In the investment world, risk and safety, in addition to timeframe and volatility, are a large part of designing a portfolio. But being too safe, especially at a young age, merely shifts investment risk into your later years when you have fewer options, and less time, to be safe.

When investing, there are many types of risks, not just investment risk. And over time, investment risk may be the least of our concerns.

Imagine if you were to consider investing in a security with a guaranteed loss each year no matter the timeframe and ask yourself how much you would be willing to commit to this strategy. The obvious answer is: Absolutely nothing.

And yet, the “investment” just described is one that we are all likely have to some, if not a great, degree. Cash held in lower than inflation yielding accounts for “safety.”

Cash is great for certain things, especially in the short term, to cover monthly living expenses, to provide an emergency fund or for upcoming expenses you do not wish to finance by borrowing. However, too much cash is like running a marathon with ankle weights; It slows down your overall return, forcing you to take on more risk than needed in your other investments to compensate.

Investment risk “over time” favors stocks over bonds and bonds over cash for one simple reason: Inflation is the silent thief that robs you of your purchasing power a little each year. But like the marathon runner above, the added weight of inflation adds up significantly over time.

Compare housing, cars, food, and energy prices today versus 10, 20 or 30 years ago. While technology has dis-inflated certain items (computers and electronics, which are smaller, faster, and cheaper than their predecessors), inflation increases your costs and acts as a regressive tax impacting those with less income more than others. A gallon of gasoline at the pump does not care what tax bracket you are in; the cost is the same for all but impacts everyone differently. The same goes for food and other energy costs.

True, with interest rates rising, savers are finally receiving more income. But if the savings rate lags inflation, the real return is still negative, and the longer your money lags inflation, the more you lose “safely” over time.

The solution? Use cash wisely to meet your monthly living expenses and to provide a cushion against an emergency or an unexpected expense. The amount you need is somewhat dependent on your income sources and stability, as seasonal workers may require larger cash reserves than salaried employees or pensioners.

Once you have established your cash reserve limit, reposition any excess cash to longer-term goals where you have a better chance of offsetting both inflation and taxes. Diversify your portfolio within stocks and bonds and use dollar cost averaging or similar strategies to take the guesswork out of investing.

 

Whatever your investment strategy, be consistent, disciplined, and patient. And when in doubt, seek professional advice from a trusted financial or investment advisor.

For more information, please feel free to reach out:

Paul Pouliot CFP®, ChFC®, CRPC®, CASL®, CLTC®

(603) 296-0030