The Greatest Risk is Not Taking OneSubmitted by Concierge Financial Planning, LLC on May 27th, 2014
Risk is a funny thing. Everyone perceives it differently. For example, I would never go bungee jumping, but I know a bungee jumper who is scared of the stock market and keeps all his money in cash.
As a fee-only financial advisor I know that the perception, understanding, and realization of risk is of the utmost importance when investing, whether for retirement or fun. It is vital to be become aware of the risks that aren’t obvious as well as to not over exaggerate the ones that are.
Many investors, both young and old, have been psychologically damaged by the market activity of 2008-2009. They are terrified of the stock market and, like my financially over-cautious bungee jumper, keep their money in cash or in a coffee can in their closet. This behavior is an example of over exaggerating a risk out of fear. The flip side of the coin is not realizing the tremendous risk they absorb by stashing cash under the mattress. Do you see the snake in the grass?
If you thought, inflation, you are correct. Never underestimate the power of inflation to do damage. It is often under-valued as a risk because it seems like a small number and we do not directly open our wallets to pay for it, but it is eroding your purchasing power as we speak. Let’s take 1965, the year I was born, as an example. If you bought goods and services worth $1,400 back then, what do you think you would have to pay for those same things today? If you said $10,000, you are correct! Yes indeed, it would cost you about seven times more today. Talk about erosion of purchasing power—in this case 86% of it disappeared—even though the average annual inflation rate for 1965-2013 was 4.24%.
Did you hear the recent story of the college students who bought an old, lumpy sofa and found $40,000 in cash hidden in the cushions? The cash was stashed in the sofa by a 91-year-old woman. $40,000 sounds like a lot of money, but consider this; In 1984 when Granny stuffed the sofa, she was able to purchase $88,000 worth of goods and services in 2014 dollars. Today that same money is only worth $40,000—less than half of what she started with! Granny lost $48,000 by leaving her money in the sofa. The average inflation rate from 1984 to 2014 was only 2.86%, very close to the inflation rate right now. Can you afford to lose 48%? This is an actual loss, not a theoretical one.
Between October 9th, 2007 and March 9th, 2009 the S&P 500 lost 56%. As a result many would-be investors now forgo the stock market and opt instead to stash cash in their sofas (or bank accounts), not realizing that they may risk losing 48%. In fact, the sofa risk is actually far greater because inflation is very rarely negative, meaning your 48% is permanently gone. On the other hand, the S&P came roaring back and was up over 60% by the end of 2009, wiping out the temporary loss and putting investors back in the black. The permanent, deep inflation loss is far more significant and damaging than the shallow stock market loss, yet people stubbornly view cash as safe, which it is definitely not.
Run, do not walk, to your “mattress” and invest your cash to, at a minimum, keep up with inflation. You are losing money as we speak! Don’t get me wrong; we all need an appropriate emergency fund. However, cash in excess of your emergency fund is losing you money.
My bungee jumper who thought he was keeping his money safe by leaving it in cash was actually losing purchasing power at an alarming rate,.Alas, he did not see the risk. By investing his nest egg in a well allocated and diversified portfolio which included equities, this young man actually reduced his real risk while boosting his actual return. I think I’ve cured him of his irrational market fears; he’ll have a much harder time convincing me to jump off a bridge tied to a large rubber band, however!