Perspective Matters
May is Investing Wisely Awareness Month, emphasizing the importance of understanding investments. Investing involves using saved money to help others produce goods or services, with the expectation of benefiting from their success. Two main types of investments are equity and debt. Choosing where to invest requires thoughtfulness and deliberation regarding the type of businesses to support.
When making financial decisions, consider whether your motivation stems from fear or greed, pleasure or pain. Recognize your natural approach and leverage it in decision-making. Be conscious of emotions to make informed choices and avoid reacting impulsively.
Getting back to those basic guidelines:
Don't put all your eggs in one basket
Something that sounds too good to be true usually is
Look before you leap
Follow the money
One of the key guidelines in investing is to acknowledge that what you don't know can be risky. It's crucial to understand that there will always be unknown factors influencing decisions. Investing often involves incomplete information, so relying on guidelines is essential.
Don't put all your eggs into one basket: Diversify investments to manage risk which is defined by the range of possible outcomes. If faced with two investments with the same return but different yearly ranges, the wider range is riskier.
If you prefer more certainty, consider investing in bonds as a lender. Bond owners receive guaranteed interest payments and principal repayment on specific dates. Market prices fluctuate based on interest rate changes. Holding the bond until maturity ensures known returns, barring bankruptcy.
There are four other risks to keep in mind:
Liquidity risk: if you need access to your money prior to the bond's maturity date, you'll likely have to sell it. However, finding a buyer may not be guaranteed.
Interest rate risk: If you sell a bond when interest rates are higher than when you bought it, you will likely take a loss because bond prices and interest rates move in opposite directions.
Reinvestment risk: If you want to reinvest your interest payments, you may not earn the same interest as the original investment.
Inflation risk, a/k/a purchasing power risk: Investing in bonds may not preserve purchasing power over the long term due to inflation being historically higher than the interest rate received on bonds.
Investing in stocks entails higher risk but offers potential for greater returns compared to bonds. By buying stocks, investors become stockholders in companies worldwide, contributing to business expansion and potentially increasing purchasing power faster than inflation.
Diversify investments to reduce risk: spread money across different stocks, bonds, companies, industries, and countries to reduce potential losses in case of financial issues.
The next guideline is something that sounds too good to be true usually is. It's crucial to understand reasonable expectations for various investments, especially bonds, which are typically long-term. Returns from bond investments depend on economic and interest rate cycles. Bonds usually yield slightly over 4%, but returns can vary based on interest rate movements. High interest rates decreasing can lead to profits, while rising rates could result in losses. Consider economic and interest rate cycles before investing in bonds.
When investing in stocks, consider leaving your money for at least five years due to day-to-day price fluctuations. Stocks offer potentially higher returns over time, with an historical average of around 10% annually but with significant short-term volatility (see chart below). Investments promising unusually high returns often come with hidden risks. Past performance does not guarantee future results. Managing expectations is crucial, as all investments carry uncertainty and risk. Be cautious of guarantees against losses or "sure things," as every investment involves trade-offs between potential gains and risks. Balancing risk is essential, as both overly conservative and overly aggressive approaches have drawbacks.
The last two I mentioned, look before you leap and follow the money are connected to “if something sounds too good to be true, it usually is.”
Look before you leap - do your homework. When investing, consider if you can afford to invest for five years or if you need the money back sooner. Be aware of what you are investing in and what you expect. If a company you invested in doesn't increase its dividend or misses its earnings estimates, decide beforehand what you will do.
Follow the money - When considering an investment, it's important to be cautious about the source of information. Be aware of individuals who may have a vested interest in promoting a particular investment. For example, someone may buy stock in a small company and then post positive comments about the company in chat rooms or on social media. This can lead others to buy the stock, which drives up the price. The person who posted the positive comments can then sell their shares for a profit. To avoid falling into this trap, be skeptical of those who "talk their book" and seek information from sources that don't stand to benefit from your investment decisions.
Neither Prism Planning and Solutions Group nor Insight Advisors provide tax advice, and nothing in this communication should be treated as such. This communication should not be interpreted as a recommendation for a specific investment or tax-
planning strategy. We are providing this material for informational purposes only. We have made every attempt to verify that information contained in this communication is accurate as of the date published but make no warranties. Before making any decisions related to your own tax and/or investment situation you should consult the appropriate professionals.
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, and CFP® (with plaque design) in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.