One of the biggest fears people have with finances is the loss of principle. This situation occurs when an investment decreases in value. To avoid losing money, there can be a temptation to invest very conservatively. While it may seem practical to some, this strategy of being overly conservative when investing comes with some serious dangers.
Bonds Carry Risk
Bonds tend to have less volatility than stocks. That does not mean there are no risks that come from investing in bonds. At times, bonds can actually lose value even though they pay interest. The interest payments are fixed, as is the face value of the bond. Stocks can increase in value as the underlying fundamentals of a company improve. Additionally, they can pay increasing dividends over time. Bonds do not perform in this way. There is likely to be little in the way of growth with a portfolio completely invested in bonds, which is why diversification is a must.
Inflation Risks
Bonds are not the most conservative investment available. There are also certificates of deposit, also known as CDs, and money market accounts. These will pay out interest, but the payments will likely not even keep up with inflation. Therefore, an investor’s nest egg might lose purchasing power over time. Over the course of a 30-year retirement, a person who chooses to spend only their interest payments could lose about a half of the value of the income their conservative investments will provide.
Longevity Risks
The longer a person lives, the more likely their conservative investments will fail. Asset depletion is a very real risk that occurs for those who do not take a sufficient amount of good risk. Living expenses are likely to go up over time as inflation takes a bite out of a person’s portfolio. This means that the portfolio might not even last a person’s lifetime, leaving them dependent upon Social Security and savings alone.
The antidote to having too conservative a portfolio is to add some exposure to the stock market. This process does not have to be overly complicated. Most 401(k) plans offer a range of stock funds. Choosing an index fund with low fees and then leaving some of the money invested in stock funds over the long term is a good way to avoid some of the major risks that come from overly conservative investing.
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