Eric Tyson - Personal Finance After 50 For Dummies

The stock market bounced back after both of the 2000s bear markets. But some damage was still done to investors’ portfolios with too large a percentage invested in stocks. Those who suffered the most were those who panicked and sold at depressed prices and those who were poorly diversified and overweighted with hot sectors that came plummeting back to Earth. And it was a nerve-wracking period for older investors — and a reminder to understand the risks in various investments and the value of proper diversification.

On a final note, we’d like to highlight the economic and financial market turmoil brought about by the government mandated economic shutdowns during the COVID-19 pandemic. Stocks were crushed in March 2020 but came roaring back so those who didn’t panic had their patience rewarded. Employment and salaries — especially in hard-hit industries, such as travel, restaurants, small retail businesses, and so forth — were another matter.

Income-oriented investments, such as corporate bonds and treasury bills, don’t allow you to profit when the company or organization profits. When you lend your money to an organization, such as by purchasing bonds, the best that can happen is that the organization repays your principal with interest.

Some types of investments are more growth-oriented and don’t pay much, if any, current income. A growth investment is one that has good potential to appreciate (increase) in value in the years and decades ahead.

Investments that are more growth-oriented, such as real estate or stocks (investments in companies), allow you to share in the success of a specific company or local economy in general. Some stocks offer dividends as well as the opportunity to participate in the appreciation of stock prices. Although the yield on a good stock from its dividend typically is well below the interest rate paid on a decent corporate bond, some stocks do offer reasonable dividend yields.

Some investments are more resistant to inflation, or increases in the cost of living. The purchasing power of money invested in bonds that pay a fixed rate of interest, for example, is eroded by a rise in inflation. The value of investments such as real estate and precious metals like gold and silver, by contrast, often benefits from higher inflation (although we must note that precious metals have generated poor long-term returns). Stocks, over the long run, have proven to be a good inflation hedge and have produced long-term returns consistently well above the rate of inflation.

When researching investments, you need to be clear about the possible tax consequences you face with the different investments you may make. Apart from investments in tax-sheltered retirement accounts, the interest or dividends produced by investments are generally taxable in the year they’re earned. The profits (known as capital gains ) from selling an investment at a higher price than it was purchased for also are taxable.

If you invest without paying attention to taxes, you’ll likely overlook ways to maximize your returns. Two simple yet powerful moves can help you to invest in a tax-wise way:

Contribute to your retirement accounts so that less of your money is taxed in the first place. Doing so reduces your taxes both in the years you make your contributions as well as each year your money is invested. For those approaching retirement with significant balances already saved in their retirement accounts, saving outside retirement accounts is worth evaluating. Consult Chapter 5for more information on retirement accounts.

With money that you invest outside retirement accounts, choose investments that match your tax situation. If you’re in a high tax bracket, you should avoid investments that produce significant highly taxed distributions. For example, you should avoid taxable bonds, certificates of deposit and other investments that pay taxable interest income, and those that tend to distribute short-term capital gains (which are taxed at the same high tax rates as ordinary income). Instead, consider growth-oriented investments, such as stocks, real estate, or investments in small business — yours or someone else’s. Long-term capital gains, which are gains from investments sold after a holding period of more than one year, are taxed at lower rates. Keep in mind that growth-oriented investments generally carry more risk.If you’re in a high tax bracket and would like to invest in bonds outside a retirement account, consider municipal bonds that pay federally tax-free interest. The interest on municipal bonds is also free of state taxes if the bond was issued in the state in which you live.

Not all investments move in concert with the health and performance of the U.S. economy. Investments in overseas securities, for instance, allow you to participate directly in economic growth internationally as well as diversify against the risk of economic problems in the United States. International securities, however, are susceptible to currency-value fluctuations relative to the U.S. dollar.

Because foreign economies and currency values don’t always move in tandem with those in the United States, investing overseas may help to dampen the overall volatility of your portfolio. Investing in U.S. companies that operate worldwide serves a similar purpose.

We understand that you already may have money invested. Even so, you can still use the information we provide in this chapter to improve upon your holdings and learn from past mistakes.

In this section, we discuss the importance of matching your financial needs, now and in the future, against the riskiness of your investments. Lastly, we discuss how to whip up the best investment mix — or asset allocation — for your situation.

A critical issue to weigh when investing a chunk of money toward a specific goal like retirement is knowing your time horizon, or the length of time you have in mind until you need the money.

The potential problem with timing is this: If you invest your money in a risky investment and it drops in value just before you need to sell, you could be forced to take a loss or a much lower gain than you anticipated. So you should be concerned about matching the risk or volatility of your investments with the time frame that you have in mind.

Suppose you’re investing some money that you plan to use for one-time expenses in a few years. With a short time frame in mind, investments such as stocks or real estate aren’t be appropriate, because they can fluctuate a great deal in value from year to year. These more growth-oriented (and volatile) investments, on the other hand, can be useful in working toward longer-term goals, such as retirement, that may be a decade or more away. ( Chapter 3provides information on how to figure out when you can afford to retire.)