The Risk of Risk-Avoidance

A recent study from UBS Wealth Management Americas shows that kids aged 21 to 36 have 52% on average in cash.

Unless you are about to buy a house, execute a major drug deal, or flee to Mexico, there is no reason to have 52% of your assets in cash.

Young people avoid investing in stocks because they endured the dot-com crash and financial crisis in their formative years. The market seems risky.

S&P 500 Index Real Returns, 1926-2012. Holding cash would have beaten the market in 2000, 2001, 2002, and 2008.
S&P 500 Index Real Returns, 1926-2012.
Holding cash would have beaten the market in 2000, 2001, 2002, and 2008.

But holding cash is equivalent to investing in a negative-yield bond. This cash holding would have underperformed the S&P 500 by 30% last year. An investor who chooses this zero-return strategy runs a risk of not being able to save enough for retirement.

People often confuse uncertainty and risk, when the option with the most certainty is often the riskiest. A cash allocation is a certainty that depreciates at the rate of inflation.

Higher education is also a frequently-mistaken risk aversion strategy. There is a lot of certainty associated with an advanced degree. An engineering PhD at least guarantees you a six-figure salary at a boring company.

However, just as a 0% return ended up being a really lame outcome for 2013, a career at Intel might end up being a really lame outcome for an EE PhD. By choosing a low-risk strategy for six years, the PhD student gambled away the most priceless asset of all.

Sometimes the biggest risk is to not take any.

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