If you don't do anything, you can't lose money. That might be true with slot machines, horse racing and the lottery, but it's not true with investing. Skilled investors know that the price of doing nothing or not enough can result in losses; not the lost value of stocks or mutual funds, but other losses not plainly visible to the eye of a new investor. Here's what you need to know about how these losses can affect you.
Beware of Inflation
If you have a few decades behind you, you probably remember the days of being a kid, where you could hop on your bike with a quarter, take it to a local store and buy a piece of candy. As you got older, you remember buying gasoline for less than a dollar per gallon.
Your money had more buying power back in those days, but today a quarter has to be combined with other quarters to have much buying power and a gallon of gas is close to $4. For an investor, inflation is fundamentally important; just as inflation has contributed to changes in the price of gas over the years, it can have a surprising affect on your investments, if you're not prepared for it.
Don't Hold Cash
Holding onto cash for long periods of time, waiting for the market to bottom, reduces the value of your money. You might be able to earn 1% from a savings account right now but if the current rate of inflation is 2.3%, inflation is causing an annual loss of 1.3%.
Holding cash for short periods of time is a wise investment choice, but over the long term you're silently losing purchasing power, and purchasing power is the only reason we hold currency. How do you combat inflation? Put that money to work but only in investments that earn a rate of return higher than the rate of inflation.
Because interest rates are so low, getting gains that beat inflation from government or investment grade bonds is sometimes difficult. Junk bonds, also known as high-yield bonds in the form of a low-fee mutual fund or exchange-traded funds (ETFs), can pay yields of more than 7%, in some cases. The downside is the increased level of risk, but for many investors the level of risk is appropriate. Bonds have been in a bull market for the past few years and there's no guarantee that the bull market will continue. Always have an exit strategy in place.
Many investors have heard that investing in big companies in developed countries may not provide the growth necessary to outpace inflation; however, investing in the eurozone, China or many other countries has proven to be too risky. Investing too conservatively can harm your portfolio, but taking on too much risk can cause even worse results. To account for world events, make conservative asset allocations changes to your portfolio, instead of an all or nothing approach.
Own Real Estate
Many current and former homeowners may still be recovering from the housing crisis, and there's no guarantee that the market is now in recovery or will recover in the near future. For those with a long-term investment objective, owning a home will keep pace with inflation and even beat it. Some investors are putting the cash to work by purchasing distressed properties and renting in this red hot rental market.
For years, gold held the distinction of being a shiny way to battle inflation but there's no guarantee that, going forward, gold will provide that protection. Still, CNBC's Jim Cramer advises owning gold for just that purpose. Gold in its physical form is better than gold ETFs or other stock market products, but owning large amounts of gold and protecting it from theft or loss is difficult.
The Bottom Line
Investing too conservatively usually means not taking on enough risk to beat the effects of inflation. The key for each investor is to take on enough risk to beat inflation without moving outside of his or her risk tolerance. The best way to strike the perfect balance is to find a trusted financial adviser to evaluate each individual situation.