The "hidden" Risks Of Money Markets

Whew! Recently, the stock market has been giving us investors quite a ride.

Sure, the market goes up, then it comes down - that's always been the case. But recently the intensity of the rises and the drops have been the equivalent of a Cedar Point thrill ride (and that's saying something). 200 points up, then 200 points down. It's outright frightening sometimes. And it's enough to send the most skittish of investors running for the hills to bury their money in the nearest hole they find, which, by the way, is Mother Nature's equivalent of a money market fund.


Each and every day I witness retirement plan participants and other investors bounce in and out of the stock funds and money market funds. They clamor for the money market funds when the stocks take a nose dive, and then they dive back into the stock funds after the Dow gains 200 points.

These investors are letting their emotions get the best of them, and consequently, they're paying the hefty price of substandard returns over the long term.

To them I say, "Stop chasing performance! Just stick with it."

To be sure, there are many individuals out there who should have a large portion of their money in principal preservation investments like a money market, but these people are typically older, retired individuals who are on a fixed income and can't afford to take the risk associated with investing in stock funds. For the average person between 0 and 55, investing in stock funds is one of the best ways to attain substantial growth on your money over a long term period of time. Just stay away from the money markets.

"But my money is safe there," they say. True, you're not going to lose your principal investment in a money market fund, but don't think you're entirely safe, though. There are "hidden" risks associated with the money market that you need to be aware of, especially if you bounce in and out of the stock and money market funds frequently (or even infrequently)

First, there's inflation risk. This is the risk that inflation will erode the value of your investment over time. If inflation is increasing at an average of 3% (which it roughly has) that means the return on your investment, in real dollars, is 3% less than what you actually see on your financial statements. So, if a stock fund has an average annual return of 10% over the last 20 years, and inflation has risen at an average of 3% each year during the same period, then your real inflation-adjusted return is really only 7%. Apply that to a money market fund that has return an average of 3% or 4%, then that money market has a real inflation-adjusted return of 0% or only 1%.

This can be made even worse during an economic period of low interest rates and high inflation (something like we are experiencing now). In these circumstances, you could actually lose real value to the dollars invested in your money market account. Makes you think, doesn't it?

Another risk relates to jumping in and out of the market, a.k.a. market timing. Chasing performance is a guaranteed losing investment strategy. You will likely be getting into an investment after the excitement has already ended, and arrive just in time for the drop. You should stay invested in the market through all market conditions. Here's why:

(The following is quoted directly from
http://www3.prudential.com/signature/Market-Volatility.html)

Equities, as measured by the S&P 500 Index between 1982 and 2001 enjoyed an 11.8% return (Past
performance does not guarantee future results). The end result is that an original $10,000
investmentif it stayed in the marketgrew to $93,075.*

But what about an investment of $10,000 during that same time frame that left the market for some
of that timeeven for small periods? Heres what happened to the account balances of investors
who missed a certain number of the markets best-performing days over that 20-year period.
Instead of their account winding up with $93,075:

- Those who missed the 10 best days had an account balance worth $56,044 ($37,031 less).

- Those who missed the 30 best days had an account balance worth $28,144 ($64,931 less).

- Those who missed the 50 best days had an account balance worth $15,781 ($77,294 less).


Of course, some of you may realize that this statistic ends prior to the major correction the stock market experienced in the early part of the decade, but you'll see similar results for any extended time period you select. The point, however, is unmistakable; ride out the market during its best and its worst. Stop trying to time it. If professional fund managers can't time the market with great success, the results of a part-time investor in a 401(k) plan will likely be minimal.

In the words of the great John C. Bogle, "Stay the course!"

By: Ryan Rush

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Ryan Rush is the owner of www.guide-to-retirement-plans.com and blog.guide-to-retirement-plans.com. Ryan has a passion for learning about retirement plans and he uses his websites to share his knowledge and experience in order to educate others.