Owning Is Riskier Than Lending But More Rewarding

Approaching your retirement means shifting your investments more towards income-based investments and away from equity-based investments. You've less time to recover from equity losses and need to rely on investment income. Here's why...

At the heart of income-based investments are loans. The most prevalent income form is interest payments for the use of your fixed dollar-denominated loan to some institution. Examples of such investments are savings accounts, CDs, newly issued bonds, and the like. You loan your $1,000 to some savings institution or company and they promise to give you back that fixed dollar amount - $1,000 - in addition to paying you interest for the use of your money.

These are essentially contract arrangements; and being so, tends to suppress risk. Getting your money back to you with interest for its use are both critical concerns to you and the institution or company.

At the heart of equity-based investments is ownership. You buy 'into' some enterprise - as a shareholder. Companies and their shares are dollar-valued investments. By that I mean whatever the company - or your shares- is worth is 'valued' by people bidding to buy it. And that amount of dollar bid for its value changes with time.

Growing value of an equity-based investment - a company - is the chief concern of the company owners. Its value will increase because of better production, better services, or more demand by buyers for its goods and services for a variety of reasons. But lack of demand can also quickly decrease its 'dollar value' giving a loss to owners and shareholders.

Equity-based investments offer the opportunity for large increases in value (your reward) but often at large increases in loss of value (your risk).

So, generally equity-based investments are riskier than income-based investments. Higher rewards come with higher risk. Of course each of these two categories of investments has a sliding scale of riskier and more rewarding examples within them.

Inflation is the bane of fixed dollar-denominated investments (income investments). It's almost an assured risk - or rather loss. That's because the 'value' of a dollar - i.e. its purchasing power - generally decreases with time.

But by the same token, dollar-valued investments (equity investments) tend to automatically adjust for inflation. If a company maintains its same 'real' value, its dollar value will necessarily be greater if a dollar's value decreases.

Income-investments tend to offer less reward but at less risk then equity-investments. To grow wealth - i.e. growing value - you need equity investments. Equity markets have always increased over the long run. But you must be able to sustain yourself through market downturns.

Income-investments tend to preserve wealth when markets turn down. But they do so at the expense of growth. Because of that, retirees should shift to a higher fraction - perhaps 60% at least, of their portfolio to income-investments during retirement.

at 6:19 PM
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