Stack of rocks balancing by the ocean.

Trading One Risk for Another? Find the Right Balance

Risk and reward. One implies danger and the other, success, right? Not exactly. With investments, it’s difficult—or even impossible—to have one without the other.

That’s why experts recommend a mix of investments: a portfolio that’s balanced and broad enough to cover a variety of market conditions and seeks to avoid volatile swings in value.

Each Investment Plays a Role

Let’s look at an example of what a balanced portfolio might look like over time—just starting out through retirement. One thing you’ll notice is that the investments aren’t static. The percentage of each type—stocks, bonds and money markets (cash)—gradually changes over time.

That gradual shift is important. Younger investors have more time before retirement to make up for any losses from market declines and can tolerate the risk inherent to stocks. Those closer to or in retirement may need more conservative choices to protect against sudden drops. But they still need some growth (via stock exposure) to carry them through a full life in retirement.

Portfolio Makeup Over Time

Hypothetical Change in Stock, Bond and Money Market Holdings

Source: American Century Investments.

The Risk of Missing Ingredients

Many investors are tempted to move out of stocks and even bonds in volatile markets. But what does that do to your overall portfolio mix? Too much in money markets, for example, leaves you on the sidelines whenever other investment types rebound.

When market volatility tempts you to pull back on your investment risk, either to run to safer choices or cash out your investments altogether, it helps to take a moment to understand what risks you face with any decision. 

Money Markets: You May Not Need as Much as You Think

Generally, you may invest in stocks for growth and bonds for income. Money markets, on the other hand, are used for their relative safety: They help preserve capital, provide liquidity if you need the money quickly, and along with bonds, they can provide hedge against major stock market swings.

Reasons to hold money markets:

  • Buffer against volatility. The stock market can fluctuate significantly and may result in a wide range of returns. Money market values are more stable because they are designed to keep a set price of $1 per share.
  • Emergency fund. Experts generally recommend that you save three to six months’ worth of living expenses. Money markets’ ability to preserve your capital can help ensure the value of your emergency fund doesn’t vary much.
  • Short-term goals. You may want to hold cash while you’re working through a large one-time purchase, such as a down payment for a house.

Too Much of a “Safe” Thing?

Many investors don’t always consider that “playing it safe” isn’t always safer.

Cashing out stocks or bonds in favor of money markets not only locks in losses, it may cause you to miss out on growth when the market eventually recovers. Rebounds are nearly impossible to predict and can pass you by while you wait on the sidelines.

Average returns of money markets are much lower than most bond and stock returns over time. Even large stock market declines during tough years eventually recovered. 

Consider the historical chart below, which uses common indexes as an example. Selling stocks during the 2008 financial crisis may have avoided a further drop in value, hypothetically speaking. But starting in 2009, stocks made up those losses—and then some. Bonds, too, continued climbing after the downturn.

Short-Term Reaction, Long-Term Regret?

Growth of $10,000

Source: American Century Investments, FactSet. Hypothetical value of $10,000 invested at the beginning of 1980 to December 31, 2019. Assumes reinvestment of income and no transaction costs or taxes. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. Past performance is no guarantee of future results.

U.S. stocks are represented by the S&P 500® Index. U.S. bonds are represented by the Barclays Capital U.S. Aggregate Bond Index. T-Bills are represented by the FTSE 3-Month U.S. T Bill Index, which is often used as a benchmark for money market investments.

Money Markets Vs. Inflation: Don’t Fall Behind

Inflation is another major risk when seeking the safety of cash investments. Money markets have only averaged an annual return of 1.78% over the past 20 years.* The rate of return on these investments simply can’t keep pace with the rate of inflation which averaged about 2.17% annually over the same period.

Assuming inflation averages about that much for the next 20 years, $1 today will only be worth $0.64 in the future.** In the pursuit of protecting your money from losses, you may also lose purchasing power over time.

Risks of holding too much cash:

  • Opportunity cost. Money markets don’t provide much opportunity for growth or income. They have historically provided a lower rate of return over time compared to most stocks and bonds.
  • Other hedges available. A diversified mix of bonds can also be used to hedge against stock volatility while having higher return potential than money markets.
  • Inflation risk. Inflation may outpace money market returns, undermining your future purchasing power.

The Fear of Running Out of Time

Many investors may be concerned that they don’t have enough time to make up losses due to volatile markets, particularly if they’re nearing retirement. Cashing out may seem like the best option to preserve a nest egg. Others may take on additional stock risk in an attempt to gain back any losses.

But investors have more options than just being all in or all out of the markets; it doesn’t have to be an either/or decision. There are a variety of options across the investment risk spectrum to choose from.



Evaluate Your Options: Bonds May Help

Bonds are a key component in any diversified portfolio and may provide a middle ground when timing is crucial. Core bond holdings provide more opportunities for income than money markets and can help temper the more volatile swings associated with stocks. Read more about the potential risks and rewards of bonds in a portfolio.

Benefits of a bond allocation during volatility:

  • Income. The yields (interest) that bonds pay can help provide steady income.
  • Diversification. Bonds can help balance risk and return because they often respond differently to market and economic conditions than other investments.
  • Capital preservation. Different maturities (the period when interest is paid on the investment) affect bond performance. Short-maturity bonds may experience lower price volatility than longer-maturity bonds and stocks and can help preserve assets.

A Path Forward

Remember, the percentage of each type of investment in your own portfolio should always depend on your personal situation, comfort with risk and time frame.

Stocks, bonds and money markets each play an important role, so be careful not to abandon any of your plans based on short-term, knee-jerk reactions.

If you’re worried about the market impact on your portfolio, we can help. A comprehensive financial plan can help ease your fears and chart a course forward.

*Money market returns are represented by the 3-Month Treasury Bill: Secondary Market. Rate represents the average interest rate at which Treasury bills with a 3-month maturity are sold on the secondary market.

**Source: American Century Investments, Financial Calculators from Financial Calculators ©1998-2020 KJE Computer Solutions, LLC. Inflation data from 1999 to 2019.

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We’re here to help you manage portfolio risk in turbulent times.

Money Market Fund: You could lose money by investing in the fund. Although the fund seeks to preserve the value of your investment at $1 per share, it cannot guarantee it will do so. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The fund's sponsor has no legal obligation to provide financial support to the fund, and you should not expect that the sponsor will provide financial support to the fund at any time.

Diversification does not assure a profit nor does it protect against loss of principal.

Generally, as interest rates rise, the value of the securities held in the fund will decline. The opposite is true when interest rates decline.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

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