Posted on 11/04/2007 8:02:30 AM PST by BenLurkin
If you're saving for a retirement decades away, Thursday's big drop in the stock market shouldn't worry you too much. But something did happen this week that you can't afford to ignore: the Federal Reserve's rate cut.
The Fed's actions could very well be ushering in a new era of inflation - and that is horrible news for your retirement portfolio.
When you save for retirement, you're saving for a lifetime supply of food, shelter and golf fees. Over time, the prices for these things only go one way: up.
The risk is that the value of the investments you're now stockpiling to pay for them may not increase at the same pace - leaving you with only enough money to pay for nine holes' worth of green fees.
With its rate cut this week, the Fed has made it clear that staving off recession is more important than reining in inflation.
But while the typical recession has lasted 18 months on average (not including the Great Depression), inflation can dog your finances for a long, long time.
Our last inflationary cycle stretched out for almost 20 years, from the mid-1960s to the early 1980s.
I'm not saying that the Fed's quarter-point rate cut is going to turn America into Argentina overnight. But you'd be wise to start taking steps to guard against the possible uptick in inflation.
Don't be too conservative
When the stock market gets especially volatile (as it is right now) there's a natural temptation to flee into conservative investments like government bonds. That's understandable - you have to be able to sleep at night.
But the risk of loss is only one of the two big risks you face. The other is the risk of inflation - and it can be just as damaging.
To see why, consider that the average rate of return on the 10-year Treasury bond has historically outpaced inflation by only about one-and-a half percentage points.
Right now, for instance, the 10-year Treasury is yielding about 4.4%, while the inflation rate is running at 2.8%.
Sure, a Treasury bond is a safe investment if you hold it to maturity. But unless you've already racked up more money than you can possibly spend, that yield will not even get you close to the stash you'll need to live on in retirement.
So to protect your portfolio simultaneously against both the risk of loss and inflation, you must be diversified.
Bonds, for instance, frequently move up when stock prices are heading south, dampening your risk of loss. But at the same time, bonds, more than any other type of investment, can get hammered by rising inflation.
Think back to the early 1980s, when inflation was running at around 10%. At the time, even ultra-safe US Treasuries were sporting double-digit yields, which certainly looked tempting. But to entice new bond investors, the government had to keep ratcheting up the interest rates they offered on new bond issues. That made the prices on existing bonds plummet (since the interest they paid was less attractive) and bond investors took big losses.
Over the longer run, common stocks have done a much better job of protecting investors from high inflation, since their returns are generally about four to five percentage points higher than high-quality bonds. But of course, stocks can crash in the short-term.
Real estate investments, such as REITS or real estate funds, typically perform the best of all types of investments during times of high inflation. But like stocks, they also carry a significant risk of short-term loss.
Add all of this up and it means that you've got to have a smattering of all asset classes. Ideally, your portfolio will hold a mix of small- and large-cap U.S. stocks, a smattering of international stocks, some REITs and some bonds.
The exact investment mix that is right for you will depend on several factors including how much time you have until retirement, the degree of risk you're comfortable taking, and other sources of retirement income you might have.
Roughly speaking, though, the targets for your retirement asset allocation might look like the following:
At 30, you might aim for 75% stocks, 10% REITs and the rest in bonds.
At 45, you'd shift to 70% in stocks/REITs, and at 60, you'd reduce your stock/REIT allocation to 60% of the portfolio (Corrected).
Even if you're already retired, you'll want to keep some exposure to regular stocks and real estate to give your portfolio a chance to generate enough income to keep pace with inflation.
I certainly can't predict the future, and neither can anyone else. One thing I do know, however, is that inflation now presents more of a threat to your retirement portfolio than it has in a long, long time.
Follow the strategies above and you'll be well on your way to handling anything the economy dishes out.
Doom and gloom. In reality our growth was an amazing 3.9%, or unemployment is a very low 4.7%, interest rates are dropping and are at 6 months low, and once you take away the temporary spike in oil prices, inflation is low and under control. The biggest problem perhaps is a weak dollar, but that is what is keeping our economy growing and has helped American companies report strong earnings. In other news, I made money being bullish on stocks last week, despite Thursday’s big drop.
Which is why one should be invested in commodities, especially precious metals and mining companies right now. It’s not too late, gold is going much, much higher. Gold miners will do even better.
Bond funds based in other countries might be a better deal...
Inflation never left. I don't know what Newt and the boys changed in the grocery basket they used to calculate inflation when they took power after 1994. I remember them talking about cell phones being added, etc. Whatever is being used now days doesn't reflect the inflation going on at the grocery store.
Recession can erase 12-15% of your portfolion in a year. Markert free-fall can take out 30% if you are overexposed to certain sectors like tech, international or emerging markets. Dividends take it in the shorts as well.
Plus, recession can mean job loss and unemployment which cuts your savings pile even further.
IF there is inflation doesn’t that mean bond and cd rates of return go up as well? Which means u put cash into zero coupon non recallables for as long and as high as u can? bring back jimmy carterville for a spell i’m down with that...
It also means that the value of any existing bonds (issued before rate increases) goes down. This may be a bad time to buy 10 year bonds.
Gold is often tied to oil. Both energy and commodities have performed best in my world, with funds gaining about 18% YTD. My stock fund is up a paltry 6%. CDs are running about 5%. To be truely diversified, I believe in real estate, both in your private home(s), as well as land, which has also gone up substantially in the last couple of years.
Gan you give some further insight into this...couple examples?
Drop in interest rates no inducement to save now. But if you are retired on fixed income, it is even worse. You end up with a income cut every time the interest rate is lowered. With an inflation boost in prices to boot.
Only if you panic and sell your entire portfolio at the bottom. The DJIA free fell 30% during 2002 and early 2003. By the end of 2003 it was back where it started.
Devaluing the dollar isn't erasing 15% a year, yet. But those losses are forever.
Exactly. I’m OK for now because I’m still working part time but who knows how long that can continue? I’m 67 and not in the best of health. My 3 1/2% raise this year has already been wiped out by increases in my rent, supplemental medicare insurance, and internet. Everybody caters to the debtors but ignores the savers. Pretty depressing.
Video here (on right top corner)
Think this isn't a problem? Wait until Nations holding our debt notes start selling off and our perceived "boom" time turns into a "crash".
The Fed was just forced to inject another $41 billion into the banking system which is foundering due to losses on highly leveraged loans.
This is different than the 30s or the 70s. The reality is that those who know what will happen are not talking while those who are talking do not know.
BUMP
What stock fund do you have that is up only 6% YTD or rolling 12m? Even my worst performer is up over 10% and I have 8 different mutual funds — With American Funds, Vanguard, and Royce— ranging from low priced, mid cap, large cap, overseas, tech, growth, etc.
Fortunately I did not get heavy into gold and was able to retire a few years ago. If I had gone heavy into gold I would still be going to work downtown every day.
Or you could do the strategy that some suggest. I was arguing with someone on this board last week. She and her hubby had obviously given $149 for a Saturday investment class that said they should put everything they have and everything that they can possibly borrow into the housing market. The concept of diversifying a portfolio (or as our parents always said “don’t put all your eggs in one basket”) was completely lost on her.
We’re following the Dave Ramsey approach. Still maxing out 401Ks, but pouring money into paying off the mortgage instead of investing outside of retirement accounts. Paying off the mortgage has a guaranteed return, and is a great peace of mind (and reduced required expenditure) if you do get laid off.
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