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The Four-Finger Theory
Linda Goin
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Once again the stock market is in the news, and the information doesn't flatter this industry and its "research integrity." Cora and I watched a woman from an investment club as she was interviewed on a television news program. She blamed a certain brokerage firm for lousy direction in portfolio management. At the end of the interview, Cora turned to me and said, "When you point a finger at someone, four fingers point back at you."
At that moment, I realized Cora was almost ready to write her own column. Cora went on to think about other things, and I continued to wonder why people - especially women - still entrust their money to information pouring from Wall St. advisors. Not all advisors are out to steal our money, but why would we open our portfolios to a total stranger on Wall St. when we're afraid to park our car alone at the local mall?
The point - if one is to point at all - is that we are responsible for our own investments. It's a matter of self-confidence and reliance upon our knowledge. If I point a finger at an investment firm's advisors, the four fingers pointing back at me might be:
1. I didn't follow up the advice with my own research
2. I allowed someone else to make decisions for my money
3. I believed advice from a brokerage firm was generated by my fairy godmother
4. I was gullible and naïve.
With this many fingers pointing at me, I would feel angry and betrayed, too. However, these feelings originate from my beliefs and lack of knowledge, not the behavior of those unseen forces in lower Manhattan.
Don't be gullible and naive, and worse - don't let this news keep you from using Wall St. to develop your portfolio. Stocks are still the best way to develop the largest return on your investment. In the "Stocks, Bonds, Bills & Inflation 2000 Yearbook" by Ibbotson Associates, Chicago, the returns on different investment categories for the years 1926-1999 and their average annual returns are as follows:
Small-Company Stocks: 12.6%
Large-Company Stocks: 11.3%
Long-term Corporate Bonds: 5.6%
Cash (U.S. Treasury Bills): 3.8%
The average annual returns include both increases in price and any dividends or interest. This information also gave the best and worst years for each category. The worst years for stocks were horrible -MINUS 58% in 1937 for small company stocks, and MINUS 45.3% in 1931 for large company stocks. This is compared to only a minus 0.02% loss in 1938 for Treasury Bills. However, the scenario from the 1930s has long smoothed out and we haven't seen a loss that large in almost seventy years, due to diligent organizations developed to monitor Wall St. mechanisms.
This comparative information also tells us high-risk investments give us the largest return on investment. High-risk is a modifier that changes dependant upon our knowledge. We can deposit our money in a simple savings account, and if our knowledge in this form of investment is limited, our money is still out on a limb over a high cliff.
For example: Mary allows her mother to scare her away from the stock market with mortifying stories from the Great Depression. She takes her money to the bank and tells the woman behind the counter she wants to open a savings account. When the woman asks Mary what type of savings account she wants, Mary responds with a shrug. The woman behind the counter is late for her lunch date. She advises Mary to open a savings account with simple interest. Mary agrees, and deposits her money.
Five years later, Mary marches to the bank snorting smoke and fire. Her neighbor just told her about her compound interest savings account. The comparisons between the two return rates on the same amount of money deposited are a bit too wide for Mary's comfort. She's angry the woman behind the counter didn't tell her about compound interest.
The woman behind the counter is long gone. She doesn't care about Mary's problem. The bank might sympathize with Mary, and help her move her money to an account with compound interest; but, when she leaves they'll roll their eyes in disbelief that anyone could be so unschooled in their own financial affairs.
Simple interest: When you deposit $1,000 in an account, the interest earned is based on this amount, which is your principal. If the interest is 5% annual, then you will earn $50.00 for the year ($1,000 x .05). You will also receive $50.00 the second year, the third year, etc. Simple interest is based on your principal. Period.
Compound interest is based on your principal and your interest earned. If you deposit $1,000 with a 5% compound interest, you will earn $50 the first year. The second year, you'll earn 5% interest on the principal AND the interest, so your return in year two will be $52.50. The third year, you'll earn 5% of $1, 102.50, or $55.13. The next year, you'll add the $55.13 to your $1,102.50, and multiply this by .05 to figure your return for the fourth year.
If you leave a large deposit in any account bearing compound interest, you could end up with a substantial sum over a period of time. You might not earn as much as you would with investments in stocks, but it would earn more than an account with simple interest. Mary pointed a finger, and four fingers pointed back at her, announcing "Gullible and Naïve" in neon lights.
The diseases of Gullible and Naïve can be cured with education. This isn't advice - this is a known fact. Gullible and Naïve are also highly contagious. Many women seem to be susceptible to these diseases, and it's high time we worked on our own recovery.
The next time you listen to advice, whether from a brokerage firm or any other business, just remember they're in business because they're making money - and their success is often based on our resources. Once we understand this simple formula, we're on our way to empowerment over our own lives.
Until Next Week,
Linda Goin
The securities markets are subject to the risks of fluctuating prices and the uncertainty of rates of return and yields inherent in investing and past performance is no guarantee of future results. Savings
accounts are insured by FDIC.
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