The Cost of Risk Aversion
The world changed dramatically for U.S. investors on Friday, Oct. 10, 2008. The Dow Jones Industrial Average closed at 8,451, dropping more than 18 percent for the week—the worst week on record. In the panic, frightened investors began fleeing corporate stocks and bonds. The stampede from the stock market didn’t stop until March 10, 2009, when the Dow closed at 6,926.
Safety Has a Price
The panic of ’08 forced many investors to redefine risk. Some swore they would never again return to the markets. But those who stuck to that pledge missed out on a 50 percent rebound from March 10 to Sept. 1, 2009, when the Dow closed at 9,311. Instead of riding out the turbulent times by sticking to a financial plan and making gradual adjustments to their portfolios, panicked investors sold everything at extremely low prices. Then, they stayed on the sidelines as the markets began to recover.
Opportunity Cost
In an attempt to completely avoid risk, these all-or-nothing investors actually took on considerable risk—the risk of opportunity cost. Now these panicked investors who remain in short-term Treasuries are earning next to nothing on their money. And there is yet another risk to consider—inflation risk.
Inflation Risk
As investors seek safety, liquidity, and yield, they should also consider inflation risk: The possibility that the value of their savings will decrease as purchasing power is eaten away by rising inflation. Some investors might be tempted to seek higher yields from longer-term Treasuries. But these can become a trap if interest rates and inflation continue to rise.
Create a Plan
To be sure, reinvesting in corporate stocks and bonds will expose investors' money to the potential of more losses. But that is the risk required to earn the gains that prudent strategies and diversified investing can bring if given a long enough time frame to work. Consider speaking to an advisor about your investment goals, time horizon, and income and protection needs so you can create a financial plan that includes investment strategies that might be appropriate for you.
This column is for informational purposes only. The information may not be suitable for every situation and should not be relied on without the advice of your tax, legal and/or financial advisors. Neither Ameriprise Financial nor its financial advisors provide tax or legal advice. Consult with qualified tax and legal advisors about your tax and legal situation. This column was prepared by Ameriprise Financial.
