There are a few roads to wealth that don’t involve an investment of some sort, whether in a vanilla retirement fund or riskier but potentially more lucrative instruments such as publicly traded shares. A “stock” can be shared in a company, but a “stock market” is also where meat animals are bought and sold. In both usages of the term, some of those involved are going to get slaughtered.
It is indeed possible to do very well in the stock market, but TANSTAAFL. Growth is not guaranteed, especially if you try to pick stocks yourself instead of letting a fund manager do the work. You may end up worse off than when you started. Stocks are “sexy” and all of us have seen “The Wolf of Wall Street” by now, but investing is something that needs to be approached calmly and rationally. Numbers tell the tale, but what you see on TV, not so much.
How Old Are You?
Wise people don’t invest in the stock market in order to buy a Ferrari or finance noncapital spending. The focus is (or should be, for most private investors) on capital growth and having a healthy portfolio by the time you retire, at which time you will probably start to cash out and put your money where the shakes and jitters of the market won’t affect your principal that much.
This means that a stock investor, while he may make relatively frequent trades, always keeps his eyes a year or five years ahead. If you’re twenty-five and you lose your shirt, it’s okay. From a practical perspective, you’re not sunk. However, things aren’t quite the same if this happens to someone at sixty-five.
What Other Options Do You Have?
If you have a mortgage at 3.5% which allows you to make additional payments, you would have to be an idiot or have very little risk aversion in your soul in order to play with stocks instead.
Every investment is a balance of possible reward and partially unknown risk. In the above case, your bank has invested money in your future earning ability, betting that the risk of a default warrants a return of 3.5%. From the homeowner’s perspective, and by “homeowner” I mean party to what is effectively a lease-to-buy agreement, paying the mortgage off as soon as possible means an absolutely guaranteed return of 3.5%.
The relative value of investments should be seen against the background of inflation. If your investment portfolio is growing but price inflation is higher than its rate of growth, you are losing money in real terms. Assuming that house prices rise in line with inflation (a pretty big assumption, but let’s keep things simple), increases in the cost of goods and services don’t matter that much since the value of the asset remains the same in real terms. Over the long term and averaging over a large number of stocks, the market can be expected to give a return of about 7%, but inflation hits this directly, i.e. real returns are only about 4 to 5%, with no guarantees, especially over any term less than a year or three. Broker and fund fees also take a little, though this is generally money well spent.
In some cases, it is also a good idea to embrace a nominally riskier investment where you have some control over the level of that risk. Investing in or starting a local business would be a good example. If you know a lot about rare coins or oil paintings, these may well be a better investment than any kinds of publicly traded stock.
How Much Liquidity Do You Need?
Robert Kiyosaki, author of “Rich Dad, Poor Dad” recommends that, if possible, you keep a year’s living expenses in cash. Emergencies and opportunities do crop up, and you may need to liquidate (sell) investment assets in a hurry.
If your investment is in real estate, you can count on needing a minimum of three months to sell it, although it is possible to borrow money against the property, too. Shares can be sold much more quickly, with one caveat: you do not want to check out at the bottom of the market. It might be wise to talk to your bank manager (yes, that guy) about what products his bank offers that draw interest but still allows you to take out money with 14 or 30 days notice. This may not form the cornerstone of your portfolio, but it is something that can make life much easier if the unexpected should happen.
Do You Have a 401(K)?
For some reason, not every company’s HR and payroll departments make sure that their employees know about the benefits of buying stocks through their 401(K) program. This allows you to invest pre -tax income, which could easily mean a 30% gain there and then, while some employers are also willing to pay matching contributions. If you plan to live past the age of sixty, getting to know your 401(K) intimately is one of the best things you can do right this minute.
Einstein famously called compound interest “the most powerful force in the universe,” but smart people don’t base their retirement planning only on the advice of theoretical physicists. As a scientist, Einstein would also have tended to specify the assumptions and boundaries of which his statement is valid: “over the long term” being the most important, and “assuming reliable growth” running a close second.
Hitting the stock market can indeed be a way of achieving financial independence, but it is not for everybody. Bulls don’t yield milk, they grow – and sometimes they turn into other animals for a while.