As a financial advisor, increasingly I find myself in a ticklish situation: Trying to convince people that taking an easy yield on cash is not a long-term investment strategy.
Here is what typically happens, in my experience. Imagine a couple in their early 60s. They have diligently saved for retirement.
As they approach the magic date, our couple naturally becomes cautious about their investments. It makes sense. Who wants to take a ride down on stocks right before leaving work? And 2022 was that kind of year.
Then the Federal Reserve jacked up the interest rate. The couple notices that bank CDs now offer an attractive 5% yield. Even plain old savings accounts pay better. This, after years of earning next to nothing.
Eager to preserve their capital and earn a decent return, they decide to move a significant portion of their retirement savings into CDs. They feel confident in their decision, especially after recent market volatility.
Nevertheless, as 2023 unfolded, the stock market began a strong upward trend, recovering from previous lows and even surpassing historical highs.
By the end of the year, the market had provided a nearly 22% run-up. Our near-retirement couple has missed out.
This is not to say that retirees and those close to retirement should be all-in on stocks. Nobody has a crystal ball that predicts future stock prices. Least of all me.
Be wary of anyone who thinks it’s possible to time the market in any economic environment. Decades of research argue against it.
It is the case, however, that being out of the market for extended periods is a sure way to miss big moves that show up unannounced.
One study showed that, from 1994 to 2023, missing the best 10 days in the market resulted in a return that was 54% lower than just staying invested. Missing the best 20 days cost investors 73% of their potential return.
And missing just 30 days out of those 10 years cost a whopping 83% of the return expected.
Which 30 days? It’s impossible to predict. But the cost of trying to guess is painfully high.
That is why a prudent advisor tells his or her clients at or near retirement to take the following action steps:
- Decide how much cash you need to pay your bills for the coming year. This cash should be money that you can keep in a series of CDs, short-term bond funds, a laddered cash product, or a high-yield savings account.
- A second bucket should be conservatively invested to produce income that steadily refills the cash supply. This money can go to dividend stocks, bonds, or both.
- A third bucket should be geared toward long-term growth, and that means owning stocks.
A written financial plan is a huge step toward understanding how big each of these buckets should be for an individual investor.
Once that is done, the final step is to construct a diversified portfolio that balances cash, income, and growth in such a way that you sleep well at night and know that your risks are minimized, including the risk of missing the future security that comes from sudden market growth.
The urge to grab a guaranteed 5% in a CD is strong, I get it. But overdoing it also has a cost.
Finding your personal balance here is important. An advisor can help you get both short-run returns and the long-term upside that comes with carefully measured risk.
