Risk at Every Turn

DEAR DAVID: LAST WEEK, you emailed me, “If you had $20,000, didn’t want to take risk and wanted the best return, how would you invest?” It’s a timeless issue, most likely first asked the day after money was invented.

You may be wondering why, besides asking where your money is currently invested, which turns out to be Bank of America at 0.2%, I haven’t asked about your risk tolerance, current financial situation and future financial needs. This was done on purpose.

I know you’re in your 50s and that you’re currently employed. But I also know most people resist sharing their innermost thoughts about money with a financial advisor, let alone a friend. Also, too much information generally leads to confusion and, even worse, to more questions. Most recipients of financial advice are reluctant to take it, and asking more questions usually won’t make them more receptive.

As I see it, these are your options:

1. High-yield savings or money market accounts. There are differences between the two, but not enough to matter. They’re both insured by the FDIC, currently offer rates north of 4% and allow immediate access to your money. One downside: Rates will fluctuate and may decrease.
2. Certificates of deposit (CDs). I’m sure you’re familiar with them. You agree to keep your money in the CD for a specified length of time. Withdrawing early means paying a penalty. While some CDs have a variable rate, most fix the yield at time of purchase.
3. Bonds, which you can buy individually or via a mutual fund. They come in many shapes and sizes: municipal, corporate, government, short-term, long maturity, high-quality, junk, foreign and so on. I don’t have any in my portfolio because I don’t find they’re worth the hassle. Instead, I prefer long-term CDs.

Now, it may appear that Nos. 1, 2 and 3 are your safest options, but their returns are limited and they’re susceptible to the risk of inflation. That’s why you should look at a few other options.

4. Dividend stocks. These have many fans, who argue that the dividends paid not only provide income to live on, but also are an indicator of likely returns. I’d like to think I busted this myth in an earlier article.
5. Stocks, both dividend and non-dividend. Picking individual stocks is just plain hard work, and best left to professionals and amateurs who live and breathe stocks. Another issue: loss aversion, a phenomenon where the pain felt when a stock holding falls $5,000 is far greater than the joy felt by a comparable increase. This can be an obstacle to good decision making.
6. Actively managed stock mutual funds. You might think hiring one of the aforementioned professionals is the way to go. Unfortunately, I’ve found they generally don’t do a good job and charge too much. Their collective efforts, hustle and intelligence tend to offset one another, making it difficult for any of them to outperform the market.

You might also think that buying active funds would simplify investing. But as there are more actively managed mutual funds than individual stocks, it can actually complicate it.

7. Broad-based stock index funds. I’m saving the best for last. These will allow you to capture the market’s return at the lowest possible cost. An added benefit: They’ll reduce your loss aversion.

I’d recommend investing $15,000 in a broad-based stock index fund and $5,000 in a five-year CD, where you should be able to notch a 4% yield. This will give you a 75%-25% split between stocks and conservative investments, which sounds about right for you. Feel free to adjust the amounts to better suit your appetite for risk. Please realize that this recommendation comes with some risk. But there’s no such thing as an investment without any. Even keeping $20,000 under the mattress entails considerable risk.

I invest in CDs through Capital One. It has a money market account with a competitive rate, a good selection of CDs and an easy-to-navigate website. Meanwhile, I use Schwab Total Stock Market Index Fund (symbol: SWTSX) as my broad-based index fund. It has low annual expenses of 0.03%, or three cents a year for every $100 invested. It also invests in the entire U.S. stock market, not just the S&P 500, offering greater diversification. Similar funds sold by Fidelity Investments and Vanguard Group would also do just fine.

I’m assuming you have an emergency fund and no credit card debt, and won’t need any money invested in the broad-based index fund for at least 10 years. By the way, consider changing banks. You can do better than Bank of America.

If you have any other questions about personal finance, affairs of the heart or economical travel, feel free to give me a call.

Regards,

Mike

P.S. Regarding your other question: Decentralized finance, also known as DeFi, uses cryptocurrency and blockchain technology to manage financial transactions. It’s another name for a screw job if you’re on its business end. Stick with centralized finance and you’ll do fine.

Michael Flack blogs at AfterActionReport.info. He’s a former naval officer and 20-year veteran of the oil and gas industry. Now retired, Mike enjoys traveling, blogging and spreadsheets. Check out his earlier articles.

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Art Felgate

3 months ago

Excellent advice, Mike. I might suggest a CD ladder instead of a single 5-year CD, though.

6

mjflack

3 months ago

Reply to  Art Felgate

Art Felgate, I like the simplicity of one CD, though a ladder may make sense. Thanks!

1

Ross Young

3 months ago

4 Week Treasury Bills are currently paying 5.48%. That’s 100% guaranteed and beats these options listed.
https://www.treasurydirect.gov/marketable-securities/treasury-bills/

https://ycharts.com/indicators/1_month_treasury_rate?_gl=1*1kyiwpi*_up*MQ..*_ga*MTUxNDc3OTY1Ny4xNzE3MjQ0MDgx*_ga_29JVRYKWPW*MTcxNzI0NDA3NS4xLjAuMTcxNzI0NDA3NS4wLjAuMA..

i bonds are paying 4.28%
https://www.treasurydirect.gov/savings-bonds/i-bonds/

0

mjflack

3 months ago

Reply to  Ross Young

Ross Young, both your options require a Treasury Direct account, which can complicate this situation. And I just bought a three month CD for @ 5.5%. Also as a man once said, “I’m not a fan” of I bonds:

https://humbledollar.com/2022/02/no-i-for-me/

1

Guest

3 months ago

“If you had $20,000, didn’t want to take risk and wanted the best return, how would you invest?”

There’s not a molecule of a chance of me offering a friend/colleague/client any advice without asking for more info even if it appears they would not be “more receptive” to a few more questions. And making assumptions about what they mean/want/need based on their question, no way.

5

Tom Kubik

3 months ago

No such thing as no risk. People need to understand that.

6

Dan Smith

3 months ago

I’ve found that when someone actually comes out and says “no risk”, they truly mean any sign of negative fluctuation in the value is going to totally freak them out. One such friend was in a Pimco TIPS fund and fired his advisor when he got a statement showing a small loss. Another guy, who is a total badass physically, is a total sissy when it comes to investing; calls me in a panic when things aren’t going well. IMO for these types it’s the guaranteed items you mentioned or possibly fixed annuities. 

9

mjflack

3 months ago

Reply to  Dan Smith

Dan Smith, 20k might be a little light for an annuity.

1