How’s the Health of your Investments?
In keeping with this month’s Health theme, I thought I would touch on an area that deals with health in another way – your investment health; especially, in light of the turmoil in the financial markets over the past few months. All investing involves risk.
However, risk shouldn’t keep anyone from investing even with the events of the past few months. Many investors understand how to manage their risk by finding a comfortable balance between the risks that they are willing to take and the rewards that commensurate with those risks. Diversification helps to moderate the impact of exceptional days.
People who are averse to risk often consider cash investments such as money market funds and CDs to be worry-free, “safe” investments. But even these safe investments have risk. With today’s low interest rates, ever present inflation even at today’s lower inflation rate eats into the buying power of your money. Only if your investment surpasses inflation are you making headway.
Historically, stocks have offered investors the highest long-term total returns. As we have seen recently, the results can be very different when measured in the short term. Over the long term, the stock market has balanced both negative and positive abnormal days; you know, the days that the stock market rises or falls hundreds of points like we have been experiencing recently. Diversification within your stock portfolio helps to moderate exceptional days. On a day when the stock market is down, some stocks are up.
Bonds are usually perceived as a lower-risk investment than stocks. When you hold a bond to its stated maturity, you should receive back your principal while having received income earned on the bond during the period you owned the bond.
However, should you have to sell the bond before its stated maturity, you become subject to interest rate risk. Bond prices are sensitive to changing market conditions. When interest rates rise, bond values fall. Therefore, when new bonds pay more income than bonds that an investor owns, the risk arises that if the investor has to sell the bonds, he or she may have to do so for less than what was paid.
Remember the key to successful investing under any market condition is adhering to an asset allocation strategy by diversifying your investments among a mix of stocks, bonds and cash reserves either by purchasing individual securities or mutual funds or a combination of both.