Before I break down the risks of investing, one of the most important things you need to look at is; what is the risk of not investing?
Whether in businesses, real estate, stocks or mutual funds – what's the risk of not investing your cash?
What is the risk of just putting it under the mattress and saving your money, or putting it into a bank account that makes a tiny interest rate every month – what are those risks?
To determine these risks, let’s start by taking another look at inflation. On average, inflation is about 5% a year – so – if you put $10,000 under your mattress every year and save it, the following year, that $10,000 is only going to be worth $9,500.
Cash is a depreciating asset because of inflation. Inflation will eat up the value of your cash over time. A dollar in 1977 is only worth .22 cents in buying power today!
Yes, the amount will still be $10,000 in a year, but it will only have the buying power of $9,500 in today’s dollars. So let’s say another year goes by and you still haven’t gotten around to making any investments for your retirement – but you did put another $10,000 in the bank. After two years of this, you have a total of $20,000 in the bank.
I expect you’d be pretty proud of yourself for having that cash in the bank – and it’s good – certainly better than buying a big screen TV.
But after the end of the second year – after inflation hits your cash again – the value of your hard earned, hard saved $20,000 is only $18,500. And that’s only in TWO YEARS. What if you kept this cash in the bank until retirement?
I think this is frightening. It makes me shiver whenever I think about it. If you save cash without investing it properly, the value of your cash shrinks by about 5% every single year because of inflation.
After five years you’ve put $50,000 in your savings account, but now you only have $42,980 worth of buying power – you just lost 15% of your total “investment”. (Note: I depreciated each year’s $10,000 investment for the number of years invested.) If you are going to wait for ten or twenty years before you retire, keeping cash under your mattress will lose you a ton of cash – just because you did NOT invest it.
This is also assuming that you’ve been able to keep the cash there, and it stays safe, and it doesn’t burn a hole in your pocket, and you don’t go spending it, and you force yourself to save that cash.
How many emergency situations have you had in the past five years where if you had cash in the bank to spend, you would have spent it on that emergency?
If you didn’t have it to spend, you probably found another way to solve the emergency, right? Having lots of liquid cash lying around is not as great as it sounds. Remember, you can always pull your equity out of real estate using loans if you have to – and you don’t have to pay capital gain taxes on that withdrawal if you do it right.
Anyway, I just wanted you to be aware of this risk. One of the biggest risks you can take with your cash and your finances is DOING NOTHING.
What happens when you bury your head in the sand like this? You get run over by a truck – and that truck is called inflation. Everything that you do, every investment that you make, is going to have a risk associated with it.
The biggest risk for sensible investors, I believe, is doing nothing.