When I was a kid my family would sit around and play cards for money – usually nickel ante poker and games like that. The stakes were never very high, but it was enough money in those days that a kid could get into some trouble if he wasn’t careful. A big pot might be $50, but in 1978 that was a lot of money.
Rule #1: Don’t risk what you can’t afford to lose.
When I started to play with the grown-ups, my Grandmother had one rule: “Don’t play with money you can’t afford to lose”. I believe the same is true for investing. To be sure, investing is not the same as gambling, and gambling is definitely not the same as investing. However, both have risks and, in my opinion, the shrewd investor never risks more than she can afford to lose.
With investing one of your primary risks is that you may lose principal at a time when you need to access your money. Parents investing for college may experience short term losses right before they need to make a tuition payment. People in retirement might suffer market losses as they are taking distributions from their accounts.
One way you may be able to address this is to avoid putting your principal at risk when your time horizon is short. It is a good idea for retirees to have income sources and assets they can tap into that don’t require liquidating shares that have been beaten down by the markets. Parents of college students may also want to have resources available to pay tuition bills without having to tap into stock related investments when the market is down.
Rule #2: Always go with the odds.
After learning Rule #1 the hard way a few times, my Grandmother imparted her second piece of financial advice, “Always go with the odds”. Drawing two pairs is a lot more likely than holding out for an inside straight. With investing for long-term goals such as retirement and college, you may want to go with the odds as well.
The stock market doesn’t always go straight up. (Maybe you have noticed.) In fact, there are many years where it doesn’t make money at all. 2000, 2001, 2002, 2008, to name just a few.
On any given day stocks are generally more volatile than bonds. Past performance, of course, doesn’t guarantee anything, but since 1926 the S&P 500 Index has outperformed 10-year Treasury Bonds on a rolling 10-year period (measured quarterly) 85% of the time – according to the Leuthold Group a Minneapolis -based market research firm.
For most long-term investors it may be a good idea to place a portion of your investments into stocks and stock related investments, but no more than you are comfortable risking given your investment time frame.
What’s the right balance for you? That depends on a variety of factors including your risk tolerance and time horizon among others.
Tuesday, March 4th, would have been my Grandmother’s 95th birthday. For her the idea was to stay in the game. By reducing risk and going with the odds you are able to stay in the game when others have long since folded. Keeping her two rules in mind when making your investment decisions will help keep you in the game as well.