For older workers starting to think about retiring, or already in retirement, the economic turmoil the coronavirus pandemic triggered caused reactions similar to what many felt just over a decade ago at the start of the “Great Recession.”
In 2008, the stock markets lost nearly 40 percent, accompanied by steep declines in real estate. The still-unfolding 2020 recession is different in many ways, but both events have had similar effects on investors.
A surprising and widely circulated article in the Wall Street Journal cited data from Fidelity Investments that suggested that as much as a third of investors age 65 and older sold all their stock holdings sometime between February and March, 2020.
I wrote an article back in early April after the market crash and briefly addressed the question, “Should I sell my stock investments?”:
If you didn’t sell the day before the crash or the first day after, you probably shouldn’t sell now. (I’m not suggesting you should have sold then. If you did, you would have booked a minimal loss. If you do so now, you will take a much larger permanent loss.)
I have heard of some people who sold all their stock investments between January and mid-February when news of the coronavirus first surfaced. They sold at all-time market highs, and are probably feeling pretty good about that now.
Anyone who had been in the markets for the last ten years would have benefited from a 300% increase in the DJIA and the S&P 500. By early 2010, these stock indexes had recovered some of their losses, but it took almost 4 years to reach their pre-crash peak.
But if they sold between March 9, 2020, and April 9, 2020, when the hard reality of the pandemic really set in, they would have booked losses of between 20% and 35% in their stock investments—ouch!
Someone who stayed in or only sold a portion of their stock investments would, as of June 23rd, recouped about 30% of their losses since the crash on March 23rd.
An understandable reaction
The WSJ article mentioned a 62-year-old doctor who said he sold all his stocks after his medical practice declined due to COVID, forcing him to take out emergency loans. He explained that he “… didn’t have 10 or 15 years to recover (his) losses.”
Actually, as a 62-year-old, he did. If he lives to age 90, he has 28 years! This speaks to the difference between a person’s risk tolerance and risk capacity (his risk tolerance is lower than his risk capacity), but that’s a topic for another day.
The good doctor’s reaction is understandable. He is near retirement and watched as the value of his investments plummeted. Even typically uncorrelated assets, such as corporate bond funds, lost value, further exacerbating the situation.
He did what lots of people do (if the Fidelity study is accurate)—he stopped the bleeding by selling out.
Did you? If so, I won’t tell you that you made a “mistake” since someone’s investing decisions (and their risk tolerance) are very personal matters. There is no “right and wrong” here. As I wrote in Reimagine Retirement,
… investing is an area of personal liberty… though, as I have shown, I believe the Bible gives us good reason to feel confident in investing humbly and wisely, you may have a different conclusion. If it violates your conscience to invest, that is okay—don’t do it.Reimagine Retirement: Planning and Living for the Glory of God, 106
I would add that there is freedom not to invest in stocks if you are not comfortable with the risks involved.
That said, I will remind you that financial professions say that almost everyone should have some amount of their portfolio invested in stocks.
The reason is that there is almost no other way to achieve that long-term gains that stocks have delivered, despite a pretty rocky ride at times.
The percentage might range from 70% to 90% for those in their 20s and 30s, down to 20% to 30% for those in their 60s and 70s. Your percentage depends on your tolerance and capacity for risk.
Even so, selling at or near market highs when it appears everything is going south in a big hurry is an understandable reaction.
If you got out of the stock market in 2008, or early 2020, and intend to stay out (but could change your mind), what is your strategy going forward? Here are a few options to consider:
Rely more on Social Security
Social Security represents a large share of most retirees’ income. The program’s progressive benefit formula helps lower- and middle-income retirees more in retirement by replacing a higher percentage of their preretirement earnings.
If 40% of a retiree’s household income comes from Social Security, then the other 60% must come from savings, a pension, or perhaps an annuity.
If your expenses are significantly less in retirement and Social Security covers a higher percentage of them, you will be less reliant on income from those other sources, such as stocks. You may be able to get by without the boost that stock investments typically provide over time.
The more you will rely on Social Security, the more sense it makes to maximize your benefit by delaying filing for it, perhaps until age 70.
Purchase an annuity
If you sold your stocks and the money is “parked” somewhere, you could use some (or all) of it as a lump-sum to purchase a deferred- or immediate-income annuity.
There is a lot to be said for this strategy, as income annuities provide you with guaranteed lifetime income without any reliance on the stock market whatsoever.
As such, income-annuities provide a fixed amount of income without adjustments for inflation or market performance. Therefore, annuity “returns” can’t be directly compared to inflation-adjusted systematic withdrawals from a risk-based investment (stock/bond) portfolio.
An income-annuity may provide a lifetime fixed payout of 5% a year, but without an inflation adjustment, that could equate to a 2% or 3% payout in real (after inflation) terms 10 or 20 years in the future.
You might consider alternatives such as fixed-index and variable annuities, but with these, you are tying future performance to the stock markets. There are also higher costs and complexity to consider, so read the fine print carefully.
Move to “safe” investments
In place of the stock investments, there are a variety of so-called “safe” investments you can consider.
Going to “cash” is probably the riskiest of the “safe” investments. That’s because you will likely experience a negative return over time due to inflation.
Other options include CDs and interest-bearing deposit accounts. Most of these will be FDIC-insured. At current rates, these are almost like putting cash in your mattress; inflation will cause minimal or no real return.
The upside is that your money will be “safe.”
Those who had a mixed stock/bond portfolio and sold out of stocks may consider moving the proceeds to the bonds component of their portfolio.
Bonds tend to be less risky than stocks, but they are not without risk. There are two types of risks to bonds: inflation risk and interest-rate risk.
Since bond interest rates are typically fixed, their value can be eroded by inflation. The longer the term of the bond, the higher the inflation risk. (On the other hand, bonds are a classic deflation hedge; deflation increases the value of the dollars that bond investors get paid.)
Interest rate risk is the possibility that a bond’s value will decline based on changes in prevailing interest rates. Increasing rates decrease bond prices, whereas falling rates have the opposite effect.
Inflation risk impacts both stocks and bonds, but interest rate risk is usually associated with bonds rather than stocks.
There are fixed-income investments that seek to mitigate interest rate risk (such as floating-rate bond funds) and inflation risk (such as Treasury Inflation Protection Securities, or “TIPS”).
With interest rates near zero, there are no “safe” fixed-income assets with high yield. For that, you have to invest in riskier assets, such as “junk” bonds (bonds with a credit rating of lower than BB, and therefore higher risk of default).
Slowly and deliberately buy back in
If you change your mind, you may decide to “get back in.” If you thought the decision to get out was hard, choosing when (and how) to get back in can be harder.
One strategy is to “buy on the dips.” You will have to decide what constitutes a “dip” for you, but generally, it means purchasing a stock (or stock fund) after a sharp market drop, anticipating that it will bounce back along with the broader market.
With a “buy the dips” strategy, you are essentially buying stocks “on sale.” But even then, in the opinion of some, the market can be over-valued.
Another strategy is to use “dollar-cost averaging.” You invest the same amount at regular intervals without regard for whether the market is up or down. In doing so, you “smooth” the cost of re-entry over time.
In other words, if you do it consistently, on average, you buy more shares when prices are low and fewer shares when prices are high over a defined period.
It does not guarantee a profit, but it helps reduce the tendency to buy high and sell low; it takes the emotion out of investing.
Invest in low volatility stocks or stock funds
All stocks carry some risk, but some stocks are less volatile than others. Some stocks in the S&P 500 are less volatile than the rest. The 100 least volatile of them make up the “S&P 500 Low Volatility Index.”
Many contend that low volatility (LV) stocks outperform during down (bear) markets but will lag market returns during rising (bull) markets.
The MSCI’s minimum volatility indexes are the most popular. For the ten years ending in 2018, the annual outperformance of the MSCI USA Minimum Volatility Index was 1.3%.
If you want to invest in stocks that may perform better during periods of high volatility in return for giving up some small gains when the markets are rising, low volatility stocks (or stock funds) may be for you.
For example, these stocks did better (in this case, lost less) than others in the March 2020 market crash, but did not rebound as well in the weeks and months following.
There are several LV stock ETFs and mutual funds to choose from if you’re not into picking individual LV stocks. Here are some of the most popular ones:
ETFs: iShares Edge MSCI Min Vol USA (USMV); Invesco S&P 500 Low Volatility(SPLV); FlexShares US Quality Low Vol (QLV); Vanguard US Minimum Volatility (VFMV); iShares Edge MSCI Min Vol Emerging Markets ETF (EEMV); iShares Edge MSCI Min Vol ETF (EFAV).
Mutual funds: BMO Low Volatility Equity (BLVAX); MFS Low Volatility Equity (MLVAX); Fidelity US Low Volatility Equity (FULVX); Vanguard US Minimum Volatility ETF (VFMV); Vanguard Global Minimum Volatility Fund Investor Shares (VMVFX).
Invest in growth-oriented alternatives
There are growth-oriented investments you can invest in other than stocks. Real estate is among the most popular.
In the right circumstances, real estate can offer lower risk, higher returns, and greater diversification. But having the “right circumstances” is critical. Both stocks and real estate can suffer during recessionary times, but during others, real estate “zigs” when stocks “zag.”
The most common way to invest in real estate is to purchase rental properties directly. But that can be difficult if not impossible to do inside retirement savings accounts. The alternative is to invest in “Real Estate Investment Trusts” (REITs).
According to Investopedia, a REIT is “a company that owns, operates, or finances income-producing properties. By law, 90% of a REIT’s profits must be distributed as dividends to shareholders.”
REITs’ relatively high dividends make them attractive to income-oriented investors, but they offer growth potential as well. Some data suggests that REITs outperform stocks over the long haul.
There are lots of REITs across many different industries. An easy way to get broad diversification is to invest in a REIT index fund. Some of the most popular ones are iShares Cohen & Steers REIT ETF (ICF), Vanguard Real Estate ETF (VNQ), and Vanguard Real Estate Index Investor (VGSIX).
Investing in commodities is another possibility. Commodities are tradable assets, just like stocks, with values set by the markets. Commodities represent the raw products sector of the market.
Commodities can be grouped into two categories: “hard” commodities, such as natural resources like oil and gold, and “soft” commodities, such as farming products (livestock, corn, and wheat).
Commodities tend to have a low correlation to the stock market, but they can be just as volatile. Thus, many advisors recommend them as a supplement to stock market investments, not a replacement.
Everyday investors tend to have the most interest in gold and silver. Some argue that they are not investments at all, but pure speculation. Physical gold doesn’t generate any income. You can only make money if you sell it for more than you paid for it.
That said, gold and silver do have a low correlation with other asset classes, such as stocks, and you might consider adding it to your portfolio to provide additional diversification.
But like real estate, it probably doesn’t make sense to replace the stock portion of a portfolio with commodities. They can be just a volatile, if not more so, at times.
Rather than purchasing physical gold or trading in commodities futures, you can buy funds that hold them. You can hold gold in an ETF like the iShares Gold Trust ETF (IAU) or the SPDR Gold Shares ETF (GLD). A popular commodities fund is the Invesco DB Commodity Tracking (DBC), which is also the largest.
If you’re still saving for retirement, rather than getting out (or staying out) of stocks altogether, I would recommend maintaining an allocation that you are comfortable with based on your risk tolerance. Diversify your portfolio with other assets that tend to have a low correlation with the stock market.
If you are in retirement and relying on your savings for some of your income, that are other things you can do in addition to diversification. I’ll explore them in my next article.