By Dennis Miller
A dear friend asked for help—the sort of help you might need too. She’s retired, lives alone, and has a modest nest egg. But the thought of losing any of her life savings terrifies her.
Let’s call my friend “Sally.” Sally doesn’t trust stockbrokers or any commission-based investment advisors, and she confided that all of her money is in a cash account, earning 0.01% interest.
Sally understands that at that rate, she’ll likely outlive her nest egg. She knows she needs to do something but is understandably afraid and feeling vulnerable.
Sally played my own warnings right back to me…
- The stock market is near an all-time high.
- The government, not solid business fundamentals, is propping up the stock market.
- Junk bonds have a higher rate of default than top-quality bonds and are currently paying some of the lowest interest rates in several decades.
- Preserving capital and earning decent yields are both essential to making a lifetime portfolio last.
- CDs are risky because they tie up your money and might lose against inflation.
These are real fears. Sally understands the risks of investing; however, she underestimates consequence of doing nothing.
Several Money Forever subscribers have expressed similar concerns. So, to answer Sally and company we’re sharing a conversation between Money Forever chief analyst Andrey Dashkov, Casey Research senior analyst Chris Wood, and me.
Dennis Miller: Andrey, I’ll start with you because I know you’re something of a financial advisor to your mother. What would you say if she asked these questions? Where would you tell her to start?
Andrey Dashkov: Dennis, yes, my mother does indeed turn to me for financial advice. Let me start by giving you a little context. She still lives in Belarus, where I was born. I will not get into great detail about the country’s crumbling economy, but as we speak, the Belarusian National Bank has hiked its interest rates (called refinancing rates) by 5 percentage points, from 20% to 25%. You can get 50% annually on a bank deposit denominated in rubles; consumer credit rates go upward of 70%.
You heard me right. I never stop admiring people who can navigate an environment like this. Granted, some go the obvious route and spend their money as fast as they can, while others try to save. But despite the attractive deposit rates, few are willing to trust the banking system. Most of the people just buy foreign currency in cash, really. Almost every new year, rumors about another devaluation start popping up, and people line up at ATMs to withdraw US dollars and euros. At the beginning of this year, the ruble was devalued by 7% in an instant.
So Belarusians are natural risk avoiders and natural hedgers. Earning interest is less of a concern; preserving buying power and liquidity is what matters. Most people just buy US dollars and euros, hoping that if one of the two depreciates, the other will move up. Compared to the local currency, they feel more comfortable.
Back to your friend, though. Since her main concerns are liquidity and stability, I would recommend she try one of the six Stable Income funds in the Money Forever portfolio. She isn’t mentally prepared to take on risk, so she needs to start slowly and build confidence. As you know, these funds function as cash alternatives. One in particular—a fund we’ve held since November 2012—comes to mind. While it pays a low rate of return, it’s still 80 times more than she’s currently earning. It’s a step in the right direction.
Diversification is important, though, so I’d also recommend that she add other vehicles to her portfolio. Her well-being shouldn’t depend on any single position.
This idea is easy to understand; my mother totally gets it. Many people of her generation have acted as amateur currency hedgers for the better part of the last decade.
I’d start by taking easy steps, allocating some of your friend’s cash into our cash-like investments. While they aren’t as safe as cash or top-quality bonds, the additional returns would have an immediate, positive impact on her savings with minimal default risk.
It’s as simple as this. If she earned 4% interest and had a 1% default, her net gain would be 3%—300 times what she’s earning now.
When she’s ready, I’d encourage her to buy some stocks, too.
Dennis: Chris, where would you suggest she start?
Chris Wood: Dennis, you aren’t the only one who gets these types of questions. Once your friends and family learn what you do for a living, it’s natural that they start asking these questions. Much like your friend, they know they should “do something.” They just don’t know how to go about it.
But back to your friend—I think Andrey is spot-on. Her primary goal should be preserving capital, but she really does need to go into the market to have any chance of keeping up with inflation, actually growing her nest egg in real terms, and generating enough income to continue to live a long and happy life.
A good way to start is to dip your toes into safe, cash-like instruments that provide a better yield than a cash account at a brokerage. Then branch out into dividend-paying stocks that also provide the opportunity for robust capital appreciation (diversified geographically and across sectors, of course). Finally, add in some higher-yield income vehicles, like floating-rate funds, preferred stocks, and even high-quality venture-debt BDCs. This three-tiered approach should provide the capital appreciation and income necessary for her nest egg to live as long as she does, and it should do that as safely as possible.
Speaking of safety, as she adds to her positions, she should limit each investment to a small portion (say 2-5%) of her entire portfolio. Other things like rebalancing on a regular basis, using limit orders so she doesn’t buy an investment at a price above what she’s comfortable with, and setting trailing stops to prevent catastrophic losses and lock in gains are important too.
Dennis: One of my fears with friends is giving good advice that later goes stale. How do you update friends and family? Chris, do you want to go first on this one?
Chris: Sure. Unfortunately, there’s no “set it and forget it” way to deal with markets à la the Ronco Rotisserie. Probably the most important thing to communicate to friends and relatives who ask for advice is that it will take some work on their part. Vigilance is paramount. Even if you’re working with a financial professional, it’s important to know what’s going on, because the decisions you’re making now will affect the rest of your life.
Obviously, there are cost/benefit tradeoffs in terms how much time you have to dedicate to such things. But in general, the more self-directed you are, the better the outcome.
Dennis: Andrey, do you have anything you want to add to Chris’ remarks?
Andrey: Sure. As Chris says, it’s important to stay informed about what’s going on around you, both in the economy and on the stock market. The caveat, though, is that there is just too much information around, and most of it is useless. So when people ask me how to become better informed, I recommend consuming less information, not more; however, you have to be selective.
Pick a couple of weekly magazines that cover the economy and business from different angles, and you’ll do two things: first, you’ll dramatically reduce the amount of information you need to consume per week; and second, what you read will often be better researched and more comprehensive than the bite-sized, out-of-context crap scattered around the Internet in the form of news and blog posts written with speed in mind, not comprehension. Also, treat all TV as entertainment.
So that’s step one. Step two is finding reliable investment advice. Granted, there are excellent people in the business, but they’re often slow to adapt to the changing environment. They keep selling you “100 minus your age,” “60/40,” or other schemes, even though they won’t produce the results you need.
Dennis: How do you deal with concerns about the stock market? When we put together the bulletproof income portfolio, we started by asking, “What’s the smallest amount we can put in the market and still safely make enough yield to ensure the money lasts?”
With the S&P 500 at all-time highs, the prices of companies like Apple are soaring. It’s pretty hard to say, “Buy high and hope to sell higher.”
What are your thoughts in this regard? Andrey?
Andrey: I don’t think about the stock market in terms of aggregates; in a sense, I don’t care how expensive the S&P 500 is. What I do care about is helping our subscribers enjoy the opportunities the market brings—and minimizing the risks.
The first risk is in following the crowd. Most retail investors tend to hold the same 20-30 stocks in their portfolio: companies they know—or think they know about. This means brands like Apple, Chrysler, Coke, Ford, and now possibly Facebook, since it’s so pervasive.
This approach is a losing proposition for two reasons. First, buying what everybody else does is irrational investing. Crowds buying (and then selling) stocks en masse creates volatility and hurts returns. Second, brands are not companies: if you like your Apple computer (or your Ford car or your Diet Coke), it doesn’t mean Apple or Ford or Coke are good investments.
Investors should look at companies with as little emotion as possible. I read once that if you’re excited about any of your investments, you’re doing it wrong. Staying objective and disciplined is the way to go.
In short, the market does what it wishes while we cut our own path. I think the Money Forever way, with our emphasis on risk management, income, and individual opportunities, is the right one.
There are still opportunities out there for great appreciation and returns. It’s a matter of finding them ahead of—and while mostly ignoring—the emotional crowd.
When the crowd starts buying is when we start looking to lock in profits. In 2014, we did this in several ways: tightening up stop losses; selling off part of our position; and in the case of HES, selling it all for a nice 78% gain.
Dennis: Chris, anything to add?
Chris: No, I think Andrey summed that up very nicely.
Dennis: Guys, thank you both for chiming in here.
To distill it down, there are three basic steps that Sally and those in similar predicaments should take: stop doing nothing; start small; and, start now. Don’t let investing worries paralyze you. You can check off the simplest first step—and find out if you’re at risk of outliving your nest egg—in the next three minutes by running your personal portfolio projection here.
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