3 Reasons Why Safe Investing Could Leave You Broke

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Did you know that safe investing really isn't all that safe? Maybe that sounds a little bit crazy, but by the end of this article you'll understand why.

For most of us, investing in the market feels fairly safe when times are good. You put your money away in some stocks or a good equity mutual fund (a mutual fund that invests mostly in stock markets) and you happily watch your money grow.

But then a market correction (recession) hits and it looks like you've just lost a lot of your hard earned money. Your natural reaction is probably to want to pull your money out and look for some safe investing alternatives that guarantee your returns. While this reaction is understandable, you may want to think twice before you proceed.

Check Out These Three Reasons Why Safe Investing Could Leave You Broke

SAFE INVESTING AND LOW RETURNS

Over longer periods of time, safe investing options usually give you lower returns than you could get in the market. While the markets go up and down every few years, over the long term the trend has always been up. As of the time of writing this (early 2009), over the last 25 years, the markets have earned about 9-10% average returns, and that includes the large correction that happened in 2008.

While a guaranteed 3% return doesn't seem that much lower than 9%, it makes a huge difference over the long term. Take $10,000 and invest it at 3% over 25 years and you'll have $20,937*. Take that same $10,000 and invest it at 9% for 25 years and you'll have $86,230*. That extra 6% return can make a massive difference over the long term, which is especially important if you're trying to save for retirement.

SAFE INVESTING AND DOLLAR COST AVERAGING

Dollar cost averaging is basically making ongoing, regular contributions to your investments. If you were going to invest $2000 a year for the next five years, and you had a choice between investing in fund A or fund B, which one would you pick? The graph below is showing the unit values of both funds.

Did you pick A or B?

If you picked B, your investments would be worth about $13,400* at the end of the period. That's not bad, that's a gain of $3,400 on the $10,000 you put in.

If you picked A, your investments would be worth about $15,650* at the end of the period.

Why did A get you better returns? Because when the value of the fund went down, your $2,000 was able to buy more units in the fund. Then as the fund value started coming back up again, you owned more units that were gaining in value.

SAFE INVESTING AND INFLATION

If you're investments are making you 3% returns, you're not really getting ahead with your savings. The reason for this is inflation. The historical annual inflation rate has been about 3%. An increase in inflation means an increase in the cost of living. If you made 3% on your investments, but the cost of living also went up 3%, it means that you didn't get ahead at all.

CONCLUSION

If you're thinking of pulling your money out of the market when it's down, you're going to miss your chance to gain it back when the economy starts picking up again. Follow the old advice – buy low and sell high. Throughout the last 100 years, the markets have always come back after a low period.

Investing in the markets isn't the best solution in every situation. If you're really uncomfortable with the ups and downs of the markets, then it's probably best to stay away from them. My intent isn't to persuade people to do things that they aren't comfortable with, it's to help people make more informed decisions.

For more information on investing, check out the list of popular articles below, or you can see our full list of investing articles.

*These calculations assume that the returns compound annually.

For a great book about investing and reaching your financial goals, check out The Automatic Millionaire: A Powerful One-Step Plan to Live and Finish Rich. This book lays out a very simple to follow plan for achieving your investing goals.