A Game of Odds

There are no guarantees with investing.  Well, I guess I can almost say there are guarantees with federal bonds, but that’s about it.  FDIC insured CD’s, too.  That’s about as close as you can get.

With anything else, the value can rise and fall sometimes, drastically.  No one…no one…knows the future.

I think this is something that is hard for a lot of people to grasp. Because Fund X has earning 11% the past 5 years, it very well may not this year.

For example, you’ll often see the disclaimer “Past performance is not a guarantee of future performance.”  That’s absolutely true.  It is always true.  Any particular investment can lose money.  Any index can lose money.  Any method or technique can lose money.

We are used to a lot of things that are more cut and dried.  When you go to a store, you pay a particular price, and you get a particular thing.  Investments aren’t the same way.  No one can see the future and so no one really knows what’s going to happen and how investments will perform.

I remember at one of my first companies, many of us started around the same time and started in to the 401k at the same time.  And it was a bad year, I believe one of the more aggressive stock funds lost 30%.  People were asking, “Why are we doing this?”  Unfortunately, I suspect some learned the wrong lesson, and stopped investing, or invested in overly conservative assets.

I remember a radio station that had a report on the stock market for the day and cynically called it “The Legalized Gambling Report.”  That’s too bad.  It sets a really negative expectation.  Investing and gambling are not the same.  With gambling, on average, over time, you lose.  With investing, on average, you win.  You don’t win every time.  And in some circumstances, you could lose repeatedly.  But it’s pretty unlikely, if you’re diversified and stick with it.

Be careful not to judge the concept of investing by single instances that went well or poorly.  Some investments won’t do well in the short term.

So we want to think somewhere in the middle here.  It is important to take some risk, buying stock funds, because over the long run, stock funds get the best return.  But is important to diversity to balance the risk, both by having a broad stock index, and balancing with bonds, which have lower return but less risk.

Being too conservative, and buying all bonds, CD’s and such, feels safer, but in the longer run has a much lower return, and most likely we’ll end up behind.

Being too aggressive, buying all stocks, perhaps even “hot” stocks, is risky.  You may do well with some.  But there is a substantial possibility that you’ll lose a lot of money, perhaps very quickly.

What we’re looking for is improving our odds of having a decent return, but also lower the odds of losing money.

Advertisements

I-Bonds

Here’s an investment choice you’ve likely never heard of.  Why?  Because no one can sell them to you.  No one has a reason to advertise them to you.  It is between you and the federal government on this one.

And, they’re “boring.”  Not going to get instantly wealthy over these guys.  You’re not going to watch a ticker during your work day and speed your heart up.  But they are a compelling piece to have in your portfolio.

I-Bonds are a flavor of US Savings Bonds.  It is debt.  You are loaning the federal government money.

Here’s some attributes of I-Bonds:

  • They are inflation adjusted.  Inflation goes up, you get a higher return, which helps you contain some inflation risk.
  • I-Bonds have a fixed and variable component.  The fixed part is determined when you buy the bond, and they vary for different 6 month periods they are sold.  The variable part is determine from the CPI (Consumer Price Index), a measure of inflation.  Something to note is that the fixed rate is not an absolute.  If the CPI indicates negative inflation, that is subtracted from the fixed rate.  The good news is it can never go below zero, so once you earn money, you can’t lose it.
  • They are backed by the full faith and credit of the US government.  If that’s a concern for you, maybe gold would be a better investment for you.  (I’m being a little sarcastic…in my opinion, gold is a rock that doesn’t create additional value.  As you will!)
  • They do not float in the market and so cannot lose value.  It’s been you and the government.  When you’re ready to sell, they cash you out.  There is no middle man.
  • You can buy a maximum of $10,000 per year.
  • You cannot withdraw the first year.
  • If you need to withdraw your month between 1-5 years, you lose 3 months interest.
  • Tax deferred.  You can also avoid federal tax altogether if the proceeds are used to pay for higher education.
  • They stop accruing interest after 30 years
  • You can only buy and sell electronically through the TreasuryDirect® website.  Your account can be linked to your checking account.
  • Compounded semi-annually.
  • They are tax deductible if the proceeds are used for education.
  • There are no costs.  There is not up front transaction fee, there is no expense ratio.

Having said all that, the interest rate has not usually been real high.  But they are very close to no risk at all, and do make income.  They are very safe.  They are tax deferred.

Being tax deferred, they are a viable instrument if you’ve maxed out 401k’s, Roth’s, and IRA’s (lucky you!) and are looking for another vehicle to put money in to.

I-Bonds are worth a look as a portion of the bond portion of your portfolio.  They are a unique investment that you are unlikely to hear much about.