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April 6, 2019

Five Concepts That May Financially Literate Investors

April is National Financial Literacy Month. As part of our participation, I’m going to discuss five key concepts that tie into the world of investing. They will serve as good reminders for those of you who are already familiar with them and help those of you who aren’t as familiar. If you know someone who can benefit from being exposed to these concepts, please share this week’s commentary with them.

1. Time and Compounding Are a Saver’s Friend—The best way to grow wealth is to invest savings for a long period of time. A $1,000 investment earning a 10% annualized return will grow to $1,100 if invested for just one year. Keep the amount invested for seven years, and it will grow to nearly $1,950. Double the period to 14 years and the balance will reach nearly $3,800. This growth occurs because returns are realized on previous gains in addition to the starting balance. A simple rule for calculating how long it will take to double a sum of money is to divide 72 by the rate of return (e.g., 72/10 = 7.2 years to double a sum of money given a 10% return).

2. Think in Terms of Goals—One of the biggest advantages individual investors have is never having to report their performance. This allows us to make decisions based on our goals (funding retirement, paying for a child’s or grandchild’s college, etc.) rather than based on how our portfolios performed during a given month, quarter or year. We can afford to incur periods of underperformance if doing so means higher longer-term returns and a greater probability of achieving our goals. In contrast, professional money managers are often hired and fired based on three-year performance—a scenario that leads to short-term-performance chasing and reduces long-term returns.

3. Process Matters More Than Returns—You have no control over whether your investments will rise or fall in price. What you can control is how much you save, how you allocate and how to decide what to buy and sell. Establishing a systematic process for all three controls based on research about what has been shown to work over the long term will greatly increase the odds of achieving your goals. Focusing on and reacting to the headlines of the day will not. In investing, discipline matters greatly.

4. History Is a Useful Guide—While history doesn’t fully repeat, there are often enough similarities between now and the past to draw useful analogies and guidelines. Having the ability to apply past lessons to the future can help you to control emotions, look past the noise, put downturns into perspective and even identify potential opportunities when they appear.

5. Ask Questions—This seemingly simple concept is a very powerful one. Asking questions can protect you against scammers, unravel “advisers” who don’t fully understand the products and services they are pushing and identify risks and potential pitfalls that may not be initially apparent. Asking questions will also increase your level of knowledge, helping you to become a better investor.

The Week Ahead
First-quarter earnings season will “officially” start with two of the largest banks reporting on Friday: Dow Jones industrial average component JPMorgan Chase & Co. (JPM) and Wells Fargo & Co. (WFC). Joining them next week will be five other members of the S&P 500 index.
The week’s first economic report will be February factory orders, released on Monday. On Tuesday, the February JOLTS report will be released. The March consumer price index (CPI) and the minutes from the March Federal Open Market Committee (FOMC) meeting will be released on Wednesday. Thursday will feature the March producer price index (PPI). March import and export prices and the University of Michigan’s preliminary April consumer sentiment survey will be released on Friday.
Three Federal Reserve officials will make public appearances: chairman Jerome Powell on Wednesday, Thursday and Friday; and New York president John Williams and St. Louis president James Bullard on Thursday.
The Treasury Department will auction $38 billion of three-year notes on Tuesday, $24 billion of 10-year notes on Wednesday and $16 billion of 30-year bonds on Thursday.
Courtesy of Charles Rotblut, CFA is the VP and Editor for American Association of Individual Investors (AAII). Charles is also the author of Better Good than Lucky. (EconMatters author archive here)   
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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