Many people come up with unrealistic answers to the question of how much risk is right for them. For instance, when they’re young and just starting out, many investors decide to move away from safe investing principles and speculate. They expect to build a small portfolio into a big one in a hurry, then shift their money into boring, but more dependable safe investing selections.
Rookie mistakes can be doubly costly
As a newcomer in any field, however, it’s easy to fall victim to ruses and snares that a veteran would spot right away. Later on, you’ll know better than to bid on an ugly painting just because it’s the work of a noted artist, or invest in a building that faces expensive repairs due to delayed maintenance, or buy a promotional stock due to rumours or touting. [ofie_ad] Then too, when a young person loses money, the loss is doubly costly. You have the obvious immediate loss. You also miss out on decades of compounding that you could have profited from in a better-quality investment.
Bonds can expose you to inflation risk
Later in life, some investors make the opposite mistake. They decide in retirement that they are too old to assume any investment risk, and that they should put most, if not all, of their money in safe investing picks, specifically fixed-return investments and government bonds. They work out a budget that shows they can live with today’s under-5% bond yields. It’s true that government bonds don’t expose you to any default risk. But it’s equally true that they are not always the best safe investing choice because they leave you at the mercy of inflation and rising interest rates. Right now, the risk of a rise in inflation and interest rates may seem small. But both are at the low end of their historical range. So the next big move, though it may be many years in the future, is likely to be upward. Meanwhile, taxes weigh particularly heavily on any interest income. A two-point cut in your rate of investment return, and a loss of the tax deferral available in stocks, can take an enormous bite out of your capital over a decade or two. In between the extremes of youth and old age, many investors repeatedly make the mistake of getting more bullish or optimistic as stock prices rise. This is the opposite of the sound, safe investing strategy that we recommend in our Successful Investor newsletter. It can leave you owning the riskiest portfolio of your life just when it can do maximum harm to your finances.
