Beware of the
“Risk-Free” Rate!

The recent rise in “risk-free” short-term interest rates has many people reconsidering the risk vs. reward dynamic relative to the stock market. While the increase in yields is welcomed relief compared to the historically low interest rates of the past 15 years, it is important for investors not to lose sight of the primary purpose of investing, which is to grow assets at a sufficient rate to stay ahead of inflation and provide a consistent stream of income for one’s life. While cash/cash equivalent investments serve an important short-term role in portfolios, do not lose sight of the longer term. Below are some concepts to help you think through the short-term desire for stability and the long-term desire for portfolio growth.

Nominal vs. Real Rates

One of the most important aspects of understanding the risk of the “risk-free” rate is the difference between nominal rates and real rates. The nominal rate of return is the rate of return before inflation, while the real rate of return is after inflation is considered. For example, if a stock investment’s nominal rate of return is 5% and inflation is 2%, then the real rate of return is 3%. Currently, the risk-free rate of return on cash/cash equivalent investments is approximately 4-5%, and with the latest inflation data running at approximately 6%, the real rate of return on these assets is still negative. So, even with a higher “risk-free” nominal rate, don’t lose sight of inflation and your real rate of return.   

Risk-Free Assets vs. Risk Assets Longer Term

While higher risk-free rates on cash/cash equivalents can be appealing in the short term, the longer- term return expectations on these assets compared to risk assets such as stocks, real estate, etc., is not.  In fact, since 1928, the rate of return on stocks, bonds, and cash averaged approximately 9.6%, 4.6%, and 3.3%, respectively. With inflation factored in, the real return for these asset classes dropped to 6.5%, 1.5%, and 0.2%, respectively. Recommendation: Structure your portfolio to provide for stability and liquidity in the short run without abandoning risk assets and the long-term growth they can offer.     

Avoid the Binary Choice (All Cash/Bonds vs. All Stocks)

With risk-free rates at their highest level in over a decade, the calls to abandon risk assets for safety and security are at a fever pitch.  While there is always a place for risk-free assets within a portfolio, investors should consider striking a balance between risk/risk-free assets.  Recommendation: Try to avoid the binary choice of all-in or all-out of risk-free assets. For pre-retirees and retirees, a heavier bias towards risk-free assets may be warranted. If you have a longer time horizon, play the long game with a healthy mix of risk assets such as stocks, real estate, etc., as they will help you better defend against, and stay ahead of, inflation. 

If you are concerned about how to balance your portfolio in a way that pays respect to your short-term desire for stability without sacrificing your longer-term goal of growth, we would love to start a conversation!

All situations are unique to everyone; be sure to consult with a Certified Financial Planning Professional to make a strategy that best fits your needs.

For weekly insights, follow The Welch Group every Tuesday morning on WBRC Fox 6 for the Money Tuesday segment. 

certified financial planner Marshall Clay wears a gray jacket and white shirt while posing for professional photo in office

Marshall Clay CFP, J.D., is a Partner and Senior Advisor at The Welch Group, LLC, specializing in providing Fee-Only investment management and financial advice to families throughout the United States. Marshall is a graduate of the United States Military Academy in West Point, New York, the Cumberland School of Law in Birmingham, Alabama, and is a CERTIFIED FINANCIAL PLANNER™.  In addition, Marshall is a frequent guest on local television stations as an expert on various financial planning matters.

IMPORTANT DISCLOSURE INFORMATION

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by The Welch Group, LLC –(“Welch“), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Welch. Please remember that if you are a Welch client, it remains your responsibility to advise Welch, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Welch is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of Welch‘s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request or at www.welchgroup.com. Please Note: Welch does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Welch‘s website or blog or incorporated herein, and takes no responsibility.