Earlier this week I spoke to a group of retired women about investment strategies in retirement. We talked about the need to review your asset allocation (my blogs The Key to Investing – Know Yourself and Asset Allocation=Investment Chili) and assess investment concentration (my blog Diversification vs Concentration) One of attendees asked me to write more about market volatility and how to remain calm.
First of all, let’s agree that none of us like the drop in the stock and bond markets nor do we like to go to the grocery store or gas station and hand over an ever-increasing amount of our income. Although unemployment has dropped—one of the two mandates of the Federal Open Market Committee (FOMC)—inflation, the other mandate, continues to rise. We feel it and it hurts!
What To Do?
I recently read an article that gave some great advice to investors, so I am going to share the key points:
- Focus on the long term.
- Don’t try to time the market.
- Control your behavior.
- Take some stock market risk.
- Don’t take unnecessary risk.
- Don’t reach for unsafe yields.
- Balance your stock portfolio with safe bonds and other fixed-income investment.
- Don’t keep all your money in cash.
- Keep enough money in cash to sleep well. [i]
Focus on the Long Term
Goal setting is an important exercise at any age. Even in retirement, your investment dollars are meant to help you reach a goal. It might be to cover living expenses, to leave a legacy, or to spend on what brings you joy and pleasure. You might want to review my blog, Set Your Investment GPS, if you need help with the goal setting process.
Do not to put money meant for short-term goals, those goals set for less than five years, into the stock market. Money for short-term goals should be put into liquid, safe savings vehicles. You might want to review Saving for Short-Term Goals, another of my blogs for some ideas. Only put what is meant to be used at least five years down the road or longer into investments and then combine stocks and bonds to match your risk tolerance considering your risk capacity.
Why not put money meant for the short term in the stock market? Because you may need to liquidate in a down market, such as what we are currently experiencing. Investing for the long term gives those investments time to recover from a downturn before it is necessary to liquidate.
Don’t Try to Time the Market and Control Your Behavior
A question posed at the meeting last week was: Why are the markets so volatile? First a review. We expect to make more, have a higher return, investing in bonds than in cash because bonds are riskier. We expect to make more investing in stocks than in bonds because they force us to endure even more uncertainty. “The willingness to endure volatility has tended to reward the disciplined investor, and often the greatest reward immediately follows the most significant times of market turmoil. The greatest folly, then, is in attempting to divine precisely when these times of volatility will begin and end.” [ii] That is impossible even for the savviest investors and professional financial advisors to consistently predict.
It is not easy to control our behavior, however. We tend to overweight losses and pain while under-weighting gains and joy, in money and life. At the same time, we also over-weight what has happened most recently while under-valuing the more likely, long-term outcome. If you feel the urge to sell your portfolio and go to cash, please consult a financial advisor who is a fiduciary first. Professionals know and understand the markets and their risks and can guide you to a smart choice that will not have lasting negative consequences for you and your portfolio.
Take Some Stock Market Risk but Don’t Take Unnecessary Risk
The Key to Investing – Know Yourself and Asset Allocation=Investment Chili cover these topics. The first addresses your unique risk tolerance and risk capacity. Knowing what risk tolerance is right for you is THE MOST IMPORTANT determinant of successful investing. If you invest to match your risk tolerance, you are less likely to panic and sell in a down market. The second blog explains how a mix of stocks, bonds, and cash make the best “tasting” portfolio. Your risk tolerance will lead you to the right mix for your taste.
To have the best chance to meet the investment goals that you set, your choices need “time in the market”. My blog, Rest is Productive, Even for Your Investments, provided evidence that the possibility of a positive outcome for your portfolio increases with time. Due to market volatility, it is important to have long-term vision. That does not mean that you keep all the same investments in place the whole time. A rebalance and performance review should be on your calendar at least annually.
Why do you need to keep some investments in the stock market? We invest in stocks for potential growth, and over the long term stocks have rewarded us with growth. Even in retirement years, investing some of your portfolio in stock helps keep up with and hopefully outpace inflation.
Don’t Reach for Unsafe Yields, Use Safe Bonds
These points refer to bonds and other fixed income investments. Remember when you buy stock you are an owner and are looking for growth. When you buy bonds or other fixed income products, you are a lender and anticipating regular income.
For example, Intel wants to build a new factory in the U.S. They could go to their bank or other financial partners to borrow the money, but one of their choices for financing is to go directly to the public. Why would they choose to do that? The reasons may be multiple, but an important one is that they could borrow money from the public and pay a lower rate of interest than they would borrowing from their other sources. They borrow directly from the public by issuing bonds.
An example of a corporate bond issued by Intel is part of my blog, What Are Municipal Bonds? That blog also talks about credit quality. How do you know that a bond is unsafe, or junk? Think about your own credit score. Credit scores and credit ratings are similar. Companies use credit scores (ranging from 300 to 850) to assess a person’s ability and willingness to make a car or mortgage payment. Investors in bonds use credit ratings to assess creditworthiness, or the ability and willingness of the issuer of the bond to pay investors (lenders) their money back plus interest.
Bonds that are safe for investors are called “investment grade”. The highest credit quality rating is AAA and the lowest is D (in default). For a bondholder, the higher the credit rating, the higher the probability you will be repaid. That means less risk. By reading my blogs, you know that lower risk typically means a lower rate of return. In general, you can expect the higher the credit quality of the bond issue, the lower the interest rate it will pay bond holders. So, when we say not to reach for unsafe yields, we mean not to buy bonds with credit ratings below investment grade. (There is a credit quality chart in the municipal bonds blog.)
Don’t Keep All Your Money in Cash but Keep Enough Cash to Sleep Well
You may be tempted to sell your stocks and bonds or part of them to go to cash. Having read this far, you know several reasons why that is not wise unless your risk tolerance has changed. One of the reasons is that it is impossible to predict precisely when to get back in the market and, if you stay in cash, you will decrease your purchasing power over time.
If you are drawing on your portfolio for your living expenses, you might want to consider a strategy that divides your money into buckets. One bucket might contain enough cash or cash-like vehicles to cover living expenses for the next year or couple of years. Another bucket may be intended for use after that, say two to five years out. The funds in that bucket might be put into certificates of deposit, short-term bond funds, or U.S. Treasury securities. All are liquid securities with limited fluctuation in value. Then the rest of your money, meant for goals five years out or longer, is invested in the mix of stocks and bonds that matches your risk tolerance.
There are many different variations of the above strategy, and your investment advisor may recommend something entirely different. The important point is this: do not sell everything and go to cash! It will take years to recover, and you will lose purchasing power.
I will be happy to address your concerns, either directly or through a future blog. Please contact me using my online form.
Stay calm. The road ahead looks rocky but stay the course.
~Beverly J Bowers, CFP®