why we invest?

You’ll often hear the phrase ‘‘invest for the future.’’ Not only is this a cliche´ ,
it’s redundant. That’s because the act of investing necessarily involves the
future, on a couple of levels. Obviously, the reason we invest is to be able to
meet certain goals in the future—be it going on vacation, buying a house,
sending children to college, or building up a nest egg. But investing also takes
time. That means, by definition, it’s a future-oriented endeavor.
While spending involves instantaneous gratification—you’re giving up
something today in exchange for something else immediately—investing is
just the opposite. It’s all about delaying one’s gratification. It involves giving
up something today—i.e., the use of your money—in hopes of getting
something greater back in the future. That ‘‘something greater,’’ of course, is
more money.
The interesting thing is, there is a relationship between spending money and
investing it. When you invest, you are often interacting with would-be spenders.
For example, if you are a stock investor and buy shares of a company,
you are giving the firm your capital (i.e., your cash), which it will use to spend
on various projects. The hope is that the company will not only survive, but
thrive to the point where its value (and the value of your shares) will increase
substantially down the road.
Investing in bonds works the same way. When you buy a U.S. Treasury
bond, for example, you are handing over your money—and all the potential
uses you might have for that cash—so the government can gratify its needs by
spending your money. In return, you are making a calculated bet that the
federal government will not only survive, but will be able to pay you back your
investment at a future date, along with an agreed-upon amount of interest.
The greater the length of time you’re willing to delay that gratification, the
greater the odds of being rewarded for your patience. Sometimes, to invest
properly and safely, youmay need to tie up your money for months, if not years,
if not decades—if not longer. Anyone who has purchased a home with a 30-year
mortgage will appreciate just how long some investments are designed to ripen.
But as any homeowner is likely to tell you, the rewards are well worth the wait.
In many ways, the greatest lie perpetrated by the Internet bubble of the
1990s was the sense that we could somehow get rich overnight by putting
money into the stock market. But an overnight investment in any market—be
it the stock market, bond market, real estate market, or whatever—is not
investing. That’s gambling.
Now, for a brief, shining moment in the late 1990s, when the stock market
was routinely returning 20, 25, or even 30 percent a year, investors truly felt
10 PART 1 Getting Ready
that things had somehow changed, and that the rules that govern investing
had somehow gone away. But the rules of investing change about as often as
the rules of physics do. The 2000-2003 bear market should have reminded us
of that.
What Investing Isn’t
Before we start discussing what investing is, it’s important to understand what
it isn’t. The bear market showed us that investing is not about getting rich
quick. Here are some other important lessons to keep in mind:

Investing is not just about stocks. For several years in the 1990s people
associated investing exclusively with the stock market. That’s because
stocks were generating returns in excess of 20 percent a year for several
years. Bonds, by comparison, were producing only single-digit gains.
Given the choice between earning, say, 6 percent a year on your money
and earning 26 percent, obviously, most of us preferred the latter. This
would explain why a generation of investors was beginning to think that
you didn’t need to own bonds in your portfolio. Some believed that
putting all your money in stocks, in fact, was preferable to investing even
a sliver of it in real estate.
But when the bear market struck in 2000, we were reminded of
two things: first, that risk must be factored into all of our investing
decisions; and second, that when one investment asset falls, another
typically rises. True to form, when blue-chip stocks lost nearly half of
their value in the bear market, and when technology stocks lost more
than three-quarters, bonds saw tremendous gains. A basic bond portfolio
gained 6.2 percent in 2000, 6 percent in 2001, and another 6.5 percent
in 2002. In comparison, an average stock portfolio gained less than 2
percent in 2000, lost 9.1 percent in 2001, and lost 20.4 percent in 2002.

Investing is not just about ‘‘financial assets.’’ Anyone who owned or
purchased a home after 2000 knows the value of not only investing in
financial assets like stocks and bonds, but also tangible assets like real
estate. As stock prices fell in 2000, investors began to move money out
of the equity markets and into real estate—and that proved to be a
winning bet, since the housing market boomed just as the equity market
ebbed. It just goes to show that something as stodgy as the house you live
in can be an attractive investment and an effective use of your money.
A study in 2004, for example, found that between 1996 and 2003,
median home prices nationally rose more than 50 percent, which was
CHAPTER 1 Why We Invest 11
comparable to the gains achieved in the equity markets during that same
time. It just so happened that stocks zigged when home prices zagged.
Another way to measure the value of investing in real estate is to
measure the performance of real estate investment trusts (or REITs),
which are shares of companies that invest in hard real estate. Mutual
funds that invest in REITs rose 27 percent in value in 2000, nearly 10
percent in 2001, more than 4 percent in 2002, and more than 37 percent in
2003. Those returns trounced the performance of stocks.
Beyond real estate, another asset investors have historically considered
as desirable for a diversified portfolio is gold and precious metals. After
decades of underperforming stocks, gold investments soared 19 percent in
2001, 63 percent in 2002, and more than 57 percent in 2003. Now, if you
neglected these alternate investments in your overall plan starting in 2000,
you would have lost money—and lost out on untold opportunities.

Investing is not the same thing as savings. While it is true that you need to
save money to invest it, investing and saving are completely different
exercises. When you save money, the ultimate goal is to protect every last
penny of that pot. On Wall Street they have a fancy expression for this.
It’s called capital preservation.
When you invest you hope that your money is protected. But your
goal, ultimately, is to grow the pot of money. Wall Street has a fancy
term for this too; it’s called capital appreciation. To reach that goal, the
rules of investing say you have to expose yourself to some risk. But over
time, and in a well-diversified portfolio of different types of investments,
that risk can be minimized. Saving and investing work in cycles.
For instance, say your goal is to invest money to buy a house. For the
sake of argument, let’s assume that you and your spouse are hoping to
put a down payment down on your first home five years from now. First,
you have to save money from your day-to-day income to get started.
This money might be set aside in a bank savings or checking account—
or in a money market account. All of these are considered ‘‘cash’’
investments. And they happen to be federally insured against losses.
As you accumulate enough savings to cover your daily expenses and
rainy day funds, you can start investing that money in higher-yielding
(and higher-risk) investments like a stock mutual fund or bonds. Now,
as your investments grow over the next five years, you will soon
approach your deadline for actually putting that down payment down
on the house. As you get within a year or two of that goal, you will
probably want to shift back into savings mode. That’s because in any
short-term window of time, your stock or bond investments could lose
value. And you don’t want your investments to lose value just as you’re
12 PART 1 Getting Ready
going to need the cash. So, this is the time to start shifting back into
‘‘savings’’ or ‘‘capital preservation’’ mode.
Confused? Don’t worry. Once we get going on the basics of investing, all of
this will seem like second nature.

Quiz
1. Investing is the same thing as savings.
a. True
b. False
2. Why are workers making more decisions about their investments?
a. Fewer companies offer pensions, which give retirees guaranteed income.
b. The Internet arms people with investing information so they can take
control of their finances.
c. A new federal law requires companies to allow employees to make
their own investment decisions.
3. Compound interest is important because . . .
a. It represents guaranteed interest accrual.
b. Its interest rate is indexed to the rate of inflation.
c. It allows earnings to grow upon earnings, leading to faster than
expected growth.
4. If you wanted to double your money in 10 years, what rate of interest
would you have to earn annually?
a. 10.3 percent
b. 7.2 percent
c. 8.4 percent

7. How many people seek professional financial advice?
a. Less than 30 percent
b. 50 percent or more
c. 90 percent or more
8. The majority of mutual fund shareholders earn between:
a. $100,000 and higher
b. Between $50,000 and $75,000
c. Between $25,000 and $75,000
9. What is capital appreciation?
a. A defensive investment strategy that calls for protecting your
portfolio against the possibility of losses.
b. Gains in the value of one’s investments over time.
c. The proper respect shown by savers to the power of saving money.
10. Which is the best investment?
a. Individual stocks
b. Mutual funds
c. Real estate
d. There is no one best investment