First let’s be clear. The stock market really IS unreliable. At least at any given moment. And for some people that alone is enough reason to stay far away from investing in stocks. Or anything other than tucking it away in their good ole bank account. Or mattress.
But there’s also a downside to just looking at the downside. Over time, at least historically, the market has done better than savings accounts. And because of inflation the interests rates that banks pay have historically been a lot lower than the inflation rate. And so, year after year, the real-world buying power of your money gets eaten away.
Let me explain what all that means
When we say that the stock market is unreliable at a given time, it doesn’t mean that you are for sure losing money. You only lose money if you sell your stock when the price is lower – no matter how unsettling daily fluctuations can be.
So what you need to do to be able to sleep at night is make sure you diversify your investments — meaning you don’t put all your money eggs in one market basket! But to help increase your total investment portfolio’s value years from now, stocks or stock funds can be a part of what you do to secure your future. [SEE stock funds section below.]
Why does this help? Because while you may not be able to sell stocks at the exact time you need money, you can turn to other investments that hold value (like CDs or certain government bonds). And then wait to sell the stocks when they go back up again. Which they should at some point as a diversified whole, even if one or two stocks in your basket stay down.
What about inflation?
Inflation is the measured increase of the average cost of things that we buy, tracked over time. Unfortunately the inflationary effect is not something we can easily see when we look at a certain amount of money we have in the bank.
Let’s say you have $1,000 in the bank and it’s still $1,000 5 years later … or maybe a little more the way some bank savings accounts pay interest. And meanwhile you’ve seen stocks go up and down in value. So your $1,000 seems like a smart bet.
But because of inflation, that same $1,000 might only buy you 90% of what it used to buy. A good diversified investment plan aims to keep you ahead of inflation, while still preserving as much principal (original amount) as possible — for emergency times when you need money fast and stocks are down.
What about stock funds vs individual stocks?
As we’ve already discussed, the stock market is unreliable. And so if you just buy a few stocks on a hunch or even with the assurance of “sure-fire” online insider tips, they can tank — or even go out of business. Even well-established companies can go under. (See Bear Stearns. Or Enron.)
What you ideally want to do is apply the diversification theory here too. If you want to buy individual stocks, go ahead, but own enough of them — in different industries — to give you some protection from any one or two stocks never recovering. Stock funds do that for you, making it easier to invest in diversified “baskets” … with professional managers paid to pay attention to business trends and company soundness.
STOCK FUND TIP: Look for no-load funds so you aren’t getting socked by fees when you buy and sometimes even when you sell. You can find information online about funds that don’t charge and even ones that have low internal management fees so you get maximum returns. (Diversify your online sources too. And choose well-respected ones.)
You can even buy growth funds that pay dividends if that gives you added comfort. The value may go up or down, but you get the dividends anyway. Some stocks, by the way, also pay dividends that you get even if the stock price itself is lower — although, while not too common, stocks / funds can cut or raise dividends, just so you know.
Is an unreliable stock market for you?
Only you know the answer … for you. I have a good friend who will only invest his money in money market funds that are made up of short-term securities (like U.S. treasuries). Though they pay less, that’s ok because safe, guaranteed investments feel comfortable to him. And he understands the inflation argument for adding riskier investments to a more diversified portfolio.
A good financial advisor will tell you that you need to feel good about where your money sits. If you would feel nervous about the ups and downs of the stock market, then you’re better off trying to earn as much as you can from safer investments.
But if you fully understand the risks and benefits, then by all means let stocks be part of where you keep your future money. But don’t put all your hard-earned eggs in one basket … nor all your money in just a few stocks. Like the lottery or Las Vegas, you can hit it big ,.. but the odds are not with you.
Best advice? Do your research. Diversify well. And remember to at least keep some funds “liquid” — as in savings or checking accounts. Or semi-liquid as in bank CDs, where at worst you might lose some interest but the underlying value stays the same. That way if the market is tanking at least you’ll have money that keeps its value if needed.
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