Why should you even think about stocks and bonds as part of your plan for future family security? The main reason is that some investments provide a hedge against inflation.
If you had $1000 in the bank five years ago, and kept it there, you would now have $1314 under the most favorable interest terms possible today. The total amount of money you have is greater, of course but, because of inflation, what these dollars can buy is just about what the $1000 could have bought five years ago. You haven’t made any progress, and if inflation continues, your money may buy even less. When you protect yourself against such a reduction in the purchasing power of money, you are hedging against inflation. A house, and certain kinds of investments, can give you that protection because their value will probably increase so greatly that, in money terms, they would bring you a big enough return to buy the same as or more than you can buy with today’s currency.
Suppose, for example, that you invest in 100 shares of common stock at $10 each today. You might buy wall-to-wall carpeting with that $1000 in terms of its purchasing power. In ten years’ time, those shares may be worth $6000, and, if you sold them, you would make a $5000 profit. Even if inflation had continued to eat away at the purchasing power of money, your $5000 would buy at least as good carpeting as you could buy today, and perhaps even a chair or a sofa in addition.
Investing is putting your money into something that might bring you a profitable return. In doing so, you are taking a clear risk because, instead of making a profit, you might lose everything. Taking the example above, for instance, the value of your shares might have dropped to $5 each, and you would have been in the hole. That is why money management experts always advise that you invest only money that is truly “extra” – anything left after meeting all daily needs for food, clothing, and shelter; after providing adequate insurance protection; and after building up an emergency cash reserve of savings or government bonds that would see you through about a six-month period of difficulty.
The first thing you will find out is that there are different kinds of investments. Some can give you regular income, others may yield more money in total (capital gains), and still others might provide a combination of both. Your first decision, then, is what you want out of your investments, and this is often related to your age. People who start investing at an older age are likely to be more interested in getting steady income. They will probably want to invest in securities that pay regular dividends – bonds, preferred stock, or blue chip commons. Younger people can usually afford to wait for long-term growth when, if they are lucky and careful, the overall value of their investments should have increased greatly. They will probably choose common stock of the kind called “growth stocks.”
Each person has a risk tolerance that should not be unnoticed. Any good financial planner or stock broker knows this, and they be supposed to make the effort to help you determine what your risk tolerance is. Next, they should work with you to locate investments that don’t exceed your risk tolerance.