Saturday, May 20, 2017

Low Risk, Low Return is Sometimes a Good Thing!

Investing in high-yield investments is fine and all, so long as they generate high yields and not high losses.

A reader writes that I am too conservative in my investments.   This statement is right and wrong.  I try to diversify my investments so that any one thing won't bankrupt me.   So about one third of my portfolio is in real estate, maybe one third in stocks and mutual funds, and one third in life insurance, government and corporate bonds, CDs, money market accounts and even cash (in the bank).

As I get older, I transfer more and more into safer harbors.  Less stocks and speculative investment which can have high yields, and more into low-yield safer investments.

Why is this?  There are two reasons.  First, making 10% a year and beating the market is fine and all, and if you can do this for a number of years on end, you can make a lot of money.   But at my age, where I am already spending the money in my retirement, there is little "gain" to be had, as the number of years I have left to invest decreases every year.

Second - and this is the more important part - is that I cannot afford to lose a lot and start over at this point.  If I invested in some risky venture at age 30, and lost $100,000, I could recover from this over time by cutting expenses, working harder, and making more money and hoping other investments will make up the difference over time.

But at age 60, your time horizon is a lot shorter, so you can't afford that risk.

It is odd, but a lot of people fail to see this.  They look at a set of investments and say, "Well, why not take the one that has the best rate of return?   This stock or bond has a higher rate or return!  Why would anyone take the lower rate of return investment?  That's just dumb!"

And I have to stop myself from thinking that way sometimes myself.  It is all too easy to get greedy and think, "Gee, this bond has a 240% rate of return, what could possibly go wrong?"

Then you pull back and think about it and realize that the huge rate of return is due to the fact that other people who are likely smarter than you and me looked at this and said, "this looks to be a sure loser!"

And in some cases they are wrong, but in most cases they are right.   High-risk investments can have high yields, but they also can wipe out your entire investment.   A CD might not pay much interest, but at least you know you'll have your investment back at the end of the deal, rather than nothing at all.

It is tempting to invest in "junk bonds" and things of that nature - as people did in the 1980's when interest rates were high.  Many people ended up getting wiped out as a result, when the junk bond market tanked.   For some reason, the term "junk bond" was not enough to deter them from buying these things.   I mean, how far do you have to go to point out the folly in this?  Call them "give me all your money you ain't getting it back" bonds?

The amount of risk you are willing to take depends on your life station and situation.   Professional investors take huge risks - with other people's money.  And today, we are seeing the downside to this model, as one hedge fund after another closes - unable to even beat a simple index fund.

For the small investor,  the equation is much simpler - we don't have much to lose, but we can't afford to lose much.  The bitter angry people in America are often the same folks who thought they would make it big in real estate, gold, or IPO stocks.   They took huge foolish risks and now want a government bailout. 

It likely won't happen. 

Diversify, diversify, diversify!