The Risk-Free Investment
May 1st 2014, by Robert B. Miller
You may know that a jackalope is a creature similar to a jackrabbit with antelope horns or deer antlers and sometimes a pheasant’s tail. (You may not know that a group of jackalopes is known as a flaggerdoot.) “What,” you might ask, “does a jackalope have to do with the topic of investing?” We’ll get to that later.
In the world of investing, it is important to remember that risk can never be separated from reward. Generally, with greater risk comes both the potential for greater reward as well as the possibility of greater loss.
Certificates of deposit are often referred to as no-risk investments. What risk could possibly be associated with FDIC insured bank CDs? The answer: purchasing power risk. Especially in our historically low interest rate environment, because of the erosion of inflation, money stashed in CDs can lose a substantial amount of its ability to purchase goods and services over time.
What about bonds, aren’t they safe? It is true that bonds have had a nice run for a number of years; however, remember that bonds are inversely related to interest rates. As interest rates drop, the value of bonds tends rise, but when interest rates rise, bonds decrease in value.
Equities (stocks) are subject to market risk. We would typically expect greater returns over time from equities than from CDs or bonds, but as we experienced in the years 2000-2002 and again in 2008, equities can be significantly volatile on the down-side as well.
So where can I find a good no-risk investment? That brings us back to the jackalope. That animal doesn’t exist. Since every investment has its own inherent risk and we all must accept the fact that risk and reward cannot be separated, the question I should really ask myself is, “What kind of risk am I willing to take with this portion of my portfolio?”
For money that I know I’ll need in the short term, CDs and money market accounts may be an appropriate parking place. Because of the current interest rate environment, bonds (especially longer duration bonds) seem to be carrying a significant amount of interest rate risk. For longer term money that can weather the inevitable market declines and stay in place long enough to take advantage of market recoveries, equities have had a long history of good performance.
There have been many “sightings” and reports of jackalopes, but no living or fossilized specimen exits. There has been no shortage of enticing banter about risk-free investments. We’re still waiting for someone to produce the first one.