|Monopoly: House Rules|
Just when I think I'm beginning to understand investing, the rules seem to change. I find that I'm not the only one frustrated. I read in the highly respected British publication, The Financial Times that even the experts find it difficult to assess risk in the new economy because the old rules don't seem to apply any more.
What Is Too Much Risk?
Many investors are chasing higher and higher yields, sometimes wanting as much as a 20% return on investment. Wouldn't you suspect that a 20% return would be on something very risky? How can you get high returns without high risk? Is it smart to invest in stocks? Gold? Bonds? Property? Despite what you might hear from sellers of those asset classes, no one really knows. How can we know if the rules of past investing will even apply to the future economy? Is it wiser to invest with high risk than to not invest at all? These are questions that bedevil those who study the economy and enliven many an online discussion.
The Wealth Effect
Can a rising stock market produce jobs? Maybe. If your 401k grows quickly because stock prices go up, do you feel richer? Would that lead you to spend more money? If so, that's called the Wealth Effect, and the Federal Reserve is counting on that to boost the economy. If more people are spending with confidence, businesses will hire more workers, and generally the economy would improve. During the housing bubble, a lot of people felt wealthier as the supposed value of their houses kept climbing. Many people took out home equity loans to finance a higher standard of living. All that spending boosted the economy and kept people employed until the bubble burst. Can the stock market be manipulated to give us another surge of spending? Some say when the Federal Reserve puts more money into the economy it gives a boost to stock prices at the cost of devaluing the dollar. Perhaps the Wealth Effect will take over our psyches and we will spend the country back into a robust recovery.
Markets Hate Uncertainty
The stock market doesn't like people to get more cautious with their money. In times of uncertainty people save more in case of job loss. I give a lot of credit to people in their 20s who are paying down their debt instead of taking on more debt. They might not be pumping up the economy by buying cars and houses, but they are helping themselves. It's a huge change, reversing previous trends.
|Luxury Tax of $1000?|
Guidelines for Investing in the New Economy
If you still want to put money into some kind of investment, here are some old rules that still apply:
1) Before you risk any money, set up an emergency fund to cover 6 months worth of expenses. This will cushion any financial blows that come your way, such as a job loss or serious illness. (Don't even consider investing if you don't have health insurance.) You should be able to access this money within a day or two if needed. You can't get much interest on that kind of account, but that's not the important thing. The old rule of thumb was to have 3-6 months of savings in this rainy day fund, but I think 6 months is safer because of the job situation now. Too many people can't find jobs that pay as well as their last one and it's taking longer and longer to find a job.
2) Do your homework. Read as much as you can about a particular investment. Be sure to read from different sources and try to find points of view that are critical of that investment. Consider all the risks and all the possible outcomes as much as possible. How much risk can you live with? The old rule is that if the risk keeps you from sleeping at night, you know it's too risky for you. That's one old rule that still holds true.
3) Only invest money that you are prepared to lose. You don't want to lose it, of course. But if this is money you need to live on or will need in the future, forget it.
4) Diversify! Don't put all your investment money in one area. Spread your investments among several asset classes. Make some investments that should do well during inflation and some that should do well during a downturn/recession/depression. I know that's not as much fun, but it is smart. Don't let your enthusiasm (or the sales person's enthusiasm) cloud your judgment. Diversify.
5) Finally, to quote some time-worn wisdom: if something sounds too good to be true, it probably is. If you watch the television show "American Greed" on CNBC at night, you'll see how many scams are out there. It's mind boggling how many otherwise intelligent people are taken in by con artists every day. Don't trust somebody's pet investment vehicle just because they are a friend, relative, member of your church, etc. Too many people are willing to believe they can get rich quick with very little work.
Bonus: Seek professional help. You can't know everything. Find a legitimate investment adviser, usually one who charges a fee for the advice and does NOT make the actual investment for you. That doesn't mean they know everything either, but if you have done your homework you will be better able to decide if they are an appropriate adviser for you. Remember they are most likely committed to the classic rules of investing which might or might not apply to today's economy.
Here is the article at the Financial Times Alphaville blog that is pretty amazing. The author wonders if the old rules apply to the new economy. She speculates that they do not and yet, no one knows what rules do apply. The comments there give more food for thought.
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