Investing in Your 20s & 30s For Dummies. Eric Tyson
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Longer-term bonds generally yield more than shorter-term bonds because they’re considered to be riskier due to the longer period until they pay back their principal. What are the risks of holding a bond for more years? There’s more time for the credit quality of the bond to deteriorate (and for the bond to default), and there’s also more time for inflation to come back and erode the purchasing power of the bond.
Stock returns
The long-term returns from stocks that investors have enjoyed, and continue to enjoy, have been remarkably constant from one generation to the next. Since 1802, the U.S. stock market has returned an annual average of about 9+ percent per year, or in other words about 6 to 7 percent per year above the rate of inflation. That’s a remarkable track record, but don’t forget that it’s an annual average return.
Now some people think that a 9 percent annual average return doesn’t sound like much. But at that rate of return, an investment will double in value every eight years.
Stocks have significant downdrafts and can easily drop 10, 20, or 30 or more percent in relatively short periods of time. Stocks can also rise dramatically in value over short periods. The keys to making money in stocks are to be diversified, to invest consistently, and to own stocks over the long run.
Stocks exist worldwide, of course, not just in the United States. When investing in stocks, go global for diversification purposes. Diversified portfolios of international stocks have produced annual returns comparable to those generated by U.S. stocks.
International (non-U.S.) stocks don’t always move in tandem with U.S. stocks. As a result, overseas stocks help diversify your portfolio. Thus, in addition to enabling U.S. investors to diversify, investing overseas has proven to be profitable over the years and decades.
Now, some folks make stock investing riskier than need be by doing some foolish things:
Chasing after specific stocks or sectors that have recently been hot: Yes, what a rich genius you’d have been if you’d invested in Apple stock (or Chipotle, Google, McDonald’s, Amazon, Ulta Beauty, or Facebook) when it went public. With the benefit of hindsight, it’s easy to spot the “best” stock investments (companies or sectors) over specific periods. It’s quite another thing to put your money on the line now and to hope and expect that you have the ability to pick the best-performing stocks of the future.
Excessive trading and market timing: Another type of wishful thinking occurs when folks would like to believe that they can jump into and out of the market at the right times to participate in moves higher and to sidestep downturns.
IS HIGHER ECONOMIC GROWTH BETTER FOR STOCK PRICES?
Stocks for the Long Run (McGraw-Hill) author Jeremy Siegel makes a surprising statement in his book: “… economic growth has nowhere near as big an impact on stock returns as most investors believe.” Siegel presents a long-term analysis going back to 1900, which shows that a country’s real GDP growth (that is, growth above the rate of inflation) is negatively correlated with stock market returns.
This surprising finding means that those economies experiencing higher rates of growth actually tend to produce lower long-term stock market returns. Siegel’s analysis shows that this fact is even more pronounced in developing countries. China is a recent example of a country that has enjoyed high rates of growth but relatively low stock market returns.
In explaining how this reality could possibly be, Siegel points out that the primary determinants of stock prices are earnings per share and dividends per share. Economic growth doesn’t necessarily boost earnings and dividends per share because growth requires higher capital expenditures, and as Siegel points out, this capital does not come freely. “The added interest costs in the case of debt financing and the dilution of earnings in the case of equity financing reduce the growth of earnings per share,” says Siegel.
Chapter 8 goes into detail on stocks, explaining how to invest in them successfully and not lose your shirt.
Real estate returns
Just before, during, and for some time after the financial crisis of 2008 and associated severe recession, most types of real estate in most parts of the country declined in value. Thus, you may think that real estate isn’t a good investment, but you’d be incorrect.
Real estate is a solid long-term investment. Real estate, as an investment, has produced returns comparable to those of investing in the stock market. Both stocks and real estate have down periods but have historically produced attractive long-term returns. Overall, real estate prices in most parts of the United States now have bounced back to record high levels.
Real estate does well in the long run because of growth in the economy, in jobs, and in population. Real estate prices in and near major metropolises and suburbs generally appreciate the most because people and businesses tend to cluster in those areas.
I’d like to make an important caution here about viewing a home in which you live solely as an investment. As I discuss in Chapter 12, your primary reason to buy and own a home should not be high expected investment returns, because you won’t be earning rental income if you live in your own home. That’s why you should thoroughly understand the effect that owning a home will have on your monthly spending and budget. (Investment real estate examples include a small apartment building and retail or office space.)Small-business returns
When we think of the “American dream,” one image that comes to the minds of many folks is owning their own business and possibly making it big by doing so.
You have numerous choices for tapping into the rewards of the small-business world. If you have the drive and determination, you can start your own small business. Or perhaps you have what it takes to buy an existing small business. If you obtain the necessary capital and skills to assess opportunities and risk, you can invest in someone else’s small business. None of these avenues is easy. In fact, all these routes require drive, determination, and some skills and money (more on this in Chapter 14).
By starting a small business and retaining a major ownership stake, you can potentially earn high effective returns. Unlike with the stock market, for which plenty of historic rate-of-return data exists, no specific data exists on the returns that small-time investors have had from investing in small private companies. (We do know that successful venture capital firms, which invest in small businesses with large potential, earn generous returns for the general partners.)
While the financial rewards can be attractive, there are other rewards from investing