Weekend Update: Kids, Risk, and Gift Cards
Saturday, 15th December 2007 (by J.D.)This article is about Spare Change
This weekend is a flurry of activity: book group, office party, family Christmas. Somehow I need to find time to write about personal finance! The last couple weeks have been crazy, but I’m focusing on January. I know that in a few weeks, things will have calmed down and I’ll be able to devote my attention to writing again. Here are some articles from around the way:
- At Consumerism Commenteray, Flexo discusses overspending for kids. I think he makes a great point. I’ve seen many parents who lavish their children with expensive things. They do it because they love their kids and want them to be happy. But does this really create happiness in the long term?
- A guest post at Free Money Finance argues that cash has been the riskiest investment since 2002. This confuses me. I’m no financial expert, but my understanding is that risk measures the likelihood that an investment will lose money. While it’s true that the U.S. dollar has actually lost value over the past few years, does that mean it’s risky? Either I don’t understand risk or the author doesn’t. Or both.
- There’s still a lot of discussion about gift cards at various personal finance sites. The Mighty Bargain Hunter argues that gift cards are gifts, and can be appropriate in certain circumstances.
- After a conversation with his son, NCN at No Credit Needed created some charts to show the expected rate of return for specific small investments. He discovered that if you save $10 a day for 50 years (and can get a 5% return on your investment), you’ll have $791,335. It’s always fun to play with numbers like this. But it’s even more fun to actually begin investing.
- Five Cent Nickel took a look at the best 529 plan. I don’t have kids, and so am unfamiliar with college saving methods. (If anyone wants to write about this, I’m open to publishing a guest post.)
Time for some chores, and then it’s off to Kris’ office party. She has a great group of co-workers, so we should have fun!
College savings plans? I could do a post on RESP accounts (Canadian education savings plan) but that would interest about four of your readers..
Mike
Wow, that FMF article was rather convoluted.
I do want to say though that there is absolutely risk to keeping your funds as cash rather than investing more aggressively. Inflation reducing your buying power is just as bad as losing money on a stock, either way you can’t buy as much stuff!
I have to try not to laugh when I recommend investments other than savings accounts to people at the bank and they say “the don’t want any risk.” Taking a .35% interest rate guarantees a loss in buying power! While cash has almost no risk of capital loss, what good is it to only maintain capital while your purchasing power is slowly eaten away?
I think maybe cash is considered “a risk” because it tends to lose its value quickly over time due to inflation.
Perhaps the post was saying that we are better off not saving a bunch of cash but instead investing our money elsewhere–putting it toward a business, real estate, etc., for example, since a dollar today is worth less than a dollar next year due to inflation.
Just a guess . . .
I was into my bank today about my RESP — to transfer it to the bank’s discount brokerage, so that I can take advantage of a wider range of investment vehicles. Okay, so, who are the other three people who want to read about RESPs?
I think it’s not so much that it’s the riskiest as that it’s performed badly lately. It doesn’t often drop in value by a lot, but does so slowly do you don’t notice. It’s just a headline.
I’m pretty sure FMF is using the definition of risk where your investment loses buying power — not nominal value. This is why inflation is so dangerous to one’s investments.
I think the FMF article was focused more on international buying power not inflation here at home. I am not sure why the author translated the falling dollar against the Euro to cash being high risk. Also, he used a very narrow time period (2002 to today) which supported his contention.
Keep in mind that the FMF article was actually written by an asset management firm, so it’s not necessarily unbiased.
Yeah, I know, but still — am I missing something? I was reading Random Walk Guide to Investing today, and again Malkiel uses the same definition of risk that I’m familiar with: it’s a measurement of predicted volatility, not a measure of actual volatility. Cash has low risk.
Also, I need to re-read the article, but it made me realize the fundamental premise may be flawed. I recall the argument is that as the dollar drops, cash is de-valued. Yeah, but so are all other investments, right? So it’s not even a real argument. It’s a red herring or something. Lame.
There are lots of different kinds of risk: inflation/purchasing power risk (your dollar is worth less over time), credit risk (the entity you lent money to won’t give it back), principal risk (your investment will lose nominal value), market risk (everyone suddenly decides stocks or real estate are overvalued) blah blah blah. They’re not really comparable. Economists like Malkiel have this drilled into them for so long they can toss the word “risk” around and intuit which kind is meant from context. Everyone else tends to confuse them.
Cash always carries the highest inflation risk (except for maybe some kinds of commodities) so FMF is right as far as that goes. And there’s some currency risk thanks to imports and exports. But cash doesn’t carry any principal risk–a $5 bill will always be nominally worth $5. So “riskiest investment” doesn’t really have any meaning until you define your terms. Investment and financial planning are interesting in part because there’s a need to balance different kinds of risk with different kinds of instruments; there is nothing that is low-risk or high-risk according to all definitions of risk. (And to think I despaired of time wasted in those graduate courses in microeconomics.)
Saving dollars isn’t that risky, in my opinion. If you have fixed rate debt (like most people) and a hoard of cash, even if the dollar goes into the gutter, your debt is in dollars so you can always use your cash reserves to pay down your debt and realize your fixed interest percentage as a return.
IOW, if I owe $100K on my mortgage at 6% and have $100K in the bank, if the dollar falls to the point that the cost of lettuce rises to $1000 a head, I can’t buy a lot of lettuce, but I can still pay off my house. That gets me a 6% return over 30 odd years.
In the meantime, if the dollar does NOT fall to the point where lettuce costs $1000 a head (the more likely scenario), I have $100K in the bank earning 4.5%.
Its a little riskier if you DON’T have any debt to absorb the risk of saving dollars, but if you are in that position you are ahead of the game anyway, so I wouldn’t worry too much.
Also, if you have a huge cash reserve, and the dollar tanks to the point where its worthless, you likely have bigger problems on your hands such as wide spread civil unrest, martial law, etc.