Many investors are looking for opportunities that are “risk free.” One of the paradoxes of investing is that many of us want something that is 100% safe — and that offers great returns. Unfortunately, this is not a practical wish. If you want investment risk, you have to be prepared to put up with smaller returns.
However, even so, it’s important to realize that it is unlikely that any investment choice you make will be 100% safe. Just about every investment comes with a degree of risk. Indeed, many people have considered money market mutual funds to be just about as safe as can be. However, even these funds, based cash and like-cash assets, are at the risk of loss — something Ben Bernanke made very clear recently.
All Investment Comes with Risk
In truth, all investment comes with risk. In many cases, it’s a matter of degree. Money market mutual funds are usually less risky than stocks, or some other investments. However, when you invest, it’s important to realize that money market mutual funds can lose money. Indeed, if there is a run on a fund, or if interest rates remain low, you could lose out on your investment. And remember that money market mutual funds are not FDIC-insured.
Even fixed investments like annuities come with risk. What happens if the company goes under? What if you chose an annuity that doesn’t fit with your long-term financial goals? Bonds, safe as many people think they are, come with the risk of default. Even the “safest” investments come with a degree of risk. You need to be prepared for that fact.
What about Cash Products? What’s the Risk There?
In order to be 100% safe, many people choose cash products. If you are putting your money in products that are insured by the FDIC, this can greatly reduce risk of loss. However, there are still risks, even with cash. For one thing, FDIC insurance doesn’t cover theft, or other types of losses. You want to make sure the financial institution has separate insurance to make up for theft and other losses that aren’t considered bank failure.
Another concern is whether or not you are beating inflation. The interest you earn on cash products is usually quite small. Indeed, you might not even be earning enough to beat inflation. The problem with this scenario is that inflation can erode your real earnings over time. Inflation reduces your spending power, so your dollars buy less over time. One of the biggest risks associated with cash is that you lose money in real terms. If your cash is earning 2% annually, but inflation is 3% annually, in real terms — in terms of purchasing power and the value of your dollars — you are losing. That’s a risk that many people don’t consider.
There is no way to completely avoid risk when you put your money into any investment or cash product. Your best option is to diversify to some degree, and to take calculated risks with the help of good research and a solid investing plan.