It’s been said that cash is the riskiest asset class. But how could this be ? Isn’t cash the most liquid asset. Is it not the most stable asset ? Is it not the one asset class that most likely will not have a negative return?

There’s a featured article (“Risk and the 401k investor: How Plan sponsors can avoid misleading employees” by Christopher Carosa) that appears in Fiduciary News (a U.S. based website providing information for ERISA/401k Fiduciaries and Trustees). He presents this scenario:

“You have a chunk of money that needs to earn 10% over the next twelve months to send Johnny to college….. You have only two investment options. The first investment option has a standard deviation of 30% (meaning there’s a 67% chance the annual return will fall between -30% and +30%). The second investment option has a standard deviation of 0% and guaranteed return of 5%. Here’s the question: ……..which investment option poses the greatest risk?

The investment option with the greatest risk is the first option. Why? Because Modern Portfolio Theory uses standard deviation as a proxy for risk. After all, isn’t the guaranteed return offered by the second investment option the very definition of a “risk-free” investment.”

But here’s the thing…. If you went for the guaranteed return of 5%, guess what ? You have a 100% guarantee that you won’t earn the 10% needed and you will not achieve your desired outcome (i.e. to have enough money to send Johnny to College). So, perhaps the 5% guaranteed return option is actually the bigger risk. That is, the risk that you won’t get the outcome that you need.

And it’s this that takes us back to our earlier comment that cash can be the riskiest asset class of all. If cash returns aren’t going to deliver to you the outcome you’re looking for (i.e. to generate enough return on your money to give you the income you need), then it will fail you.

You can look at volatility as a way of measuring investment risk but our message is this: do not do so in isolation of looking at the risk of your chosen investment not acheiving your objectives.

If you’d like assistance in determining the investment strategy that is right for you and your future needs, please contact Harvest on (02) 8908 4300.