Anyone in the stock market has to be feeling great with the major indexes near all-time highs, assuming you have a reasonably diversified portfolio. So, I feel this is a good time to inject some perspective.
The purpose of investing in the stock market is to be able to use these investments as part of an overall strategy to provide for your financial security at a later time in your life. If you are 30, the later time will be much later. If you are 80, the later time is either now or in the near future. Anyway, financial security is different for each person as is the timing. Until a few years ago, there were basic rules that held pretty firm. Now those rules might not be applicable anymore. By the way, if you are a stock trader or are investing to make a “killing,” this is not for you, so stop reading now.
The basic rules were to have a balanced portfolio with a major portion split between fixed income and the stock market. How that split was accomplished depended on individual circumstances including the need for certain amounts of cash flow. Traditionally long-term bonds paid significantly greater interest than shorter-term bonds or bank certificates of deposit and the dividends from a well-diversified stock portfolio. That has changed. The dividends on an S&P 500 index fund are significantly greater than most short-term fixed-income investments, and the yields on many longer-term bonds have dropped reducing any substantial benefit from the risk of owning long-term bonds. Thus many people that would have never considered the stock market have now started to look at it as a possibility.
What has been discarded is the theory that the cash flow from a fixed income portfolio would anchor the overall portfolio while waiting for the stock values to increase. That has occurred over time, but not in the recent past. People that have continued with fixed income have seen their cash flow reduced as the funds that matured are reinvested. For many people, this cash flow has proven to be inadequate to maintain the lifestyle they could have been relied upon until five or ten years ago, and this has been with pretty mild inflation. We’ve had a big jolt in the market in the last year because of the pandemic but this trend preceded COVID-19 and the trend has continued unaltered by that.
So, there are new rules and here are some of the choices. Note that these are solely my opinions and are presented to introduce you into thinking a little differently about your investments.
1) Keep your investments in bank CDs as you always have. If the cash flow is adequate for your needs, then there is no reason to make any changes. You will have a secure asset base with cash flow that suits you.
2) If your cash flow is inadequate you can still keep your CD investments, but you can make up the cash flow shortfall by withdrawing some principal as you need it. An example is that if you need 3% of the account balances but are only getting .5%, you would withdraw the needed 2.5% each year until the rates go back up.
Three things could result from this:
- The rates might not go back up and you would continue to deplete your account balances. If you are age 90, this might not matter. However, if you are age 65, it might cause you to run out of money at some point, so sticking with the CDs might not be a viable option.
- The rates will get back up in a short period and you would then stop the principal withdrawals without much diminution of the principal.
- You could reduce your spending, assuming you can.
3) If your cash flow from CDs is inadequate you can consider making some changes in your investments. When some CDs come due, invest those proceeds in the stock market, Using the S&P 500 index as a guide this would provide you with about a 1.75% dividend. This would be with the risk that the stocks would lose value, but also with the potential for them increasing in value. Either way, the dividend in dollars should remain pretty stable and should continue (based on what we’ve seen in the past year). This would increase your cash flow and you would still need to reduce some of your principle withdrawals but it would be less than if you did not invest in the stock market. Also, hopefully, the stock values and dividends would increase over time and your withdrawals from principal would eventually be reduced and possibly stop.
4) Irrespective of anything else, you should never assume a risk greater than you need to. This is not a new rule or a new choice, and should always be considered. Collateral to this is to consider taking on added risk if what you are doing will not get you to where you need to be.
No matter your investment proclivities, use the above as an introduction to a potentially different way of securing your future. I will address these issues further from time to time, but if you have any questions or concerns before then, contact me for a brief discussion.
If you have any tax, business, financial, leadership or management issues you want to discuss please do not hesitate to contact me at [email protected].
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