“Risk is good – not properly managing your risk is a dangerous leap”—Evel Knievel
For those of you that don’t remember or are that were born after 1980, Evel Knievel was a daredevil who jumped motorcycles ramp to ramp over things like buses, Mac trucks, rattlesnakes and failed at an attempt to jump the Snake River Canyon in Idaho. He was, at the time, an international celebrity appearing on shows like ABC’s Wide World of Sports and an icon of adolescent boys such as my brother and me who built ramps and jumped our bicycles over things like Tonka trucks and GI Joes.
Of course, each success would encourage a little more ambitious jump until inevitable failure. This was the two trashcan jump of 1973 which ended with me crashing badly and my brother visiting the emergency room with a broken collarbone. Being bulletproof at that age, my brother and I failed to understand the risk involved in making the jumps.
Savers and investors have the same problem of understanding the risks involved in their investment and saving strategies. BlackRock, the giant asset manager recently released its global investor pulse survey which polled 17,500 investors including 4,000 Americans. U.S. investors are holding 48% of their investable assets in cash as they are still risk averse despite the huge rally in the stock market over the last few years, and widespread concerns about saving enough for retirement.
While cash has a place in every portfolio, do investors understand the risks involved in holding too much of their assets in cash? One risk is opportunity cost—cash holding can’t participate in gains in the stock market. Another risk is purchasing power risk. That is the effect of inflation on the return of an asset. Since cash currently has extremely low yields (Fidelity Cash Reserves as of 10/31/13 was yielding an annualized 0.01%–that is not 1%, but 1/10 of 1.10 of 1%) an investor is not being compensated for the risk of increased inflation.
The Federal Reserve currently has an inflation target of between 2-2.5%, the average inflation rate for the last 100 years in the U.S. has been 3.22%.
Woody Allen said, “A stock broker is someone who invests your money until it’s all gone.” Inflation can have similar effects on your portfolio
If the Fed’s monetary policy is successful and inflation hits its target rate or returns to historical averages, the cost to savers of holding too much cash could be significant. If I put the right formula into my spreadsheet $100,000 today would be worth about $77,600 in buying power in 10 years assuming a 2.5% inflation rate and no return on the money. These numbers are generalizations and a lot of variables can come into play, but serve to illustrate the point.
What are investors to do in this low rate environment? Consult with your advisor and develop a long term plan to help make sure that you asset allocation and risk assumptions are consistent with you financial goals and consider all the risks associated with a saving/investment plan.
James Mathis, managing partner of Echelon Investment Management, believes in enriching his clients’ lives by identifying, preserving and achieving their goals. Echelon partners with clients through every leg of their race ~ asset management, investment advice and retirement planning. Contact him at firstname.lastname@example.org.