My education of late has taken me into the field of financial planning. It’s been eye-opening and I’ve come away with more than a few insights. One which has shifted my perspective is the concept of when you take risk in your investing lifetime, and how that relates to your portfolio allocation and cash.

Consider the following questions, for instance.

Is holding cash safer than owning stocks?

Are bonds safer than stocks?

Go ask these questions to 10 people walking around your city and I bet they all answer “Yes.” Once upon a time, I would have answered yes myself. But I’ve gone beyond the point of no return in my understanding and now know the correct answer is “No.”

Cash is not safer than stocks.

Bonds are not safer than stocks.

To understand the reason, you first have to learn the correct definition of risk in the context of a lifetime of investing. But first, let me clarify what I do and don’t mean by “stocks.” I don’t mean buying a single company like Apple or Intel. That’s not investing in stocks; it’s speculation. I do mean investing in a broadly diversified basket of the biggest and best companies on the planet. Such as the S&P 500, for example.

History is replete with examples of once-great companies that have ultimately gone to the graveyard. Some stocks fall and never get up. But not the S&P 500. It always gets back up. ALWAYS.

What is Risk?

If you define safety as, “an asset that fluctuates very little in value,” then cash and bonds are indeed safer than stocks because they are less volatile. But volatility isn’t risk.

The only sane definition of “money” in the long run is “purchasing power.” In that time frame, risk is not the loss of principal, it’s the loss of purchasing power.

In 1950, my grandpappy buried $1,000 in a mason jar behind his house. His aim was to keep it safe for his grandkids. He just delivered it to my doorstep, pleased as punch that he had kept the money “safe.” But did he? NOT AT ALL. It’s not the principle that needs preserving, but the purchasing power!

It takes $10,751 today to buy what $1,000 purchased in 1950.

If gramps really wanted to keep the purchasing power safe, he should have invested in stocks. Historically, they’ve done better than any other asset on the planet at outpacing inflation. Better than real estate, better than gold, better than bonds, and certainly better than cash.

To be clear – in the long run, stocks are safer than cash and bonds because they are far more effective at preserving purchasing power.

Trouncing inflation doesn’t come without a price tag, however. You subject yourself to far more volatility in the hear and now. But if you’re investing this capital for uses far in the future, then why are you so obsessed with current volatility?

The Choice

Nick Murray phrases the choice as follows

“On which end of your investing lifetime do you want your insecurity so that you can have security on the other end?”

Pick Your Poison

Do you know what security looks like right now? Put all your dough in cash or a CD or Treasury bills. It will barely budge. No volatility or nothin’. You can rest easy knowing that the invested money is “safe.”

Eventually, however, you’ll run out of money. It may not be for years or decades. But just like my grandpa’s buried mason jar, you sacrificed security and wealth in the future for sleeping like a baby today.

On the other hand, you could take your insecurity on this end by investing in a broadly diversified portfolio of stocks. The value of your portfolio will hop around like a jackrabbit, threatening to scare you out of the best wealth-building asset known to man.

Volatility and spooky twists and turns on this end. Wealth and income generation on the other end. Unfortunately, you can’t have it both ways.

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