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Don't Sacrifice Growth for Stability of Principal

by

Adam Starchild


What percentage of your money should be invested in common stocks or stock mutual funds? One financial expert suggests a simple formula of subtracting your age from 100 to determine the appropriate allocation of investment dollars to equities. For example, if you are 50, half your investments should be in common stock or stock mutual funds.

However, most people have much less invested in equities than they should. Of all mutual fund investments, 70.5 percent are in bond funds and money market funds; only 29.5 percent are in equities. Retirees often have their money too conservatively invested, thinking only about stability of principal. Even young people often have too large a portion of their portfolios invested only in fixed-income investments, which traditionally have yielded much less than common stocks.

No one should have all of his or her investments in growth securities. However, it is equally dangerous to be totally invested in short-term income securities. For example, in 1981, $250,000 invested in certificates of deposit would have provided more than $3,000 of income each month. Today, just 13 years later, that same nest egg would yield less than $700 in monthly income. Although the principal has remained safe, monthly income has decreased more than 75 percent, while inflation has continued to increase the cost of living.

Although common stocks and stock mutual funds offer some short-term market risk, serious, long-term investors know that equities also offer the opportunity to stay ahead of inflation and keep income growing.

Staying ahead of inflation is particularly important to retirees. Today, a 70-year-old has a 63 percent chance of living another 15 years. Inflation as low as 3 percent annually will reduce purchasing power by more than half in those 15 years. Selecting only fixed-income investments may not allow investors to stay ahead of inflation. Common stocks of large corporations, on the other hand, have yielded an average of 6 percent more than inflation since 1926.

If you are heavily invested in fixed-income securities such as U.S. Treasuries or CDs, and you want to add some growth to your portfolio, how should you begin? First, don't try to do it all at once. Early redemptions could cost you penalties. Plan ahead, and find out when your securities mature.

Next, decide how much of your portfolio should be invested in common stocks or equity mutual funds. As your securities mature, or as new money becomes available, gradually move it into the new investments. Typically, taking one to two years to adjust your portfolio is best. This allows for market fluctuations and reduces your exposure to unexpected drops in the market.

Selecting only fixed-income investments may avoid the risk of losing principal, but it also may expose you to the biggest risk of all -- outliving your nest egg. Don't forget about the importance of growth and staying ahead of inflation when choosing your investments.

About the Author
For twenty years Adam Starchild has been writing books about these subjects, and they are published by a variety of publishers. They are available in many bookstores or public libraries.

For more information on global investing, see The Offshore Entrepreneur.

Copyright © 1995 by Adam Starchild
The Investor's Library has reprinted this copyrighted article with the permission of the author.


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