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Saturday, August 23, 2014

Understand Investment Risk

Would you say that U.S. Treasury Notes are pretty safe investments?  My guess is you would.  Most people would argue they are a lot less risky than, say, the stock market.

Really?  You think?

Suppose we go back 10 years and look at the guy all invested in 10-year Treasuries.  Investment advisors run into this guy all the time.

It is 7/1/2004, and Riskfree Randy sidles up, swells up to twice his normal size, and proclaims he has  investment assets of $500,000 invested in 10-year Treasury notes paying 4.57%.  The notes pay $22,850 and, with Social Security, he is in great shape, he tells you.  Smugly, he lets you know that he doesn't need the riskiness of stocks--he is set for a nice retirement.

Now it is 7/1/2014.  Randy is 75 years old.  His 10-year Treasury notes are maturing, and newly issued notes yield 2.58%.   $500,000 now produces $12,900.  Ouch!

But that's not all.  Over the 10-year period, consumer prices are up 25%!  Thus, Randy's $12,900 buys $9,675 in real terms.

Say hi to Randy as you leave Walmart!

But, as they say in the infomercials, there's even more.  Over the period, stocks have more than doubled!  Double ouch! 

This, of course, isn't the worse case.  Talk to those who avoided risk by rolling over CDs.

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