One of the gifts Santa brought our family this Christmas was the classic board game Monopoly. I hadn't played in 20 years, and as I hopped around the board and built houses on Marvin Gardens and Tennessee Avenue, I was struck by a couple of things:
First, bankrupting your wife and eight-year-old son sure is a lot of fun. And second, there are a lot of parallels between Monopoly and the real world of investing, which helps to explain why the game is still going strong 76 years after it was patented by an unemployed Philadelphia salesman named Charles Darrow.
So grab a token and shake those dice. Today we're going to look at what Monopoly can teach you about investing.
Take some risk
In Monopoly, it's tempting to sit on your cash. Cash gives you a feeling of security and keeps you from going bust. But if you don't invest in some real estate, utilities or railroads, you'll eventually lose. It's the same in the real world. After the financial crisis, frightened investors fell in love with cash and low-yielding bonds and GICs. As a result, they missed out on the powerful market rebound. You should be sensible, of course: Just as you shouldn't blow all of your money in Monopoly, you shouldn't put all of your savings into the stock market.
Get out of debt
It's fine owning high-end properties such as Boardwalk and Park Place, but if you have to mortgage them to stay liquid, they won't do you much good because you won't be allowed to collect rent. It's a lesson more people should take to heart. Many of the financially secure people I know have one trait in common: They abhor debt. They focused on paying off their mortgages early, and they prefer to save up for a new car or trip instead of borrowing the money. In addition to the financial benefits, having no debt gives them a sense of freedom.
Sometimes you get lousy rolls. You land on "Income Tax." You get sent to jail. The stock market is the same way. On any given day it can drop hundreds of points. Worse, bear markets can last months or even years, wearing down the patience of investors. The good news: Over the long run, the stock market rises, rewarding investors who buy and hold. You can't control your rolls in Monopoly, but by creating an investment plan that suits your goals and risk tolerance, you can increase the odds that you'll ride out the stock market's nasty surprises without panicking.
Capitalize on other people's misfortune
Sure, it sounds callous, but it's a tough world out there. In Monopoly, if one of your opponents is experiencing a cash crunch, it's the perfect time to make a low-ball bid for that property you need to complete a colour group. Similarly, one of the best times to buy stocks is when prices are plunging and other investors are getting hit with margin calls or dumping stocks in a panic. That's why it's important, in both Monopoly and life, to keep some cash on hand. You never know when someone will need your, um, help.
If someone quotes you an outrageously high price for a property you covet, it may be best to pass until a more attractive buying opportunity arises (see Lesson #4). The parallel in the investing world is a stock whose price is out of whack with the earnings the company generates, because speculative investors have driven it higher. By focusing instead on stocks with reasonable price-to-earnings multiples and avoiding those trading at lofty valuations, you'll be able to minimize disappointments that happen when expensive growth stocks come crashing back to earth.
Rather than spend all your money building hotels on one colour, it's better to spread your cash across several property groups. According to a detailed analysis on this website, you get the best return on your investment by building exactly three houses - no more, and no less - on each property you own. With investing, staying diversified is also critical: The more you spread your money around, the less likely that any one stock will drag down your portfolio. One big difference: In Monopoly, you can't buy the whole board, but with index funds you can buy the entire stock market.
Focus on dividends
In Monopoly, there is no greater joy than collecting rent when an opponent lands on one of your properties. Similarly with investing, nothing beats receiving a dividend cheque. That's why I'm a big fan of companies that pay dividends, particularly those with a track record of raising them. Whether you're playing with Monopoly money or investing the real thing, building a portfolio that pays you a steady, solid income is the key to success. Just remember not to yell too loudly as you count up your cash.