Let’s discuss what the definition of “risk” is, in the first place?
If you look it up in the dictionary, you’ll see that it is defined as “A chance of encountering a loss or harm, a hazard or danger”. Now, you’ll notice it doesn’t say. “loss of principal”, it just is defined as “loss”. This is a major distinction we need to make here.
Most investors think “risk” means that you put your investments somewhere, and the $100,000 you started with is now worth far less than $100,000. Like someone who had invested $100,000 in the stock market in 1998, and would now maybe have a value of $80,000 of the original $100,000 they started with.
And yes, this is one type of risk …and a real one at that! But it is only one type of risk. There are others that are just as scary and that can hurt you just as badly as losing principal!
For example, if I told you that you are actually losing real money in the bank, would you believe me? Would you think I was lying, because CD’s are insured by the FDIC?
A client that’s either going to be, or already is, retired, will say something like, “We don’t want to take any `risk’ with our retirement funds! We want them to be totally safe and free of ‘risk.
I guess this is the time to explain what I mean. Here’s a simple example:
If you are making 2% interest on a CD, and you are in the 28% tax bracket, your net, after tax, yield is only 1.44%!
x 28% tax =
0.56% lost to taxes
1.44% net after tax yield.
Now, that would be bad enough, but we cannot forget about our friend, inflation. Yes, they claim inflation has been licked. That it’s gone.
Why? Because it’s been hovering around 2 – 2.4% for the last couple of years. Now, that is considered low, low inflation by today’s standards.
Could it be that inflation has changed, or is it more likely that the government has changed the way they want us to view it? Anyway, how does inflation affect our CD example?
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