By Serenity Melnick, Associate Financial Advisor
Running errands a few weekends ago, I overheard a piece of a conversation that stuck with me. Two young men were talking about investing in their company’s 401(k), and as I walked by one of the guys remarked, “I don’t want to put my money in the stock market, it’s too risky.” This got me thinking about the perception of many adults, especially young adults my age. Many people today have this vague notion that the stock market is “risky” and that perceived risk keeps them from investing. But what about the risks we take by not investing? Now we all know that investing comes with risks; there is the risk that our investments could lose value (market risk), the risk that interest rates will rise causing our bond prices to decline (interest rate risk), the risk of political unrest affecting our foreign investments (economic and political risk) and the risk that the companies we invest in might fail (business risk). Fortunately, through diversification we can minimize most of these risks. I believe the benefits of investing, especially for the long term, outweigh the risks we face through those investments. And while there are many things we can do to reduce investment risk, there is no way to reduce the risk of not investing.
I believe the most sinister, and often overlooked, risk is inflation. Historically, inflation has steadily marched along at about 4% per year. For example, in 1961 a new house cost about $12,500, a postage stamp was .04 cents and one year of tuition at Harvard was $1,250. Inflation is especially cruel because it robs us of our purchasing power. Every year, our money essentially loses value and is able to buy fewer and fewer goods. In 1961, $1.00 at the grocery store would buy you a pound of ground beef, a loaf of bread and a dozen eggs. Today, $1.00 at the grocery store buys you… a single serve yogurt? Maybe? Inflation is the reason that hiding your life savings under your mattress is probably one of the riskiest things you can do. Let’s look at a tale of two women. Mary is a 32 year old nurse who works full time and invests $250 a month into a retirement plan. Mary is invested in a diversified portfolio that returns an average of 7% per year. By the time Mary is 65, she will have accumulated about $386,000.
Sarah is a 32 year old accountant who also works full time and saves $250 a month for retirement. Instead of investing it, Sarah stashes her savings in a safe under her bed. By the age of 65 Sarah will have accumulated $99,000 for retirement. In 33 years, $99,000 will have the purchasing power of approximately $27,000. Every year that Sarah stashes her money under her bed, she essentially loses 4% of it.
I think Warren Buffett said it best in his February shareholder letter when he explains why he and Berkshire Hathaway continue to believe in equities over any other investment. “The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a non-fluctuating asset can be laden with risk.”
When we build investment portfolios for clients, we are trying to protect future purchasing power. Historically, equities have been the best way to protect that purchasing power while also gaining value over the long term. If you invested $100 in the S&P 500 in 1965, you would have $6,072 today. You won’t find that kind of return in gold, bonds, T-bills or especially cash. As long term investors, we must learn to make peace with the risks we face instead of simply letting our fears make decisions for us.
Serenity Melnick is a Registered Representative offering securities through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Legacy Wealth Management, LLC and Cambridge are not affiliated. Cambridge does not offer tax advice.
Copyright 2012 Serenity Melnick. All Rights reserved. Commercial copying, duplication or reproduction is prohibited.
