Saving for the Future Means Learning to Invest in It Now
This is a great time for people to learn what it means to be an investor.
Sure, it may not seem so. The stock market is jumping up and down like an irregular heartbeat just when $110 billion worth of certificates of deposit are coming due, forcing a lot of people to think about reinvesting.
It’s a tough call. Banks and money market funds are now paying only 3.5% and will reduce even that following the Federal Reserve’s action to lower rates last week. But the stock market’s fibrillations show that a move into mutual funds is no guarantee of calm waters.
So now is the time to become an investor. Prepare to find out more about the many ways available to do what you need to do, which is earn a return that keeps you ahead of inflation and taxes to build a nest egg for retirement.
It’s not something you can be casual about. Fidelity Investments, the mutual fund firm, calculates that you’ll need more than 60% of your present income to live in retirement. Social Security will provide 40% of that amount--so there’s a gap to be filled from other sources including earnings on savings.
That’s the challenge.
But investing is not a grim exercise, like beetling over your income taxes. It’s a game more like bridge than poker--skill counts as much as luck. “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return,” wrote Benjamin Graham, in “The Intelligent Investor,” an old but still valuable book.
Investing involves hope, a peculiarly human emotion, and faith that America will work out a bright future--and these days that the whole world will work one out as well.
That sounds like high-flown rhetoric but it’s not. Unless you have a confident perspective you’ll be battered by the passing winds. The problem of the many CD-holders who are angry about low interest rates this month is that they don’t see the big picture. Interest rates are down because inflation is low. Despite monthly fluctuations, inflation is now about 2.5% on an annual basis. And that’s good for business and investors, allowing real returns to be made without excessive risk.
Indeed the U.S. stock market, after suffering reflected pain from Tokyo, rebounded strongly last week just because investors see a low-inflation recovery developing.
To invest well “you think of how the world works, and how the business you invest in works,” in the words of Charles T. Munger, the partner of Warren Buffett in some of the most successful investments of the last several decades.
Munger and Buffett invest on a different plane from small savers, but the principles they follow contain lessons for all.
They assess a company’s long-term prospects and the quality of its management, and then try to buy at a sensible price. Three years ago they decided that in a world of rising living standards, global brand names would gain value. So they invested $1 billion in Coca-Cola--for a stake that is now worth $3.7 billion.
But they don’t sell the businesses they buy into--they’re owners for the long-term. And they buy very little: In 35 years they have made fewer than 20 major investments--jewels are rare, after all. And even then Munger and Buffett have made mistakes--notably with a stake in now-troubled Salomon Bros.
Other major investors buy and hold for decades, too, achieving gains as companies grow with the U.S. economy. But while patience is good policy for small savers, few can afford a decades-long perspective--they might need money just when an otherwise good company hits a dry patch.
The lesson is that investing in individual stocks is risky. “If you have less than $500,000 to invest, you’re better off with mutual funds,” says one investment professional. True enough, but picking a good fund is often as hard as finding a good stock. The best rankings are published annually in Forbes Magazine, which grades stock funds over three rising and falling markets. Over the 1980s, the composite of all stock funds ranked by Forbes returned 12% annually, but in the latest year that average return has fallen to 6%.
To be sure, you can preserve capital at 6%--and you can do so with even greater safety in a 10-year Treasury bond at 7%.
But most small investors want more than that static return--if they can get it with safety. “And I agree with them,” says Michael Tennenbaum, managing director of Bear Stearns in Los Angeles, who suggests that electric utilities offer one way to have a relatively safe dividend with a chance for growth.
Utilities are regarded as safer than other industrial companies because they earn a steady profit as regulated local monopolies supplying an essential commodity. So they can pay dividends--and also offer the possibility of a rise in the stock.
When they’re good they’re very good. The stock of North Carolina’s Duke Power, for example, has risen 13% a year for the last decade as its dividend has risen 5% a year, for a very fancy total return.
But even utilities can screw it up. Unwise diversification has driven Tucson Electric to near bankruptcy. Its stock has fallen from a peak of $60 a share in 1988 to $6.75 today, and it hasn’t paid a dividend in three years.
Pacific Enterprises, the Los Angeles-based natural gas utility, made similar diversification blunders, and so has hurt shareholders by stopping the dividend.
“It’s important to judge the management, the regulatory climate and the financial fundamentals of each company individually,” says Edward Tirello, senior utility analyst at the Smith Barney investment firm.
That is, if you’re going to invest for a livable retirement, it’s important to do your homework.
