It is looking somewhat like 2007. Stocks have risen by more than 30% during the last year and investors are starting to feel pretty good about their future. Perhaps you are thinking about retirement again after putting your plans on hold after stocks fell in 2008, figuring you’d need to work until you were 70 or 75. If you are even thinking about retiring in the next five years, consider taking advantage of the market rally by selling some stocks and raising some cash. Don’t let 2008 happen again.
The sad thing is, people really shouldn’t have needed to put off retirement after the 2008 crash. Those that did were not properly positioning their portfolio against the risk of a market crash. They should have been about 55% in bonds and income assets and 45% in stocks. If they had been they would have only seen the value of their portfolio decline by less than 10% – hardly enough to change their plans.
Instead many were nearly 100% invested in stocks, having been chasing gains since the market bottomed in 2003 and rose from 2003-2007 (the Bush tax cuts certainly ignited the stock market). They ignored the ever-increasing bubble in housing, perhaps even using the easy credit to take equity out of their homes or buy a bigger home using liar loans or option ARMs. This is the time they should have been looking to cut expenses and pay off their mortgage so they would enter retirement with a paid-for home instead of a load of debt.
The behavior of the crowd in the markets is really a lot like what happens on a craps table. For those unfamiliar, in craps a shooter continues to roll, and people continue to make money, until the shooter rolls a seven. At that point almost everyone loses the money they have on the table. Often in craps, when a shooter gets on a roll and is shooting for a while, people start to bet more and more. They keep winning and they keep increasing their bets, forgetting all about the risk or keeping track of how much money they are betting and how much they have actually made when the shooter started rolling. Eventually the shooter rolls a seven and everyone loses their bets. At this point most people end up with just a little more than they started with in the first place.
In the markets people tend to be the same way, taking more and more risk as the market goes up. Unlike craps where the dice have no idea what was rolled before, in the markets the higher prices go the more likely it becomes that a correction will occur. Right when people should be taking some money off of the table, they are going “all in” and sometimes even borrowing money so they can invest more than they have. Someone near retirement right now may be looking at a 30% gain from last year and decide that if they stay heavily invested for one more year they might make another 30%.
Unfortunately this can backfire if the market decides to fall. Unlike the younger individual who can simply stay invested and regain losses, the individual near retirement may need to sell stocks at lower prices to raise money needed for expenses. They might also need to delay retirement if the market takes too big a toll on their assets. The ability to continue working may also be questionable. This assumes that a layoff doesn’t occur as the economy sours. There are a lot of people in their 60’s or even their 50’s who were laid off and unable to find another job that pays anything comparable to the position they lost.
We’re at a point again where the market has risen dramatically, providing an opportunity for those near retirement a chance to get out at a good time. The markets may very well continue to do well for another year or two, but that cannot be predicted. For this reason, those near retirement should take the opportunity to raise some cash and shift to some income investments. Some things to consider:
1. If you are within 5 years of retirement, think about putting 5-10 years worth of expenses into cash. This will allow you to pay for expenses should the market falter. Because the market has almost always risen over a five-year period, and has always risen over a ten-year period, chances are good that the market will recover before you run out of cash if your stash is large enough.
2. Consider shifting into income assets. Normally one would shift into bonds to stabilize a portfolio and reduce the chances of losses. Unfortunately, bonds are way overpriced and pay paltry yields right now. Worse yet, bond prices will likely fall if the Federal Reserve starts raising rates, which they’ll need to do eventually. Instead of bonds, look for income in high quality, dividend paying stocks (look at banks, blue chips, and utilities). Also look at real estate (rentals or through REITs) and limited partnerships (although beware the taxes for these can be tricky).
3. Diversify internationally. Buying stocks in foreign countries will reduce the effect of a US slump somewhat (the global economy is connected, so this will not eliminate your risk entirely). One easy choice is a global mutual fund such as the Vanguard Total International Stock Index Fund or the equivalent ETF (Vanguard International Stock ETF, VXUS).
4. Did I mention cash? For money that you’ll need in the next few years, there is nothing like cash placed in a set of CDs or money market funds. In the case of inflation, the interest rate the money market pays will increase automatically, although not quite enough to make up for inflation, so this is not a good long-term plan. Alternatively, buy shorter term CDs if you worry rates may rise soon to avoid locking in a low rate.
Don’t let 2014 be a repeat of 2008. There is no reason to run to the sidelines if you have years before you need the money, but if you’re looking at retirement soon, it doesn’t hurt to pull money you’ll need out and diversify your holdings as a hedge against a market plunge.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.