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8:53 am - Monday November 24, 2014

Extreme Risk Aversion Paradoxically Leads to Another Huge Risk

| Investing | Rating: 4.5
by Numan

Afraid to take investment risks? Be aware, you’re taking a huge risk of another kind.



Lately I’ve been giving serious thinking to my asset allocation. It’s been a rough year in the markets and only a selected few managed to escape the storm. One question, how ever, is always on the table – How should we allocate the savings we have?

When asked about their asset allocation and the share of stocks and bonds in their portfolio many investors and savers often reply the same: “Too risky for my taste”, “I can’t sleep straight when I know my money isn’t safe” or “my savings account is enough for me”.

There are other, more creative, versions of these answers out there. These answers are obviously all about a person expressing his or hers risk aversion. Stock and bonds investments are often thought of as risky investments only rich people can succeed in, usually at the expense of household investors.

This risk aversion is not to be trifled with. Some people may say ignorance plays a role in the decision making. While this could be part true I do believe financial “street smart” plays a key role as well. Many people subconsciously know, or learned through painful lessons, how cruel stock gambling can be and how tough it is to build and maintain a disciplined portfolio for the long-term.

After learning they might lack the discipline, financial education or funds many choose to save their money in different, low yield, savings accounts while banks cash-in on their deposits.

This alternative is obviously preferable to losing on investments but there is something else here. Paradoxically enough the most risk adverse people are taking on what might be considered an even bigger risk – The risk of not being in the market.

When you think about it the risk of saving for years on year in basic savings accounts is enormous. These investors actually give up on money they could have earned on their hard earned capital.

Much has been written on the benefits of long-term stock investments. While I’ve written, in length, in the past on why you definitely shouldn’t count on so called “average” yearly returns of 8% good diversification and a sound portfolio has incredible chances of performing much better than any 3.3% APY savings account.

I’ve found this nifty little retirement gadget on e-trade’s site. It gives an excellent demonstration of the importance of a good portfolio. The differences are overwhelming and they speak for themselves.

Avoiding investment risk generates another equal or greater risk: The risk of not meeting your retirement or life goals. It’s not about letting the bank cash-in on our savings it’s about letting our money grow as it should.

As I’ve mentioned, paradoxically enough, risk adverse individuals are unknowingly taking on another huge risk. Financial literacy and education can greatly enhance our overall quality of life and help us achieve our goals. Moving the slider a bit more to the aggressive side might do wonder. I certainly don’t encourage rash and irrational decisions, just a bit more spice in the portfolio.

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