Why do most people invest when they really don’t know what they are doing? While I have performed a survey on the matter, but my best guesses would be the thrill of making big gains on Wall Street or maybe it is preparing for retirement. Either way, investing without know what you are doing sounds a lot like gambling to me and if you asked most people on Main Street they would tell you that this is a foolish thing to do with your hard-earned money.
So why do people invest when they have no idea what they are doing? Well, this article might not give you a definitive answer to this question but it aims to spell out what most people don’t know about investing.
This is important stuff as it doesn’t matter if you make hundreds of thousands of dollars a year or if you win a million dollars as part of an accident settlement. In fact, JR Reyna, the Founding Partner of the Reyna Law Firm noted that ‘your family’s future ability’ might depend on it.
- The Impact of a Drop in Portfolio Value
Ok, this wasn’t a problem that most people needed to worry about in 2017, but it would like 2018 is the year that volatility reemerged with a vengeance. Just look at the stock market a there have been numerous days when the Dow has fallen 100 points or more.
This sort of volatility can make any investor feel unsure but the reality is that a drop-in portfolio value means different things to different people. Two variables which way into this are your age – as it pertains to retirement – and your investment goals.
As to your age, the reality is that the closer you get to retirement age more risk adverse your investment strategy should become. The reason is simple – you have less time to recoup the losses. Sure, the market has ups and downs and you can never eliminate all risk but your fifties or sixties is not the type to start investing all your money in corporate junk bonds.
That being said, younger investors, those in their twenties and thirties are better positioned to recover from unexpected setbacks. Now, this doesn’t mean they should put all their money into risky investments.
Instead, even younger investors should allocate a large portion of their portfolio in less-risky investments. This is due to the time-value of money, which essentially states that a dollar lost today, might cost as much as two dollars to earn back tomorrow.
Beyond this, younger investors do have the potent to take on slightly more risk than older investors – assuming the risk is well managed and is in line with their goals.
- How to Allocate Your Funds
Therefore, investment managers get the big bucks; in theory. However, the reality is that many of these so-called ‘professional investors’ are no better than the average person on the street when it comes to picking winning assets. A perfect example of this is Warren Buffett’s famous bet, which he won by investing in a simple ETF product.
What is the reason for this? Volatility. Sure, small caps stocks tend to deliver big returns over time. But with the reward comes risk and many of these stocks can implode at a moment’s notice
As such, a smart investor knows how to balance the risk and the reward, allocating only a portion of their total funds into riskier investments and only after they have performed extensive due diligence. Things can still go wrong, and they do sometimes, but the idea is to win big(-ish) but lose small.
- How to Bonds React When Interest Rates are Rising
Even people in finance have no idea how bonds work. The reality is that they are priced in an inverse manner to stock. As such, rate rise when there is less demand and they fall when there is more demand.
However, there is a wrinkle. When the Federal Reserve raises interest rates, bond values tend to drop. This is because the yields are based on the interest rates at the time the bond is issued. The impact is that older bonds tend to become less sought after. While this means that you could swoop in and get the cheaper bonds, the lower yields will result in a smaller return.
As such, the trick with bond investing is know where to finds the sweet spot between the price and the bond yield.