Jason Stipp: I'm Jason Stipp for Morningstar. Volatility has returned to the markets this fall as concerns weigh over the sluggish economy and the ongoing European sovereign debt crisis.
And as we know, volatile markets can make nervous investors of us all. Here with me to offer his tips for tumultuous markets is Ross Levin. Ross is a certified financial planner, a founding principal and the president of Accredited Investors.
Thanks for calling in, Ross.
Ross Levin: Thank you, Jason. I look forward to talking with you about this.
Stipp: First question for you. You've probably received a call like this before, but let's say that I am a nervous investor. I've just gone through several weeks where we've had up and down markets, and I call you up and I just say, 'Ross, I can't take the volatility anymore. I need to get out of equities. I can't sleep at night. Can you get me out of my stock positions?'
Levin: Well, Jason, the first thing to think about ... I really appreciate how anxious people are regarding what's going on. The most important thing for people to step back and think about is, what is the ultimate use for this money? What is their time horizon? And how should they be invested given that time horizon?
So, the question should you completely get out of equities or should you completely get into bonds, it's not really as simple as that, and I think the first thing we need to do is acknowledge how difficult things are, but I think also we have some experience for people to think about. And that experience may be uncomfortable for them, but 2008 and 2009 was not that far away, and for those clients who could not take the volatility or the losses that they were experiencing, and sold out in March of 2009, they missed a rally of epic proportions. And again, I think what people end up doing at the extremes both when the markets are too strong and when the markets are too weak, at the extremes is when people end up making decisions that go against their best interests.
Stipp: Ross, you mentioned there that time horizon is an important thing to consider as you're thinking about where your clients would have their assets. So, if I am near retirement or in retirement, and I'm calling you with these concerns, what sort of checklist would you go over with me in that case, given that I obviously have a more immediate need potentially for my portfolio?Read Full Transcript
Levin: Yeah. That's a great question, Jason. The first thing is there is a big difference between being near retirement and being in retirement, and the distinction is that, let's say, you're 55 and you're going to retire in 10 years or you are 60 and you're going retire in five years--you've got two different time horizons to think about. The first time horizon is when you're going to be spending money. And the second time horizon is your life expectancy and the joint life expectancy if you're partnered with someone.
So, the way we handle things for people who are in retirement or who are approaching retirement, we carve out three years' worth of their spending needs, and we put that in a cash bucket. And if you literally think about a bucket, it's money that we know is going to be spent, so if a portfolio is, let's say, a $1 million portfolio, and they're going to spend $50,000 a year, we carve out a $150,000 of that, and that just simply goes into high-yield savings accounts, online savings accounts, money that's completely accessible to them.
Then the rest of the portfolio can be invested in an allocation that's appropriate for them. So, let's say, it's 70% stock and 30% bonds, where the bond bucket is your middle bucket. So, if you go through those three years and the market has been terrible, then you start to spend some of that bond bucket, and at 30%, bonds that gives you another six years before you have to start spending the stocks. And, again, for most people if you use 2008-2009 as an example, people were whole within a two- or three-year period from that.
Stipp: So, that cash bucket, that three years, unfortunately a lot of retired investors know this, they are just not making anything on those liquid holdings. Is there any way that you found where that money that is immediately available to them can be working a bit harder?
Levin: The two things you've got to think about are, what is the risk that you want to take with that money in order to get a little bit of incremental return, and remember the keys for investing are time and compound interest. So, money that's going to be spent in three years, there is really not that much time for that money to compound effectively enough. So, we use high-yield savings accounts online. There are places where you can actually ... Ally Bank has a high-yield savings account that locks up your money for five years theoretically. It's paying over 2%. If you break that five-year CD, there is only a two-month interest penalty. So, if you end up keeping that money in that five-year CD for five months, you are better off than a traditional money market fund or a traditional online savings account.
So, there are some vehicles to get a little bit better return, but I would be really careful about chasing big returns. Your point, though, I think is really important when you think about equities in general, for example. If the S&P, Standard & Poor's 500, largest stocks are yielding about 2.3%, and long-term bonds are yielding somewhere around 2%, the question to ask yourself is, over a 10-year period of time, am I better off owning stocks, taking that 2.3% and spending it and betting that the market is going to be higher 10 years from now than it is today. That feels like a pretty good bet.