I know the speech.
“Mr. Moore, this is all the money I have in the world.”
She is clutching an investment account statement pulled from a tattered envelope. She has told me about the years of hard work she’s put in, saving as much as she could while putting three sons through college. Now she’s within a month of retiring and anxious about her ability to make it all without a paycheck.
“I want to make as much money as I can with this, but I don’t want to take risks.”
“What do you mean by risk?” I ask.
The corners of her mouth turn down as she thinks. “Well, I guess I don’t want to lose all my money.”
“OK, we can certainly both agree on that. Losing all your money would be very, very bad. What else? What else does risk mean to you?”
“Umm…I guess that’s pretty much it – I don’t want to lose my money,” she says, not sure if she means it.
“OK. I get that. So, what about income from the money. Is the risk of getting no income from that money an issue for you?” I ask.
“Yes!” she says, her eyes getting wider. “That’s why I’m here. I really need this to make me some money!” Her voice is urgent.
“So, losing some or all of your money is one of the risks you want to avoid. And getting no income off of this money is another risk you want to avoid. Is that right?”
“Yes. Absolutely,” she says. “That’s what I want. I want enough income from this money, but I don’t want to risk losing it.”
“I think I understand,” I answer. “But here’s the thing. You’ve got a choice to make.
“Option one means your account value is guaranteed to be steady and stable, guaranteed not to go down. With this option, your monthly income from the account would be about $1,600 today.”
“Option two means your account value is not guaranteed to be steady. In fact, I promise it will jump up and down. Historically it trends up, but there can be prolonged periods of time when the value of the account goes down.
“On the other hand, the income from this kind of account is about $3,500 a month, based on the amount of money you have. And there’s a decades-long history of the number going up every year by the rate of inflation or more.”
Option one describes a bank account. The money in the account is guaranteed and you know you won’t make much money off the current interest rates.
Option two describes a portfolio of financially stable bonds that pay interest and stocks that pay dividends to their owners. These days, a portfolio like this would earn significantly more than a bank account. But you’ll have to put up with some fluctuation (risk!) in the stated value of the account over time.
I don’t think it is possible or realistic to try to avoid all risk with your money. You must choose which risk is right for you.
Are you better off accepting the risk of low income? Or are you better off accepting the risk that your account will fluctuate in value (sometimes significantly), while at the same time paying your much higher consistent income?
The question isn’t “how can I avoid all risks?”
The real question is “which risks should I accept?”
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