Editor's note:This is the first of a two-part series on off-farm investing.

If , beginning at age 30, you set aside $3.34 a day knowing you'd end up with more than a half a million dollars at age 65, would you do it? For most dairy producers, young and old, this sounds like an incredible deal. How can it be done? Lottery? Gambling? No, just off-farm investing.

Starting at age 30, if you invest a mere $100 per month at an 8 percent rate of return, by the time you reach 65 you'll have $214,256 of assets outside of your dairy farm business. However, if you achieve a 13 percent rate of return, your investment becomes $694,242. Not a bad nest egg for a total out-of-pocket expense of $42,000.

That money is earmarked for your retirement. And, more importantly, you generated it without having to rely on the sale of your dairy farm. That means you have more maneuvering room as you enter retirement.

Without the money from off-farm investments, some producers find themselves in a situation where they're ready to retire, but can't find a buyer for the dairy or land prices have declined so the sale price will be less than what they paid. Or, the payment they need to receive each year, is more than the children can really afford at the beginning of the transition.

David Chlus, dairy producer and financial consultant with Smith Barney in Utica, N.Y., says you should not pour all of your money back into the dairy farm business. Instead of relying on the farm to finance your retirement, you should invest at least a portion of your income off-farm.

Invest in your future
If you think you need to invest all of your money back into the dairy farm business, you need to change your strategy. If you put all of your earnings back into the business because you need to just to keep the business going, perhaps you need to get out of the business. Always look at the rate of return each investment earns. If your return is negative, or barely positive, you need to ask yourself why you're working so hard to earn so little. Remember a passbook savings account will earn about 3 percent. Or, if you deposit a large amount and make a committment to keep it there for several months, you can probably get a bit more.

Keeping your dairy in tip-top shape doesn't guarantee a buyer come retirement time, either. The market for selling dairies – and farmland – has changed. For example, in 1997 the number of Grade A and Grade B permits to sell milk in the U.S. declined by 6,632, or 6 percent. That's 6,000 dairies that no longer exist for one reason or another. That means buyers for your dairy could be hard to find.

However, that doesn't mean you should never invest in your dairy farm business. When you do something well – dairying, for instance – you can gain value by expanding. But before you do, you need to weigh the rate of return and the level of risk for that investment, says Dave Lins, of the Center for Farm and Rural Business Finance at the University of Illinois.

Say, for example, $100 currently invested in your dairy earns a rate of return of 6 percent. But you know that if you expand, the next $100 invested will earn 18 percent. That means you'll receive an overall rate of return of 12 percent.

However, if the combined rate of return after the added investment for the expansion would have been the same 6 percent, then you must view that investment differently. Sure, it generates a positive return, but you probably could have earned more investing elsewhere.

Invest outside of agriculture
Diversification limits risk. However, diversifying what you produce – raising corn, soybeans, alfalfa and milking cows – doesn't count toward diversifying your investment. Long term, the revenue streams from all of these ventures move together, explains Mike Boehlje, professor of agribusiness at Purdue University. So, when the value of one agriculturalcrop goes down, all of agriculture tends to trend down. Short term, you may have high corn prices and low milk prices. But long term, the level of return for most commodities tends to move together because they are driven by the same forces.

Investments outside of agriculture, such as technology stocks for example, will generally move independently of the ag market. This is called a negative correlation. Using such a strategy means that you should always have some investments that do well, some that do average and some that may be in a downward cycle. But when you add them together, you should come up with a good rate of return for your portfolio.

Diversify your investments
Using a mix of investments takes advantage of the benefits of negative correlation, lowers your overall risk and provides an acceptable return. It's a strategy that all investors should use – not just dairy producers.

Some investors routinely invest in agriculture for just that reason. For example, one group, the Chicago Farm Club, schedules presentations from producers on their ability to manage their dairy or farm and what type of return they can expect. They don't look for the highest rate of return for all investments, but look for investments which help reduce their overall risk while generating an acceptable return. Investing in agriculture allows them to diversify their portfolios, lower their risk and achieve a good level of return.

Research has shown that the optimum portfolio has never been 100 percent farmland. Instead, investors should opt for a mix of farmland, stocks, bonds, treasury bills (T-bills) and other investment opportunities. (See the chart, "Investment portfolio options," on page 44.)

Granted, farmland as an investment carries a relatively low risk, but the level of return falls short of what outside investments can generate. For example, according to Chlus, several industry sources list 5 percent as the average income rate of return for farms. (To get at the total return, you must include capital gains and losses.) That rate of return about equals the average rate of return for long-term government bonds and barely beats the long-term performance of T-bills and the inflation rate at 3.7 percent and 3.1 percent, respectively.

Your age, when you want to retire and how much money you have saved all are keys in your investment strategy.

Before you make any investment – in your dairy or off-farm – measure the predicted rate of return. Sure, sometimes investing in your dairy can earn an attractive return, but if you never compare that return with what your money can earn elsewhere, you'll never know how much income you may be losing or how much money you could have had at retirement.

Investment portfolio options
Selected asset categories 1970 – 1996
Although investing in farmland is not considered an optimal investment strategy on its own, when looking for ways to limit investment risk, it quickly becomes a popular addition to diversify a portfolio. Each line of the chart below shows the mix of a sample investment portfolio and its historic rate of return and level of risk.
Standard deviation(3): 15.57%
Percent invested by category:
S&P 500 100%
Standard deviation(3): 14.65%
Percent invested by category:
Farmland 5.30%, S&P 500 94.70%
Standard deviation(3): 6.72%
Percent invested by category:
Farmland 53.06%, S&P 500 36.82%, Long-term corp.bonds 10.12%
Standard deviation(3): 2.04%
Percent invested by category:
Farmland 17.68%, S&P 500 0.63%, Long-term gvmt. bonds 2.55%, Long-term corp.bonds 7.74%, T-bills 71.41%

(1) Portfolio with highest rate of return.
(2) Portfolio with least amount of risk.
(3) Standard deviation is the percent change you could expect to see in the rate of return from year to year.
Source: Dave Lins, Center for Farm and Rural Business Finance, University of Illinois.

Investment growth potential with an 8 percent rate of return
• AGE: 20
Monthly contribution: $50
Value at age 65: $298,793
Monthly contribution: $100
Value at age 65: $480,576
• AGE 30
Monthly contribution: $50
Value at age 65: $130,311
Monthly contribution: $100
Value at age 65: $214,256
• AGE 40
Monthly contribution: $50
Value at age 65: $54,406
Monthly contribution: $100
Value at age 65: %90,899
• AGE 50
Monthly contribution: $50
Value at age 65: $20,209
Monthly contribution: $100
Value at age 65: $33,760
Source: David Chlus, Smith Barney, Inc.

Factor in inflation
Don't forget to include the cost of inflation when computing your retirement needs.The change in a cost of bread shown below illustrates inflation's effect.
1992: $105 1997: $1.32