Dr. Mike Walden
North Carolina Cooperative Extension
There’s rarely a meeting at which I’m speaking where someone doesn’t ask me about investing. Often it’s about the stock market, but sometimes there’s a question about gold, foreign currencies or even options.
Economics is a discipline that changes as new theories and research alter the way we look at economic issues. But not so with investing – at least that’s my opinion. Many argue the principles most people should use to guide their investments are timeless.
What are these principles? Each academic and analyst has his or her own group. Mine includes six principles that I think are fairly representative of a logical approach to investing. Here they are.
Invest early and regularly: This is one of the most fundamental of investment principles. Due to the power of compound interest (earning interest on interest), regularly investing a smaller dollar amount over a longer period of time usually beats investing a much larger amount over a shorter period of time. Also, starting earlier with a smaller amount is easier to fit into a person’s budget.
Here’s just one example: Jessica begins her work career and immediately invests $1,000 a year in an investment paying 4 percent annually. After 30 years she would have accumulated more than $56,000. If Jessica had waited to begin investing 15 years into her career and invested twice as much ($2000) a year for 15 years, she would accumulate only $40,000.
So, “time is money,” and, in this case, the time works in the investor’s favor.
Watch the little stuff: The most common complaint heard about investing is that money is too tight and people just can’t find the funds to invest. Here’s where the dreaded “b” word – budget – comes in. It’s amazing how we can lose track of where our money is spent. This is the benefit of a budget: It lets us see where our dollars are going. And once people do budget, it’s also amazing to see how easily they can come up with $1,000, $2,000 or more a year to invest. Cutting back on eating-out, personal care, cell-phone contracts, cable contracts and other entertainment is among ways experts recommend to free up money for investing.
First, take care of emergencies: Everyone faces unexpected expenses that can’t be put off: A new car engine is needed, the roof leaks or medical care requires a big deductible be paid. Before any investing is done, a reasonable amount of money – probably several $1,000s – should be put aside in a safe place where it can be accessed quickly. The best options are checking accounts or money market funds that allow quick withdrawals.
Diversify: I know the stories of investors who “went for broke,” put all their money on a single investment, then won and made a fortune. While such tales make for great headlines, they aren’t normal. Indeed, for every investor who “rolls the dice” and wins, there are several more who do the same and lose.
With investing comes risk. Risks vary, but the pay-off to taking more risk is to earn a higher “expected” return. “Expected” means you’ll usually earn a higher return, but sometimes you’ll earn much less if the worst-case scenario occurs.
Investors can control overall risk and still pump up their return by putting money in a variety of investments, each of which has different risk/return combinations. So at the top of the risk/return measure might be stocks, while at the bottom would be government-insured bonds. Also recommended would be some real estate and some precious metals.
The percentage splits the investor would put into each of these risk/return investment categories importantly depends on the investor’s age. Typically it’s suggested younger investors – who have more time ahead of them – put relatively more in high risk/return categories like stocks, whereas older investors who probably need their investment funds sooner edge toward lower risk/return categories.
Watch fees: Fees will often be paid to invest your money. The institution handing the investment, like a stock brokerage firm or a mutual fund, will receive the fees.
However, fees can vary – and by a very wide margin. This means you should compare investment returns only after subtracting investment fees.
There’s a big debate in academic literature about what investors get for the fees they pay. Specifically, do higher fees correlate with higher rates of return and better investment management? If the answer is “yes,” then the fees may be worthwhile. But if the answer is “no,” then the investor probably wants to shop around for the lowest fees possible.
Expect a cloudy crystal ball: Both economic and financial forecasting are tough. I know – I’m in the business – and I’m the first to admit my crystal ball is very cloudy. So don’t expect you or your investment advisors to “get it right” all the time; no one can.
I hope that these timeless investment rules are helpful – but you decide!
Dr. Mike Walden is a William Neal Reynolds Distinguished Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of North Carolina State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The College of Agriculture and Life Sciences communications unit provides his You Decide column every two weeks.
Previous columns are available at http://www.cals.ncsu.edu/agcomm/news-center/tag/you-decide
Related audio files are at http://www.cals.ncsu.edu/agcomm/news-center/category/economic-perspective