When I am acting in a fiduciary capacity, my number one concern for every client I meet is whether they have an adequate emergency fund. Having cash on hand can be a beautiful thing, for many reasons. Besides handling an emergency, cash in the bank can make you less likely to panic when the value of a long-term investment has declined. It can also provide the opportunity to take advantage of a good investment when one presents itself. But sometimes I meet clients who have too much money in cash and they are nervous (in many cases, rightfully so) about taking on additional risk. It is important to remember that there is a lot of “ground” between no risk and lots of risk.
I like to imagine this “ground” as a ladder with various rungs. At the bottom you have your checking account with FDIC insurance. The bottom of the risk ladder carries no risk at all. As we climb on to the first rung, we find US treasury bills and bonds. The interest rate paid by these instruments is known as the “risk-free-rate”. Yields on Treasuries are very similar to CD’s at a bank. Short term corporate bonds and municipal bonds would be located on the next step up the ladder, followed by bonds with lower credit ratings, better known as junk bonds. The top of the ladder has always been occupied by real estate, stocks, and private equity, but now digital assets like crypto currencies have added new rungs. I assume 100 years from now lunar real estate will invent more rungs still.
Halfway up the ladder, looks can be deceiving. I have already mentioned junk bonds, which at times can behave similarly to stocks; but now even equity mutual funds, using options strategies, can have similar risk profiles as their bond counterparts. For most of the 20th century publicly traded securities basically meant stocks or bonds. The beginning of the 21st has seen an explosion of new “alternative” investments. With very little historical data to analyze, placing these alternatives on the risk ladder is a matter of perspective, the statistics only offer so much. As the pace of technological change continues to accelerate, ideas and concepts brought to the financial marketplace will increase. Identifying which are worth our time and money will be difficult to determine, as well as their place on the risk ladder.