Rate of Return on Investment versus Rate of Interest on Debt

A common goal of those who manage large sums of money is to consistently beat the rate of inflation, year after year after year. Consider the miracle of compounded returns. Invest $100 in a stock that grows at an average of ten percent a year. It doubles in value in roughly seven years. Invest in that hypothetical stock when you are twenty-five and when you are sixty years old it will have doubled five times. (2x2x2x2x2=32) The stock purchased for $100 will be worth $3,200. If an investor buys more of the stock each year, reinvests dividends in dividend stocks, and avoids risky investments, he or she can something in the range of $32,000 saved for an early retirement at age 60 with only a $100 a year investment. Invest $1000 a year in our hypothetical stock and you get around $320,000. It is good investment advice to let the value of compounded returns work for you.

Now consider the drag on your investment portfolio of interest payments on debt, especially credit cards. Paying 18% on what you have borrowed? Unless you pay off credit card and other high interest debt first, your rate of return on a great long term investment will be a trifle compared to what you pay out to the credit card company, bank, or other money lender. It is sound investment advice to pay off credit card debt and put six months worth of living expenses in the bank before looking at any other investment.

Your Home

Over the years inflation tends to raise the value of property. It is sound investment advice to own your own home instead of paying rent so that someone else can benefit from the appreciation of the housing market. This is a case in which paying interest on debt is not so bad because mortgage interest is still tax deductible. Sound investment advice in this case is not to bite off more than you can chew. People who fell for the argument that low interest rates would stay low forever lost their homes when the economy collapsed a few years back. Buy what you can afford and trade up as your income grows. These may not have been the hot investing tips that you thought you would see in an article about sound investment advice but they will serve you well over a lifetime of investing.

More Resources

We all look for short cuts to make our lives easier. When we have a successful routine worked out we repeat it to save time and money. Sometimes when investing we look for efficient shortcuts to sound investment advice and find ourselves falling prey to clichés.

Although Xerox fell prey to the “you can manage anything” cliché years ago so did its investors. After Xerox started the business of making copiers sound investment advice was to buy Xerox just like sound investment advice was to buy IBM until the personal computer changed the world and IBM found itself a step behind.

By the late 70’s Xerox had tons of cash and chose to reinvest instead of paying taxes on profits and then paying dividends with the taxed income. So, they looked around for a business they could buy and manage, namely insurance. While Xerox was dealing in clichés and losing money on its insurance business it neglected to make its copier business more efficient and Asian competitors ended up sending copiers to America and selling them for the same amount of money that the inventor of copiers spend getting their copiers out of the door of the factory.

Clichés were nearly fatal for Xerox. Then Xerox changed management, wrote off the failed insurance business over several years and improved the quality of its copiers while reducing cost. By the mid 1980’s it was sound investment advice to buy again. However, an attempted buyout emerged.

In the midst of the buyout the folks running the attempted takeover ran out of money and had to sell stock to cover options. Xerox’s price dropped from the 60’s to less than 30 in an hour. At that point anyone following sound investment advice bought Xerox and lots of it. At that point, all clichés aside, Xerox was doing well, making money, and, as it was writing off its insurance company losses, not showing a profit.

Those who knew what was happening with Xerox and followed sound investment advice found that their just recently purchased $30 shares of Xerox were worth $70 the next day.

These sorts of situations are always present. A current situation is the set of clichés all stating that the old line media companies will all go under based upon competition from the internet and bloggers. That is not sound investment advice. It reminds one of the clichéd that books would disappear when computers became popular and that all reading would be online. Someone needs to go out and get the news, organize it, report it, and be a standard reliable source for accurate reporting. Sound investment advice is to look past the clichés and find which media companies are undervalued, have cash, have good products, and will survive. Then invest on a downturn and replicate what those following sound investment advice did years ago with Xerox.