Protecting Your Nest Egg in an Upside-Down Economy

H.W. "Skip" Weldon

Whether we're in a recession or an economic boom, the same tried-and-true rules apply.

But on the assumption that some individuals haven’t done that, the way I would suggest that people protect themselves is not to make wholesale changes in the money they already have invested. Invariably, investors make those changes at market extremes, and they will regret it.

Instead, I would focus on my current ongoing contributions and consider redirecting them to a fixed-type account like a money market account fund or a stable-value fund—something that doesn’t fluctuate in value and pays interest. I care less about the interest rate (net of inflation and taxes, it’s always negative anyway) and more about the idea that the principal won’t fluctuate. And then by sending my ongoing contributions to that account, I would build it up gradually so that by retirement the allocation would be correct. Again, this is for investors who got caught with the wrong asset allocation.

But as for making major changes now—and by that, most people mean get out of the market—that’s probably the worst thing they could do. And I would try to explain them out of it. Still, there are people who constitutionally can’t do it. They can’t sleep at night, they toss and turn, they’re irritable. Sometimes it even affects their health and their personal relationships. That person should get out of the stock market and go into a money market/stable value fund.

For the short term, though, where people save is not nearly as important as continuing to save somewhere. So, leave the money in a 401(k)-type investment and continue to contribute to it. Just change the investments because most 401(k)s offer the same type of investments you can get anywhere else, and you still continue to get some very valuable tax breaks. Those types of plans are the best place to put your money because there are no commissions, they can be done via payroll deduction, and you get those tax breaks.

Q: But what if someone is nervous about the stock and bond market today and wants to move their money to a more stable-value fund for a while. You think that’s a bad idea?

A: The key point is your term "for a while," which means eventually you intend to get back in. For most people, that’s poison. If people are not going to commit for the long term, they shouldn’t be using long-term investments. Where people get hurt is that they use long-term investments but treat them like short-term investments, hopping in and out. That is a basic error that some investors make.

Q: In the year 2000, if you had put your money into a stock index fund, you would have made zero profit by the spring of 2008. Does that mean that stocks are no longer the best place to put your money for the long term, or is this just a bad eight-year patch?

A: Well, I don’t consider eight years to be long term. I have been investing for almost four decades now, and when I started in the S&P 500, it was at $100 a share. Today it’s at almost $1,400 a share. But you are absolutely correct that the recent experience with the S&P 500 is disappointing because we’ve had both a serious bear market and a recession. Given that, stocks won’t shine. But looking at it another way, this has been a heck of a time to buy because it [the rough patch] will end, and when it does end, the people who have been accumulating stocks at lower prices during that same crummy period of time will be the ones who will be taking trips to Europe, retiring early, and things like that.

Q: The U.S. economy is on the skids. We’re losing 50,000-plus manufacturing jobs a month, we’ve got a huge trade deficit, and the dollar is sinking. Some people think that we’re seeing the descent of the American Empire. If this is true, then maybe the way the stock market has been during the past eight years is the way it will continue to be because of the fundamental shifts in the economy. So how can an investor keep doing the same things?

A: The mantra, "This time it’s different," has been heard in every bear market and every recession that I have seen in my time. The fact of the matter is that what we’re going through right now is normal and healthy; however, it is also terribly upsetting, which makes us susceptible to the "This is the decline of the American Empire and we’re all going to die" argument. That is typical of a bear market. That’s the aura of fear and concern and worry that lengthens a bear market. But one thing that everybody should keep in mind is that every recession has ended—every one of them. And, if you can get away from the concern and the headlines every day in the paper, the odds that we are living in the end time of the American Empire are zero.

Q: But the American economy is certainly different today than it was in the 1950s and 1960s when we were on top and we didn’t have much, if any, Asian competition. There are so many fundamentals now in the American economy that are not good. So maybe it really is different.

A: Of course things are different—change is and has been constant. All of the recessions have been caused by different things, lasted different lengths, caused different pain. But they all ended. Those who buy into a different ending believe in something that has never happened before, such as California falling into the ocean. There’s always that chance over the long run. But we’re in the middle of a bear market now. There’s fear, there’s concern. And so my answer is: heck no, it’s not different. This is just what always happens, and the concern about all these side issues is a distraction that prevents most investors from achieving real success.

Understand, I’m not saying that this isn’t going to be bad. This is bad. It could easily get worse. I am not immune to waking up in the middle of the night and wondering, "Well, what if you’re wrong, Weldon?" But one of the benefits of having been around awhile is that I have seen more than most people who are out there. And one of the benefits of getting older is that you do have a different perspective on things.

But "this is the end of the American Empire" talk is the kind of thing that drives the market down. That’s the only way you’ll ever get the low, and we’re getting it. We’ve had it now for some time. The stock market always anticipates weakness. It goes down before the weakness occurs. It’s been going down since 2000, in fits and starts. And this is the low. And so you have to understand that and profit from it. And you profit from it by accumulating at these prices because every recession has ended, and when it’s over, the people who have been accumulating and saving regularly will be unbelievably better off than they were before the recession started.

Q: So back again to the original question. How exactly do you protect yourself?

A: I believe that the way you protect yourself, whether it’s boom or bust, is to live within your means, to build cash reserves for when things go bump in the night, and to save regularly. Now, there are an awful lot of people who are not doing that. They’re spending all of their income, they have consumer debt, and they have little or no cash reserves. They’re living from paycheck to paycheck. They’re the ones who are at risk in something like this downturn, because the smallest little bump in the night—the kid has to have braces, hail hits the roof, there’s a car wreck, someone has health problems, husband or wife gets laid off—means there’s nothing between them and the abyss at that point. But if you are saving regularly and living within your means (which means no debt, except perhaps for an affordable home mortgage), you’re going to be fine, no matter what. So that’s what I would be doing – working towards that and not investing differently, because once you have cash reserves and are used to living within your means, you can take whatever comes.

Q: Same advice for everyone—those still working and those who are retired or about to retire?

A: Same advice, yes. The ability to live within one’s means, avoid debt, and build savings is not a class thing or an age thing. It’s an individual thing. I’ve seen professionals who earn serious six-figure salaries but spend it all. They have huge mortgages on their homes. They’ve got kids in private school and can’t max out their 401(k). You would think they’d be well off; they’re not. The key is, whether it’s a boom or bust time, to be smart with your money, and I’ve already defined what that means. If you’re doing that, I would just suggest switching your future contributions to a fixed account. But if you look at your situation and see that you’re not doing what you need to do, your first order of business—even in the middle of a recession—is to stop it and get back to living within your means.

Q: Are you still bullish on America and the American stock market?

A: I am still bullish on America, and one of the reasons is that the falling dollar is just like our boom-and-bust cycle; the dollar goes up and down, too. Remember some years ago when Japan was going to take over the world? They were buying all the real estate in Hawaii, they had such great marketing and business skills. Then the dollar changed and nobody heard about the Japanese anymore. The dollar is what’s driving these foreign stock markets. The dollar will be down as long as we have to cut interest rates, as long as the Fed has to do that. But the reason I’m bullish on the American stock market is that it’s down. It’s true that a good foreign stock index fund has, over the last 10 years, probably outperformed the S&P 500. But all that means is that this is a good time to be buying American stocks.

Q: How about tax-free municipal bonds and inflation-linked bonds? Are they good for retirement accounts?

A: They would be if you had bought them five years ago. They would be getting the returns that you see so widely trumpeted right now. But the problem is that when you look at historical performance, and make investment decisions based on that, the natural inclination is to gravitate toward those with the highest returns, or the most consistent returns. But you’re picking the ones that have done well, which means you’re buying at a high point, not a low point.

The trick is to pick good, solid, diversified investments that don’t cost much in terms of fees and commissions, and start buying those because those will be the next things that everybody’s talking about. It won’t be this year, it won’t be next year, but it will happen. For example, right now, I’d invest in the S&P 500. It’s down right now, but it’s a good investment, it’s blue-chip America, it’s diversified, it’s extraordinarily low cost. So, buy it. And people will look at you and say, "Are you nuts?" And that’s exactly why you should buy it. So I am not a fan of making investment choices based on "superior returns" because you’re going to get a superior boot in the butt eventually.

Q: Anything else we should tell our readers?

A: We haven’t talked yet about what is a good mix of investments.

During the accumulation phase, I would prefer that investors are 100 percent in stocks. I know that is contrary to the conventional wisdom. My reasoning is: people who counsel folks to have a mix of stocks and bonds—and they have all sorts of formulas based on age and length of time, and so on—I don’t like that. What they’re trying to do is build an account that is less volatile. That’s what bonds do; they make the overall portfolio less volatile.

But all of the information we have is that stocks outperform bonds by almost 2-to-1 over time. So I would say until people are in about their mid-50s (assuming retirement in their mid-60s), I would want them—through thick and thin, through expansion and contraction, through ups and downs – to be buying stocks. And I’m talking about a basket of stocks; I’m not talking about picking stocks, which is a special thing that I really wouldn’t advise usual people to do. The big granddaddy CREF Stock Fund would be an example of what to buy. The big granddaddy Vanguard 500 Index fund, the granddaddy Fidelity Growth and Income Fund—those are the types of places that I would concentrate the consistent dollars.

Now, when you get closer to retirement, you do need to start having a little bit more conservative stuff thrown in. So by the time they’re retired, I would want them somewhere near 50/50: stocks (and by that I mean a good blue-chip American stock fund) and something that doesn’t fluctuate in value. I probably would not want bonds because bonds lock in the interest rate and at this point in the interest rate cycle, this doesn’t excite me. That’s because I think over the coming decades – and that’s where retirees should be focused – interest rates are going to go up. I’m not doing that by reading tea leaves but simply by understanding the reality of business cycles. ¨