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My Two Cents

Worry Free Investing

Chris Farrell Aug 30, 2007

Are the wild gyrations in the market troubling you? Then I’d suggest picking up a copy of “Worry-Free Investing” by finance professor Zvi Bodie of Boston University (with Michael J. Clowes). It was published several years ago, but the advice remains timely. Instead of asking, “How much money will I make?” Bodie argues the fundamental financial question is “How much can I afford to lose?”

Bodie believes that most of want to sustain our standard of living throughout our lives. The way to accomplish that is to limit downside risk, and to save a substantial portion of your income every year. Stocks, he says, are too risky for most people. Instead, savers should try to lock in a long-term standard of living while taking as little risk as possible. His preferred investment in retirement savings accounts is U.S. government inflation protected securities (Tips), and Series I savings bonds for taxable accounts. Both are risk free investments that designed to protect the saver form the ravages of inflation.

I’m more convinced that equities play a major role in the average portfolio than Bodie. But I like his book partly because he makes you think through what you’re doing and partly because his philosophy is in such stark contrast to so much financial advice peddled on TV, on Wall Street, and other media. If you’ve watched any of the business television shows you know they’re incessantly hyperventilating over the latest rumors, market gossip, and fast-buck trading schemes. They’re obsessed with finding the next winning stock. It’s as if everyone is supposed to be a Wall Street trader or hedge fund gunslinger wannabee.

Well, most of us aren’t.

Indeed, there is a great divide in the world of investing: The entrepreneur and the insurance buyer. And knowing which you are can save you from a lot of money mistakes. Entrepreneurs, whether they call Wall Street, Main Street, or dot.com home, are out to make big bucks. And they’re willing to risk losing a bundle, perhaps everything, in their pursuit of a large payoff. Entrepreneurs are obsessed with their market, and they’re constantly seeking an information edge on the competition. Many of these risk-takers use leverage lots of borrowed money–to magnify their potential gains and losses.

Insurance buyers periodically set aside money into the market through a tax-deferred savings plan, such as a 401(k) or 403(b). Maybe they put some additional savings into an equity mutual fund and a 529 college savings plan. In essence, their taking out an insurance policy against the risk of a lower living standard in retirement or to limit how much their children will have to borrow to attend college. The goal is to constrain the downside rather than to reach for untold riches. And Bodie has savvy advice for the insurance buyer.

Of course, which would you rather be called, an entrepreneur or an insurance buyer? Yet “insurance buyers” investing in Tips, Series I savings bonds and, yes, a low-fee equity index mutual fund will do well financially over the long haul, and still have the time to do many other things that matter, from work to family.

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