Fixed income investments – bonds, CDs, and other cash investments – involve great risks of their own.
Nashville, TN (PRWEB) July 18, 2013
“A common misconception amongst investors is that most people invest in the stock market to get rich,” says Paul Winkler last saturday on "The Investor Coaching Show" radio program in Nashville, TN.
The desire of some stock investors is to get very rich, Winkler finds. “We’ve all heard stories of investors, like Warren Buffett, who have amassed great fortunes by investing in undervalued companies that have skyrocketed in value,” Winkler reflects, “and the desire of many is to join their ranks.”
Some investors want to be like Buffett. To the other extreme, there are investors who won’t put any of their assets into the stock market.
Winkler says that this second kind of investor believes that they are avoiding risk by staying out of equity ownership. To put it another way, such investors believe that avoiding stocks altogether is a buffer zone between them and the negatives of the economy. They might rationalize that stocks are too volatile, and, anyways, they are not “trying to become wealthy.”
Winkler says that the stock-averse investor misses a crucial point, however. Fixed income investments – bonds, CDs, and other cash investments – involve great risks of their own. “One of the most significant risks for this kind of investing is inflation,” he says.
When an investor puts their money into CDs – a certificate of deposit with a financial institution – or buys bonds – federal, municipal, company, or others – they have, in effect, agreed to lend someone their money. Here’s how CD and bond investing usually works: The investor agrees that an organization can use their money and, in return, the investor gets a set interest rate, or a fixed rate of return. Winkler suggests thinking of fixed income investing as a rental agreement, where the asset being rented is not a home, but your money.
Here’s the risk in fixed income: The borrower is obligated only to pay the loan back according to the value of the dollar at the time of the agreement. What if the purchasing power of that dollar drops – or what if it drops significantly? They could see a return that is less, in spending power, than what you put in. That’s not a secure investment, is it? There is nothing in the agreement that states the dollar you invested in the past – three years ago, for example – holds the same purchasing power today, or whatever the maturity of that investment.
Winkler, who hosts the “Investor Coaching Show” on regional radio station WWTN-FM, provides an easy analogy for this loss in value: “What if grocers demand twice the amount money for a basket of groceries due to a drop in the value of our nation’s currency?”
If investors keep inflation, or the consistently rising costs of goods, in mind, as Winkler urges you to do, an aversion to stock investing would not be appealing. An investor who thinks about swearing off stocks should be cautioned by the prospect of an extended bout of inflation, especially since the value of the dollar isn’t tied to anything tangible.
“The beauty of owning stocks, as I often tell my clients and radio or TV audiences, is that I own the entities raising prices when I own stocks,” Winkler says with his characteristic, bright grin. “Historically,” he explains, “it takes well over 100 years for short term government bonds – treasury bills – to double in value, after inflation. With stocks, depending on the area of the market, that period of time drops to around 10 years.”
Winkler makes the simple point that everything in life comes at some sort of cost and involves risk. He then adds, “The cost for protection against inflation is putting up with volatility. Markets will go up and down on a daily basis, but look at it this way: if it weren’t for volatility, stock returns would likely be no greater than those from CDs.”
On that, Winkler concludes: “My advice: embrace the risk. It is your friend.”
Of course, the closer people get to retirement, the more concerned they become about the risks in investing. So what should an investor do as they close in on retirement? Quite simply, Winkler advises that older investors should continue to own both stocks and bonds.
“The stocks are there to protect against inflation risk, and the bonds will be there to draw from when stocks go through their inevitable downturns,” Winkler says. “The saving grace is that (stock market) downturns don’t last forever.”
About Paul Winkler of Paul Winkler, Inc.:
Paul Winkler, QFP, ChFC®, RFC, CLU, LUTCF, CASL, AAMS, is president and founder of Paul Winkler, Inc., a registered investment advisory firm located in Goodlettsville, Tennessee. Paul has been in the financial services industry since 1989, and has been published extensively in industry and mass media publications. In addition to being the host of the long-running radio program, “Investor Coaching Show,” on WWTN-FM, often Paul has been a guest on nationwide radio and television programs.
Paul's unique approach to the world of investing and financial planning stems from his strong belief that the traditional approach to the discipline is often driven by promoting financial products rather than by sound investment philosophies. Paul is the author of the book, Above the Maddening Crowd, which is endorsed by many financial teachers and university professors around the country.
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