Waiting for the other shoe?

by Don Kuehn

If you are an active investor, or even if you just take automatic investment deductions from your paycheck, you probably know that it has been more than three years since the stock markets peaked and plunged. But unless you pay close attention, you might not believe that it has been more than a year since the markets shook off their gloom and began a more or less steady climb.

We just don't feel like things have gotten better, even though by October the Dow Jones Industrial average climbed 32 percent from a year before. During the same period, the Nasdaq soared more than 70 percent.

So why do average Americans feel so skittish about investing today? I think many of us are convinced that there is still another shoe to drop. Maybe it's the "jobless recovery" that still has record numbers of Americans out of work, but investor confidence has not rebounded at the same rate as the stock markets, and that rubs off on most of us.

It might be a long time before some people are willing to take a risk with stocks or mutual funds. By the time they become believers again, the chance to join the run-up may have passed.

Of course, there are many people who missed the bear mauling of the new millennium because they never invested in the first place. Others are new to the job market and have never had the opportunity to put their money at risk in the markets.

Three years ago, technology and telecommunications stocks led the raging bull markets. Today, the same groups--although not necessarily the same companies--are again in the lead. Some traders (there's a difference between savers, investors and traders) are borrowing heavily to buy speculative stocks. It's enough to convince average people that another bubble is building as they see prices of equities growing faster than corporate profits.

At the low point of the recent downdraft, the S&P 500 lost about $5.2 trillion of its value (41 percent). Investors have seen waves of scandals in corporate America and in the administration of the markets. A few accountants, analysts and, recently, a couple of mutual fund traders have shown the dark side of the world of investments … and they're going to jail for it.

Persistently low interest rates, thanks to the policies of the Federal Reserve, have left few other alternatives for individuals who want to see their nest eggs grow. That has begun pushing people toward mutual funds again. Since March, there has been a fairly steady inflow of money into funds.

It is amazing to me that this is the sixth year that I have been writing this column. From the response I receive after almost every issue, it is clear that there are many readers who just don't get it when it comes to money and investing. It's understandable. Unless we are motivated to learn how other people are able to get rich (many making about the same income we are) the pieces just don't seem to fall into place.

Let's start with the basics: As Harry Domash wrote recently on MSN Money, "getting rich is simple." Not easy, mind you, just simple. Falling off a log is easy … 1, 2, 3 is easy … pie: easy. Getting rich is just, well, simple. All it takes is a willingness to live below your means, the discipline to invest regularly, and the time to let your investments compound and grow.

The first part sounds pretty simple. Most of us have had a great deal of practice living below our means--perhaps more than we'd like. But think about it: If you never see your money, you can't spend it. If you invest your salary increases from year to year, you'll never miss them. Finding even a small amount of money to dedicate to building an investment portfolio is the most important thing you can do for yourself and your family.

It isn't hard to find a little surplus for most of us. It could be the designer coffees on the way to work, or limiting restaurant meals, quitting smoking or buying house brand rather than premium. If you can scrape together $20 a week, that's more than a thousand dollars a year.

The discipline thing isn't so hard, either. Automatic investment plans such as 403(b) and 457 plans are a great way to start, as are IRAs and Roth IRAs for those who are eligible. The important thing is to invest like clockwork, every month, without regard to what the markets are doing.

It's called "dollar-cost averaging" and it means that whether stocks go up or down, you buy a set amount. If the markets happen to be up, you'll buy fewer shares. When the prices of stocks head down, you'll get more shares for your money.

Many mutual funds are willing to help you invest this way. Some will even lower their minimum investment requirements if you agree to an automatic transaction from your checking account each month. What could be simpler?

The third requirement is time. Time is the friend of every investor because while there may be a lot of things we don't know about the stock markets, one thing we do know is that the prices of stocks move in both directions: up and down. Over time, however, we know that markets go up. Maybe not today, not necessarily this week, but it is almost assured that five, 10, 20 years from now we'll look back on a 9800 Dow or a 1900 Nasdaq with dewy-eyed nostalgia.

The key is compounding: earning interest on the money you invested plus the interest you've already earned. It's simple. If you had $1,000 and earned 8 percent per year, you would have $1,080 after the first year. Reinvest that at the same rate and in two years you'd have $1,166.40. Let it ride and in three years it's $1,259.71. You can double your money in just nine years. How do I know that? Simple, I used the Rule of 72 (divide 72 by the rate of interest and you get the time it takes to score a double). It also means that the dollar you invest today will be worth more than the one you invest next year.

Keep adding to you stash every month and over a decade or two you'll get rich. Invest more aggressively (not foolishly) and you can reach your financial goals, prepare for an active retirement and send those kids off to college.

Today, there are really no risk-free ways to grow your money. Interest rates have been kept low by the Federal Reserve to fight inflation. While that's good for prices and the economy in general, it stinks if you are on a fixed income or depend on a conservative strategy.

Inflation can undo an investment plan that relies on fixed income CDs or bonds or savings accounts. Even though the Fed's low-rate approach has kept inflation at bay (about 2 percent) for the past few years, during the early 1980s it reached a staggering 14 percent (remember Gerald Ford and his WIN buttons?).

If you are only earning 3 percent or 4 percent on your money, inflation (even at today's low levels) is eating away half or more of what you think you are earning. The answer is to get part of your investments into stocks. Do it through mutual funds--or buy individual issues, if you prefer--but historically, stocks have outperformed every other investment option by a staggering amount.

Unfortunately, too many of us got burned pretty badly during the past few years and we just know that other shoe is going to drop pretty soon: "Sure the markets are up now, but what if I get back in just when the bottom falls out again?"

There are no guarantees here. And there are no shortcuts, either. Barring a large inheritance, a lottery windfall, a slot machine jackpot or some other (legal) accident, you get rich just like everyone else before you has done it … one dollar at a time. It takes patience, time and a steady commitment to the task, but, really, it's pretty simple. And it is your money.