1 Invest in Stock and Bonds? Why?

If you have money to invest that you are not going to need anytime soon, or have already saved it in a bank certificate of deposit (CD) or savings account, you should consider investing it in a portfolio of securities (these are shares of stock, bonds, funds, etcetera). Why is that? Basically because a CD or savings account will hardly be tailored to your particular situation, but a stock and bond portfolio can be, if you have more than a few thousand dollars to invest and won't be needing them for the following two years or more (or at least you think you won't).

Absorbing a calculated risk for profit

When you invest money, you provide a service to a company or government that requires funds, so you earn income for that service. If it includes some kind of risk absorption, then your earnings will be higher. For example, if the economy suffers a momentary setback one year, companies might find it difficult to pay their debt obligations that period. Thus, they prefer to have some of the financing they acquire to be tied to their performance. That way, if they perform poorly one period, their cost of financing will not be as high. Hence, that financing produces less risk for them than issuing all debt. For those investors it means taking more risk, because they are not so sure about how much they will earn. But in exchange for that risk absorption, during those years when the company does well, they earn more. Clearly, some risk was transferred from the company to the investor, who receives, when several years are averaged, a premium for that.

If the securities in a newly-acquired portfolio are going to be sold in a few months, there is a possibility that they are sold in the middle of an unanticipated downfall. Thus, such short-term investments are quite risky. But if the funds are going to be kept in the investment for several years, then there's plenty of time for the value of the portfolio to catch up, because it is very unlikely to have all-recessive years.

A CD or savings account assures you that your investment will keep its value during the next few months. Do you need that? If your investment horizon (this is, the time you plan to keep the money invested) is several years, you can have a reasonable assurance that a portfolio of stock and bonds will be worth the same or more after that many years, no matter if it loses value in the short term. The savings acount's short-term assurance would be almost useless for you in that case, but you would be losing the opportunity to trade it for significant earnings.

The real difference is not small

The historical profit (return) of the stock market has been approximately an 8% per year, in average. Savings accounts and CDs normally return about a 3.5%. Such a difference is significant because of the power of compounding. A $10K (ten thousand) investment would grow to $21.6K after 10 years at 8% per year, while only to $14.1K if the rate is 3.5% per year. Nevertheless, the difference is more impacting if we consider inflation. If we calculate with an inflation rate of 1.5% per year, which is normal, the stock investment would be turned into $19.4K at current dollars (this means the $21.6K dollars would buy about as much as $19.4K dollars can buy today) but the savings account into just $12.1K. The real profit on the first case is four and a half times as much! That premium only requires some risk absorption in exchange, much of which we don't need if we are investing for the long term. Besides, if the risk happens to be too much for our particular situation, we can design a more conservative portfolio, allocating a portion in bonds for example, to adjust it to our preferences.

Investing isn't gambling. Actually, it only is in those extremes cases where investors decide to assume an enormous risk. There is no reason for you to do that. On the other hand, in a sense, isn't it risky to earn much less than you can? I mean, are you considering the possibility of having less than enough savings when you retire, only because of an excess of conservatism with your investments?

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