Investing For Dummies. Eric Tyson

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contemplate selling an investment.

      Individual-investment risk

      A downdraft can put an entire investment market on a roller-coaster ride, but healthy markets also have their share of individual losers. For example, from the early 1980s through the late 1990s, the U.S. stock market had one of the greatest appreciating markets in history. You’d never know it, though, if you held one of the great losers of that period.

      Consider a company now called Navistar, which has undergone enormous transformations in recent decades. This company used to be called International Harvester and manufactured farm equipment, trucks, and construction and other industrial equipment. Today, Navistar makes mostly trucks.

Graph of a company’s stock that traded at more than 400 dollars per share. It then plunged more than 90 percent over the ensuing decade. Navistar stock still trades at less than 35 dollars per share.

      © John Wiley & Sons, Inc.

      FIGURE 2-3: Even the bull market of the 1990s wasn’t kind to every company.

      Just as individual stock prices can plummet, so can individual real estate property prices. In California during the 1990s, for example, earthquakes rocked the prices of properties built on landfills. These quakes highlighted the dangers of building on poor soil. In the decade prior, real estate values in the communities of Times Beach, Missouri, and Love Canal, New York, plunged because of carcinogenic toxic waste contamination. (Ultimately, many property owners in these areas received compensation for their losses from the federal government as well as from some real estate agencies that didn’t disclose these known contaminants.)

      

Here are some simple steps you can take to lower the risk of individual investments that can upset your goals:

       Do your homework. When you purchase real estate, a whole host of inspections can save you from buying a money pit. With stocks, you can examine some measures of value and the company’s financial condition and business strategy to reduce your chances of buying into an overpriced company or one on the verge of major problems. Parts 2, 3, and 4 of this book give you information on researching your investment.

       Diversify. Investors who seek growth invest in securities such as stocks. Placing significant amounts of your capital in one or a handful of securities is risky, particularly if the stocks are in the same industry or closely related industries. To reduce this risk, purchase stocks in a variety of industries and companies within each industry. (See Part 2 for details.)THE LOWDOWN ON LIQUIDITYThe term liquidity refers to how long and at what cost it takes to convert an investment into cash. The money in your wallet is considered perfectly liquid — it’s already cash.Suppose that you invested money in a handful of stocks. Although you can’t easily sell these stocks on a Saturday night, you can sell most stocks quickly through a broker for a nominal fee any day that the financial markets are open (normal working days). Mutual funds offer daily liquidity any day the financial markets are open.Real estate is generally much less liquid than stock. Preparing your property for sale takes time, and if you want to get fair market value for your property, finding a buyer may take weeks or months. Selling costs (agent commissions, fix-up expenses, and closing costs) can approach 8 to 10 percent of the home’s value.A privately run small business is among the least liquid of the better growth investments that you can make. Selling such a business typically takes longer than selling most real estate.So that you’re not forced to sell one of your investments that you intend to hold for long-term purposes, keep an emergency reserve of three to six months’ worth of living expenses in a money market account. Also, consider investing some money in highly rated bonds (see Chapter 7), which pay higher than money market yields without the high risk or volatility that comes with the stock market.

       Hire someone to invest for you. The best funds (see Chapter 8) offer low-cost, professional management and oversight as well as diversification. Stock funds typically own 25 or more securities in a variety of companies in different industries. In Part 3, I explain how you can invest in real estate in a similar way (that is, by leaving the driving to someone else).

      Purchasing-power risk (also known as inflation risk)

      Increases in the cost of living (that is, inflation) can erode the value of your retirement resources and what you can buy with that money — also known as its purchasing power. When Teri retired at the age of 60, she was pleased with her retirement income. She was receiving a $1,600-per-month pension and $2,400 per month from the money that she had invested in long-term bonds. Her monthly expenditures amounted to about $3,000, so she was able to save a little money for an occasional trip.

      Teri has reason to worry. She has 100 percent of her money invested without protection against increases in the cost of living. (Her Social Security does have inflation adjustments.) Although her income felt comfortable at the beginning of her retirement, it doesn’t work at age 75, and Teri may easily live another 15 or more years.

Inflation Rate 10 Years 15 Years 25 Years 40 Years
2% –18%

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