Let’s recap: If you have extra money to invest, consider paying off some debts first. Then work on a rainy day fund because life has plenty of rainy days. Next, consider the advantages of a match in your 401(k) if you are fortunate enough to have a job that offers a match. Remember, it is free money. Now let’s consider what defines your tolerance for risk. For you it could mean avoiding or minimizing risks. When we invest, what risks should we be aware of? First is inflation. It is subtle; so many people don’t recognize it. Like the frog placed in water that eventually starts to boil, you may not notice the gradual change. Eventually you’re cooked. Historically, inflation has averaged around 3% per year. We don’t know what the future holds, but at 3% per year, our money is worth much less 20 years from now. Do you remember 1980, 1970, or earlier? The cost of living was much different. Here’s the point. If inflation is 3%, and your investment returns 1%, how much did you make? 1%? Technically, that’s correct. If my cost of living went up 3%, then I need make 3% on my money to break even, or keep pace with inflation. If I only made 1% on the investment, then I actually lost 2% because my purchasing power, measured by inflation, actually declined by 3%. Some people call CDs Certificates of Depreciation because they often return less than inflation. It may be predictable, and have a guarantee, but the risk of inflation affects everyone. The next risk is the risk of loss. Can you afford any loss? That may depend on how long you will invest the money. In the short term – less than one year – you may consider investments which have a guarantee. Most investments which come with a guarantee do not pay high interest rates. In this environment, the rate is often less than inflation. Considering an investment in the stock market is too risky for a one year time frame. While past performance cannot predict future results, historically the markets have increased about 75% of the time during a 12 month period, while 25% of the time, the markets declined. Just look at last year. Many major market indices declined 35%-40%. If you can only invest for one year or so, do you really want to risk that type of loss? Doesn’t seem worth it to me. If you cannot afford to lose any of your money, then you may not want to risk any of the principal. Medium term investments may last two-five years. With that time frame, your goal may be to keep up with inflation, or try to grow your money. The longer your time horizon, the more risk you may want to take. We cannot address specific investments or what may be appropriate for your situation. However, we all need to remember some basic principals. Attempting to achieve a higher return usually means a bigger risk. And most importantly, if it sounds too good to be true…it probably is.
- Video Central
- About WWAY