One of the most challenging situations we see is when people have sat on the investment sidelines for years and now want to catch up. Many exited the market in 2008, and retreated to the safety of cash and CDs. Now, years later, they’re realizing that growth has passed them by. Cash is paying nothing, CDs scarcely more, and they’re having a tough time making ends meet.
Now comes the dilemma. Their assets have dwindled, and time is running out. What should they do? Stick with their 1% returns and watch their assets deplete further, or make a last ditch attempt to catch up on the gains they’ve missed?
We’re not talking here about “catching up” by saving more. It’s never too late to do that.
We’re talking about radically changing your investment strategy to catch up for lost time and missed opportunities.
We worked with a retired client we’ll call Martha. Martha had a balanced portfolio of roughly half stocks and half bonds. That worked well for her, because she needed that growth to supplement her Social Security income and cover her retirement expenses. Martha was divorced and had to support herself through what could potentially be a long retirement.
That all worked well until 2008, when Martha – frightened by the turbulent financial situation – sold all her stocks and bonds and insisted on retreating to just cash and CDs. Unfortunately, as the economy improved, Martha resisted emerging from her “safe” investment cocoon.
As a result, she earned minimal returns on her portfolio … year after year after year. And despite the official statistics about inflation staying low, Martha’s living and medical expenses just kept climbing.
So combine portfolio income – going down, down, down – with expenses – going up, up, up – and what do you get? A depleting portfolio, where you take out money faster than you can earn it back. Not a good situation.
What to do?
The problem is, of course, that we never know what the investment future will bring. What if you finally decide to invest right when the bull market is coming to an end? It’s like wading into the ocean just when the tide is going out.
If you’ve undersaved (or overspent), you may be tempted to invest more aggressively to catch up.
But there’s a danger in doing that. The less you have, the less risk you can take.
“If investors have not saved enough for retirement, each dollar of savings becomes that much more valuable and needs to be protected,” says James P. Lauder, chief executive officer of Global Index Advisors Inc.
The best solution is not to get in this situation in the first place. When markets get unfriendly, as they did in 2008 and will undoubtedly do so again, make gradual adjustments to your asset allocation. If you’re at 60% stocks and can’t take the volatility, drop down to 50% stocks and see how that works. If your allocation was well-chosen to begin with, you want to try to stick with it.
If you make portfolio changes that result in much lower returns, like Martha did, you really need to make corresponding cuts in your spending. The longer you combine lower returns with higher spending, the more irreparable harm you do to your portfolio.
If your portfolio is not earning decent returns, you can’t withdraw as much as someone with a more growth-oriented investment mix (disregard that reality and you’ll run out of money way too early). If you can’t cut spending, see if you can pick up extra income through part-time work, like consulting or substitute teaching.
If you’re out of the market now, and want to get back in, do it gradually. We’ve worked recently with some ultra conservative investors who now realize they need more growth in their portfolios, a decision prompted by lower bond yields and longevity fears. But they’re not going hog-wild. They’re starting by introducing a very moderate weighting – say, 30% – of dividend-paying equities into the portfolio.
If you’re contemplating wading back into the investment pool, ask yourself how it will be different this time. If you didn’t have the discipline to stick it out before, delegate decision-making to a professional advisor to tune out the emotions. Learn from your own history and keep investment allocations less aggressive than the ones that made you bail last time around.
Realize that higher returns almost always come with higher risk, and the potential for short-term losses. Ask yourself if you are ready and able to absorb those losses this time around, and if your time horizon is long enough – at least five years out – to even think about adding stocks to your portfolio.
Otherwise, you may end up like our friend Martha, painting herself into an investment corner, desperately needing growth, but waiting so long to re-allocate her portfolio that she can no longer accept the risk that long-term growth entails.