When discussions of risk arise among investors, most of the talk centers around the risk associated with instruments that are subject to regular volatility, are highly illiquid, or are unusual enough in some way that the chance of investment failure is substantial. There is, however, another kind of risk that is not normally considered, largely because it exists as a function of the fact that the instrument itself is secure. The instrument about which I’m speaking is cash (or cash equivalents), and the risk is that which comes from being “invested” in cash for so long that your long-term investment objectives become unachievable due to the abysmally low return. Think of it as “the risk of no risk.”
A while back, the popular and well-regarded website Bankrate.com ran a piece, written by Claes Bell, wherein some disconcerting information for those who understand the risks of investing too conservatively was cited. In that piece, entitled Upbeat Americans Wary of Stocks as Investment, the results of Bankrate’s own monthly financial survey were cited, and it turns out that cash and cash equivalents topped the list of answers when survey subjects were asked their thoughts on the best place to keep money not needed for at least ten years.
This is a problem, to be sure. For one thing, even if you were willing to tie up your money in a CD with a five-year maturity, the very best rate, at this writing, is slightly above 2 percent per year – this while the rate of inflation remains at roughly 3 percent annually. Even during periods when CD rates exceed inflation, the nature of the economy is such that the interest earned in such vehicles will generally never beat the rate of inflation by such a margin that its erosive effects on your wealth building efforts will be effectively counteracted. While a 3 percent annual inflation rate, to many, sounds relatively harmless, its long-term effects are pretty devastating; at that rate, the cost of goods doubles roughly every 25 years, which, put another way, means that the purchasing power of your money is cut in half during that same period (by the way, if you want a great read on this, refer to The Effect of Inflation on Purchasing Power by Robert Urie, posted at Advisor Perspectives.com).
One of the great challenges that investors typically face is the ability to stay the course in more volatile investment instruments during periods of substantial fluctuation, and while that’s understandable, given the choices we have by which to see our money grow over the course of decades, it is in your best interests to prioritize a diversified portfolio that prominently features appropriate equities. Cash has a place in your portfolio, but not as a long-term “investment.” Outside of using it for your reserve fund, or as a place to only temporarily move while you’re considering your next genuine investment position, it shouldn’t be a place in which you find yourself at all.
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