Monday, July 26, 2010

What Does “Safe” Really Mean Anyway…


Pathways Advisory Group, Inc.
Michelle Carter, CFP®
 











About a month ago, I was asked to give a presentation for the ladies at church. They wanted a basic overview of financial planning in about 20 minutes. Not an easy task, one could say even impossible. But we did have a lively discussion touching on many topics.

At one point in the discussion, I used the word “safe” when describing an investment. Without thinking, I immediately lifted my hands to make the infamous finger quotes as I said that word. After the presentation, I asked myself, “Why the finger quotes?” Either an investment is safe or it’s not, right? Is there such a thing as a safe investment?

There are many ways to think about this, but I would like to concentrate on just two: market risk and inflation.

For a long time, the general investing public considered bonds as a fairly safe investment. Sure there were some risks (such as rising interest rates during the life of your bond), but, for the most part, people believed they would collect their interest regularly and receive their principal back at some point. The bear market of 2007 – 2009 changed their minds quickly, as investors learned it is possible to lose principal in the bond market.

Nowadays, it seems savings accounts and CDs are the go-to safe investments. At 1% - 2%, they don’t offer much in return, but at least you know the money will be there when you need it.

Market risk may be the first thing on an investor’s mind when looking for a safe place to invest. However, I would also like to consider inflation.

If you invested $100 at 2%, you would have $110 in five years, and about $150 in twenty years. This is fine for a cash reserve or if you are saving for a short-term goal.

But what happens in retirement?

The average inflation rate over the past 20 years or so is about 4.5%. A service or product that costs $100 today could cost $125 in five years, and a whopping $250 in twenty years. Suddenly, your safe investment simply can’t keep up.

Seems the investment wasn’t that “safe” after all.

So, instead of defining what is safe versus what is not, let’s look at what is safer.

It is safer to keep your cash reserve in a bank account or CD, rather than subjecting it to short-term market fluctuations.

It is safer to keep your retirement money working for you inside a diversified investment portfolio with an allocation that matches your goals and risk tolerance.

And it is safer to stick with your investment plan over the long haul, realizing the market rewards patient investors.

On that note, I think it is now “safe” to end this blog posting. :)

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