Risk, Volatility and an Unpredictable Market: Should *You* Worry?

[sabrinamari]

My clever friend flamespirit asked me a really, really good question. She was reading one of my posts closely and caught a very important detail that I have not addressed.

She saw that I have both an FDIC-insured money market account and a money market *fund* account that's not FDIC insured. A money market fund is a mutual fund that invests in conservative equities with the goal of keeping its value stable at $1 per share. It's a fund that *acts like* a money market account, but is not *actually* a money market account. Money market funds are not FDIC-insured, but money market accounts do carry FDIC insurance.

FDIC insurance is a guarantee of your money from our federal government. If an FDIC-insured bank fails, each depositer's money will be returned up to a certain amount (I think it's $100,000 per depositer, but I need to check).

Being a smart woman, flamespirit asked why I would even consider putting my money in an account that is not FDIC-insured.

The answer is important, because it will help you think about:

1. ...Your own tolerance for risk

2. ...Any anxiety you may feel about the current bear market. In a bear market, lots of stocks and funds are losing their face value, and consequently, people's portfolios are losing money. Many people are afraid to invest during a bear market.

My answer:


No individual investor has ever lost money in a money market mutual fund. It has only been a possibility once or twice and on each occasion the fund company involved has made good on any potential investor loss.

Money market funds also invest in extremely conservative equities---very conservative! However, these equities provide a higher return (a higher interest rate) because they are slightly riskier than regular money market accounts. In investing, the more risk something carries, the greater its potential return.

I have an Emigrant Direct online money market account because my dad fears another Great Depression, and he wants me to have plenty of $ in an account that carries FDIC insurance. I don't worry about the risk of a money market fund too much, although I respect his opinion. It is, after all, the safest course of action to choose an FDIC-insured money market account.

But I don't think there is any real risk of a money market fund loss. The economic downturn required for this would be exceptional, and I don't think it's likely at all. I think we're on board for a multi-year recession at worst.

The Vanguard money market fund also allows me to move $ between my major emergency fund/savings account and my Roth and taxable accounts very easily. In other words, I can buy a little bit more of the mutual funds in my Roth accounts quickly and easily by transfering money from one account to the other. I like to do this on days when the market is very stinky and it has plunged dramatically.

(This is the equivalent of waiting until the expensive shoes you want at DFW have been put on the 70% off rack at the back of the store.)

That said, how much risk a person can absorb is very particular to each person. I can tolerate a moderate level of risk for a slightly higher return, but it's not a good idea for everyone. A money market account is as close to a sure thing as you can get, but a money market fund is a little riskier---theoretically, you *could* lose your money. But to compensate you for this, money market funds pay higher interest than money market accounts.

This doesn't make me uneasy, but it might make you nervous. And in general, if something makes you uneasy, *don't do it*!

The sleep you lose is *not* worth the extra money you could make. On the other hand, I can watch my portfolio drop like a stone and be cheerful and happy--extra happy, even, because I know that this means that funds and stocks are cheap right now, and I can buy more for my money.

I learned about investing late in life, from books and websites, and I started with Modern Portfolio Theory. So from the beginning, I built my understanding on the theoretical principles that:

1. You must buy cheap and sell dear, and

2. That short-term volatility is irrelevant---it's long term asset allocation (creating a pool of diversified long-term choices) that actually counts

So short term bear markets don't worry me at all. They are part of the market's normal behavior (and by short term, I mean a few years or so).

Since I am a new investor with only little $ in the market and only a little $ to spend, I *need* a long bear market to make the most of my money while I build up my portfolio. A bull market (a happy, rising, seemingly low-risk market environment) is not good for me right now.

I want that later, when I am getting ready to retire. Now, a happy, rising market would mean that I could buy less for my investment money. Later on, though, a rising market would mean that the money I have built up will be preserved rather than diminish right when I need it.


So, more risk and more volatility helps me right now: less risk and lower volatility would actually *impede* my progress. And if you are a new investor with a moderate-to-high tolerance for risk, this is a GREAT time to invest.

If, however, you are a new investor with a lower risk tolerance, it's a good time for your portfolio but a bad time for your peace of mind.

Comments

[wild-place-king.livejournal.com]

At the risk of being pedantic, while FDIC insures bank accounts, SIPC insures investment accounts. While there is ALWAYS risk when you invest your money, there is some protection. However, protection does not take the place of common sense.

I can't emphasize strongly enough, when you invest, use the services of an investment professional (IP). Yes, there will be fees, but only when you place a trade. If you need help finding someone reputable, let me know. I work with IPs all around the country and I know who pays attention.

[sabrinamari.livejournal.com]

Please, never hesitate to add your knowledge and expertise to our lives, my dear!

Can you tell us a little more about the SIPC? What kinds of investment accounts are insured?

Thank you, honey.