A conservative investment approach
Question: Hi All, Love the show! I listen every day, from the Morning Report all the way through Marketplace Money on Friday.
Anyway, I wanted to pose a question to the folks on Marketplace Money. I turned 30 a few years ago, right during the financial crisis. Like a good Marketplace listener, I’ve been contributing to my employer sponsored defined contribution plans since the day I left college. I’ve had the benefit of buying into equities during several major downturns, and even with the great recession, I’m still doing okay.
However, now that I’m in my thirties, I feel like I need to shift some of my market exposure away from high risk, (supposedly) high growth investments to something designed to protect rather than grow. Given these low interest rates and low yields on safer investments, what is a thirty-something to do when shifting into “protection mode”? So many of the safer places to keep my wealth seem to be returning almost nothing. I’m very worried about the upcoming baby-boomer bust when I’m guessing a lot of them will be pulling their money out of risky things like equities.
How can I hedge against this? I’m not overly concerned about chasing high-yield, but at the same time, I’m not thrilled at all with how little my safer investments like money market are returning. It seems like they will barely be able to keep up with even moderate inflation.
Can anyone give me some ideas to research about where to go at 30? Best Regards, –Chris, Hattiesburg, MS
Answer: It’s so good to hear that you’ve been saving for your retirement and that the investments are working out for you. I like that instead of asking, “How much money can I make?” you’re wondering about a more fundamental financial question, “How much can I afford to lose?”
Now, most people, including me, will remark how young you are and that you can continue to bear the risk of owning equities. That said, I am a big believer in diversification.
But in thinking over your question I realized my best suggestion is for you to pick up a copy of Worry-Free Investing by Zvi Bodie and Michael J. Clowes. Bodie is a leading finance professor at Boston University. Michael Clowes is editor at large at Pensions & Investments, a trade publication. Their basic message fits in with your question. (You can buy a PDF version of the book for $5 here.)
They advocate investing the core of long-term retirement savings in U.S. government inflation-protected securities, better known as TIPS. The bonds preserve the purchasing power of a dollar against the danger of inflation. Although the price level is tame right now, inflation remains a major financial worry for long-term savers. For instance, one hundred dollars loses half its value in 20 years with a 3.5% average annual rate of inflation. The same sum falls by about a third over two decades even at a modest 2% inflation rate. And your time horizon is at least another 30 years.
Of course, you’ll take a lower payout on your savings in exchange for the inflation protection. So many people want to own safe securities that your getting paid practically nothing on the investment. Still, you’re limiting downside risk while building up savings with your 401(k) contributions..
The authors deal with other conservative investments, but the core of their approach is government-backed inflation protected securities. That said, they aren’t stock-phobic. They’d just prefer that individuals roll the stock market dice only after looking after their baseline financial goals.
Worry-Free Investing is simply written and well illustrated with examples. The authors walk you through the mathematics of their computations so you can do them on your own with a simple calculator. I think you’ll find it compatible with your questions.
Professor Bodie has been a strong influence on how I look at long-term savings. I take a slightly different approach in my book The New Frugality, although my emphasis is also on wealth preservation. I also emphasize simplicity and diversification.
By the way, I’m not concerned that when aging baby boomers retire and draw down their private pensions the massive asset sale will depress stock and bond values. To be sure, it’s a risk. But I don’t think investors shouldn’t fear the march of time.
The main reason is the embrace of markets around the world (with a few notable exceptions). The spread of private property rights and openness to the world economy is encouraging vast amounts of capital to flow across borders. By the time boomers need to sell, markets will be far more international. There will be a lot of foreigners with the means and desire to buy U.S. equities if for no other erason than diversification into the world’s largest economy.
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