Beware this stealth risk
There are many investment risks. You have interest rate risk. Business risk. Credit risk. Taxability risk. Call risk. Inflationary risk. Liquidity risk. Market risk. Reinvestment risk. Social/political risk. Currency/exchange rate risk. I would add advisor risk, investor risk, accounting risk, integrity risk and foreign investment risk.
Whew! That’s exhausting!
A FEW RISKS EXPLAINED
What is the most dangerous, most deceptive, most-over-looked, least-recognized and least-accepted risk? This supposed “stealth” risk? We’ll get to that in a bit. For now let’s look at a few of the biggies.
Everyone is aware of MARKET RISK. This one’s simple. The stock, bond, real estate and other markets yo-yo in value. Things go up and things go down.
Next up is INTEREST RATE RISK. For retirees and other conservative investors this is an important one to understand. This is where you invest at a fixed-interest rate and then rates go up. This usually makes your lower-rate investment drop in value.
Lastly we have LIQUIDITY RISK. This means your investment is hard to cash-out. For example, real estate is classically hard to turn into cash quickly. It can be done but can result in drastic price drops. Another lesser-known, but potentially very dangerous, example is annuities. Some annuities lock an investor in for ten or more years with exit fees as high as 5-15 percent. Beware.
Are any of these the stealth risk? Not quite.
DRUM ROLL, PLEASE…
The stealth risk is…INFLATIONARY RISK. This is one I see a lot of investors burying theirs heads in the sand over. We go to the bank and ask for a CD. We’re thinking safety and security but ignoring a huge risk. According to WSJ.com, the current five-year CD rate is 1.35 percent. Even if you believe the governments “official” inflation rate of 2.2 percent, a CD investor is losing to inflation.
Also, the American Institute for Economic Research has their EPI (Everyday Price Index) that says 2012 inflation is actually around 5.2 percent. Their index factors in real-world expenses like postage, gasoline and groceries. So CD investors may be even worse off.
There’re many possible ways to battle this risk. One way is to invest in high-income stocks and stock mutual funds. Another way is to invest in municipal bonds that produce high income. With municipals you also get tax-exempt income from a very secure asset class.