This guest post is from William Cowie, who has contributed to Get Rich Slowly and other personal finance blogs. He also blogs about investing and offers a free Investing Basics course on Bite the Bullet Investing.
Earlier this month our readers were asked, regarding your personal financial journey: “What is the next step?”
The answer J.D. offered in his 2009 article was… investing.
In today’s economy, we can get income from only two possible sources:
- our work (a job or business)
- our investments
Most people start at No. 1 and work their way to No. 2. It’s what J,D, did and he’s been at No. 2 for a while now.
Getting rid of debt, living frugally, saving — all are elements of our strategy to move to No. 2, whether we articulate it that way or not.
Only at No. 2 (with income from investments) do you obtain the freedom to pursue your dreams to the max. If that’s your goal, then investing is not optional.
But what if I lose it all?
A friend recently told me she was about to receive an unexpected inheritance. Naturally, I asked if she was going to invest it. Her surprising response: “No, I don’t want to lose it all.”
She’s not the only one to react like that to the word “investing.” Many shy away from investing because they’re afraid of “losing it.”
Asked why they think they’ll “lose it,” some say investing is too complicated or tricky. Others say Wall Street is a rigged casino; individuals don’t stand a chance.
Don’t misunderstand, caution is a good thing. Warren Buffett’s first rule of investing is: don’t lose it. His second rule? See rule No. 1. Avoiding undue risk, therefore, is good.
So, are there any safe investments?
This may come as a surprise to some, but the stock market is not the only thing to invest in. In fact, stocks are not even the most popular investments.
Here’s a list of some investment options:
- Savings accounts
- CDs (certificates of deposit)
- Real estate
- Stocks (equities)
- Precious metals
- ETFs (Exchange Traded Funds)
- Mutual funds investing in any or all of the above
- Private businesses
So… what’s the most popular investment worldwide?
The answer, which might surprise you, is bonds. And it’s not even close. Far and away more money is invested in bonds than in any other investment category.
Who invests in bonds? Insurance companies, pension funds and university endowments, as well as foreign governments, like Japan and China. In other words, the elephants of the investment world prefer bonds.
Also, the investment portfolios of the uber-rich are dominated not by stocks but by bonds. If you’re seriously rich, it would appear, you invest in bonds. (So that’s why I’ve never owned bonds! Now I know.)
What’s so special about bonds? Two things:
- the return never changes (predictability)
- the principal always gets repaid (safety)
Hard to find fault with that.
What are bonds? Simply put, bonds are IOUs, typically for $1,000, carrying a fixed interest amount, and a set maturity date at which the full $1,000 gets repaid.
Who issues these bonds? National and local governments, for starters, but large corporations also issue bonds.
The reason bonds work is because so many big investors crave the safety and predictability they offer.
Why not bonds?
If bonds are so perfect, why aren’t you and I fully invested in them? One reason might be their absence from media headlines because, well, they’re boring (and we know how the media feels about boring). Many individuals therefore have simply never considered bonds.
Then there’s the return: 2 percent annually on a 10-year U.S. Treasury bond these days. Does that excite you? It may beat a savings account, but your money’s tied up for 10 years.
There’s another reason some investors avoid bonds. Unless you hold your bonds to maturity, you can lose money. Bonds, you see, are freely traded, just like stocks. Open your newspaper to the pages where they list stocks. You’ll probably find a listing for the most commonly traded bonds as well. It’s a long lesson to explain, but bond prices on the open market go up and down, depending on interest rate movements. So it’s possible for you to buy a bond for $1,000 and only get $900 when you sell it on the open market. (You also could get $1,100 for it.) If you keep it till maturity you’ll get your $1,000 back intact, but the volatility in open market bond prices adds an element of risk if you sell earlier.
The biggest reason people avoid bonds, though, is the low yield. Yes, we like safety — who doesn’t? But 2 percent? Come on, man!
Are higher returns possible? Yes, but those come with higher risks.
Yes, there is a chance the sky will fall tomorrow. There’s also a chance you’ll get fired, get killed by a runaway truck or eat contaminated food. “There’s a chance” doesn’t stop you from working, driving or eating, though.
Why? Because there’s a world of difference between a chance (risk) and a certainty. You assess your risks daily and find ways to reduce or avoid them.
Same with investing. You can get higher returns than on super-safe bonds, and many people do. The key, as with the food you buy or your driving, is understanding the risks and doing something to reduce them.
How do you reduce your investing risk? The same as with your other risks: you start with knowledge. The more you know, the more comfortable you get making good decisions.
The important thing to know is you have a wide choice of investment types. On one end of the spectrum are super-safe investments with low returns. On the other end are riskier but higher-yielding alternatives. Somewhere on that spectrum there’s a good fit for you.
The secret to success as you creep up the risk/reward scale is knowledge. The more you know, the better you can discern which risks to take and which to avoid.
Investing is not rocket science. If it was, millions wouldn’t be doing it successfully every day. Granted, it’s not picking up trash either, so there is some knowledge to be learned.
Learning is the key. It’s the best remedy for the fear of the unknown.
The good news is the internet is full of free knowledge on just about any topic. Furthermore, you can learn now, even if you don’t have money ready to invest. In fact, learning before you invest is best.
In other words, nothing stops you from preparing today for the ultimate step in your personal financial journey: investing. All you need to do is bite the bullet and start learning.
Have you invested in bonds? How much of your portfolio is in bonds compared with stocks or mutual funds?