Too-conservative investing approach can cause problems

Paula Dougherty is a Chartered Financial Consultant and Certified Life Underwriter with American Express Financial Advisors Inc.

When you think of "safe" investments, do you think about leaving your money somewhere secure for a long time with a low, steady rate of return? What most people don't realize is that investing too conservatively can be just as dangerous as investing too aggressively.

Striking a balance between risk and return is the key to creating a sound investment strategy. While there is no one guaranteed "safe" investment product or one-size-fits-all investing strategy, the following investment tips are generally deemed "safer" than others.

Growth and value are two fundamental approaches in stock and mutual fund investing. Many growth fund managers look for stocks of companies they believe offer strong earnings growth potential, while value fund managers look for stocks that appear undervalued by the marketplace. Some fund managers even combine the two approaches.

To create the safest possible investment environment for your particular situation, you must find ways to reduce the volatility of your portfolio while simultaneously stabilizing or, better yet, increasing the rate of return on investments. Ultimately, balance and safety are achieved in a portfolio when you don't have to trade too much risk for extra yield.

Also, make sure that a percentage of the portfolio is positioned to outpace inflation. This may involve a small amount of risk, but without it, you may "safely" grow your assets at a conservative rate of only 2 percent. Unfortunately, inflation has historically averaged an annual increase of 3 percent, and it will appreciate faster than the return on investments.

Spreading a portfolio among a sufficient number of investments in each asset class helps reduce the volatility and risk from any particular investment. A diversified portfolio generally includes stocks, bonds, real estate and cash investments, such as money-market accounts. When diversifying, consider the following investments:

Stocks To understand how safe a stock purchase is, work with your financial advisor to better understand the company's balance sheet. Ask the following questions: How much cash is available in the company? Is there a positive cash flow on a quarterly basis? What are the company's assets? What is the debt-to-equity ratio? Are the company's revenue sales increasing? What is its market share in the industry? Is the company a market leader? Has the company grown by acquisition or organically? Also, look for high-dividend-paying stocks, because they offer a dependable yield that is shared with investors on a quarterly or annual basis.

Most importantly, as market averages begin to recover, investors can reap the benefit at the lowest cost if they have bought stocks from many companies in a mutual fund that mirrors the total market e.g. a broad index fund.

Bonds A six-month Treasury bill currently yields 0.8 percent. Interest is free from state and local taxes, and you can buy T-bills free through the government directly at www.treasurydirect.gov.

Like regular Treasury bonds, Treasury Inflation Protected Securities promise a fixed rate of return on the principal. But the principal on this bond is adjusted twice a year based on changes in the Consumer Price Index. Its interest payment is then calculated on the inflated principal.

For example, if you buy a $10,000 TIPS bond and the next year inflation hits 4 percent, as measured by the Consumer Price Index, you would begin earning interest on the inflation-adjusted principal which would be $10,400. At maturity, the TIPS bond would be redeemed at the original amount or at the greater value of its inflation-adjusted principal.

Remember that many bonds will underperform when better economic growth starts to take hold. Long-term rates will eventually rise, and when they do, bond prices will begin to fall. Investors who think they have stashed a lot of money into safe bond funds may pay the price if they haven't created a diverse portfolio using a variety of investments.

Bank CDs Banks set their own rates, and many don't mind offering slightly higher rates to lure money-fund investors. Although you'll pay a penalty for cashing in a CD before it matures, a high-yielding CD could increase money-fund rates. You can find high-yielding bank CD rates at www.bankrate.com.

Real estate Many people have become as irrationally exuberant about real estate as they were about tech stocks a few years ago. Real estate is a unique investment because it serves two purposes: It is an investment that has the potential to grow in value while at the same time it is where we live and grow our families. You probably shouldn't think of a home the same way you do about mutual funds, stocks and bonds, unless you are ready to convert that equity into cash. However, a home is still a valuable asset, and how well you manage it can have a profound effect on how much wealth you eventually accumulate.

Work with a financial advisor to find out what role your home should play in your overall portfolio and what investment strategies and products are safest for you and your family's personal economy.

This information is provided for informational purposes only.