“Mattress risk”
Given the recent market crisis, we’ve heard a lot about how the “only safe place” to invest your money is your mattress.
One of my colleagues forwarded me this story from CNN. It’s about an older woman who had stuffed her $1 million life savings into her mattress—only to be horrified when she learned that her daughter had gotten her a new bed as a gift … and thrown out the mattress with the money in it.
The story says more about the nature of risk in just a few sentences than I could in pages. The bottom line: There are always risks out there, and avoiding the risks of investing—or even avoiding doing business with others generally—doesn’t mean you’ve done away with risk.
Another lesson: There are risks you bear that can earn you a return, and some you won’t get paid a thing for. The great thing about bearing the risk of diversified investments is that hundreds of years of history, as well as basic financial principles, suggest that you’re justified in expecting to earn a “return premium,” on average, for doing so.
Of course, expecting a premium doesn’t guarantee you’ll get it. That’s the risk part. But putting up with a measured amount of financial risk strikes me as a lot more attractive than a hoarding strategy.
When you hoard cash, there’s little or no possibility of gain, and at least some exposure to other potentially disastrous risks, such as inflation, fire, and flood, as well as some of the more unusual risks that are a part of life. And those are risks that you don’t get paid a cent to bear.
Notes:
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Excellent site, keep up the good work
My mother held her life savings of 3 million in cash in 20 different banks from 1998 to today. She still has it all while most of her baby boomer peers have lost over half of their net worth via stock investments at their late age. Nobody laughs at mother any longer!
All in cash-really? Nothing in interest bearing FDIC insured CDs? Or FDIC insured savings accounts?
How much has she lost in purchasing power over that time period? About half? The increase in cost of living has gone up about 2.5% per year since 1998. Some individual items far more.
Investing in 3-month FDIC insured CDs would have offset that loss.
Investing in 6-month treasury bills would have also.
Investing in a mix of short and medium term U.S. treasury obligations would have more than offset her loss in purchasing power.
Investing in the U.S. bond market as a whole would have done even better, averaging about 6% per year.
Having $3 million in cash at any time puts your mother in a good financial position, but I suggest that it is not the position of the over-whelming majority of baby-boomers at any time. Now, or at any time in the past.