A lot of retirees are wondering how they should react in the current economic crisis. My “Top Five” list of things for retirees to consider (or at least what I’ve told my retired parents) includes the following:
1. Some of your portfolio should be in cash. For years, long before this crisis broke, Vanguard’s experts and others have recommended that retirees consider holding 6-12 months’ worth of annual expenses in a money market or other liquid account. More than 6-12 months may be appropriate only if you’re really risk-averse or extremely pessimistic.
As Wall Street Journal columnist Jason Zweig pointed out (subscription required) in an article late last year, in addition to bank deposits and your investments in real estate, you probably have a significant portion of your assets in the form of Social Security entitlements—which are arguably safer than cash in this environment (see below).
2. Stay diversified. There’s no single “safe” place for all of your assets. It’s true that the government now guarantees up to $250,000 in bank deposits, so these assets are insured against bank failure. But these deposits are very much subject to inflation risk, which could be a problem going forward given the amount of cash currently flooding the markets.
Risk premiums are significantly higher across virtually all types of risky assets, and if you’re willing to take some risk, you can reasonably expect to be better paid than at any time in recent memory. No one knows when this situation is going to turn around. An implication of the potential inflation risk from the amount of liquidity flooding the system now is that when sentiment turns, a lot of money is likely to move in a hurry. Retirees—especially recent retirees—should carefully consider the potential opportunity costs of holding much more than 12 months of expenses in cash.
3. Take action only if you can’t sleep—and even then, a good rule is to step only halfway into or out of any position on any given day. Hedge your bets; no one can predict what will happen tomorrow. As convinced as you may be that markets are at the bottom or still have further to go, you can’t know for sure, and so it’s unlikely that a wholesale change of strategy is the right thing to do. Any investment strategy adjustments you make should be marginal and gradual.
4. Recognize that this is a financial crisis, not a natural disaster. The economy’s productive resources (property, equipment, and workers) are all still here. So, capacity in the economy to create goods and services of value is basically entirely intact. At its core, the current financial dislocation is a result of the fact that we’ve collectively come to the realization that our productive capacity is allocated very inefficiently. What is going on now is a painful process of correcting that.
It’s true that there has been, and will continue to be, economic fallout from the credit crunch. But retirees hold claims on financial assets that, though risky and volatile, can typically be broadly diversified to reduce some risk, and in many ways are more fungible and flexible than the assets of those who haven’t been able to build a retirement portfolio yet.
In other words (cue the Monty Python number “Always look on the bright side of life”!), the one thing you don’t have to worry about in retirement is being laid off.
5. Decrease the amount you’re spending from your portfolio. The bottom line is that virtually everyone has less wealth today than they expected to have a year ago. This means that our “budget constraints” are tighter than we thought they would be. Whether the downturn in asset values is permanent or not, we should all be considering how to revise our plans for spending to accommodate this new reality.
Even if you expect (as most of us do) that this crisis will pass and asset values will rebound at some point in the not-too-distant future, no one knows how long that will take—or even, with certainty, that it will happen. Given this new reality, it’s only prudent to scale back at least a little, if at all possible, and even think about scaling back further in the future, should that be necessary.
I’d be interested to hear what other Vanguard investors are doing to weather the current economic crisis. What’s on your “top five” list?
(We’re not able to publish your comments, but we’ll read each response, and I’ll discuss a few of your best tips in an upcoming post.)
All investments are subject to risks. Diversification does not ensure a profit or protect against a loss in a declining market. Bank deposit accounts and CDs are guaranteed (within limits) as to principal and interest by the Federal Deposit Insurance Corporation, which is an agency of the federal government.
An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.
Notwithstanding the preceding statements, all Vanguard money market funds are participating in the U.S. Treasury’s Temporary Guarantee Program for money market funds. The program generally does not guarantee any new investments in the fund made after September 19, 2008, and is scheduled to expire on April 30, 2009. For more information, please see the fund’s most recent prospectus as supplemented on October 8, 2008.
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