If you don't, you'll never be able to get your money out of the investment. Pricing. Prices for collectables are determined by a number of factors, including rarity, condition, age, historical importance and perhaps most critically, current fads. However, at the end of the day, the only thing that determines the price of an item is what another person will actually pay for it. Research. Just like regular investing, you shouldn't buy until you've done your research. Books, price guides, antique dealers, antique shows, the Internet and other collectors can all be important sources of information. Emotion. Unlike the stock market, investing in collectables is about more than simply buying low and selling high. The most successful collectors are truly passionate about the items they collect. At the same time, you have to keep your emotions in check--if you fall in love with a particular item, it's very easy to pay too much for it. THE BOTTOM LINE: Your chances of Grandpa's antique fishing lure funding your retirement years are slim. While investing in collectables might be fun, it's likely to be highly profitable only if you're an expert and you use the same discipline to make those investments as you would any other. PS: There's a great example of a Ringling Bros. stock certificate (1969) for sale for $295 at Scripophily.com. No clowning around!

Sector Funds:Investing Deep and Narrow

Question of the week:I've noticed in the mutual fund rankings that some technology funds have done extremely well over the last three months--way better than the market overall. Why not just put all my money in them? If they go down, then I can just switch to whatever is doing best at that time. --Max L. Dear Max, Be careful here. What you're talking about is chasing performance, one of the classic traps that many mutual fund investors fall into. Sector funds--mutual funds that specialize in one industry, like the technology funds you mentioned--will always tend to lead the performance charts. This obviously makes them very tempting for many investors. The problem is that sector funds can also be found at the bottom of the performance rankings. By the time you buy into last quarter's hottest sector, the market could have a new favorite sector and you may find your own funds in the basement. So you really need to look at much more than just performance when deciding if a sector fund is right for you. When we asked Armchair Millionaire community members about how they choose their funds, we found that most people look at a broad range of factors. This comment from Jeremy is typical: A mutual fund laundry list. "I first look for funds from well-established mutual funds companies with long track records of success. Next I look at the expense ratio. Also, the turnover in a fund is very important to me. Finally, I want to own a fund with competent managers who have been with that fund company and particularly that fund for a substantial amount of time and who done well against their appropriate benchmark." As long as you evaluate them carefully on their merits--and that means much more than just recent performance--sector funds can have a place in a common sense portfolio. If you choose to dive into these specialty funds, my guide will get you started. The Armchair Millionaire Guide to Sector Funds How to use them. Sector funds are useful for increasing your position in a particular industry, especially if you don't want to buy individual stocks in that industry. As always, however, you don't want to go overboard and reduce the diversification of your overall portfolio. For this reason, I recommend that no more than 10 percent of your portfolio be in sector funds. What's available. Sector funds span the entire breadth of the economy. For example, there are funds in the financial services, health care, real estate, and consumer services industries, to name but a few. Some funds may specialize even more deeply. A technology fund, for instance, might invest only in wireless services and products. How to buy them. The volatility of sector funds means you should pay special attention to how you buy them. You can even out this volatility and avoid the temptation to time the sector by making your fund purchases with monthly dollar cost averaging. What to watch out for. Sector funds tend to have some of the highest expenses in the mutual fund industry. Since these expenses come directly out of your returns, it pays to shop around for funds with lower expenses. Check the prospectus of any fund you're considering to find out its expense ratio. THE BOTTOM LINE: The beauty of mutual funds is the broad diversification they deliver to your portfolio. Because sector funds go deep and narrow, the concentration they offer has to be taken into consideration along with the rest of your portfolio. So make sure to consider sector funds as a part of your overall strategy and not the whole strategy itself .

Putting Your Money Where Your Mouth Is

Question of the week:I'm just starting to invest and feel very strongly that I want to invest in line with my own personal values. I've recently heard about socially responsible investing. Can you tell me what that's all about? --Maria H.

Dear Maria,

The Social Investment Forum, a trade group for the social investment industry, says that there are more than one hundred socially or environmentally responsible funds today, and that they include every type, from growth and value funds to bond funds and money market funds.

So you're clearly not alone in giving some thought to the impact your dollars have on the companies where you invest. When we asked members of the Armchair Millionaire community recently about their thoughts on the subject, we heard two very different angles:

Go socially irresponsible. "Even though I invest in the Vice Fund and Invesco Leisure fund, which both invest in gambling, alcohol and other sinful causes, I am not at all embarrassed. I feel as I am doing my part to get the economy back on track. I also look at it from the standpoint that people are going to smoke, drink and gamble whether I invest in it or not." --JP

Go socially responsible. "I have to believe that in some small way that the way you invest makes a difference ultimately. It's like voting--your one vote might not make a difference, but all together they do. At the end of the day, business only listens to one thing: money." --Jen

At the heart of it, socially responsible investing is making your investment decisions not just with a financial goal in mind, but a social or environmental one, as well. The easiest way to do this is by investing in socially responsible mutual funds, which use screens to either exclude or include particular types of companies. A "negative screen" will exclude companies for practices or products considered negative (for example, the sale of tobacco products), while a "positive screen" will include companies that are seen as taking positive actions, such as friendly environmental practices.

And while some believe that you have to give up performance to invest in a socially responsible manner, this isn't always the case. According to the Social Investment Forum, three-quarters of the socially responsible funds with at least $100 million in assets earned top marks from fund analysts Morningstar and Lipper for the one- and/or three-year periods ending June 30, 2003.

If you decide that mutual funds are the route you want to take to be a socially responsible investor, my guide will get you started.

The Armchair Millionaire Guide to Choosing Socially Responsible Mutual Funds

• How does it fit with your portfolio? Just because a fund invests according to your values does not make it an automatic choice for your portfolio. It still must fit into an asset allocation that is suitable for your goals, time horizon and risk tolerance.
• How does it screen? Some funds might use many screens, others only one. You'll need to choose according to what is most important to you. A fund that only invests in companies known for excellent labor relations for example, might still allow investment in other companies involved in activities you object to--for instance, animal testing. Bear in mind that when a fund has more stringent screening, the fund manager has fewer investments to choose from, potentially making it more difficult to deliver good performance.
• How long has it been around? Many socially responsible funds are relatively new on the scene, so check on how long it's been in business. Also, find out how long the current manager has been running the fund.
• If you need it, get expert advice. Some financial advisors specialize in socially responsible investments. You can find a directory of these advisors at www.socialfunds.com.

THE BOTTOM LINE: If you want to put your investing dollars to work at more than just achieving your financial goals, socially responsible investing is absolutely worth investigating further.

Putting Your Money Where Your Mouth Is

Question of the week:I'm just starting to invest and feel very strongly that I want to invest in line with my own personal values. I've recently heard about socially responsible investing. Can you tell me what that's all about? --Maria H.

Dear Maria,

The Social Investment Forum, a trade group for the social investment industry, says that there are more than one hundred socially or environmentally responsible funds today, and that they include every type, from growth and value funds to bond funds and money market funds.

So you're clearly not alone in giving some thought to the impact your dollars have on the companies where you invest. When we asked members of the Armchair Millionaire community recently about their thoughts on the subject, we heard two very different angles:

Go socially irresponsible. "Even though I invest in the Vice Fund and Invesco Leisure fund, which both invest in gambling, alcohol and other sinful causes, I am not at all embarrassed. I feel as I am doing my part to get the economy back on track. I also look at it from the standpoint that people are going to smoke, drink and gamble whether I invest in it or not." --JP

Go socially responsible. "I have to believe that in some small way that the way you invest makes a difference ultimately. It's like voting--your one vote might not make a difference, but all together they do. At the end of the day, business only listens to one thing: money." --Jen

At the heart of it, socially responsible investing is making your investment decisions not just with a financial goal in mind, but a social or environmental one, as well. The easiest way to do this is by investing in socially responsible mutual funds, which use screens to either exclude or include particular types of companies. A "negative screen" will exclude companies for practices or products considered negative (for example, the sale of tobacco products), while a "positive screen" will include companies that are seen as taking positive actions, such as friendly environmental practices.

And while some believe that you have to give up performance to invest in a socially responsible manner, this isn't always the case. According to the Social Investment Forum, three-quarters of the socially responsible funds with at least $100 million in assets earned top marks from fund analysts Morningstar and Lipper for the one- and/or three-year periods ending June 30, 2003.

If you decide that mutual funds are the route you want to take to be a socially responsible investor, my guide will get you started.

The Armchair Millionaire Guide to Choosing Socially Responsible Mutual Funds

• How does it fit with your portfolio? Just because a fund invests according to your values does not make it an automatic choice for your portfolio. It still must fit into an asset allocation that is suitable for your goals, time horizon and risk tolerance.
• How does it screen? Some funds might use many screens, others only one. You'll need to choose according to what is most important to you. A fund that only invests in companies known for excellent labor relations for example, might still allow investment in other companies involved in activities you object to--for instance, animal testing. Bear in mind that when a fund has more stringent screening, the fund manager has fewer investments to choose from, potentially making it more difficult to deliver good performance.
• How long has it been around? Many socially responsible funds are relatively new on the scene, so check on how long it's been in business. Also, find out how long the current manager has been running the fund.
• If you need it, get expert advice. Some financial advisors specialize in socially responsible investments. You can find a directory of these advisors at www.socialfunds.com.

THE BOTTOM LINE: If you want to put your investing dollars to work at more than just achieving your financial goals, socially responsible investing is absolutely worth investigating further.

The Portfolio Rebalancing Act

Question of the week:At one point, my portfolio had exactly the right asset allocation. But now, it's totally out of whack. What should I be doing to get it back where I want it? --Joseph J.

Dear Joseph,

Because different parts of the stock market almost never go up or down at the same rate, every portfolio tends to get out of balance over time. But the large swings in the market over the last several years have really pushed portfolios around. What you need is a good rebalancing.

How to accomplish this? We recently asked members of the Armchair Millionaire community about how they do it and heard plenty of details. Here is one such comment:

"I rebalance on the final trading day of the year. I simply move my money (all mutual funds) back to the target allocations. My allocation is 40 percent S&P index fund, 20 percent small cap, 20 percent international and 20 percent U.S. government bonds." --Robbie

The idea behind portfolio rebalancing is simple: You sell a portion of your investments that have done well and buy more of those that have failed to keep pace. By shifting assets from one class to another, you restore your original asset allocation--the mix of investments that is best for your goals, risk tolerance and time horizon.

Many people tend to shy away from rebalancing because it feels counterintuitive. It means selling some of your winners--those that have done the best--and buying more of your losers. But it actually is essential for keeping your portfolio in sync with what you want to achieve. And recent academic studies show that annual portfolio rebalancing will add up to one percent or more in returns over a market cycle of five to seven years. It also has been shown to lower overall risk.

My guide will get you started on this all-important investment management technique.

The Armchair Millionaire Guide to Rebalancing Your Portfolio

• Set guidelines. Choose a margin of deviation for your portfolio that you can live with. For example, I aim to keep one-third of my own portfolio in large cap stocks, one-third small cap stocks and one-third international stocks. Whenever any one portion climbs above 40 percent, I know it's time to rebalance.
• Never act on impulse. Part of the benefit of being a long-term investor is not having to watch the markets every day. To avoid over-reacting to short-term market movements, commit to looking at your balance once a year, preferably in January. If each asset class of your portfolio is within your margin of deviation, leave it. If one class deviates too much, however, go ahead and rebalance.
• Consider adding money. Many people sell part of their over-performing investments in order to free up cash to buy more of the underperforming investments. There's another way, although it involves more active involvement with your trading. You can re-direct new cash purchases towards the asset that's underperforming, both buying on the cheap and re-balancing your portfolio. Then, put any automatic investment plan back on auto-pilot once you're back on track. The best advantage of this? When you avoid selling, you also avoid paying capital gains tax.
• Adjust your allocation as needed. You initially set your asset allocation because you had certain goals that you wanted to reach in a certain amount of time. As your financial goals change along with your time-horizon, re-consider your allocation and your portfolio's overall risk exposure as part of your regular rebalancing.

THE BOTTOM LINE: A smart portfolio is made up of investments that don't all move the same way at the same time. But sometimes this will lead to a portfolio that's gotten too far away from your original blue-print. By occasionally rebalancing your portfolio, you'll ensure that you stick to your original plans and have the kind of discipline that leads to long-term success.