When most people think of risk in terms of their investments, they think of cash vs. stocks. They view their ‘low risk’ holdings as cash, blue chip stocks, bonds and their risky assets as stocks in general, especially small cap stocks. While there is an element of truth in this, a key point in understanding risk is time frame.
It is definitely true that cash is far less risky than stocks in the short term. After all, cash is cash. A dollar today is worth a dollar tomorrow. Whereas with stocks, any one company’s stock can go to zero. While holding a diversified portfolio reduces risk from any one stock, your portfolio can drop by 50% in a year, as happened to most investors in 2008.
The key element of this though is that cash is much safer in the short term. It is very risky though to have strictly cash in the long run. Let’s say you are a 25 year-old saving for retirement. You allocate $500 a month towards savings, putting $500 a month for the next 20 years for retirement. Your choice is stocks, cash, or bonds. You may think you are playing it safe if you just put that $500 in cash every month and conservative if you do a mix, though mainly cash and bonds. In fact, you are doing something that is quite risky. You are making a huge bet that cash will outperform the stock market over multiple decades, which has never been the case. It is true that the daily, monthly, and even yearly swings of the stock market are painful. But if you truly do buy and just hold for decades, you will come out a winner in the long-term. Since your time frame as a 20 something and 30 something saving for retirment is well over 20-30 years, putting your money in anything but stocks is a very poor bet. If you are putting your money entirely into cash, then you are in fact taking a large risk with your money.
If you put your retirement savings in cash instead of stocks for 20-30 years, then you will slowly see your retirement savings dwindle in comparison to what you put in, since inflation will eat away at it. Whereas your colleague who put his money in stocks will see capital appreciation. Your colleageue will have a much earlier and better retirement than you, since you scared yourself out of ever making a decent return on your money.