Gone are the days when funds invested in a bank savings or money market account earned about 4% interest with virtually no risk, near instant access and little else to think about.
Many say they keep their money in the bank because they are “risk averse,” i.e., “It’s what my parents and grandparents did.” Consider the risk of keeping most of your money in a savings or checking account or Certificate of Deposit (CD) today. In this low-interest rate environment, banks typically provide a rate of return that often leaves the depositor at a loss after accounting for taxes and inflation. You may feel safe but you can actually be losing money or as we say: “Go broke slowly,” by tying up your cash in a bank. As each of us typically needs to keep our money “working hard,” the search for investments that can provide some investment growth and/or interest in the form of a dividend has led many to invest in stocks and mutual funds.
Stocks and mutual funds can each be a worthwhile investment depending on your circumstances which frequently include such issues as long-term financial goals, risk tolerance, personal debt, years to go before retirement, health/family/personal status etc. Typically, the more time during which money is invested, the greater are its growth prospects. One way to achieve this over the long term can be by investing in a well-diversified mix of quality stocks and/or mutual funds.
Those with relatively low amounts to invest may find mutual funds attractive. If you do not like “keeping all of your eggs in one basket,” consider mutual funds. These are professionally managed, pooled investments with a stated objective, such as “capital growth” or “income generation.” Sort of like investing on auto-pilot, mutual funds investors have no say in how the money is managed. Many mutual funds have low initial investments but can charge management and other fees which can erode the value of potential returns. Some invest in a mix of bonds as well as stocks or in particular categories and hold some cash so they may be ready when opportunities arise. Risk is ideally reduced because your money is invested in the stock of numerous companies, providing diversification. So if one or two of the stocks in the mutual fund portfolio perform poorly, your overall results will probably only be minimally impacted. Like stocks, some mutual funds pay dividends and capital gains which can be automatically reinvested in the fund, potentially adding to your initial investment. This is generally a good course for the risk-averse and/or novice investor looking to build a nest egg.
Similar to mutual funds, most invest in common stocks with the hope that their investment will increase in value over time, i.e., provide capital appreciation. Many stocks also offer their investors a dividend, usually paid quarterly.
The share price of stocks, while not necessarily volatile, can move more than those of mutual funds, however, they can also offer the potential for larger gains over time and typically with far lower fees. When it comes to common stocks, finding the right companies is as important as the right price. A quality company with a strong balance sheet, competitive, forward-thinking management, a good product and/or service plus a longstanding reputation in the market may be a smart, long-term investment. Hypothetically speaking, if the price of your selected stock increased at an annual rate of 3%, after five years you’d see a 15% gain in value plus any dividends the stock may have generated. However, the risk can be that if you picked wrong, your investment may decrease by a similar amount over the same time period.
There is no “perfect investment.” Each has risks and expenses. You can lose some or all of your money. Even investment professionals with years of experience and thorough research behind them do not always get it right. But not investing may be the biggest risk of all.