Our previous letters have talked about the three buckets you have for your money: short term, long term, and in-between. Each one serves different purposes. Today we will dive into the details of the different assets you can put into those buckets.
The simplest and most familiar asset class is cash. It has a fixed value and is completely liquid, available to spend any time you want. While the change jar on your counter is not exactly an investment, you can put it in a savings account and generate a little bit of interest. Short term certificates of deposit and Treasury bonds can also be considered cash equivalents as long as the maturity is within a few months. They can not be spent without notice, but could be turned into cash quickly for major expenses.
Longer duration CDs and bonds fall into another asset class: fixed income. You can expect higher interest by accepting longer maturities and shakier credit ratings, so fixed income will generate more income than cash. There is a reason for this: your risk exposure also increases. Buying bonds with poorer credit quality increases the risk that the borrower will go broke and default. And if you lock in your money long term at a fixed interest rate, you will be in for pain if inflation and interest rates rise. This can make fixed income investing difficult in a low interest rate environment.
The third main asset class are equities, or stocks. These are what you are thinking of when you talk about the stock market. Stocks represent partial ownership in a given company. Exchange-listed stocks are liquid, and owning a share of a rapidly growing company offers the potential for higher returns. But again, these returns come at a trade-off of volatility and risk. There is no fixed face value or interest rate on equities, and the market price can change rapidly.
There are also alternative investments outside of these three main asset classes. Most alternative investments are tangible assets such as real estate or physical commodities. These assets are largely speculative: they do not grow on their own and do not pay out interest. As such, we do not generally recommend them.
Different assets are useful for each bucket. Your short-term bucket needs both liquidity and stability, so it should be mostly or entirely in cash. Your long-term bucket can tolerate more volatility and will probably want to seek higher returns, so equity investments may be more appropriate. The intermediate-term bucket can hold a range of investments, although you will probably want a healthy proportion of cash and short-term investments.
Your financial situation is unique, and there is no one-size-fits all approach. Clients, if you want to discuss what is in your buckets, please call or email us.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
Government bonds and Treasury bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.
CDs are FDIC Insured to specific limits and offer a fixed rate of return if held to maturity.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
Stock investing involves risk including loss of principal.
Alternative investments may not be suitable for all investors and should be considered as an investment for the risk capital portion of the investor’s portfolio. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses.
All investing involves risk including loss of principal. No strategy assures success or protects against loss.