What are today's best investment rules?
Confused about what to invest in today? Join the club! The stock market has made up most of what it lost during the recession, but some say it’s gone too high. Gold is down from its peak, yet worries about inflation may push it back up. Real estate appears to be coming back, but for how long? Safe investments, like certificates of deposit and government bonds, are available but are paying near-historic low rates.
So there’s uncertainty and worries in the investment world. This isn’t new. There are always worries, confusion and unpredictability with investing. Investing deals with the future and, of course, no one can perfectly foresee what’s ahead.
What’s an investor to do? Fortunately, there are some traditional investment rules that I believe still apply to today’s turbulent
times. There’s no guarantee that following them will make you rich, but I’m hopeful they will prevent you from making some big mistakes.
Here are my top five rules.
Risk and return move together: One of the most frequently asked questions in my 35-year career has been, “Where can I invest my money to get higher earnings yet take no risk?” My answer is always short – nowhere! One of the basic rules of investing is that risk and return move together. To get a higher return on your money, you must take more risk. And to have less chance of losing some or all of your money, you have to accept a lower return.
This relationship should make sense. The only way someone will expose their hard-earned invested money to more risk is with the expectation — if things work out — of earning more on that money.
This is not to say people shouldn’t take some risk in investing. Indeed, most experts say some risky ventures should be part of any investment portfolio. But investors should know the level of risk they’re taking. Also, investors shouldn’t think they can have the free lunch of low risk and high returns!
Learn, and only then, leap: I can remember by late mom and dad sitting around the kitchen table 50 years ago and listening to someone making pitches for investments. My parents never went to college — indeed, neither finished high school — and while intelligent, they simply didn’t understand the terminology or ideas of investing. I know they had no clue as to what the salesperson was saying.
Any investment worthy of consideration should and can be presented and explained to you in an easily-understood fashion with a minimum of jargon and complications. And if it can’t be explained to your satisfaction, then you should walk away. For any investment, you need to know exactly how your money will be working, what can go right and what can go wrong. Don’t let someone wave their hands and say, “It’s complicated, but it will work out – trust me.” That’s not good enough.
Find fees: Investment managers and companies have to earn money. So somehow they will be compensated. That’s understandable. But before you put your money in any investment, find out exactly how the compensation occurs. Sometimes it will be when you initially invest the money, sometimes when you withdraw the money, sometimes while the investment is working and sometimes a combination of the three. The point is, know how you pay and what you pay.
And beware, fees do vary. So if an investment charges higher fees, ask what you are getting in return for those costs.
Decide to diversify: A traditional way of dealing with risk — as well as with the reality that knowing which investments will do best in the future is difficult — is diversification. Diversification means putting your investments eggs into many baskets. How many baskets? Experts say to consider stocks, inflation hedges like gold and real estate, short-term “cash” investments such as money market funds and long-term bonds paying a fixed interest rate. Mutual funds are a great way to access most of these baskets.
How much money you put in each is a personal choice, but having greater percentages in safer investments — like cash and bonds — as you age is usually recommended.
Timing is tough: Most investors have dreams of timing their investments, meaning moving money in just as the investment is ready to take off, then moving money out prior to a drop or crash. It’s good to have dreams, but this is one that is very, very difficult to achieve. Many have tried — and may succeed for a while — but eventually the odds catch up to them. So rather than trying to hit a home run with your investments, the alternative is to go with singles and doubles!
These investment rules have made sense (and cents) in the past. Do they still make sense today? You decide.
• Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy.