Quote:
Originally Posted by syracusa
I need to learn how to go beyond savings account/CD and retirement.
We have saved a bit more money lately and would not mind investing it into something that would bring better interest than what you can get now with non-rsky options. Stocks? Money markets? Which?
Is there a book you would recommend? Where do I even start?
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I would recomend reading forums on investing, seeing the opinions which exist, and learn from experience while seperating personal experience from fact and opinion.
The basics
1) spend less than you earn
more than likely because you have money saved already, this is true for you, but make sure this is "always true" and you will be successful with money, regardless of investment performance.
2) Understand risk
most people skip to #3-4-5 without doing this first. There is more than one kind of risk, and NOTHING is risk free. Any invesment which eliminates one type of risk, probably has another risk. If you understand the "risks" of every investment you take, you will be extremely successful managing your money- probably.
Types of risk
Principal risk- this is the most common item discussed with word risk. It means when you invest $10,000, the $10,000 might be worth $9,000 (10% loss), $8000 (20% loss), $5,000 (50% loss) or $15,000 (50% gain) because the investment has risk which changes its value constantly.
Inflation risk- this means the $10,000 you invest today may not be able to buy $10,000 worth of goods next year or next decade. For example if you put a $10,000 addition on your house this year, in 10 years, that same $10,000 buys you less addition, or it takes $25,000 to build same addition (because costs went up).
Interest rate risk- this means the investment is subject to changing interest rates. Not all investments have this risk. This means if you invest $10,000 earning 3%, that you are subject to one of 2 things happening- the 3% is "locked" in and you pay a penalty if you choose to withdraw and invest for a better rate, or the 3% changes constantly (every day/week/month/year) so the rate itself is not guaranteed.
Investment risk- this means if you choose investment A, you run the risk that investment B will have a better return.
Time risk- this means if you need money at a specific time, you have the risk you might not have the money when you need it.
Liquidity risk- this means you may have to pay a fee to get access to your money if you need it tomorrow, or in some cases you have to wait 10 days to get access to money if you need it tommorrow. It also means you might need to sell the item (like a house) and because you cannot sell it quickly, its an asset with liquidity risk.
Currency risk- if you invest in a canadian company or a mexican restaurant, you are subject to the currency that company does business with. If the US government weakens the dollar, its possible that even though the investment itself was good, the currency it is valued in might decrease, causing you to lose money. Most typical when you invest in stocks or bonds which are foreign
Tax risk- the risk the government taxes you, and also the concept that the government can change the tax code whenever it chooses.
3) Pick an asset allocation which accounts for "all relevant risks". Not all of the above risks apply to every person or every situation. There are many risks I did not mention, and this is where no book is going to help you... decide what your goal is, what your risks are, how much of each risk you are willing to be subjected to, and define what mix of risks you want to take.
4) Pick investments which fit the asset allocation.
Asset allocation is "usually"
% stocks- % bonds
it is "also"
% stocks- % bonds % cash
and also
% domestic-% foreign
If you identify a given asset allocation, you can be told from many sources two charactoristics:
1) return (predicted 10 yr return)
2) volatility (how much returns change from year to year)
Most of the time volatility is measured with standard deviation, and if you are not familiar with statistics, I like to point out this information
100% equities has about an 11% return over 10-20 year periods. This is "relatively" consistent. This has a standard deviation of at least 14.
This means you are as likely to see -3% (11-14) returns as you are 25% (11+14) returns.
Think about that... -3% (lose money) is as common as +25% (incredibly high returns).
80-20 (80% equities-20% bonds). This is consistently about 10% returns (might be 9.5%, it is high) and the standard deviation is around 12. Meaning -2% as likely 22%.
60-40 is about a 7.5% annual return over 10-20 year periods, and the std deviation here is about 9% (-2% as likely as +16%).
40-60 is an important allocation. This is the first allocation where the deviation is less than the return. Meaning return is something like 6.5% and deviation is only 6%, meaning you are as likely to see 1% returns as 12% returns... but the amount of ups and downs (and negative years) is significantly less than any of the allocations above.
Most people choose an allocation because they see the return it "projects" without really understanding the standard deviation.
I point this out because if you get an investment which has a -25% return, more than likely it is as likely to get +40% another year to "balance out", but you need to be willing to accept the pendulum swing one way to get the pendulum swing the other way.
If you do not want the swings, hopefully the risk profile you defined in step 2 captures that, and puts you in 60-40 or 40-60 allocation.