Thursday September 18, 2008
Crisis Bulletin 1
Five Ways To Bulletproof Your Savings
Most investors are reeling from the country’s financial crisis. Home prices are tumbling. The stock market has come down 24% since July ‘07. For the first time ever, money market funds have lost money. And several major financial institutions have gone bust or been forced into government receivership.
It’s no wonder that anxious investors are looking for guidance and safety.
What can we expect?
I expect even more turmoil ahead as housing prices continue to correct and institutions continue to identify, then write down, problem loans and investments. We are all paying the price for “irrational exuberance” gone mad, gone unchecked, and gone under-regulated. As I state emphatically in Cash-Rich Retirement, any market — stock, bond, real estate or derivative — always corrects after it hyper-inflates or performs irrationally. And bigger “bubbles” such as our massive real estate mess result in more painful corrections.
So expect more pain ahead.
However, you can shield your savings from permanent damage. Here are several ways of protecting your nest egg from more harm.
1. Don’t panic! Most investors sustain their worst losses when they succumb to emotion and panic. I’ve been a professional wealth manager through the stock whiplashes of 1987 and 2000 and I’ve learned one lesson well: Knee-jerk reactions to investment volatility always produce bad results. Don’t sucker yourself into selling off good investments out of fear! Foremost of it, it’s time to remain calm.
The sky isn’t falling. There are insurance nets (like FDIC insurance) protecting many of our assets. Most financial institutions have perfectly sound balance sheets. And many talented men and women in the private sector, Federal Reserve, Securities and Exchange Commission and Department of the Treasury are hard at work to defuse the current crisis.
Don’t panic.
2. Stay diversified in income-paying investments. In Cash-Rich Retirement I explain why a broadly diversified array of income-paying investments is one of the best ways of protecting yourself from harm.
My book specifically recommends keeping about 50% of your savings in dividend-paying stocks (or in funds of dividend-paying stocks), 25% in an assortment of high-quality interest-paying bonds, and 10% in “safe haven” investments.
By “safe haven” investments, I mean keeping approximately 5% of your savings in a gold or precious metals fund — not, however, gold ingots, gold coins or gold-plated chains from QVC. Another 5% can be placed in a mix of commodity, natural resource, and/or Swiss Franc investments. In Cash-Rich Retirement I identify some of the specific kinds of funds to consider.
My book likewise shows that income-paying investments (like dividend-paying stocks) tend to go up more in “up” markets and down less in “down” markets than investments that do not pay income. So make sure that most of your investments pay you dividend, interest or rent income in addition to being high-quality, low-risk kinds of placements.
Of course, a key point to remember is that keeping too many eggs in one basket is always dangerous. Be sure to split your money between varieties of different investments so that no single one represents more that 10% of your total wealth. If you have more than 50% of your money in stocks or stock funds today, it may be time to overhaul your allocation — check with your financial advisor.
3. Hold TIPS and I-Bonds. As the government pumps more liquidity into the market and attempts to defuse the current crisis, federal debt is sky-rocketing and inflationary pressures are on the rise. Inflation, I believe, is going to be our next predicament.
Now more than ever, it’s time to protect our nest eggs from higher inflation ahead and the loss of purchasing power.
There are two kinds of “inflation-proof” bonds that are available from the U.S. Treasury and which may be suitable for your portfolio as well — TIPS [“Treasury Inflation Protection Securities”] and I-bonds.
You can learn the basics about “TIPS” and “I Bonds” by reading my earlier articles here or by visiting the U.S. Treasury’s website. It’s time to read up on them.
A number of excellent asset management groups — Fidelity, TIAA-CREF, Vanguard, PIMCO and others — have TIPS funds. But only buy and hold them in a 401(k) or IRA account that is tax-sheltered. Otherwise, you will incur taxes on the inflation adjustments prematurely.
And, yes, even TIPS can experience volatility — particularly as more investors move into them for safety, driving their prices up. At this writing, some TIPS funds are actually down just under 1% for the month, but up about 3.9% year-to-date.
I-Bonds are U.S. Treasury bonds which likewise pay interest and give you adjustments for inflation. You can buy up to $5,000 of I bonds each year. So either TIPS or I-bonds can be part of your bond [i.e. 25%] allocation. They will give you interest and some inflation comfort as today’s market excesses continue to burn off.
When you buy bonds of any kind, however, remember that current interest rates are being kept low because of the financial crisis. They are likely to rise some time soon. So stick to bonds with maturities of 3 or 6 months only so you are not locked into today’s low rates long term.
4. Get insurance. Many U.S. financial institutions give their clients FDIC [“Federal Deposit Insurance Corporation”] insurance. It is a guarantee from the federal government that protects the first $100,000 of your deposits, saving accounts, and/or Certificates of Deposit — provided you hold such deposits with an FDIC-covered institution in the United States. And the coverage can go up to $250,000 if the deposit or CD is in an IRA account.
If you are seriously alarmed about the current crisis, you can put money into savings deposits or time deposits having FDIC coverage.
However, please note: stocks, bonds, mutual funds and money market funds are not covered by FDIC insurance even if they are held with an FDIC-covered institution. Only time deposits, savings deposits and CDs qualify. But check the FDIC’s website for updated information.
5. Seize the opportunity! If Wall Street’s rollercoaster volatility isn’t keeping you nights, this can be an outstanding time to buy high-quality stocks at bargain prices. It’s not a strategy for the faint of heart! But if you have the tolerance for on-going turbulence, invest some of your money each month in more low-priced, dividend-paying stocks or funds. Scoop up the bargains!
Warren Buffet has done just that by taking a stake in Goldman Sachs. Other high-quality stocks and dividend-focused funds are worth considering as well. They should prove to be superb long-term investments.
These tactics won’t give you total immunity from market upset, but they can help mitigate the damage you incur. Stay away from speculative investments. Stay away from mortgage-backed investments. Check the underlying contents of your money-market funds and make sure they do not contain mortgaged-backed securities. Meet with a professional financial advisor or CFP to guide you. And make sure your savings are prudently diversified in high-quality, income-paying investments.
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The information and views contained in this column do not represent a recommendation or solicitation to buy or sell any particular security or fund.
At the time of publication, the author may or may not have held any of the investments cited. His holdings may change from time to time. The opinions and recommendations expressed in these articles may likewise change from time to time without prior notice. Hence, readers are urged to conduct their own, independent research and consult their personal investment counselors before making any investment decisions.
Past results are not a guarantee of future outcomes. Investments of any kind can result in losses. When considering any investment, you should independently judge the content, management, fees, tax implications, historic performance, and risk factors of the investment and, in particular, read its prospectus and/or other offering materials.
The communications, comments, and opinions contained herein are intended solely for informational purposes. Mr. Schlagheck and this blog are not responsible for the accuracy, timeliness, or soundness of the information provided. All of the above commentary comes without warranty or guarantee of any kind. Neither Mr. Schlagheck, this blog, nor any other party can be held responsible for the validity, accuracy, or efficacy of these views or for the investment performance resulting therefrom.