Investing: Risky Business, Like it or Not
Using the words investing and risk in the same sentence makes some cringe. Risk, however, comes hand in hand with investing if you want to accumulate assets -- of course, some decisions carry more risk than others. In this interview, Rand Martin, Ph.D., professor from the Department of Finance at Bloomsburg University discusses risk, accumulating retirement assets, diversification and common mistakes that investors make.
For risk-averse investors, how would you characterize the necessity of including stocks and other risky investments to achieve their financial goals?
It is necessary that they include risky investments. If they are too conservative because of risk aversion, they won't earn as much in the long run and they won't accumulate enough assets.
Do individual investors accurately assess the importance of accumulating retirement assets?
Many of them do not. They start too late, around the age of 35 or later. Some people don't understand the likely growth patterns of the value of assets and some people don't think they are able to afford it when they really can. They should start early in life with even very small savings contributions. If you are talking about retirement savings through an IRA or a plan with an employer like a 403(b)(7) account, they should put in at least small amounts every month. Everyone should start saving for retirement early in life so savings will accumulate to a larger sum at retirement.
What is the single biggest mistake you see individual investors make?
I think it's trusting too much in the advice of others, especially financial planners. There is very good literature on investing out there -- books such as "A Random Walk Down Wall Street" by Burton Malkiel -- that emphasizes the value of diversification and topics like starting early with saving. I think more people should be reading that kind of information and acting on it rather than paying for advice.
What are the pros and cons of including international investments in an investor's portfolio?
It's very good to invest internationally if you do not have more than 20% of the portfolio in those investments. It is good because economic conditions in other countries are not always highly correlated with those in the United States. Their securities markets may be doing well while ours may not or vice versa. That tends to smooth out swings in the value of one's portfolio. In other words, it reduces risk. It's also possible when investing internationally to see returns that may be better in emerging markets and countries that are experiencing a lot of growth, more so than in the U.S. The negative side of investing internationally is that you don't know as much about the situation in foreign markets as you do in the United States, and sometimes it is difficult to assess where to invest. When investing internationally, I think most people would do well to use an index mutual fund that has an investment objective to be well-diversified in international stocks.
What are the pros and cons of including real estate investments in an investor's portfolio?
It is a good idea for diversification. The value of real estate fluctuates based on factors other than those affecting the stock market. So, just as international investment affords diversification because of lack of correlation, the same is true when comparing real estate to financial securities. Also, real estate is not increasing in supply; there is increase in demand, so the values on average are going to increase. The negative aspect of real estate investing is that the assets are not as liquid as financial investments. It can be difficult to get out of them, that is sell them, compared to selling stocks and bonds.
What role should alternative investments play in an individual investor's portfolio, and what are the pros and cons?
In my opinion, real estate can be considered an alternative investment. But if it is gold, silver and collectible artworks, it should only be considered after the investor has a fairly large accumulation of financial securities -- $400,000 or more. The advantage would be if you are familiar with that particular market and your insights could help achieve high profits. The negatives are that you may not know how to evaluate the value of these assets and might invest for an inappropriate price, or they may not be investments you can include in a qualified tax-deferred retirement savings plan.
Special thanks to Rand Martin, from the Department of Finance at Bloomsburg University for participating in this interview. Greg McBride, CFA, senior financial analyst for Bankrate.com, prepared the questions for this interview.