Everyone has irrational fears; it’s an outgrowth of the way our brains are wired. We can’t help it any more than we can help how tall we are, or the color of our eyes. It starts in childhood with the monster in the closet, or under the bed. Irrational fears helped keep our ancestors alive, kept them from taking unnecessary risks.
Unfortunately, those irrational fears do not serve us as well in the modern world, and can be devastating to your financial future. The monster under your financial bed will keep your cash in a money market fund making 1.5%. That’s not the path to a comfortable retirement.
Mastering irrational financial fears means understanding the risks in a cold, hard light. Risk itself is also a moving target that changes over time. The risks the younger you can afford are different from the risks the older can consider. When you have 10 years, the market will sort itself out, even if you bought in the day before the next big crash. If you have less than 10 years before you’ll be drawing on that money, your risk profile changes. Risk is a balancing act— and here are five risks everyone should understand to achieve that balance.
5. The Risk of Doing Nothing
You may think putting your cash in a money market fund is the safe road — but even the safe path is beset by a risk called opportunity cost. Putting your cash into a 10-year CD may seem like you’re protecting it, but what you’re really protecting it from is the opportunity to grow. In that 10 years, you’ll miss out on all the gains and dividends of the stock market and, if interest rates rise in that ten years, you’ll be stuck with a lower return on your money.
4. The Risk of Taking Financial Advice From Salespeople
Anyone getting close to retirement starts getting calls about rolling over their IRA, with the promise of fabulous returns. The sales pitches are very convincing — and the majority of the time those programs are fronts for IRAs with insanely high fees, and the people pitching them are salespeople competing for bonuses and lavish vacations by convincing you to rollover your 401(k). Conservative investing is not rocket science, and it’s hard to miss putting your 401(k) money into a self-directed IRA with part of it in cash, part in a municipal bond fund, and part in a low-fee market index fund.
3. Timing Risk
Trying to time the market carries a unique set of risks, and has proven nearly impossible to do on a regular basis. Sure, there are always people who sold out right before the big crash, just like there are people at slot machines who hit the big jackpot. That doesn’t mean either of them has any particular insight — it means they were lucky. Every day there’s someone on TV saying the market is overbought and due for a correction. One day one of those lucky pundits will be right. The way to even out that risk is called dollar cost averaging, and means making smaller buys over a longer period of time. Time is everything; timing is just luck.
2. Liquidity Risk
Just as risky as having all your savings in cash is having none of it in cash. When you have all your money invested, particularly if it’s locked in for a long time horizon, it’s not available in the event of a job loss, medical crisis, or other emergency. You can be rich, really rich, and still get caught in a liquidity trap, if all of your money is tied up at the time unexpected bills come due.
1. Debt Risk
One thing that just astounds me is how Wall Street has been able to make debt a way of life for so many. Many people don’t even think about having a mortgage for their house, a car loan, and credit card bills on top of all that. Few consider the devastating impact on their finances if they’re leveraged to the ceiling when a layoff, accident, or illness strikes. According to American Debt Advisor, the best guess is somewhere in the neighborhood of 80% of Americans owe some type of debt, and half are actually in debt, truly astounding numbers. One of the greatest risks in our financial lives is one frequently given the least thought.
Understanding the risks is the first step in learning to avoid them. Don’t cave in to these common fears and your financial life won’t be keeping you up at night.