Sunday, May 2, 2010

A Conservative Approach to Investing

Not everyone agrees that you should invest in stocks to meet critical financial goals. It’s probably a good idea to at least consider this viewpoint, and familiarize yourself with a conservative alternative investment strategy. In the end, you must decide for yourself how much risk is appropriate for you, and make your investment decisions accordingly.

A conservative approach to investing is presented in the book Worry-Free Investing, which I’ve added to my recommended investment book reading list. The premise of this book is that you shouldn't invest in risky assets (e.g., stocks) to achieve critical financial goals like retirement and college. Instead, the authors recommend investing primarily in TIPS (Treasury Inflation-Protected Securities) and I Bonds (Inflation Indexed Bonds), and only investing money you can afford to lose in stocks. Unlike many other investment books, they present the case that stocks are risky even in the long run. They emphasize saving more, rather than taking more risk, to meet your goals. They present a very methodical approach to determining your goals, calculating the amount needed to finance your goals, determining your required savings, and putting together an investment plan. They emphasize considering social security and pensions in developing your plan.

This certainly is a valid approach, especially for investors with low risk tolerance. Although stocks have provided a relatively high inflation-adjusted return over most long time periods, there have been long time periods when this has not been the case, and we don’t know for sure that it will be the case in the future. If you are unwilling to take the risk of a possible poor outcome in return for the probability of a better outcome, and you are willing to increase your savings rate or lower your future living standard as necessary, then this low risk approach to investing may be right for you.

At this point, I’m still encouraging my children to allocate a high percentage of their investments to global stocks (US and non-US), using low cost index funds as much as possible. I also continue to recommend an appropriate level of stock exposure to people of all ages; of course the percentage allocated to stocks is generally lower the older you are. The bottom line is that I’m optimistic about the growth of the global economy in the long run, and like John Bogle (founder of Vanguard), I believe in casting your lot with business. Nevertheless, it’s wise to remember that stocks are risky, and that there are alternative ways to invest that may be more appropriate for you.

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