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Choosing the right type of investment
doesn’t have to be difficult or confusing. In a moment, I’ll share a
simple analogy that will empower your investment decisions.
If you are like some people, you may find the world of investing
complex and hard to understand. You know you want to do something
with your money but you don’t feel you have the knowledge to choose
the right kind of investment. All too often this can result in
getting stuck with an investment you didn’t really want or that
doesn’t perform the way you expected.
Understand all investments have risk and that there are many
different kinds of risk. Some think that a Certificate of Deposit at
a bank if risk-free because it is guaranteed by the government. It
is free from the risk of the bank defaulting, but it is NOT free of
interest rate risk or the risk of rising prices.
The key to successful investing is to determine the various risks
you face and then to select the investments that best protect you
from those risks. You will almost always find that you face more
than one type of risk.
For instance, on the one hand you may need to keep your money stable
so that it can provide you the income you need to live. On the other
hand, prices for medications, insurance, food and fuel keep going up
each year so you need some way to protect the purchasing power of
your income from the long-term effects of rising prices.
Not keeping all of your investment eggs in the same type of basket
may be the solution. Having a portion of your money in investments
that are stable and designed to produce steady income will help you
meet your current needs. Having another portion of your money in
investments designed to protect you from rising prices will help
meet your future needs. The portion you have in each should depend
on the amount you have and your comfort level.
Here’s the simple analogy. In general, all investments fall into one
of two basic categories. There are investments where you loan your
money to someone and there are investments where you own something.
Loan investments are designed to provide a stable source of income
but don’t protect you from rising prices. Owned investments, such as
mutual funds that invest in stocks, are designed to protect you from
rising prices but have a return that fluctuates.
Think of it this way. In all likelihood, you own or are purchasing
your home. Why? Why not rent? People buy homes because they know
that over time their home will appreciate in value and be worth more
than they paid for it. Renting, most people feel, is like putting
their money down the drain—you don’t get anything for it in the long
run other than the dividend of a place to live.
How much will you make on your home this year? There’s no way of
knowing. It depends on interest rates, the economy and the cost of
raw materials in your area. Some months and years your home will
actually lose money, but that doesn’t mean a home is not a good
investment because, generally, real estate will appreciate in value
over time.
So here’s the bottom line. For money you plan to use in the next 1-3
years or for that portion that you must have to provide income, it
is better to rent your money—to use loan type of investments. The
other portion of your money should be used to buy investments where
you own something that will appreciate in value over time.
Of course, not all loan or own investments are created equal. Within
each category, there are many choices available, some better than
others. And you will want to further diversify within each category.
But understanding the basics of loaning versus owning will help you
know where to start.
Lastly, recognize that there is no such thing as a perfect
investment. Beware of investments that attempt to meet all of your
needs in one product. Often, these end up being a jack-of-all-trades
but a master of none. You can have better control and flexibility if
you look for the best investment for the particular risk you face.
Mr. Voudrie is a Certified Financial Planner and President of Legacy
Planning Group, Inc., a Private Wealth Management Firm in Johnson
City, TN. He can be reached at www.guardingyourwealth.com or by
calling 1-877-827-1463.
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