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When talking about beginner investing, you need to be very careful when comparing equity funds to bond funds, as most beginner equity funds are unfamiliar with bond funds. When I think about it, most of the people who invested money with me when I was a financial planner didn’t understand their bond funds, especially not. In 2014 and beyond, this could be expensive.
Stock funds are a great investment option for beginners looking to invest money in stocks. Most people understand the concept and understand the risks involved. Pension funds are a different story. The majority of the people who invest money in them tend to find these funds very investor friendly. After all, over the past 30 years they have outperformed equity funds (equity funds). In addition, they have rarely had a bad year while equity funds have had some very difficult times.
For the past year or so, a handful of my readers took offense at my warnings about bond funds versus equity funds for 2014, 2015, and beyond. Let me explain and make investing easier for beginners because this is a topic that matters to all investors. After all, to have a balanced portfolio, you must own both types of funds; and this should be one of the goals of every investor.
Issuing equity funds vs. bond funds is really a question of risk vs. potential returns. People understand that the former can be risky, but they accept it because they know it can be very rewarding too. Equity funds, for example, achieved returns of around 30% in 2013. They rose by around 150% from their lows in 2009. For such returns, it pays to take risks. That’s investing for beginners 101. The higher the potential returns, the higher the risk.
On the flip side, few average investors today understand the risk vs. potential return issue in bond funds for 2014 and beyond. In fact, many have committed to these funds. After all, they have been steady performers since the early 1980s and have paid attractive returns (dividends) over safe investments like bank CDs. At the same time, the share price (value) has risen. The problem is, most investors don’t understand the risk involved; and few understand WHY these funds were such good investments.
What I emphasize about Investing for Beginners 101 is that there are few things in the world of investing that you can rely on. For example, you can bet that there will always be uncertainty. And there is one more rule of thumb that you can rely on. When interest rates fall, bond prices (and bond fund values) rise; and when rates go up, they go down. When I was a financial planner, I explained this to every client I sold these funds to. It was seldom an issue, with interest rates peaking in 1981 and essentially falling for over 30 years.
The average investor today has never experienced an extreme economic environment with rising interest rates. In the late 1970s and early 1980s, interest rates rose to historically high levels. Some investors found themselves in their bond funds with losses of almost 50% in 1981. These investments are not safe and higher rates are expected in 2014 and beyond. With interest rates near record lows, that means you run the risk of receiving a dividend of around 3% per year in longer-term annuity funds. Also, the potential for stock prices (value) to rise is bleak as interest rates can’t really go much lower.
Investing successfully is always a challenge, and investing for beginners can be scary at times. I believe 2014 and beyond could be a scary time for investors. Our government has cut interest rates to EXTREMELY low levels to stimulate the economy. Now those in power are trying to defuse the situation. Interest rates could rise faster than expected.
In the debate on equity funds and bond funds, I see the main problem as the fact that the risk is not cheap compared to the potential returns for bond funds because the potential returns are limited, as has been the case in recent years. If the economy falters and interest rates rise, both can be losers … both pose significant risk in 2014 and beyond. Investment Rule # 1 for Beginners Investing: When interest rates go up, bond prices go down and bond funds go down in value.
Don’t despair, investing for beginners can be a challenge. Remember: the risk-reward potential still makes investing money for higher returns a winner instead of safely giving it away and making peanuts.
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Source by James Leitz