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Beyond Capital Preservation

Preserving Capital

In a recent article I took a look at safe, interest bearing investments comparing their historic returns with inflation rates. (See, "Zero To Minimal Risk Investments") The conclusion was that such investments are fine for preserving your capital, but won't give you much growth of capital.

You might well ask, what's wrong with that? After all I won't lose my hard earned money, and the interest I earn will keep pace with inflation so the buying power of my money is preserved too. What's wrong with that, huh?

Well, there's absolutely nothing wrong with that. In fact, it's clever of any wise family money manager to keep some portion of capital in safe, easy to access interest bearing investments to prepare for unexpected emergencies. It is also wise hold some of your available capital-above that set aside for emergencies-in safety rather than risk all of it in the markets. Some investors manage their portfolios so as to have a predetermined ratio of capital in safe, "cash equivalent" interest bearing investments at all times. For example, a younger person might have 40% in cash equivalents and 60% at risk in the markets while an older person might have 60% in cash equivalents and 40% invested in the markets and each might then rebalance the portfolio at regular intervals, (at least every year), to maintain those ratios. Nothing wrong with that, but consider the following.

The Inflation Factor

Say you're thirty years old and currently making $40,000 a year. You plan to retire by age sixty five, and you figure you could happily live on the future equivalent of your present salary if you are reasonably frugal. Let's do a calculation to see how much money you'll need every year.

Assuming an average annual inflation rate of 3.5%, you will need enough retirement funds to provide you with $133,334 every year to live your current life style. Let's speculate further that you'll use 10% of your retirement funds each year, well, you'll need $1,333,340 at a minimum. If you already have $40,000 invested in capital preservation kinds of investments, you'll just about get there. But if not, then you'll need to look at other kinds of investments that provide growth of your invested dollars.

If you want to play with other "today's" income levels to see how much money you might need thirty five years into the future, multiply your today's income figure by 3.33334 to be the equivalent of current buying power.

Growth Beyond Inflation

Probably the surest way of gaining growth of your dollars is by investing in common stocks of American companies. Stock market prices have averaged 10% annual growth in value for over one hundred years. It's true that some years the market decreases in value, but it is also true that in other years the growth has been very significantly above the 10% simple average.

If you have some time, say at least ten years, before you will need to draw on the money so compounding can work for you, then stocks are your best growth option. Studies show that in any ten year period of time stocks are always higher at the end of the period, sometimes a lot higher.

When you buy stocks, you are buying shares in a successful business. You're a minority owner of the business so, in addition to share price appreciation, you get to share in company profits in the form of dividends paid to share holders-if indeed the company declares dividends. Not all publicly traded companies declare dividends each and every quarter, but some companies have a long history of paying regular dividends.

Using The Stock Market

So, to grow your invested money beyond the rate of inflation, you'll need to consider using the stock markets-and there's a lot to consider.

The first consideration is that, while stocks are the best way to grow your dollars, buying stocks doesn't automatically mean you're going to make money with them. Buying stocks isn't like putting your money into interest bearing investments where you're basically assured of getting a stated return over time, assured of getting your principal back, and your money is insured by an agency of the Federal Government. Stock purchases are not insured, and your money is at risk.

A second consideration is that using the stock markets will require you to be more active in looking after your money than you have to be with interest paying investments. To be successful, you'll want to (have to) spend more time learning about the stock markets and how to use them, and you'll spend more time monitoring your invested money.

There are probably hundreds of ways of using the stock market, some very risky and some remarkably free of risk. You can use stocks buy investing in mutual funds or by buying them separately. You can use stocks for speculation purposes, hoping to find one really big payday. There are many different strategies you can use including day trading, market timing, buy and hold, buying long, selling short, dealing in puts and calls, buying on margin, to name a few. There are literally thousands of mutual funds to choose from ranging from indexed funds to specialty funds for industry sectors.

There are so many approaches to using the markets, and we can't possibly deal with all of them, but future articles on this website will discuss a few of them in a little more detail and will speak to such factors as risk, study time requirements, and management time requirements. Your best "insurance" against the risks of using the stock markets is to educate yourself and pick the approaches, strategies, and stocks that best fit your goals and your level of risk tolerance.

So, please keep checking back with the ITS: FYI page from time to time for more information on using the stock markets.

arley