If you don't understand the investment, don't put money in until you do
These e-mails, typical of those I receive daily, show the need to keep emphasizing the basics:
Q. My husband's CD at our bank matured. Not knowing much about investing and fearing loss, I advised him to roll it over into a CD at our credit union. But the bank convinced him to invest in some sort of mutual fund. The money has gone from around $86,000 to $78,000. Help!
A. By investing in "some sort of mutual fund" your husband violated a cardinal rule: Never invest in something you don't understand.
I don't know what type of fund this was and how much was invested. I assume it was a stock fund (a mutual fund that invests in stocks), as a decline of 9-10 percent at the time I got this e-mail was not uncommon for many stock funds.
Actually, much bigger stock market swoons are common during periods of economic uncertainty. Losses have averaged more than 26 percent in the 10 US recessions since 1945, according to Ned Davis Research.
Even without a recession - and officially we are not in one - stocks can suffer steep losses in response to events affecting the overall economy, individual companies, or industries, or even just the mood of investors.
Despite periodic declines, stock prices historically have risen over time, outpacing inflation and the return of fixed-income investments.
My mantra: Never put money in stocks if you need the cash in less than five years and never put in so much that you can't sleep.
Q. Do I just ask for a Roth IRA that pays compound interest?
A. At a bank you can get a CD that pays compound interest as part of a Roth IRA. Investment firms may not know what you mean, although they too offer what you want.
A Roth IRA is simply a type of retirement account, not an investment. You can open a Roth IRA at numerous financial institutions, including banks, mutual fund companies, and brokerage firms. You don't get a tax deduction but withdrawals can be tax-free.
Compound interest may be more appropriately called "compound earnings." It means the money your investments earn - interest, dividends, or capital gains - can earn more money.
Banks use the term compound interest to mean the interest rate they pay on a deposit will be credited not just to the original principal but also to the previously earned interest.
But the concept works with other investments even if they don't pay "interest." For example, if you invest $10,000 in a mutual fund and achieve a 5 percent return the first year, you will have made $500 and you will have $10,500. The second year, if you again make a 5 percent return, your account value will go up not $500 but $525 (5 percent of $10,500) and your account will be worth $11,025.
Humberto Cruz is a syndicated columnist. He can be reached at AskHumberto@aol.com.
