01/02/2009 05:12 am ET Updated May 25, 2011

The Risky Flight to Safety

Imagine this.

Your broker calls and offers you a portfolio "guaranteed" to reduce your purchasing power every year.

Any takers?

Of course not. Yet that's what investors do when they "flee to safety" by dumping stocks and investing solely in CDs, Treasury Bills and other "risk free" investments.

Some of the most respected fund families have seen huge net outflows. These include stock funds managed by American Funds, Legg Mason, Vanguard and Fidelity.

Where are these investors putting their money? Mainly in Treasury Bills, causing those interest rates to plummet. The investment rate for a 52 week Treasury Bill issued November 20, 2008 was 1.063%.

Does this make sense for the vast majority of investors saving for retirement?


Let's take a 45 year old investor who expects to retire at 65. This investor has $100,000 in savings. How much will she need to have the same buying power at age 65?

I don't have a crystal ball, but I can compute the answer for the past 20 years, starting in 1988: $183,071, based upon the average Consumer Price Index for each year.

An interest rate of 1.063% for 20 years will increase her portfolio to only $123,476--a shortfall of a whopping $59,595.

Interest rates could increase over the next 20 years which would have a positive impact on returns. However, if they did, it is likely that inflation would also increase, resulting in a reduction of purchasing power even though returns would increase.

Historical data is not predictive. Recent market events make that painfully obvious. With that caveat in mind, what if this investor studied the long term historical data and decided to assume as much risk as she could take? She would invest 100% of her portfolio in a globally diversified portfolio of stocks, recognizing that she would not need access to this money for 20 years.

Her $100,000 investment in 1988 was worth $673,493.20 as of October 31, 2008.

What if this investor thinks "it really is different this time"? She wants a much more conservative portfolio. She decides to invest only $15,000 in stocks and the balance in bonds, using passively managed stock and bond funds.

Even with this extremely conservative portfolio, over the same time period, her original $100,000 investment would be worth $324,179.

There is no way to keep pace with inflation and taxes over the long term by investing in risk free Treasury Bills or FDIC insured Certificates of Deposit.

Investors who have less than a five year time horizon should have little or no stock market risk. However, if you don't need access to your money for a longer period of time, your investments should consist of an appropriate balance of stock and bond index funds, ETFs or passively managed funds.

Risk, like beauty, is in the eye of the beholder. A "risk free" portfolio can be the riskiest investment you will ever make.

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