I have to confess to leaving most of my portfolio in cash. With the markets so crazy and Europe so scary, I have been afraid to do anything. My initial plan was to have 60% in fixed income—now that I’m 60—and 40% in equity. Is that still a good idea? I definitely need a pep talk.
I think you need to cancel your cable TV and perhaps your newspaper, too. You are right that the markets are crazy and Europe is scary, but what is even crazier is leaving your portfolio in cash. Less news might be just what you need to get yourself back on track. Here are a few points to ponder:
You may have heard the expression “If it bleeds, it leads,” in reference to how the media often prioritizes stories. That’s not to say that stock market gyrations and the European financial crisis aren’t real or relevant. They are. But in the last 12 months U.S. markets are basically flat and while the TSX is down 10%, it is still up almost 70% over the last 10 years. My concern for you is that fear has you behaving in a less than rational way.
Inflation eats cash
Prices rise over time. The cost of a cup of coffee next year will be more than it is today. Over the long term, inflation will clock in at about 2% a year, which means that your money needs to increase in value by at least 2% per year just to keep up. If it doesn’t, you lose purchasing power. In other words, that cup of coffee gradually becomes harder and harder to afford, which is not good as you head into retirement. Sure, you might be a very conservative investor, but you need to factor in not only stock market risk, but also inflation risk, and then take rational steps to avoid it.
Fixed income is different than equity
You are leaving most of your money in cash when, really, your fears are mostly linked to the equity portion of your portfolio. (Said another way, you’re throwing the proverbial ‘baby out with the bath water’). Fixed income and equity don’t behave in the same way. In fact, the reason you should hold both is to diversify your risk. If you are concerned about the stock market, then you’re concerned about your equity holdings. And if you really are as afraid as you say you are, then you have even more incentive to hold fixed income vehicles such as government bonds, GICs, a bond ETF or a low cost bond mutual fund. You’re using the basic rule of thumb on how much fixed income to hold – an amount approximately equal to your age. To answer your question, yes I still think that basic asset allocation is a good idea.
Timing the market is virtually impossible
I was going to say that timing the market was impossible, but I decided to add “virtually” to help silence the howls of protest that would accompany such an unequivocal remark. Your decision to hold cash is basically an attempt to time the market: To figure out when to put your money back in for maximum gain. The data against this strategy is pretty compelling – even among professional money managers – so I wouldn’t recommend it for you.
You still have some time for investments to recover
It may not feel like you have time, given that you’re just five years away from when many people retire. But you do. After you retire you’ll rely on your investments to supplement any other income you have, such as CPP, OAS and/or a pension. Your fixed income investments will provide income of course, and you’ll start selling off your equities bit by bit. But you won’t selling them all on the day you turn 65 years old. Some you’ll hold onto for many more years and so there is time for them to rebound in value.
As per your request for a pep talk: Put your money back to work for you, in low-cost vehicles that give you a balance between capital appreciation and preservation. Said another way, “Keep calm and carry on.”
Please send your money questions to Bruce Sellery at firstname.lastname@example.org.