Some people can see the logic behind investing, however others either don’t or are reluctant to do invest due to misconceptions. I will try to provide some explanation and clear up some misconceptions about investing.
What is investing?
I think first you need to understand investing and the “risk” involved with it. Investing is defined as “laying out capital with the expectation of a profit”, so you put money somewhere and expect a profit, simple. Some get worried about the “risk” that is involved with investing however the amount of risk is somewhat exaggerated than the real risk involved with investing.
When investing there is always a risk of losing some capital, although theoretically there is the risk of losing all capital this hardly ever happens especially if it is invested in a mutual funds and quality companies. So if you are afraid to invest because you belief you can potentially lose all your money, rest assured that it is not the real case.
There are also different levels of risk, from low to moderate, high and all they way to speculative. Your advisor has a responsibility to match your investment with your risk tolerance. Generally if your risk tolerance does not match the investment chosen the dealer will reject the order. There are different types of investments from low risk to very high risk, there is always an investment that fits your risk tolerance.
Investing vs. Saving
Some ask why should I invest and take the risk when I can put it in a savings account or GIC and receive 3.5% with no risk? The simple answer is because you have the potential of much higher return than 3.5% when invested.
The more complicated answer is that those rates just keep up with inflation and have in fact a negative real rate of return. If you are earning 3.5% interest and the inflation rate is about 3% your return is 0.5% and remember since it is interest income you’ll be paying tax at your MTR on the 3.5% gain which creates the negative real rate of return. So basically you are losing purchasing power with your money. All you savers are LOSING MONEY! Let me try to illustrate the power of inflation. What you could buy in 2006 with $10,000 would cost you now, in 2008, $10,446.67 that is an increase of 4.47% over 2 year period 2.21%/year in other words you have lost over $400, use the inflation calculator at the site to do your own calculations.
This usually brings up the question of “how much can I make in an investment?”
Well there is NO guaranteed rate of return in an investment, the potential return is directly related to your risk tolerance (more risk = higher potential return), but generally moderate (balanced) mutual funds have averaged about 8%/year in the long term. There are more aggressive funds which have averaged historically 10-15% and even more sometimes, however those are also more volatile and go up and down a lot more hence you need to be stronger emotionally.
Investing, if done properly has tremendous upsides to it, but wrong decisions can wipe out ones savings. It is important to have an advisor who have access to markets and data and can provide their clients with best recommendations.
It is always advised to draw up an investment policy with the advisor and stick to the plan.
There are many investment vehicles available I will discuss the most common vehicles in an upcoming post.
People don’t plan to fail…..they fail to plan!
Ray is an ex-financial adviser and the founder of Financial Highway. Currently working in the financial industry and working towards completing his Chartered Financial Analyst, CFA, designation.