In times of economic uncertainty and market volatility, we often hear about the importance of investing in “safe” assets. This is a natural tendency. After all, it makes sense to want your money to be kept safe from the vagaries of the markets.
However, even as you add safety for your portfolio, it’s important to realize that always playing it safe is a recipe for falling short financially in the long run.
Safe Assets = Low Returns
There are certain asset classes and products that are considered “safer” than others. Cash, kept in properly insured financial institutions, is considered the safest. United States treasury securities are considered among the safest investments in the world.
Safe assets are those that are almost guaranteed to keep you from losing your principal. These assets also promise some sort of return. From the life insurance policy that guarantees an annual cash value increase to the bond backed by the full faith and credit of the United States government, you expect that you will at least get the money you put in—no matter what happens with the economy or the stock market.
This safety comes with a price, though. And that price is a low return. Yes, your principal is (probably) safe. However, the returns you receive are meager. Even the best of the high-yield savings accounts offer an annual yield of only 1 percent. At the time of this writing, the yield on the 10-year Treasury note is 1.861 percent. You’d be very lucky indeed to find a cash-building life insurance policy that guarantees 2 percent a year.
With these low returns, it becomes practically impossible to build wealth, even over the course of decades. The safer the investment, the lower your returns will be. And, not only do you have to contend with low returns, but you have the eroding power of inflation to worry about. In some cases, if the inflation rate exceeds your yield, you are actually losing money in real terms. You can’t become wealthy at that rate.
Add a Little Risk to Your Portfolio
There’s nothing wrong with including a little safety in your portfolio. Indeed, safer assets can help provide a safety net so that you aren’t completely devastated by unexpected events. However, if you want to effectively build wealth over time, you need to consider “riskier” assets like stocks.
It’s also worth noting that even some of the “risky” assets aren’t that risky. Indeed, over time, stocks have shown that they can provide a solid way to build wealth. Index funds and ETFs, as well as carefully chosen dividend stocks, can provide you with options for calculated risks that result in better returns than you are likely to get with the safer assets. Real estate is also seeing some popularity as low prices and low interest rates inspire some investors to buy property, or to invest in REITs.
For those with a little higher risk tolerance, it’s even possible to add currencies, commodities, and other asset classes to the portfolio. You can limit your exposure to risk with these assets with the help of funds. There are plenty of ways to boost your earnings without putting your entire financial future at risk.
If you want to build wealth, especially over time, you can’t rely solely on the safest assets. Investing only in safe assets won’t provide you with the returns that you need to build wealth adequate to your future needs. These safe assets may not even offer the returns necessary to allow your purchasing power to keep up with inflation. Remember that you need to venture something if you expect to reap bigger results. Don’t go crazy, but don’t rely only on safe investments to get you through. You need to take risks, too.
Miranda is a freelance contributor to several investing and personal finance web sites. She also writes for her own blog, Planting Money Seeds.