Separate Your Investments And Your Fruit

David Frost // Better Investing


September 4  

All investors who pay any attention to the financial media should be wary of a common discussion that can be hazardous to your wealth.  There are frequent guest on the television shows and articles written about the issue of low interest rates and how investors can help themselves to a better return.

The federal reserve has pushed interest rates to all time lows in an effort to stimulate the housing market, the economy and allow the banks access to cheap capital to lend to the American people.  This hasn’t worked as advertised, and has even produced some “UN-intended” consequences, especially for those who need a return on their savings for everyday spending and living expenses.

The frequent comments are about how certain high quality stocks have better dividends or yields than treasury bonds.  The main problem with this type of advice is the absence of a basic understanding of how people think about risk and more importantly, what they know and don’t know.

Yes, many stocks that pay dividends can earn you a better return than treasury bonds, but what do apples have to do with oranges?  They are both fruit, but that’s where the similarities end.  When an investor thinks about risk and how their money is allocated across various types of investments, they typically consider both risk free investments such as cash, CD’s and Treasury Bonds, as well as investments that can produce a better return if they are willing to put some of their hard earned money at risk in exchange for a higher return.  Risk comes into play because in exchange for the return, you may be subject to lose all or part of the original investment.  If you’re not willing to “risk” any part of your savings, then you shouldn’t make any purchases other than cash equivalents.

Now, when someone compares the dividend of a stock to the interest paid on treasury bonds, they are mixing risk free and investment risk in the same conversation which can potentially confuse an investor. They are not comparable and should be kept separate and apart from each other.

The portion of money that anyone may have in treasury bonds or CD’s at your local bank is there because you don’t want to put that money at risk and refuse to lose any portion of it.  That being said, why would anyone compare the return on these type of investments with that of a stock paying a dividend.  While the income from a higher yielding stock may produce better cash flow, the potential loss if that stock goes down due to unforeseen circumstances or just plain poor market performance can be devastating.

One of the issues with listening to or reading the financial media is that they are always trying to find reasons for you to buy stocks.  Most people are better off with objective opinions and pure advice based on what direction a market or investment may be headed rather than a one way ticket on the hope train.

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About the Author

Trading and investing in markets is second nature to some, but a mystery to others. The goal is to provide a forum where everyday people aspiring to be part time or full time traders will learn how view markets differently and profit beyond their wildest dreams.

David Frost