Financial planners advise different investment plans for the different stages of life. They advise young working people to buy a more aggressive and riskier portfolio of stocks and bonds, with the hope of building assets quickly. Older people, especially retirees, should buy a portfolio that preserves assets, and possibly provides income. This approach, however, has benefits and liabilities.
The safest stocks are blue chips. They are companies that consistently earn a profit and pay a dividend, so their stock maintains its value. The downside of blue chips is that it takes many years for your portfolio to double in value. Growth stocks do not pay a dividend, as the company reinvests its profit. They present a greater risk to the investor, since you will not receive any payments to offset the cost of buying shares. However, you may earn a significant profit in several years, if the company has talented management to guide its growth. Penny stocks are junk stocks in poorly funded companies. Some may be newer corporations with a stellar product, offering the chance for a tremendous profit. However, most investors lose money when buying shares in this category, as there are many more losers than good companies.
The average investment portfolio has a blend of stocks and bonds. The stock ratio is the percentage of stocks in your portfolio as compared to bonds. Determine the ratio by subtracting your age from 100. For example, a 25-year-old would have 75 percent of his portfolio in stocks. Since stocks are riskier than insured or government-backed investments, it is prudent to lower that exposure as you get closer to retirement.
Investors can increase wealth quickly with a more aggressive portfolio. This is especially beneficial to young people with little or no assets, as they can build a good financial base during their best working years. Even if some of the companies flounder, a worker in his twenties has many years to recover from any losses, especially if his employer matches contributions. Traditionally, young people increase their salary every year as they climbed the corporate ladder, so an early financial setback in the stock market is acceptable.
The stock-bond ratio worked well during the era when our country experienced growth every year, paid good returns even on modest investments (i.e. 6 percent savings accounts) and had a strong manufacturing base to recover from recessions. This situation no longer exists. Additionally, workers pay significantly more taxes now than the previous generation, and their after-tax dollars have less buying power. The dollar, as of the time of publication, is only worth 13 cents compared to the 1960 dollar. The result is less money at all ages for investment. Some financial analysts are recommending an adjustment in the stock-bond age ratio to 120 minus your age, meaning a 20-year-old investor would have all of his money in the stock market. This presents the possibility of complete loss of assets, an unlikely scenario if part of the portfolio were in quality bonds.
- Deutsche Borse Frankfurt: Investment-Strategies: Share Ratio = 100 Minus Your Age
- Federal Reserve Bank of San Francisco; Boomer Retirement: Headwinds for U.S. Equity Markets?; Zheng Liu and Mark M. Spiegel; August 2011
- Dollar Times: Inflation Calculator -- The Changing Value of a Dollar
- Investopedia: Blue Chip
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