We spent a fair amount of time exploring investments in the month of March. We looked at how to ladder certificates of deposit (CDs), scrutinized the decision to include gold in your portfolio, and even considered the growth of hedge funds. Over the months and years, we have discussed rental properties, peer-to-peer lending and everyone's favorite, the index fund.
There are a lot of reasons to invest — you are planning for retirement, you want to provide a college education for your children, or you've decided to buy a house and need to build up funds for a down payment. But the nitty-gritty of investing comes down to risk and reward: What kind of return can you expect and how much risk will you have to accept?
What is a good return?
As Robert Brokamp stated in his article on gold last month: “The wisdom of an investment decision depends on when you buy and when you sell. This makes all kinds of things — from dot-com stocks to Beanie Babies — extraordinarily good investments … as long as you sell before prices plummet.”
But beyond that, you are apt to find that specific advice on what is a realistic return on your investments gets fuzzy. Quite frankly, it is all over the map. I'm reminded of the joke that 43.7 percent of all statistics are made up on the spot. (Yes, I just made that number up.)
A 5-year certificate of deposit can yield a little better than 2 percent these days. Is that a good return?
Isaac W believes (comment #30) that paying off your mortgage can yield “a guaranteed return on the interest that you're NOT paying, for many that is over 5% APR.” Is that a good return?
Peer-to-peer lending sites offer returns north of 6 percent. Again in his article on gold, Robert Brokamp noted that “The average annual return for the S&P 500 over the entire period —“ from 1975 to 2014 “—was 12.1 percent…” Are these good returns?
What is an acceptable amount of risk?
When my husband tells me there's a great buy on socks or whatever, my frequent response is, “There's a reason for that.” It's like that with investing. If you are looking for a better return, inexorably, you must accept more risk. For example, peer-to-peer lending is, as Jeff Rose clarified, “a risky asset class because you are relying on strangers to pay the loan back.”
The amount of risk you are willing to accept probably has to do with your personal time horizon for investing and how comfortable you are that you can recover from any losses in that period of time. But Warren Buffett's famous Rule No. 1 is: “Never lose money.” Rule No. 2 is, of course, “Never forget Rule No. 1.”
So does a 5-year CD yielding a mere 2 percent these days have a little more respectability? It quite possibly does, especially if you have very little tolerance for risk.
So what is your time horizon for investing? Are you just getting started, playing catch-up, or happily on auto-pilot? Have you decided what an acceptable level of risk is for your investments? What kind of returns are you seeking, and why?