No one - not even the most informed economic analyst - can know exactly where the economy will be tomorrow. But the greatest risk in an uncertain economy is not doing anything.
Kathleen Adams, RDH, BS
It`s one thing to discuss the merits of creating your own financial plan, planning for your retirement, and investing in mutual funds, but it`s quite another when it comes to actually taking action. Procrastination is extremely common when it comes to taking the steps necessary to actually implement your own good ideas.
How many patients do you have who fully understand what their periodontal problems are and the consequences of not following their treatment plan, yet still don`t follow through? In finance, people often site "risk" as a reason not to get started with a financial plan. Risk has a variety of meanings, but one of the most common is worrying about losing the money you invest. Given the recent fluctuations in the market and the economy, this is a good time to take a closer look at this potential problem.
A way to potentially reduce risk, while improving the strength of your overall portfolio, is by diversifying your investments. You can diversify by asset class, by industry, or even by investing internationally. How does diversification work? When your money is all tied up in one place, you stand a higher risk of losing that money. Investing in a variety of investments can moderate that risk, because different companies, sectors, and asset classes respond differently to changing economic conditions. For example, during an economic downturn, stocks may perform poorly, while bonds might perform well. That`s because a slow economy may be accompanied by lower interest rates, which cause bond values to rise.
There`s no such thing as a risk-free investment - not money markets, not CDs, not even savings accounts or other insured investments. This may come as a shock to some investors, but while these types of investments may offer safety of principal, they also carry their own type of risks. Loss of principal isn`t the only risk investors face. In fact, loss of purchasing power can be just as - if not more - threatening. In other words, you can lose money without actually losing your money!
Consider interest rates and inflation. If the rate of inflation exceeds the interest rate you`re earning, then your money will be worth less in the future. You may end up with more dollars, but be able to buy less.
Take, for instance, postage stamps. In 1973, a regular postage stamp cost 8 cents. Today, the same stamp costs 33 cents. When you consider that automobiles, homes, food, and other necessities also cost significantly more today, you begin to understand the impact of inflation and the risk of utilizing a short-term investment to achieve a long-term goal. A savings or money-market account may be the ideal vehicle for financial emergencies (short-term goal), while a growth-oriented investment may be more appropriate for retirement (long-term goal).
On the other hand, investments that offer a greater potential for return may offer less safety of principal. So what`s an investor to do? In a word: diversify.
What about watching market swings to determine the right time to make those diversified investments? The economy has been slowing lately, so you might be thinking that it`s too risky to invest right now.
Put it into perspective
It`s rare when the economy doesn`t send at least some mixed signals. The fact is that no one - not even the most informed economic analyst - can know exactly where the economy will be tomorrow. But the greatest risk in an uncertain economy is not doing anything. The average investor still can make money by following some basic guidelines.
Set realistic goals
Getting rich on your first investment in one year is not a realistic goal. On the other hand, if you`re 25 years old and want to retire as a millionaire, your goal may be well within your reach. So, the first important step in investing is deciding what you want to achieve with your money. Where do you want to be in five years? 10 years? When you retire?
Keep an eye on priorities
Don`t attach long-term significance to short-term events. What happens to the market on any given day has little, if any, impact on where it will be five, 10, or 20 years from now. While you shouldn`t ignore short-term economic signs, you must view them in perspective. Today`s housing starts, manufacturing index, or other indicators are just snapshots of the economy. They don`t tell you anything about previous performance, and they don`t tell you anything about the long-term future. By themselves, such snapshots have little bearing on your long-term financial goals.
Money is an emotional issue. That`s understandable. After all, you don`t want to lose what you work so hard to acquire. What happens today can cause you to doubt your financial decisions.
But, by separating your short- and long-term objectives and by viewing today`s events with a broader perspective, you can minimize any short-term anxiety you feel. Don`t become overly concerned with the long-term meaning of doom-and-gloom predictions. Remain confident in your personal goals and objectives.
Most importantly, try to remember that losing buying power is just as risky as losing principal. Regardless of where you place your money, it will be exposed to at least some type of risk. Since 1987, stock market investors have seen more changes in the market than many investors have in a lifetime. In less than a decade, investors have experienced dramatic rises, as well as a "leveling out" and corrections in the market.
So, predicting the market with accuracy is a difficult challenge, even for the experts. Time - not timing - remains the most important investment key. Patience and diversification are the watchwords for most successful investors. Nobody has a crystal ball, and there will always be risks involved with investing. But consider the real risks of your current financial situation and remember ... there is no perfect time to invest!
Kathleen Adams, RDH, BS, is a financial adviser with Waddell and Reed (www.waddell.com). She is currently trying to initiate money-management workshops for hygiene students and specializes in working with dental professionals. She can be reached at (800) 210-1357.