Basic investing for a new generation

Six principles that may help

[May 2, 2012]

By Doreen Kelsey

The financial crisis caused the median American family's net worth to fall by 39 percent, primarily due to lower values in real estate and investments, according to the Federal Reserve's Survey of Consumer Finances. Nearly three-fourths of the loss was due to falling home prices as middle income households tend to have much of their net worth tied up in home equity.

Housing prices have yet to fully recover, but the stock market is almost back to its pre-crisis value. Yet many stock investors won't recover their losses because they did not wait out the crisis or their investments did not track the market.

That's left many of us wondering what we could have done differently? And should our investing principles change in this new environment?

The basics remain the same, especially that most important one – discipline. What is different, however, is increased market volatility, and that makes discipline difficult to maintain.

A roller coaster market

Sam Stovall, strategist for S&P Capital IQ, observes that from 1950 through 2000, the S&P 500 Index had moves of 2 percent or more an average of five times per year. During the next ten years, the average was 15 times per year, and in 2011, it was 21 times. That's enough to make the average equity investor beg to get off the roller coaster.

In fact, the average equity mutual fund investor holds investments just over three years. This behavior has resulted in an average annual return of just 3.49 percent over a 20-year period, according to the 2012 Dalbar Quantitative Analysis of Investor Behavior. At that rate, investors might as well have kept their money in modestly earning certificates of deposit.

Clearly, circumstances have changed for today's generation of investors. In addition to market volatility, interest rates are historically very low, and wages haven't kept pace with inflation for most families. Fewer workers have traditional pensions to rely on, and Americans are living longer.

The implications of these changing circumstances are daunting:

  • Workers will be responsible for more of their retirement savings;
  • Less home equity is available to supplement retirement income thanks to a combination of lower real estate values and the popularity of second mortgages;
  • Lower yields compel investors to take more risk to keep ahead of inflation;
  • Yet, the lack of a pension argues for taking less risk, so that you are not left with nothing at retirement;
  • And, the volatility of the market means investment-time horizons should be longer to let you dodge major market corrections just when you need the money.

Six investing principles that may help

What's an investor to do? The following principles are timeless and may help:

  1. Pay off debt and immediately earn a double digit return by avoiding credit card and other  finance charges

  2. Build a substantial emergency fund to avoid future debt and having to cash out your  investments during a down market;

  3. Have a budget and include retirement and other savings in that budget;

  4. Study investing and know what you’re investing in;

  5. Diversify investments to balance risk with return;

  6. And, consider joining a non-profit investor organization such as the American Association of  Individual Investors or the National Association of Investors Corporation, sources of  unbiased educational support to investors.

Get started now!

The most important choice is to start early. Time is one thing that cannot be recovered, and the sooner you start investing, the greater the possibilities for compounding earnings to build wealth. A delay of just ten years means you'll have to save more and/or earn higher yields than the investor who starts ahead of you.

*Doreen Kelsey is an Albuquerque, N.M.-based financial writer, public speaker, and money management expert. Kelsey can be reached at (509) 499-5223 or doreen@doreenkelsey.com.

 

 


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