By: Steve Metzenthin
As I write this, the Dow Jones Industrial Average is down 742 points or about 3% on the day. It got me to thinking (again) whether the market is overpriced or not. What are we to think when market moves result from novice investors, some apparently investing their stimulus checks, chasing gains on Tesla and Apple shares on new cell phone apps featuring no commission trades? What are we to think when we suspect that markets are responding to the so-called Federal Reserve “put”? The Fed’s policy has been most accommodating to equity investors (and the United States government) for years, maintaining interest rates that have resulted in negative real yield on savings and CD’s and forcing investors into riskier investments.
Is it possible that the Fed “put,” creating consistent new demand for equities, along with possible moral hazard, will result in a fundamental change in the way in which equities are valued? If so, you certainly don’t want to be left behind. Or is it more indicative of speculative excess? (Which will turn out the way all bubbles throughout history have.) If so, you want to be out of the room when the music stops.
Here are some things you might want to consider as you ponder the possibilities:
- Avoid sequence of return risk – It is well-documented that the risk of portfolio failure (i.e., running out of money before the end of retirement) is greatly increased if portfolio losses are incurred immediately before or after retirement. Portfolio losses are more likely to occur when current equity valuations are high relative to historical standards. Unless you have plenty of time and assets to ride out the storm, you may want to lighten the percentage of equity holdings in your portfolio if you are nearing retirement and equity values are historically high. If the equity values are historically low, you might want to consider buying more.
- Remember that in retirement, income generally counts more than asset value – you’ve spent your working lifetime building up a nest-egg. Now is the time to let go a little and enjoy it in the form of lifestyle. For many of you that could include converting assets into cash flow by purchasing annuities, creating bond ladders, or buying target date mutual fund shares. Generally, people in retirement are happier if they feel they are spending income as opposed to savings. You may feel better if you know that your basic expenses are covered no matter what.
- Don’t forget inflation – The Feds stated objective of 2% inflation should be troubling to all savers, especially in light of the current interest rate environment. Unless you have the right amount of equity exposure, you risk losing purchasing power over time. This should concern retirees since the expenses they incur (particularly medical expenses) inflate at rates in excess of the rate on expenses incurred by the general population and reflected in the Consumer Price Index. It is generally necessary to tradeoff between the short term safety, and the lack of volatility, in assets needed soon and the inflation protection over time provided by equities and alternative investments.
All of these concepts are grounded in the larger context of proper asset allocation. However, not everyone appreciates it. Some years back I stressed the importance of portfolio diversification as I explained the relatively poor return on an asset class to my now 98 year-old mother. She wasn’t buying. “Oh, fiddle. To think what your father and I went through to send you to college so that you can now tell me it’s a good idea to invest in things that lose my money. Mix me a martini, please.”
In my next post, I’ll unpack how each outcome of the election could allow for tax plans that may negatively affect your retirement.
[This Insight is the first in a series devoted to issues related to retirement planning]