Life has risks. We weigh comparative risks constantly. Do I have enough gas to skip this crowded station and make it to the next one? Can I make it through the intersection before the light turns red? Is it safe to cross the road? Do I dare drive in Tampa during rush hour?
Similarly, investing involves risk assessment. But here is a thought you may never have had: doing nothing with your money involves risks as well! Putting it under the mattress risks fire and theft.
But putting money in a bank doesn’t involve risk, does it? Yes, it does. In fact, putting money into a savings account involves more than just a risk; it involves a virtual certainty of loss! Money in a bank, a credit union, or money market fund will earn negligible interest income. Typically, you might get, at the very most, 1 to 1 ½ percent. Inflation currently is above 2%, guaranteeing a loss if your money earns only 1% or 1 ½%. If you have $1,000 earning 1% per year, you earn $10.00. But if inflation is 3%, your money lost $30 in value over that same year, making your net loss for the year $20.
Putting your money in a Certificate of Deposit (CD) only reduces the loss a little bit because, except for rare times of deflation, CDs typically earn less than the rate of inflation. At the time of writing this article, the only rate available above 3.0% was for a 5-year CD, which is generally not considered to be a wise investment choice. because interest rates may rise (and they are rising when this article was being written).
So yes, putting your money in a bank has risks. All decisions about money involve risk. The only questions are, (1) “How much risk is there?”, (2) “How much risk should you take?”, and (3) “How much risk is acceptable to me?”
The answer to those questions involves a blend of thought, planning and guidance. The only way to fully answer those questions is to factor in these variables:
- Where are you in life, including your age, health, and employment future?
- Where do you want to be financially and at what age?
- What will be the likely effect of inflation in the time between the answers to #1 and #2?
- Are you willing to settle for less?
- Are you willing to work more or longer or risk more to have more to reach the goals you have set?
Five “simple” sets of variables? No, there is nothing simple about them! The answers you give to the variables determine what is realistically possible and what may be out of reach. By way of a simple illustration, if you are 60 and have no savings, your options are very limited. If you are 25 with a professional degree and a good job, there are many options. In between those two extremes there is a wide range of unclear options, each and every one of which involves some risk.
You need to have savings for several different reasons; you need an emergency fund, you need savings for your retirement, you need savings for education, for travel, and for your senior years when medical care and assisted living may cost astronomical amounts.
The problem is that to make wise choices takes a level of skill and knowledge that may require professional help. Regardless, here are a few ideas.
Stocks are often a necessary investment option
If you are starting early enough, in your 20’s or 30’s perhaps, some of your end goals, such as retirement, are far off. However, the amounts needed are great, so you should start as early as possible. Even then, if all you do is put money in the bank, you will actually lose some of your savings to inflation. As a practical matter, the best and most reliable way to stay ahead of inflation over the long haul of 30 to 40 years is in the stock market. It has been far more volatile since 2000, but historically it has averaged 10%, by one source and slightly less by others (depending on the time frame used and how costs are factored in). Regardless of the source and data applied, the market has averaged well above inflation and far more than average savings account or CD rates over lengthy time-periods.
Understanding how the market can potentially make early retirement possible is necessary to allow a person to determine if it is personally worth the risk. One way to get some estimates is from a website calculator such as calculatemywealth.com. If you input your information, it will calculate how much you could have at your desired retirement age. For example. If you are 30, want to retire at 66, have saved $25,000, and can save $100 per month, the calculator tells you that you have a range of possibilities (based upon assumptions shown on the website), as follows:
$114,523 if you just put your cash in a bank savings account,
or
$365,496 if you put half your cash into a savings account and half in stocks,
or
$1,290,286 if you put all of your cash into stocks
How you save makes a huge difference in whether you can retire, when you can retire, and the quality of life you can have during your golden years.
There are alternatives
Some advisers do say there are alternatives to the stock market – and they are correct. However, those alternatives all have their own risks and uncertainties. See, for example, Top 5 Alternative Investments for 2018, 3 Ideas to Build Wealth Outside the Stock Market, and 7 Alternatives to Investing in the Stock Market.
Alternatives include the following:
- Real Estate. This has had its own dramatic ups and downs such as during the recession in 2008. Real estate is not a liquid investment, meaning you can’t be sure of having cash when you need it. Owning real estate includes buying units to rent. That adds significant work as well as risk of loss due to bad or no tenants.
- Gold and silver bullion and coins. Precious metals have significant market risk. Most commonly, the stock market increases in times of economic growth and stability while precious metals benefit from times of financial distress.
- Owning your own business. Needless to say, this approach typically takes money to start, requires a lot of effort, and has high risk,
- Equity crowdfunding. This is a high-risk new investment scheme with no long-term history of success.
- Peer to peer lending. This is another relatively new high-risk investment scheme with no long-term history.
- Antiques. They are difficult due to valuation and liquidity problems. How people value old items has a huge degree of uncertainty.
Perhaps the stock market doesn’t sound so bad now.
Controlling the risk
There really is no eliminating risk, but there are steps you can take and ways to invest that can help reduce the risk. Things you can do to reduce risk include diversification, index funds, and index Exchange Traded Funds (ETFs). On what to do while you are still young, see 6 Ways to Reduce Market Risk, which will give more information on index funds and ETFs as well as additional ways you can reduce risk.
Read 8 Ways to Lower Your Stock Market Risk in Retirement for ideas on reducing your risk further as you reach or are near retirement. Part of what the author is proposing is that your risk should drop as your get closer to retirement because you have less time to make up for losses. That is typically a wise decision.
You need diversification and perhaps more than just stocks
The idea of diversification is often oversimplified to mean just having different stocks. However, real diversification means holding investments in different companies, sectors, markets and types. The idea of diversification is that if one investment drops, the losses may be offset by gains in a different investment. But to be truly diversified, your investments can’t be all in one company, one sector, once market or be of the same type.
- Sector diversification involves different market sectors such as manufacturing, financial, energy, or technology. The hope is that when one sector, such as energy stocks, have a bad year, those losses may be offset by gains in other sectors.
- Diversification in markets is another strategy of diversification. Losses in international stocks hopefully will be offset by gains in American markets.
- Diversification in investment type means you have some bonds, real estate investment trusts (REITs) along with stocks, perhaps some real estate and other investments.
You need time and patience
The greatest market trick you need is one you can’t control – time. The worst client for a financial adviser is the investor who watches the markets daily and wants rapid adjustments. Studies have shown that this increases the work and cost but not the return, just like guessing at market timing has proven to be an unsuccessful way to beat the market.
The stock market is best with time and patience as you can see in this 90 year chart.
The last 5 years show a steady upward trend.
There will be bad days and more. But time has shown the stock market offers the best opportunity to make long-term gains so long as the investor has a diversified portfolio and does periodic adjustments to keep investments balanced.
Over a period of years, stocks have a tendency to out-perform other means of investment and do it with less effort and time. Yes, those dips on the chart can be terrifying, but the market has no losing periods over any 25-year period. It looks volatile day-to-day or week-to-week, but over longer periods, especially over decades, the market smooths out and gives meaningful growth over inflation. In other words, start early and stay steady!
Conclusion
That is only the beginning and it is a lot. I highly recommend a qualified and capable financial adviser to help you with these decisions. Will there be a cost to you? Of course, but a good adviser will often give gains greater than the costs. If you would like help locating a good Christian financial adviser, please feel free to call us at The Idlewild Foundation, (813) 264-8713.
About the Author
John Campbell has retired from a 40-year legal practice as a trial attorney in Tampa. He has served in multiple volunteer roles at Idlewild Baptist Church in Lutz, Florida, where he met Jesus. He began serving as the Executive Director of the Idlewild Foundation in 2016. He has been married to the love of his life, Mona Puckett Campbell, since 1972.