For many, the world of investing is mysterious and complex. That should not be the case. Investing is by definition something that is forward looking. Successful investing is based on goals; unsuccessful investing is totally enamored with the random day-to-day markets.
No Perfect Investment
Investing is also highly personal. Your goals…your investments. One size does not fit all. One of the first steps to begin de-mystifying investments is to acknowledge that there is no “perfect” investment, one where maximum returns accrue with minimum risk. Higher returns usually come with higher levels of risk in terms of market volatility, illiquidity or other risk components. The quest for the optimal point on the risk /return continuum is as illusory as the horizon. It’s really just a mental construct.
Identifying the Real Risk
The next step to de-mystifying investments is to totally change the way you think about risk. Yes, losing money from investments (market risk) is one form of risk. Perhaps more important, however, is the risk of not keeping pace with living cost increases over time. By this measure, investing in certificates of deposits might be riskier than a well-diversified low cost portfolio of stocks. With CD’s, you are essentially guaranteed to lose purchasing power over time. With stocks, you have a realistic and reasonable chance to keep pace with living cost increases.
A few words about real versus official inflation measures might be helpful. For about 20 years, we have experienced an official inflation rate of about 2% per year, more or less. It is important to understand, however, that real estate costs, fuel costs and food costs are excluded from the core Consumer Price Index (CPI) calculation. Since most of us live somewhere, drive somewhere and eat somewhere, the official CPI likely understates real living cost increases.