Basics of investing – Risk vs reward

19
8718

In 2005, people spent 125% of what they made. They spent money that they hadn’t yet earned, so they racked up debt and paid interest on that debt every month. If you spent less than what you actually earned, you paid interest on your money, on the contrary. The return you can expect from this hard-earned money depends largely on the level of risk associated with it. However, no risk equals no reward; risk is not a big scary animal that we all run away from.

The first thing to decide is how much money you want your investments to earn. It could be 1% to 30% and everything in between. A percent return is incredibly low but very sure. In fact, 100% safe since that’s what your savings account pays for. If you think you’re making money in your savings account, you’ve forgotten to think about inflation. Suppose inflation is around 3% per year. If your investments are 3%, you have reached the breakeven point. You haven’t made a dime because inflation took 3% of the purchasing power from your money a year ago. $ 100 today is only worth $ 97 in a year. If your investment made 3%, or $ 3, you come back to $ 100. Take 3% off your return and it’s your real return.

If you want a high return, don’t expect to be risk averse. The higher the reward, the higher the risk you need to consider. Bonds are currently around 5%. It’s a 5% safe and you won’t lose that money. Once you consider inflation, it suddenly turns into gasoline money. Stocks beat all other investments over a 20-year period. Stocks are the cringe most, but there are plenty of ways to reap the benefits of the stock market without worrying about losing your children’s college funds. You can buy an index fund that invests in the S&P 500 or the Dow Jones. The S&P 500 is 500 companies if you invested $ 500, $ 1 would be in each company. The S&P makes about 10% per year. There is very little chance that the S&P will go to zero although there are years of correction. That is why you need to invest for the long term. If you start buying in one of those good years you will lose money, but think long term and you will realize that you will be buying a lot in those correcting years. Buying low and selling high is the game, but many of us are doing it the other way around.

When you invest, not only the risk and the reward are important, but also your age. It may be new to you, but age is very important when it comes to investing. Age tells us what level of risk we should expect. If you are in your twenties, you should invest in the riskiest funds possible. The reason is that a person has more time to replace that money if they lose everything. An older person does not have those years and the advice is just the opposite. Little to no risk and only invest in fixed income securities which are bonds and CDs and 100% safe alternatives. The older you get, the less risk you should take. 10% fixed income for every decade that you are old is a general rule. Do the math and determine your level of risk.

There are many safe investments, but as the saying goes, “no pain, no gain”. The reward for “the pain” is the return of 10% or more that you might enjoy.



Source by Michael Russell

Comments are closed.