I remember the time I was ‘double dog dared’ to ride my bike at full speed off this crazy hill by grandma’s house called Crabtree Hill. I considered the multiple risks, hitting a car coming around the blind corner, not making the turn and ending up in the brush, and looking like a chicken if I didn’t do it. There are risks in every part of our lives.
There are real risks to investments too that a wise investor must plan for and try to minimize. The three basic types of investment risk are market risk, interest income risk, and inflation risk.
Market risk is the potential of your investment’s value to decline in price over time. For example, this means you could buy stock for $100 per share and in two years it could be worth $80 per share, which is less money than you invested. Every investor understands and fears this risk.
Interest income risk is the risk when interest rates are declining on maturing bonds or Certificates of Deposits (CDs) and they are reinvested at lower interest rates than they were previously invested. Many elderly Americans are experiencing this right now with historically low bank CD rates. Older investors who were accustomed to averaging 4-5% CD rates are struggling with CD rates that are about 1/5 of a percent (0.19%) according to Bankrate.com.
This has resulted in lower income, which lowers a person’s lifestyle.
The third investment risk is inflation risk. We have discussed this a lot lately, but I want to look deeper into inflation here. Inflation is where the purchasing power of a dollar declines. As the purchasing power of your dollar declines, it lowers or lessens your ability to pay for products, because of ever-increasing prices. The wise Larry Burkett says in his book Preparing for Retirement, “For the majority of retirees, inflation is the most disastrous of all the circumstances they may face”, because inflation “will eat the heart out of any retirement plan at a time when the retiree has little or no flexibility.”
Inflation is not likely to slow down anytime soon. The single greatest mistake retirees make is misjudging inflation. The account balance looks huge when you retire, but it looks small after just a few years of retirement. Inflation, over a few years, drastically erodes the buying power of our retirement savings. A $100 bill today won’t buy today what it would only two years ago and it will only get worse over time with inflation. Our income always shrinks over time!
I did ride my bike off Crabtree Hill at full speed that day and though I counted multiple risks, I forgot one, equipment failure. My worn-out bike chain came off leaving me with no breaks. I was going so fast around the corner that I had to lean low to make the turn and my petal hit the ground and threw me in the brush. Other than my pride I wasn’t hurt much, and my brother Jeff helped me fix my bike. (This kind of decision making might be why kids wear bike helmets these days.)
Just like my bike wreck story, we diversify our investments because there might be risks, we haven’t considered. Diversifying your investment portfolio will help you pursue your investment goals over time and can soften the effects of market downturns.
Have a blessed week!