Going into the pandemic in March 2020, many investors (rightfully) questioned whether our national economy would be able to recover. As humans, we are designed with a fight or flight instinct that has preserved our species for thousands of years of recorded history. When it comes to investing, resisting this natural survival instinct is paramount to being successful over the long term.
We need to return to the fundamental reason why we started investing in the first place. Our belief that American businesses will continue to innovate and create new and exciting ways for us to work, communicate and prosper is the driving motivation that keeps us investing for the future. We also know that inflation, driven by a fiat monetary system, creates the need for us to earn a long-term return on our savings to preserve our spending power. If the value of money was constant or deflating, we would require much different rates of return focusing much more on savings programs than on investing programs.
Let’s get back to the basics of asset allocation and the types of places you can invest your money.
Stocks/Equities – Owning stock represents an equity stake in the ownership of a business. Investors who put money to work in owning businesses through stock purchases essentially become owners of that business. Depending on how well that business does and how rapidly its company achieves profits and distributes those profits through dividends will govern how fast the value of a stock may grow. When taking ownership in a company, though, there is an inherent risk that the company may go out of business. In that case, you would lose your entire investment. Historically, stock investors require an approximate ten percent rate of return.
Bonds/Fixed Income – Corporate bonds are another asset in which you can invest. Letting a corporation borrow your money, you enter into a contract in which there is an agreed upon interest rate paid, and a set date by which the company is required to return the original principal amount. In the event the company goes bankrupt, bondholders get paid out ahead of stockholders and would likely be paid in full before any stockholders are paid out. Having a set time for return of principal and an assumed interest rate that has to be paid periodically, a bond investor requires roughly half the return rate of a stockholder. Historically, bondholders have needed between 4-6 percent as their interest rate payments based on the amount of risk and the underlying company’s viability.
Cash/Bank Savings – Keeping cash on hand or money in your bank savings used to pay a much higher rate than it does today. Because there is essentially no risk to these investments, their rates of return are essentially non-existent, but at the same time very safe and very easy to access (liquid).
Investing is not a short-term endeavor – Any time period shorter than five years could be viewed by many as gambling versus investing. As a potential investor, I would take the time to research your individual risk tolerance and develop an asset allocation between the simple assets listed above that will help keep you comfortable investing for the long term. If that isn’t something you feel qualified to do, I encourage MCM readers to meet with a financial advisor and develop a personalized asset allocation of investments to get the best long-term return rate for the amount of risk you are willing to take. As always, investments can have short-term volatility and those who can stomach that volatility have an opportunity to make good returns, outpace inflation and preserve their spending power.