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How to Explain Risk Free Investments Don’t Exist

The stock market has been in bull market territory for 10+ years.  Yields have been low for a long time.  Investors are looking for ‘the next big thing.”  Of course, they want it to be risk free.  Thank goodness, your client has approached you before buying something.  What could you tell them?

The True Risk-Free Investment Really Isn’t

Years ago, people talked about “putting money in their mattress.”  Today, the equivalent might be a money market fund at an insured bank.  They feel its risk free because of the FDIC insurance.  They can take out their money anytime.

But it’s not really risk free.  According to BankRate, the average money fund rate in the US (as of Feb 18th) is 0.24% annually. (2)  Some places might offer 1.85%.  According to USinflationcalculator.com, as of January, 2020 the official inflation rate is 2.50%. (2)  This is a pretax rate of return.  It isn’t even keeping up with inflation.

What are Some “Risk Free” Investments Clients Find?

Clients hear about lots of “Sure Things.”  Here are a few popular ones.

1. Real Estate. Blame it on cable TV.  People watch programs about house flipping.  Someone buys a house, puts money into it and sells at a profit a short time later.  It appears the rules of how much you recoup after remodeling have been suspended.  Here’s a reminder from CNBC. (3)  Let’s not forget the maxim: “You don’t wait to buy real estate.  You buy real estate and wait.”  There are carrying costs (mortgage interest, taxes, insurance) to pay between the time you buy and the time you sell.

2. Fine wine. People hear about collectible wines selling at auction for huge prices.  You need to own the right label (a smaller universe than you imagine) from the right years.  Storage is important.  It costs.    If you object to a 1% fee on asset management, wait till you find out the costs of buying and selling at auction.

3. Precious metals. Gold has been described as a hedge against inflation.  It’s even been said the price of gold never changes, using the example of the amount of gold (value) it would have taken to buy a car many years ago is equivalent to the amount of gold (value) it would take to buy a car today.  Gold and other precious metals might be considered a category of alternative assets, but the price of gold fluctuates like everything else.4.

4. Gemstones. People look to jewelry as a form of portable wealth.  You can always turn them into cash.  I’ve heard estimates the markup in the jewelry business might be as high as 400%.  If that makes no sense to you, ponder this question: “How can they run 50% off sales and still make money?”

5. Sports betting. People may not understand the financial markets, but many think they understand their favorite sport.  The ability to bet on your favorite team is quite attractive.  However, it is a form of gambling and the existence of spreads tends to even the odds.  Put another way, your winning team isn’t a winner if they don’t cover the spread. CNN explains the difference between sports betting and investing here. (4) When you invest in a stock, you own a piece of something.  With a sports bet, you’ve either won or lost.

6. Gambling. Many people claim to have a “system”.  Their system “can’t lose.”  First of all, the odds are always in favor of the house.  Take American roulette.  There may be 36 spaces on the wheel divided between red and black.  There’s also the green 0 and 00.  If you bet red or black, the house has about a 53% chance of winning.  Suppose you doubled your bet each time as you lost, in hopes of regaining lost ground?  Starting with $ 1.00, after seven losing spins, your eighth spin requires you to put $ 128.00 on the table.  Although you might think the odds of your color coming up is high, each spin starts over again as an independent event.  The house still has its 52.63% chance of winning.

Yes, there are degrees of risk.  But there are no “can’t lose” investments.

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