The Risk in Seeking ‘Safety’

Upon perusing financial news this week, one Bloomberg piece caught our eye. It highlighted a recent survey of 2,000 investors and concluded some 40% of respondents shifted their portfolios ahead of November 3’s midterm elections—especially younger investors.^[i] The main move? They sought to reduce “risk”—seeking “safety” from feared election outcomes. Set aside, for a moment, midterms’ strongly bullish history. We see a different investing philosophy problem: Safety doesn’t exist in investing. All assets have risk. Every decision is about tradeoffs.

Investors generally define “safety” as avoiding or mitigating market declines. Some may target “capital preservation,” or avoiding downside risk entirely. They care more about protecting what they have than reaping growth or cash flow. To them, sacrificing potential returns for greater certainty is a worthy tradeoff. This might mean owning money market funds, certificates of deposit (CDs) or other cash-like investments. Others see “safety” in minimizing short-term volatility. To avoid motion sickness, they try to shrink swings with assets like US Treasury bills or bonds.

But risk is omnipresent. Take US Treasury bonds. They are widely considered “safe” as their full-faith US government backing gives them negligible default risk. But they carry other risks, like shifting interest rates. Because bond prices move opposite their yields, rising interest rates hurt bond prices. See … well, this year. Long-term Treasury rates returned to their pre-2008 levels absent Fed bond buying, and inflation expectations add upward pressure. We doubt the latter lasts, but this year’s volatility cuts against “safety” claims. Bonds are down -3.0% year to date.^[ii] Stocks? Up 13.7%.^[iii] Anyone who chose bonds seeking capital preservation or “safety” still experienced short-term declines even as bonds did their core job: They swung less than stocks.

Buying short-term Treasurys when issued and holding them to maturity can avoid interest rate risk. As can holding cash, money market shares or plowing into a savings account. But you still aren’t risk free. There is inflation, when rising prices erode coupon payments’ purchasing power. These low-returning assets are particularly at risk from even modest rises in prices, given typically low yields. Even today, three-month T-bills yield 4.25%.^[iv] Headline inflation is upward-skewed by oil, but it is running at 3.7%.^[v] Excluding Energy, it is 2.6%. That doesn’t leave a lot of return. And then you may face reinvestment risk. When your short-term bond comes due, where are prevailing interest rates? Can you get the same quality bond at the same or better rate? Or are they worse? Many overlook this.

Other so-called “safe havens” are anything but. For instance, many see gold and other precious metals as “stable stores of value.” This is likely rooted in metals’ tangibility and long-standing use as money. But this label is false—gold has a spotty record against inflation, often swinging sharply and unpredictably on sentiment. This year proves that point, with gold down -4.6%.^[vi] And a longer-term look shows it is more volatile than stocks with lower long-term returns. That doesn’t strike us as “safe” … or even all that alluring. Silver suffers from all the same things.

Other debt and debt-like securities fail the test, too. Corporate bonds carry higher risk than government-issued debt, as companies lack tax-and-inflation powers to service debt. Preferred stocks (which grant dividend and liquidation priorities over common shareholders) carry even more risk. Some of these hybrids of debt and equity allow issuers to suspend dividends without default. Liquidity is another risk with preferreds, given the market for them is often quite thinly traded. Put simply, if someone tells you an investment is “safe,” ask “from what?”

Think longer term when weighing risk. Short-term market volatility can be trying. We don’t dismiss that. But if you need equity-like growth to reach your goals and objectives, it is unavoidable. Stocks’ long-term returns—which include bear markets and volatility—swamp all other similarly liquid asset classes, reducing the risk of missing your goals (the crucial, oft-overlooked risk). That is the reward commensurate with volatility risk. Yes, owning some bonds can make sense if you need relatively high cash flow rates, can’t stomach volatility or have a short time horizon. But your asset mix should be guided by your long-term goals and overall comfort with volatility in general—not fear around short-term possibilities. Especially considering midterm elections are usually very bullish.

To us, investors’ pre-midterm shifts reek of political bias. They dismiss that when you combine a midterm year’s Q4 with the following year’s first two quarters, stocks rose cumulatively in 92% (!) of these nine-month stretches. Plus, America’s economy is broadly growing.^[vii] It seems to us those repositioning on midterm fear disregard these key, powerful factors and seek safety that never exists from fear. In doing so, they add two more risks: The risk of missing returns they need. And the risk in trying to short-term time exit and entry points.