| |
Some folks just can’t stand the thought
of losing money. Well-meaning investors, fearful of the fluctuations
of the stock market, decide the safest place to put their nest egg
is in the ‘safety’ of fixed investments, like CDs or government
bonds. They’ve heard horror stories of friends who lost a bundle in
the 90’s ‘Tech Bubble’ or in the aftermath of 9/11. “That’ll never
happen to me,” they say. “I’ll never put my nest egg at risk.” But
they don’t realize that their actions are bringing about the very
thing they fear the most.
To understand the risks of being ‘overly risk adverse’, you first
have to understand the two basic types of investments. I call this
analogy “Loan vs. Own”. You can either loan your money to someone or
you can own something with it. That’s simple enough, isn’t it? You
can loan your money to the bank, the government or a corporation.
You can own something by buying a home or other real estate, owning
a small piece of a company by purchasing its stock, or by investing
in a stock mutual fund.
Loan investments are designed to provide a stable source of income
but don’t protect you from rising prices. Own investments, such as
mutual funds that invest in stocks, are designed to protect you from
rising prices but have a return that fluctuates.
Think of it this way. Most people buy homes instead of renting
because they know that over time their home will appreciate in value
and be worth more in the future than what they paid for it. Renting,
most people feel, is like putting their money down the drain—you
don’t get anything for it in the long run other than the dividend of
a place to live.
Your home will fluctuate in value depending on interest rates and
the economy in your area. There are some months and years your home
will actually lose money, but that doesn’t mean a home is not a good
investment because, generally, real estate will appreciate in value
over a period of 5 or 10 years.
So here’s the bottom line. For money you plan to use in the next 1-3
years or for that portion that you must have to provide income, it’s
better to rent your money—to use loan type of investments. The other
portion of your money should be used to buy investments where you
own something that’ll appreciate in value over time.
This brings us back to our main point; investing the money you need
for the long term in mostly ‘loan’ type investments will actually
cause you to lose money in the end. The Rule of 72 clearly
illustrates this point by allowing you to quickly estimate how long
it will take you to double your money. Say you’re earning 5% on a
fixed investment. By dividing 72 by 5, you find it’ll take you
almost 14 1/2 years to double your money. Even a small increase in
return makes quite a difference. At 7% interest, it would take just
over 10 years for the same results.
When you consider that the historical average annual stock market
return has been 10-12%, compared to 6% for fixed investments, you
can see that it can take twice as long to double your money with
‘loan’ type investments. With life spans constantly increasing, most
retirees will be depending on their nest egg for 25 years or more.
You can’t afford to ‘safely’ park your nest egg in bonds or CDs and
hope to maintain your current lifestyle, unless you have a very
large nest egg.
It’s true that over the past couple of decades ‘loan’ investments
have performed very well. That’s mainly because we’ve been in an
environment of falling interest rates. When rates fall the value of
a bond increases. That trend is coming to an end. Bonds are not
expected to repeat their past performance in the foreseeable future.
Keep in mind, with the right advisor, the volatility of investing in
equities can be reduced through proper management. So if you’re
serious about achieving and maintaining the lifestyle you desire,
you must take steps now to make those goals a reality.
For free, clear, unbiased advice submit your questions to www.guardingyourwealth.com/askjeff.htm.
You’ll be glad you did.
Mr. Voudrie is a Certified Financial Planner, nationally syndicated
newspaper columnist and President of Legacy Planning Group, Inc., a
Private Wealth Management Firm in Johnson City, TN. He can be
reached toll-free at 1-877-827-1463 or at jeff@guardingyourwealth.com
|
|
