Basic Truths Can Help Avoid Investment Flubs Following Some Simple Rules May Pay Dividends For Investors

From out of the din and confusion of daily events there arises some inalterable truths about one’s personal finances that tend to be overlooked.

That, for example, there is no investment without risk, no matter how hard you seek it and despite the assurances of some investment advisers. You can limit risk, but you cannot eliminate it.

Equally true is that investing isn’t speculation.

The speculator, said Benjamin Graham, the Moses of prudent investing, seeks to profit from market movements, without primary regard to intrinsic values.

In contrast, the prudent investor buys at prices supported by underlying value, and even pares holdings when speculation becomes the market’s dominant force.

True also is the fact that time and compounding are as important as perhaps any other investment factor.

You won’t find this advertised nor probably even mentioned by vendors whose income is made on commissions, because it is not in their interest. But it is in your interest.

A hyperbolic illustration demonstrates the power of time and compounding:

Which would you rather have, $35,000 for 30 days’ work, or 1 cent paid on the first day only, but doubled - or compounded at 100 percent - each day for 30 days?

Choice one would assure you of $35,000, a pretty good wage even for a ballplayer, but the second would give you millions of dollars more. Compounded, investments become stronger with time. Incredibly stronger.

And that brings up another fact of life that often is lost in the swirl of daily events: You can earn a million more quickly with small stocks than with big-name stocks.

That is, the return on small stocks, the kind you don’t hear much about, is bigger than that of big stocks, whose names are referred to daily, and it has been that way for decades.

And, of course, so is the risk. Still, the risk can be reduced through prudence - by avoiding speculative initial public offerings, penny stocks and illiquid private investments, and investing only in quality companies.

To illustrate: Between the beginning of 1940 and the end of 1992 the Standard & Poor’s 500-stock index of blue chips returned an average of 11.8 percent a year. But small-cap stocks earned 15.7 percent in the same period.

That 2.9 percent difference between big and small stocks multiplies over time. For example, $10,000 at 15.7 percent compounded annually becomes $1 million within 35 years. With big-cap stocks it would take 49 years.

It is far better to save and invest - get off to a fast start in the race - than to borrow, indulge and hope that future income will help pay the bills. In short, it is better to have money coming in than money going out.

The lesson is especially pertinent these days, when families are living to the limit of their incomes and, through the use of easy credit, far beyond. Consumer installment credit rises as the savings rate falls.

Those who fall behind in the financial race could find themselves unable to catch up. Millions of people are in that position, paying bills instead of enjoying the return on investments.

The good news is it’s never too late to change, and it may be easier than realized. For many households, it could be accomplished without any real lowering of living standards.