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(We discuss index funds in Chapter 9.)
The general partners that run venture capital funds make more than the limited partners. Estimates of the general partners' returns range from
17 or 18 percent to as high as 30 percent at the most successful firms.
You can attempt to do what the general partners do in venture capital firms and invest directly in small, private companies. You're quite likely to be investing in much smaller and simpler companies. Earning venture capitalist returns isn't easy to do. If you think you're up to the challenge, we explain the best ways to invest in small business in Chapter 16.
This may seem like an extraordinarily stupid question for us to ask you! Who doesn '/want to earn a high return? However, although investing in stocks, real estate, or small business can produce high long-term returns, you invest in these vehicles with greater risk, especially over the short term.
Some people can't stomach the risk. Others are at a time in their lives when they can't afford to take great risk. If you're near or in retirement, your portfolio and nerves may not be able to wait a decade for your riskier investments to recover after a major stumble. Perhaps you have sufficient assets to accomplish your financial goals and are more concerned with preserving what you do have, rather than risking it to grow more.
If you work for a living, odds are you need and want to make your investments grow at a healthy clip. If your investments grow slowly, you may fall short of your goals of owning a home or retiring or changing careers. The next chapter helps you with the important issue of making investing decisions that fit with your financial goals and situation.
Hour Much 'or Want to Earn?
In This Chapter
► Managingyour debt
^ Establishing financial goals
► Funding RRSPs and other tax-sheltered plans
► Understanding tax issues ^ Diversification strategies
!#ou want to know how to earn healthy returns on your investments У without getting clobbered, right? Who doesn't? Although you generally must accept greater risk to have the potential for earning higher returns (see Chapter 2), in this chapter we tell you about some free lunches in the world ofinvesting.
We know that you're eager to make some great, wealth-building investments. But if we told you to get your financial house in order first, you'd say "Forget it!" and likely close the book. The truth is that understanding and implementing some simple personal financial management concepts will pay off big for you in the decades ahead. You have a right to be skeptical about free lunches — but this chapter points out some easy-to-tap opportunities you likely have overlooked in managing your money.
Establish an Emergency Reserve
Warren owned his home as well as an investment property that he rented in the West. He felt, and appeared to be, financially successful. But then Warren lost his job, a not-uncommon occurrence given the North American corporate downsizing mood, accumulated sizable medical expenses, and had to sell his investment property to come up with cash to tide himself over.
Part I Investing Fundamentals
Like Warren, you never know what life will bring, so it makes good financial sense to have a liquid reserve of cash to meet unexpected expenses. You likely don't have tens of thousands of dollars languishing in a low-interest bank account. If you have a sister who works on Bay Street as an investment banker or a loaded and understanding parent, you can use them as your emergency reserve. (Ask them how they feel about that before you decide to depend on them.)
If you don't have a financial safety net, you may be forced, as Warren was, into selling an investment that you've worked hard for. Selling some investments, such as real estate, costs big money (transaction costs, taxes, and so on). Warren wasn't able to purchase another investment property and missed out on 300 percent-plus appreciation over the subsequent two decades. Between the costs of selling and taxes, getting rid of the investment property cost Warren about 15 percent of its sales price. Ouch!
Should you invest emergency money in stocks?
As interest rates drifted lower during the 1990s, keeping emergency money in money market accounts became less and less rewarding. When interest rates were 8 or 10 percent, fewer people questioned the wisdom of an emergency reserve. However, in the late 1990s, with money market interest rates of 5 percent or less and stock market returns of 10to 25 percent peryear, more investors balked at keeping a low-interest stash of cash
Why not simply keep your emergency reserve in stocks? After all, you can easily sell stocks (especially those of larger companies) any day the financial markets are open. Why not treat yourself to the 10 to 20 percent annual returns that stock market investors regularly enjoyed during the 1990s rather than earning a paltry 5 percent?