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I recently spoke with a young woman who has a goal of buying a home within 15 years. She was advised by her friends to save for her goal in a high-yield savings account. She’s not the only young person I’ve seen considering ultra-conservative investing for long-term goals.
Over the past few years, I’ve seen many young people turn to CDs, high-yield savings accounts, money market accounts, Treasury bills, and other very conservative investments for far-reaching, broad-based goals. I did. While all these investments may be preferable to stuffing money under your mattress, they may not be the most efficient means of achieving your long-term goals. Let’s discuss ultra-conservative investing, why people get into it, where it’s useful, and whether other types of investments may be more useful.
Why do people invest ultra-conservatively?
Here’s why investors choose to hold a 3-6 month or longer emergency reserve in cash and cash substitutes.
- They need cash in the short term.
- They are afraid of the stock market.
- They don’t understand the basics of investing.
- They are trying to time the stock market.
- They don’t really know what their financial goals are.
From an investment and return perspective, reasons 2 through 5 are not reasons to make ultra-conservative investments. From a purely logical point of view, short-term cash needs are the only valid reasons.
When ultra-conservative investing works
If you need a large lump sum to buy a home, buy a car, finance a wedding, pay for college tuition, or do something else in the next 0-3 years, consider investing in high-yield savings, CDs, money market accounts, etc. Super conservative investing is best. , and short-term Treasuries may make a lot of sense. You will receive liquidity and a small return by the designated date of your choice.
These types of investments also work well as emergency funds for the same reason. If you don’t have an immediate need for cash and have more than six months of expenses in your emergency reserve, it may be time to consider a different strategy.
When ultra-conservative investing isn’t effective
If you’re saving for medium- to long-term goals (3-year goals or more), ultra-conservative investments tend to be less effective than other traditional investments.
Consider stocks for the long term
If you invested $1 in U.S. Treasury bills (short-term bonds backed by the U.S. government) in 1926, you would have $22 today. When you look at this, you might think, “It’s not so bad that my money has grown 22 times his in about 100 years.” That’s true until you compare those returns to the stock market.
Stocks are ownership rights in a company. This discussion assumes that investors invest in a diversified bundle of stocks, known as a fund, rather than picking individual stocks. If he invested $1 in an index of large companies in 1926, he would have $11,527 today, and about 2.5 times that amount if he invested in an index of small companies.
Granted, not everyone has a nearly 100-year time horizon. So let’s look at a shorter period. If you look at his 30-year period in the S&P 500, the average annual return has never been less than his 7.8%.
Like the “lost decade” that began on December 31, 1999 towards the top of the dot-com bubble and ended on December 31 towards the bottom of the housing crisis, when people held more cash than the S&P 500. There was a period of about 10 years where it would have been better to have it. 2009. But when investing, you shouldn’t just invest in the S&P 500. The small business index returned 74.4% during the same period. Investors with plenty of time and a widely diversified stock portfolio can end up owning far more assets than conservative investors.
Bonds and income generation
Bonds are considered a conservative investment, but even bonds have more firepower to help people reach their investment goals than the ultra-conservative investments we’ve been discussing. Essentially, bonds are debt instruments. You lend money to an organization for a specified period of time, and in return you are paid interest until the loan is repaid in full. Many bond investors also choose to diversify the interest on these bonds by investing in funds that hold and manage many bonds. For a 100% bond investor, the average return from 1926 to 2021 was 6.3%.
Bond funds can come with some risks, such as interest rate, reinvestment, default, and inflation risks, but they are effective at generating income without requiring investors to touch the original investment. For this reason, many retirees hold a significant portion of their retirement assets in bonds.
conclusion
Cash, cash alternatives, and other highly conservative investments have their place in financial planning, but before allocating more than your short-term cash needs to these types of investments, consider your financial goals. You need to think critically. Investing involves risk, but if your portfolio is diversified, greater risk usually yields greater returns. Consider talking to a qualified financial professional about your goals and risk tolerance, and to see what other types of investments may be suitable for you.
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This information and educational article does not provide or constitute tax or financial advice and should not be relied upon as such. Your unique needs, goals, and circumstances require individual attention from a tax and financial professional, whose advice and services supersede any information provided in this article. Equitable Advisors, LLC and its affiliates and affiliates do not provide tax or legal advice or services. Equitable Advisors, LLC (Equitable Financial Advisors of Michigan and Tennessee) and its affiliates do not warrant, endorse or make any representations about the accuracy, completeness, or appropriateness of any content linked from this article. It is not intended to be done. Past performance is not indicative of future results. Results for individual investors will vary. Asset allocation is a diversification method that places assets among major investment categories but does not guarantee a profit or protection against loss. CDs are FDIC insured. An index is an unmanaged portfolio of specific securities. Individuals cannot invest directly in an index. Funds that invest in fixed income securities are subject to interest rate risk and may lose principal value if interest rates rise. Investing in large capitalization companies may involve the risk that larger, more established companies may not be able to respond quickly to new competitive challenges. Investing in mid-capitalization companies are generally less established, and their securities may be more volatile and less liquid than the securities of larger companies. Investments in small capitalization companies may be more vulnerable to adverse business or market developments than larger capitalization companies.
Cicely Jones (CA Insurance Lic. #: 0K81625) sells securities through Equitable Advisors, LLC (New York, NY 212-314-4600), member FINRA, SIPC (Equitable Financial Advisors of Michigan and Tennessee). and offers annuity and insurance products through Equitable. Network, LLC does business in California as Equitable Network Insurance Agency of California, LLC. Financial Professionals may only transact business or respond to inquiries in states in which they are properly qualified. Any compensation that Ms. Jones may receive in connection with the publication of this article is made separately and solely in Ms. Jones’s capacity, separately from Equitable Advisors, LLC and her Equitable Network, LLC (Equitable Network Insurance Agency of California, LLC). You can get more than that. AGE-6225608.1 (1/24)(Exp. 1/26)
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