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Makin' Money

Kathy Kristof on the riddle of risk

Chris Farrell Nov 1, 2010

Question: In addition to owning my home outright (a duplex in a historic district, both sides of which are currently rented out as I care for my elderly mother in HER home, rent-free) as well as a new car outright and having NO debt (I pay off my credit card monthly), I have over $178,000 just sitting in the bank earning 1% interest. This is killing me! I’m about five years away from early retirement and want to see my money work for me, but also want a safe and SENSIBLE investment. Needless to say, the stock market is out of the question. I have located two separate properties I could purchase — again, outright, and still have some left over — and rent out, but find I am choking on pulling the trigger(s). Lucrative, low risk (the only risk being landlord troubles and/or being unable to resell one day). What is wrong with me, LOL? Others take BIGGER risks without batting an eyeball. Do I need therapy? Ellen, Frankfort, KY

Answer: No, but you are thrifty.

Here’s a riddle. You’re given two investments. One investment is for $1,000 and you are going to lose that investment. There’s no doubt about losing it all. The other investment is also for $1,000 and you could end up losing 75% of it or it could be worth 5 times more by yearend. Which is the riskier investment?

It’s the second one. In finance, the more variable the return the greater is the risk. And by this measure the stock market is risky. But many investments that we think are super-safe aren’t really. It’s that the risk come from a different direction.

Take rental property. One risk is that it’s illiquid, meaning you can’t just sell it quickly. There’s also the risk that your tenants won’t pay the rent. But if you put money into the stock market your risk is limited to what you invest. If you invest $100,000 all you can lose is $100,000.

You might want to think about putting a portion of your cash into a low-cost balanced fund, the kind of fund that that invests in both stocks and bonds,. For instance, the Vanguard STAR fund (VGSTX) is 60% stocks and 40% bonds. It will still lose money when everyone else is losing money, just less. And when everyone else is making big gains it will still be up, just less.

I’m concerned about you putting all your investment eggs in one real estate basket.

(You can listen to the whole answer here, as well as learn how Ellen manages to save so much.)

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