These days, many are tired of the crazy gyrations of the
stock market, and worried about losing their savings. How do you invest your money and still sleep at night?
This article gives the most common options for investing hard
earned but frightened dollars, ranked from worst to best.
5. High-Interest Savings Accounts
Worried investors love the idea of savings accounts because
they are guaranteed by the government (up to limits), because the money can be
taken out anytime, and because you don’t have to make any future decisions –
just leave the money there. However,
savings accounts always pay far less than the rate of inflation – usually 3%
less. For example, if the rate of your
high-interest savings account is 1.5%, the inflation rate for the same period
is probably 4.5%. So, you are actually
losing 3% of your purchasing power for every year you keep your money in the
account.
If you invest $50,000 in a
savings account and keep it there for 2 years, you appear to have
$51,511. But in fact, the purchasing
power of your money is now worth only $47,045.
No one should leave money in a savings account unless it is for a few weeks
or less.
4. Guaranteed Mutual Funds
Guaranteed mutual funds are a relatively new concept. You buy a mutual fund today that has a
“maturity date” of, say, 10 years later.
As long as you hold the mutual fund until the maturity date, your
principle is guaranteed! Even if the
market crashes you can’t lose your principle.
Sounds great, except that the issuer (typically a bank) can change the
nature of the fund at any time.
Say,
for example, you buy a guaranteed fund full of stocks and then the market
drops. The bank can remove all risk for
itself by changing the holdings of the fund from stocks to safe but low-paying
government bonds. After the change, there is no hope
for you to make any substantial amount of money. You can hold this now ultra-safe fund for 10 years and get your
principle back, or sell it and lose money.
In short, guaranteed funds tend to charge higher fees for their
“protection, ” then screw their investors anyway.
3. GICs
Guaranteed Investment Certificates are extremely popular
because they pay more than savings accounts and feature two beautiful words –
“guaranteed” and “investment.” Some
people love rate shopping for GICs, and pride themselves on getting the best
rate. Professionals consider people who buy GICs as long-term investments foolish. That’s because GICs are designed
to give rates close to the rate of inflation but not exceeding it (see option
1, Savings accounts). So, the only
thing that is guaranteed is that you will slowly lose money.
GICs are excellent for elderly
clients who are unable or unwilling to understand any other type of investment.
2. Index-Linked GICs
The best way to explain an index-linked GIC is to give an
example. Say you buy a 5-year S&P
500 index-linked GIC. Over 5 years, the
return of your GIC will be half that of the stock market, as measured by the
S&P 500 (500 large US companies).
So, if the stock market goes up 25% in five years, you will get
12.5%. If the stock market goes up 80%,
you will get 40% and so on. If the
market drops, you will get your principle back.
Index-linked GICs are a great way to play the stock market for
those who are too skittish to invest directly.
1. Short-Term Bond Funds
When you buy a short-term bond fund, you are lending
your money to large and reliable companies and the government, who in turn pay
you interest. Because the money is
leant over a short period of time, there is little danger that a company’s
fortunes will change, rendering them unable to pay you back. And, because each bond fund holds so many
companies, you don’t really need to worry even if a couple of companies do go
bankrupt. Since the bonds are short-term, you won’t lose money due to changes in interest rates
(long-term bond prices go down when interest rates go up). Finally (and importantly), short-term bond
funds always beat the
rate of inflation.
For these reasons
and more, short-term bond index funds are great investments. Do not confuse short-term bond funds with
more risky high-yield bond funds, long-term bond funds, or real estate bond
funds. Note that although short-term bond
funds are very safe, they are not guaranteed by either the bank or the government
– they are subject to the good credit of the companies in the fund.
Short-term bond funds include:
VCSH - Vanguard Short Corporate Bond Index
ETF
SCPB - SPDR Barclays Capital Short Term
Corporate Bond ETF
BSV – Vanguard
Short-Term Bond ETF (mix of corporate and government)
So there you have it – five common ways to invest without
losing your shirt, the final two of which I highly recommend.
Investing safely is a solid first step to investing, but far
from the last. To be a superior
investor, you really shouldn’t be worried about money at all (something that is
far easier said than done). Ironically,
the more worried you are about losing money, the more likely you are to do
something silly and lose money. For
those who know they have not mastered their fear of loss, please note that I
wrote a book specifically for the purpose: The Intelligent Investor’s
Mind. The link can be found at the top
right of this page.
Good luck and happy investing!
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"The first rule of investing is don't lose money; the second rule is don't forget Rule #1."
Warren Buffett
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