I'm often asked about bad investments and to me they're usually quite obvious.
Think of that mining company a mate recommends, with its key project in Afghanistan: bad investment!
Then there's financing Mel Gibson's latest film, no doubt there's an audience of three people left to watch that one: bad investment!
You may be thinking, I will just get a term deposit at the bank and not have to take any of the investment risks. But you would probably be surprised if I said, "Term deposits: bad investment!"
That's right; long term, your money in the bank is a bad investment.
If you start thinking something like "This is all of our life saving, we can't afford to lose any of it, or we can't afford to take any risk in the stock market." I would ask, can you really afford not to invest? Are you sure about that?
For those not lucky enough to win Powerball millions, or inherit a large amount of money, or perhaps strike it big with a tech start-up, few people will be able to save enough for financial freedom or retirement without help from compound interest via investments in the stock market.
Time travel back to the mid-80s, Lethal Weapon is released, and Mel Gibson is king.
Squeeze into your acid wash jeans and wander into a Holden dealer with $40,000. Negotiate hard and you'll buy three Commodores.
Return to 2010 and just like Mel's career, your money isn't what it used to be. That same $40,000 only buys you one Commodore.
Now look at your 'safe' 3.4 per cent bank interest (current maximum interest rate you can get on a five year bank TD).
Assume 30 per cent tax; there goes 0.8 per cent. Then assume an inflation rate of 2 per cent, there's 2.8 per cent of your interest gone. That 3.4 per cent in the bank is a real rate of 0.6 per cent.
We often focus on the most obvious threat to our money: losing it, which is common sense. Yet we then ignore the silent threat to our money: the loss of purchasing power through inflation.
If interest rates further drop or inflation rises, the remaining 0.6 per cent is easily swallowed, leaving you with a negative rate of return.
That's not to say cash doesn't have benefits. If you want to offset risk, save for a significant purchase or keep a fund for emergencies, cash is the way to go.
Stock market risk vs volatility – what you need to know
Financial planning for your future retirement can easily become a daunting task without proper guidance. Throw in some stock market volatility, political discord, and the 24-hour news cycle and it may make you impatient and worried. Our view is that you either take the time to understand how the market works, so you can ask the right questions and protect your wealth, or you allow your emotions to drive your decisions.
Stock market risk simply put is the probability of losses relative to the expected return on any particular investment or investment vehicle. To give an example, a risky stock or investment could go up big time, but it also comes with a larger potential to be a big loser. Picture a tech stock – that is hoping to be the next Google or Facebook, but with the risk of becoming another long-forgotten social media platform.
Stock market volatility is another fancy way to describe the unpredictable fluctuations in the value of an investment. In plain English, it refers to the movement of the stock market both up and down, or down and up over and over again.
Diversification is your friend. Sound investment starts identifying the risk worth taking and minimising the risks that don't come with an expected reward. You can reduce risk and increase flexibility by diversification.
Seeking investing help:
While it may be normal to be scared during the roller coaster ride of market volatility, however, the chances of your achieving and maintaining financial freedom without at least some investments are not very good.
You don't have to go on this journey alone. You can work with an investment fiduciary who should be able to help you reassess your attitudes towards investing and the inevitable stock market volatility. All your financial decisions should be made based on your specific financial goals, time frames, and tolerance for risk. Just be aware that too little risk may cause you to run out of money in retirement, the one thing you were hoping to avoid by not taking more risks.
Face your financial fears and take proactive steps towards your important financial goals. Having a financial plan can you make smarter financial choices over time. If you know where you want to be, it can make getting there easier.
- Nick Stewart is an Authorised Financial Adviser, Accredited Investment Fiduciary® and CEO at Stewart Group – a Hawke's Bay-based CEFEX certified advisory firm helping people make smarter financial decisions since 1986. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver solutions.
The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz