3 Investment Risks and What to Do

Risk #1: Falling Behind Inflation

Seeking the safety of cash investments? Inflation has averaged 2.13% since 2000, but money markets have only averaged 0.13% during that same time.* Money market returns have beaten inflation twice since 2000, but when inflation wins, you could get negative “real” returns (i.e., the returns after subtracting the rate of inflation).

Seek to Avoid Negative “Real” Returns

Historical Money Market Returns After Inflation

Data from 1/31/2000 to 3/31/2021. Source: FactSet, Bloomberg, American Century Investments. The inflation rate is annual calculated every month. Past performance is no guarantee of future results.

*Money market returns are represented by the FTSE 3-Month U.S. T Bill Index from January 2000 to March 2021. Inflation returns are represented by the Consumer Price Index. Data from January 2000 to March 2021.

What Can You Do?

Consider investments that have the potential to outpace inflation. Bonds, particularly those designed to fight inflation, can also help. They provide more return opportunities than money markets, plus they aren’t as volatile as stocks.

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Are you getting what you expect from your portfolio? Learn how different kinds of bonds can help you address your needs.

Is Your Portfolio Prepared for Inflation? 

Want a deeper dive into inflation preparation? Bond expert Robert Gahagan leads you through the current drivers of inflation and what it means for your portfolio.

Risk #2: The Extremes

You’ve probably seen this warning in the fine print: Past performance is no guarantee of future results.

But in general, certain investments do have characteristics that make them more or less likely to perform a certain way. Stocks have the potential for high growth—but also major losses. Bonds are typically less volatile but can still have wide swings. Money markets rarely have high returns but don’t have a high risk of losses. 

Seek a Smoother Ride

Best and Worst Years 1908-2020

This chart is for illustrative purposes only. It does not constitute investment advice and must not be relied on as such. Assumes reinvestment of all income and no transaction costs or taxes. The Balanced Portfolio consists of 10% T-Bills, 35% bonds and 55% U.S. stocks. The Balanced Portfolio is neither a real, nor recommended portfolio. It was rebalanced each January. All investment returns are compound annual returns.

Sources: Data as of 12/31/2020. Morningstar Direct. Federal Reserve Bank of St. Louis. American Century Investments®. U.S. Stocks data: S&P 500® Index, U.S. Bond data: Bloomberg Barclays U.S. Aggregate Bond Index, T-Bills data: 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.

Stock and bond returns assume reinvestment of all income. Past performance is not an indicator of future performance.

What Can You Do?

So which should you pick? A balanced portfolio of all three might help you balance any extremes that pop up over your investing time frame. If your portfolio is heavy on either stocks or money markets, it could be time to strengthen your bonds. 

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Risk #3: Your Tax Burden

Your portfolio might be positioned for various market conditions, but is it prepared for taxes? The amount you pay in taxes can cut into the returns you receive from your investments.

Many people incorporate specific strategies to cope with their tax bill, including investing in tax-free bonds. Taxable bonds might provide higher returns, but tax-free bonds have the potential to make up for the gap with their tax-friendly status.

Here’s how to calculate the difference:

Tax-Equivalent Yield   =      A Tax-Free Bond’s Yield  

1 – Your Tax Rate

The tax-equivalent yield can help you compare taxable and tax-free bonds: It’s the return that a taxable bond needs to earn to equal the yield on a comparable tax-free bond.

Tax-Free vs. Taxable Bonds

Comparing Hypothetical Tax-Equivalent Yields

Federal tax rates used to calculate tax-equivalent yields: Moderate Tax Bracket – 28%; High Tax Bracket: 40.8%.

Source: American Century Investments, IRS.gov.

What Can You Do?

Municipal bonds (munis), which are loans to cities, states and other political entities, are a common type of tax-free bond. Muni interest is free from federal taxes (and sometimes state and local taxes) and may help you build a more tax-efficient portfolio. 

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Need a middle ground? Let's get started.

Find out if it's time to strengthen your bonds.

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.