Laguna Niguel, CA
Tuesday, June 26, 2012
Too often when making an investment, an inordinate amount of effort is devoted to estimating potential returns and neglecting the implications of the investment and the potential risks. Many investors have unrealistic expectations for the returns they anticipate. The average annual return from 1928-2008 of an investment in large capitalization growth stocks was 11.1 percent; in large capitalization value stocks, 15.1 percent; in small capitalization growth stocks, 11.1 percent; in small capitalization value stocks, 18.5 percent; and in S&P 500 index, 12.0 percent. During that same time period, annual inflation averaged 3.2 percent. From 1958 to 2008, the yields on six month T-Bills averaged 5.6 percent; from 1964 to 2008, Certificates of Deposit averaged 4.5 percent; from 1962 to 2008, five year Treasury Notes averaged 2.5 percent and ten Treasury Bonds averaged 7.0 percent. While recent returns have differed from these averages, it is still instructive to compare them against historical averages in projected anticipated returns on future investments.
Perhaps one of the more important concerns of investors is the safety of principal. The shorter the investment time horizon, the more defensive the investment should be. This means that money should be placed in Certificates of Deposit, FDIC insured savings accounts, and Treasuries. As the investment time horizon becomes longer then riskier investment classes such as equities become more appropriate. Irrespective of the investment opportunity, investors should satisfy themselves that the risk of losing their principal is manageable.
Inflation, the erosion in the purchasing power of the dollar, must be considered in planning one's investments. While inflation has not been an issue for investors in recent years, it should not be taken lightly. From 1914 to 2008, inflation averaged 3.45 percent per year. This means that it would take $25.08 in 2008 dollars to purchase what $1.00 would have bought in 1914. From 1928 to 2008, inflation out performed equity and fixed income investments 9.9 percent of the time.
Returns from an investment come from two sources, income and capital appreciation. Those who need funds to sustain their current lifestyle need current income. For these investors, it is important to consider not only the rate of return but also the certainty that such payments will in fact be received. Others, whose investment needs are longer term, tend to prefer capital appreciation. This is not to say that an investment can't produce both current income and long term appreciation. Dividend paying stocks and rental property are examples of investments that generate current returns in the form of dividends and rent as well as long term capital appreciation potential.
Being fortunate enough to have invested in a financially lucrative opportunity is great. However, one should also be concerned about the liquidity of the investment. For certain investment classes such as stocks and bonds, there are liquid markets in which they can be sold and the value received in the matter of days. Other investments such as real estate can take months to monetize. Investments in partnerships can take even longer to liquidate and often at substantial discounts to the underlying value. The lesson here is to be sure that all investments can be liquidated within your investment time horizon. About The Author
Marvin H. Doniger has been an avid investor since his early teens. During the course of his lifetime he has developed a philosophy that has served him in his own professional development and in the creation of an investment portfolio for his family's financial needs. His perspectives have been developed from his lifelong study of investing, his actual experiences as a registered representative, an individual investor, as well as from working for large companies in industry and as a management consultant to Fortune 500 companies.
He is the author of A Common Sense Road Map to Uncommon Wealth
, which is a treatise on managing careers and finances, A Common Sense Approach to Successful Investing
, in which he first introduced stratamentical analysis, a unique approach for identifying long-term investment opportunities, and Common Sense Prescriptions for Financial Health
which presents quaestrology, a unique perspective on managing one's finances. He is also a regular guest on the Business Talk Radio Network and other radio shows. His articles have been published in media outlets such as Investor's Digest of Canada and Morningstar.
Mr. Doniger received a Masters in Business Administration from Columbia University Graduate School of Business and a Bachelor of Science Degree in Mechanical Engineering from Tufts University. He has taught undergraduate and graduate level courses in production control, inventory management, information technology and finance at Fitchburg State College and Webster University. He currently resides with his wife, Marsha, in Laguna, California.
Marvin H. Doniger
Laguna Niguel, CA