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The problem with safe investments

My dad used to keep large amounts in his checking account (no interest) and a passbook savings account (4%, if I remember). Whenever I wanted to talk about investments, he’d tell me to “go blow”, and how happy he was that his money was safe and he wasn’t losing anything.

Then he got into the hands of a charming broker, who (he pointed out) called him more often than I did. The broker recommended tons of what Dad thought were “safe” investments—can’t miss stocks and bonds, which Dad was sure were safe. Unfortunately, the stocks missed, the bonds were junk, and when I wrested control of it all in 2007, I calculated the charmer had lost him about $300,000 in junk investments and commissions from churning the account.

Dad was completely wrong in both instances.

The second is easily addressed—don’t invest in anything where you don’t understand the rationale. If someone is recommending something, understand why you should invest. And if someone is your investment advisor, at least understand what their recommendations are based on, and whether they have a plan for your entire portfolio, not just a bunch of “hot” investments. Invest in individual stocks if you want, but be okay with losing Every. Last. Cent. (I’ve had a few of those.)

If only I had a buck for everyone who told me how nice their broker was! Do you think they’d ever sell anything if they had horns and a forked tail?

But let’s look at Dad’s first principle—cash is safe. Is it?

Mom and Dad were flying high in the early 80s, when they were buying and rolling over CDs that were paying somewhere around 15%. They were living off the interest and living well—nobody had ever explained to them “safe withdrawal rates” and they spent all the interest, because after all, their principle was safe. It was only when rates began to crater that they fell into the clutches and promises of Todd, looking to replace that great, but now unobtainable return. So here was the first problem (ok boring name): reinvestment risk. We’re seeing the same thing today with CDs, which have hovered over 5% for some months now—it seems like a fortune compared to what they’ve been paying for years. But most of these high flyers are only for 6 months or 1 year. Bankers aren’t that stupid, and they don’t want to be locked into paying higher rates if and when interest rates drop. The longer the current CD term, the lower the rate.

Mom and Dad couldn’t find anything that paid 15% by the 90s. Since they’d spent all the interest, and inflation had definitely gone up in the meantime, their principal couldn’t pay for as much as it once might have.

This is why cash isn’t as safe as they (and maybe you?) believe. It’s called lost opportunity cost.

I’m going to work through some figures here to see what those CDs actually cost them. Bear with me. Let’s work with $10,000, available and invested on March 31, 1980 and kept invested until 1990 reinvesting the original $10,000 and putting whatever they made in their mattress. That’s not what they did, but let’s compare. Based on what I was able to find, they would have made 98.94% on their money, or $9,984=$19,984. This is figuring only simple interest for each year, and does not reflect the value of compounding—i.e. leaving the money invested, or reinvesting the total principle + earnings each year.

However, let’s say they’d picked a relatively benign fund, like the Vanguard Wellington, which was around back then. In simple interest terms, they would have earned 164.54% on their money, or had $26,454 in simple return ($36,454 total). No compounding—and this return would be a combination of yield and share price improvement. NB if we were to include compound returns (which I wasn’t able to calculate for the CD), the Wellington would have had a total return of 372.21%, or their $10,000 would have grown to $47,220.57 (Source: Morningstar & Forbes).  Their opting for “safety” actually cost them at least $16,470. That is LOST OPPORTUNITY. *

It’s true that Wellington actually lost money in two of those years (1981-82, -1.32% and 1987-88, down 0.94%), but in every other year it exceeded returns of CDs, sometimes by 20 points or more.  Granted, these were go-go years, but that was true for both investments.

The take away? If you absolutely must have your money, with no loss whatsoever, in a very short period, you probably need to suffer with cash. Having cash can tide you through some bad market years if you must meet expenses during those years from a portfolio. But if you can afford to park your money for a longer period (say, 5 years or more), you are paying an awful lot for supposed safety—the lost opportunity of far better investment returns.

*Please forgive me that these figures are somewhat imprecise depending on what date I picked and the difference between simple and compounded. But I’m certain the general principle holds.

Image of a money ladder

Dollar cost averaging: what is it and should you do it?

Dollar cost averaging is contributing money to an investment over time, rather than plunking in a big chunk at one time. You might designate a specific amount to be invested each month (or week, or quarter). Conversely, you might put in your whole amount at the beginning or end of year, or whenever you get that bonus or pension payout or inheritance. Which is better?

I was recently reading an investment article by a well-known academic. He used his model 12 asset portfolio and explored the option of investing $100 every month in that portfolio, for 25 years. The ending account value was $68,580 (your investment was $30,000 total). That didn’t look so hot to me, so I used an online investing calculator which gave an annualized return of 6.062%. He’s weighting each of the assets equally and rebalancing once a month (!!!)   That gives him approximately a 65/35% balance in favor of equities. He is using 12 indexes, which as we all know are not directly investable—mutual funds will likely have a slightly lower performance because of management fees. And, without at least knowing the Standard Deviation, it’s hard to see how much risk an investor would be taking. ~6% is pretty standard a performance.

But there is one advantage of investing monthly—potentially it allows you to buy at a lower average cost per share. If you buy on any given day, you have only one chance in 252 market trading days of hitting either the highest or lowest day. If you invest monthly, you have 12 chances, but it’s still unlikely that you’ll hit the lowest or highest trading day, unless you are very, very unlucky—you’ve diversified your risk. Still, since the market is up more than it’s down, your share cost will increase over time (which is what you’re hoping for, in a way, if you want to make any money). Also, if you’re investing a specific amount of money, you’ll buy more shares when the investment is cheaper, and less when it’s expensive. Finally, setting up monthly investments has the advantage that you might actually DO it. Dithering usually results in skipping at times—and there is never a good time.

But what about if you get a lump sum? By reserving some portion, you’re losing all the dividends and capital gains payments made, if reinvested. Let’s say that instead of investing $100/month over 25 years, you had invested that $30,000 all at once in his asset portfolio, held it for 25 years, and earned 6.062% annually. If I’m pressing the buttons on my calculator correctly, you’d have $130,652.15, over 45% more—so dollar cost averaging a lump sum over time could cost you a lot. But managing $100 a month contribution into 12 assets over 25 years is a pretty daunting prospect—if you can even find funds that would allow you to contribute $8.33 a month to each fund. So, let’s look at something easier. What if you had put that $30,000 “inheritance” into just one balanced fund, say Vanguard Wellington (no investment recommendation intended).  $30,000 invested on December 31, 1997 would have grown to $184,743.75 by December 31st, 2022, according to Morningstar. (I’m using the article’s measurement dates—Dec. 31, 2022 wasn’t a trading day.) I wish I could show you dollar cost averaging into VWELX, but it’s beyond my powers to calculate and the data obtainable—they only show 15 years, where the annualized return is 7.45%.

Those who are more skilled at statistics than I am may find these figures arguable (isn’t almost everything, depending on how you set it up?), so I refer you to this article. Investing regularly has the advantage that you might actually do it. But, while investing a large lump sum may require a big gulp and a leap of faith in the future (and some scary days of bad markets), you’re probably going to be better off than holding back anything in cash.


Very surprised dog

Get off the ledge: financial planning in a crisis

It just won’t do any good—no matter what action you can think of, it’s already too late. You couldn’t see it coming, nor could you act fast enough to stop anything. As Dorothy Parker said, you may as well live.

In my more-than-a-decade of telling people they need an emergency fund, never did I think everyone would need an emergency fund at the same time. But such are the times we are living in. And if you have that emergency fund, you now have the freedom to pat yourself on the back and do absolutely nothing.  The working person’s emergency fund should carry you through an interruption in pay checks, even for a significant amount of time. Since you’re going to be at home, you probably won’t be putting a lot of discretionary money into restaurants, air travel, etc. No, this isn’t the happiest news, but adaptability is one of the secrets to a satisfied life.

The retired person’s emergency fund should be larger—2 years. Call it the bucket strategy if you wish, but that cash should carry you into a recovery. Maybe the market won’t be back to where it was, but it’s extremely likely that it will be better than it’s been for the last few weeks. Sure, some things that are passed up never come back—especially services. We might schedule them again, but the missed time is probably gone. On the other hand, no one’s shoes, or tv, or car lasts forever. Eventually consumer demand will swing back up.

I’ve been invested for at least 40 years now, and I’ve seen numerous times where pundits thought the world was coming to an end. Other things I’ve heard way more than once:

  • This time it’s different (Only in the specific details, not in the fact of a downturn or reaction to it)
  • I want to sell everything, wait for the market to bottom, then jump back in (How will you know?)
  • It may never come back (Well, then prices will go down since we’re all in the same boat)
  • I need a much more conservative portfolio (too late on that one)

And in about a year or two…

  • Gosh, I wish I would have bought when the market was down
  • I stayed in cash but then everything took off and I missed it

When the market is high, no one wants to take profits because things could go higher. When it’s down, no one wants to buy because things could go lower. So, it’s never a good time.

No matter what you regret, you can never redo the past. All you can do is learn from it, with honest assessment and perhaps revision. Maybe you’d forgotten what it felt like in 2007-2009, when the S&P dropped to 676—it closed at 2,386 today). Maybe you were too young then to have any money. Maybe you’ve found out that in fact you are far more risk averse than you expected, and when things get boring again, you may want to adjust your portfolio. In the event that you are indeed flush with cash, and can take the risk, there are bargains to be had.

The correct portfolio has the correct balance FOR YOU. If you find you are having heart palpitations, either it wasn’t right for you or you need to get off the screens and go for a walk. Your dog is waiting for you.