Safe Investing for Beginners
Can a beginner practice safe investing easily with quality returns? Absolutely. Exactly how you decide to invest safely depends mainly on your answers to "what is the money for?" and "when will you need the money?" and "what is your tolerance for losses?" Some people also look to throw safe investments into their portfolio with riskier investments to balance out potential losses.
Why are you looking into safe investments? The recent downturn may have scared you away from taking higher risk options with your money. This is fine. You've realized that you just don't sleep well with your money in stocks. Good for you. You've figured out who you are. You have a low tolerance for the natural ups and downs of the stock market. Its important though to not get excited about stocks when they recover (and they eventually will) and jump right back in. If this is your pattern of behavior, please stop it now! You're going directly against the old saying, "buy low, sell high." You're buying back into stocks after they have risen and selling them when they've fallen.
Don't let your emotions regarding the short-term movements of the stock market sway your investing decisions. If you control your emotions, then your investments become safer and more stable. For many people, they are their own worst enemy. They pay too much attention to the day-to-day or even month-to-month gyrations of the stock market. Ignore the stock market almost every day of the year. The more you look at the short-term performance of the market, the more you'll be susceptible to your emotions.
You may want safe investments because you have a short time horizon for when you'll need the money. The general idea is if you will need the money you're investing in less than 5 years, then don't put it in stocks. For example, lets say you're saving up for a down payment for a house in 2 years. If you put your money in the stock market, there's a chance that you won't be fully funded to the down payment you want to make in 2 years. However, with a lower risk investment, like a money market account, CDs, or maybe bond investing, you can know exactly how much you need to put in your down payment account to make your goal.
Let me define what I would consider investment safety to be. I would say that the less likely that you'll lose all or most of your investment, the more safe that investment is. Also the less likely that you're going to panic and sell at a loss, the safer an investment is. There are three huge investment safety factors to consider:
(1) Risk of complete loss of money put in:
- The best way to make factor (1) top the safety scales is to put the money in an FDIC insured money market account or by investing in CDs (also FDIC insured). You can't lose your money here. However, there is a chance that your purchasing power will decrease if inflation is greater than your low earnings rate.
- A slightly less safe option, but still with a near zero chance of big losses is bond funds investing. You get a larger gain with very little downside. Yes, it may fall, but on the average you'll do better than CDs and money markets. Also, if you buy a general bond index, there's basically no chance of losing all your money. The whole economy would have to collapse. In that case, it wouldn't have mattered where you put your money. Also, you have a greater chance of beating inflation than with the FDIC insured methods.
- Even less safe are general index funds of stocks. I know what many of you will be thinking - "Stocks aren't safe!" I believe they are if your time horizon is long, you invest in a general index, you're patient, and you don't let your emotions about the short-term conditions overwhelm you. If you're looking at a long time horizon, this will safely give you good returns.
(2) The second factor determining "risk" is how fast value of the investment changes - up or down:
- If you expose yourself to sudden and large gains, you have to expose yourself to sudden and large losses. There is no way to get around this. Anyone who tries to sell you on something that gives you sudden and large gains with no chance of losses is lying or misinformed.
- Stocks have a greater chance to go down in value than the other asset types I've listed. They also go down further when they go down -- as I'm sure you have experienced within the last few years. However, they also have a greater chance to go up by more. Overall, with patient and consistent investing, they will gain you more in the long-run. Therefore, stocks have a greater risk of suddenly dropping.
- CDs and money market accounts might not ever really go down (not including inflation), but they also will never shoot up in value or give you 20% return in a year. Therefore, they have low "risk."
(3) The third factor is Asset Correlation. Having good Asset Correlation is important to safety. For example, an internet stocks index fund index fund isn't diversified simply because they're spread across many different companies. All the stocks within the fund will, for the most part, move up and down together. When your different assets do not move up or down together, then your risk is much lower because big losses in one area are often offset by big gains in another.
Putting it all together leads me to what I think is the best way to invest money. My best way is relatively safe -- yet it still gives you solid long-term returns. Check it out by clicking on Best Way to Invest Money.
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