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## Investing Basics – Risk vs. Reward

In 2005, people spent 125% of what they earned. They spent money they hadn’t earned yet, so they racked up debt and paid interest on that debt every month. If you spent less than you earned than you were actually paid interest on your money, quite the opposite. The return you can expect from that hard-earned money largely depends on the level of risk associated with it. However, no risk equals no reward; risk is not a big scary animal that we all run away from.

The first thing to decide is how much money you want your investments to earn. It could be 1% to 30% and everything in between. The return of one percent is incredibly low, but very safe. In fact, 100% safe, since that’s what your savings account pays for. If you think you’re making money from your savings account, you’ve forgotten to think about inflation. Let’s assume that inflation is around 3% per year. If your investments are making 3%, you break even. You didn’t make a dime because inflation took away 3% of the purchasing power your money had a year ago. $100 today is only worth $97 in a year. If you made a 3% investment, which is $3, you’re back to $100. Take 3% off your return and that’s your actual return.

If you want high returns, don’t expect to be risk averse. The greater the reward, the greater the risk that needs to be considered. Bonds are currently around 5%. This is 5% safe and you will not lose this money. Once you factor in inflation, it suddenly becomes gas money. Stocks have outperformed any other investment over any 20-year period. Stocks sink more, but there are plenty of ways to enjoy the rewards of the stock market without worrying about losing your kids’ college fund. You can buy an index fund that invests in the S&P 500 or the Dow Jones. The S&P 500 is 500 companies if you invest $500, $1 would be in each company. The S&P gains about 10% annually. There is very little chance that the S&P will hit zero even though there are years of correction. That’s why you need to invest for the long term. If you start buying in one of these correct years, you will lose money, but think long term and you will realize that you will buy a lot in these correction years. Buy low and sell high is the game, but many of us do it the other way around.

When investing, it’s not only risk and reward that matters, but also your age. This may be new to you, but age is very important in investing. Age tells us what level of risk we should expect. If you are in your 20s, you should invest in the riskiest funds possible. The reason is that a person has more time to replace that money if they lose it all. An elderly person does not have these years and the advice is just the opposite. Little or no risk and invest only in fixed income, which are bonds and CDs and 100% safe alternatives. The older you are, the less risk you should allow. 10% of fixed income for each decade of age is a general rule. Do the math and determine your risk level.

There are many safe investments out there, but as the saying goes, “no pain, no gain.” The reward for “the pain” is the 10% and up yield you could enjoy.

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