PERSONAL FINANCIAL STRATEGIES
While taking a course in economics is no guarantee of great wealth, the principles of modern finance can definitely help you invest your nest egg wisely and avoid the worst financial blunders. What lessons does economics teach about personal investment decisions? We have culled the following five rules from the wisdom of the best brains on the street.
Lesson 1: Kinky they investment The absolute bedrock of a sound investment strategist to be realistic and prudent in }’OW’ investment decisions. For important investments, study the materials and get expert advice. Be skeptical of approaches that claim to hare found the quick route to success.success. You can’t get rich ~ listening to thereabout or consulting the stars (although, unbelievably, some financial advisers push astrology to their clients). Hunches work out to nothing in the long Moreover, the best brains on Wall Street.do not. on. average, beat the averages (Dow:Jones, Standard and Poor’s, etc.). This .is not surprising. Although the big money managers have plenty of money for research, they are all competing with one another.
Lesson 2: Diversify, that is the prophets of ‘finance. One of the major. lessons of finance is the advantage of diversifying your investments, “Don’t put all your eggs in one basket” is one way of expressing this rule. By putting funds in a number of different investments, you can continue to average a high yield while reducing the risk. For example. suppose that stocks and real estate each have average returns of 10 percent while index (standard deviation) is 30 . A portfolio that contains equal shares of each investment would also have an average return of 10 percent. But because a bad year for one of them ·may. be balanced by a good year for the other: the risk of the overall portfolio can be reduced. Under simplified conditions :(independence of risk. and a normal probability distribution), the risk.index for the diversified portfolio is only 21.2 .. percent. Calculations show mat by diversifying their wealth among a broad array of invest common stocks, conventional and inflation-indexed bonds, real estate, domestic and foreign securities-people can attain a good return while minimizing the downside risk on their investments.
Lesson 3: Consider ammo-stoic underfunded. Investors who want’ to invest ·in the stock. market can achieve a good return with the least possible risk. by holding a broadly diversified portfolio of common stocks. A good vehicle for diversifying is an exactitude. This is a portfolio of the stocks of many companies, weighting each company in proportion to its market value, and often trading a major stock index like the S&P 500. One major advantage of index funds is that they have minimal expenses and tum over-induced taxes.
lesson 4: ,Minimize unnecessary expenses and taus. . People often find that a substantial amount of their investments earnings is nibbled away by ·taxes or expenses. For example, some mutual funds charge a high initial fee when ) purchase the fund. Others might charge a management fee of 1 or even 2 percent of assets each year. Additionally, heavily “managed” have high turnover and may. lead to -large taxes on capital’ gains. Day traders may find great enjoy in lightning movements in and ow, and they mar strike it rich, but they definitel), will pay heavy brokerage and investment charges. Br choosing )’0~11′ investments carefully; you can avoid. these unnecessary drains on your investment income.
Such are the lessons of history and economics. But no one can guarantee that the next decade will be as buoyant as the 19905. Many economists believe that the stock market was Significantly overvalued in 2000 and look for a major stock-price decline in the future. So take care’that you don’t repeat the take of 1929 investors who bought at the peak of a speculative frenzy and didn’t recover their losses for three decades. ·If, after reading all this, ‘you still want to try your hand. in the stock market, do not be daunted. But take to heart the caution of one of America’s great financiers, Bernard Baruch.
If you are ready to up everything to study . the whole history and background of the market ‘and all me principal companies whose stocks are on the board as carefully as a medical student studies anatomy-if you can do all that, and, in addition, you have the cool nerves of a great gambler, sixth sense of a kind-of clairvoyant, and the courage of a: lion, you have a ghost of a chance.
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