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Midlife Bachelor

October 18, 2008
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Thanks to the credit crisis and the stock market collapse – there has been so much tension out in the world the last several weeks.  People have seen the value of their investments and retirement accounts drop by huge percentages – especially those who held large stakes in domestic and especially foreign stocks and mutual funds.   What do you do now – with whatever you still have left?  Do you sell it all now?  Do you simply ride it out?  Who do you listen to?  The answer is – everything is entirely up to you.  Here are my thoughts, and what I’ve been doing … but I’m not necessarily right or smart … and anyone who tells you they are is a liar because no one really knows what is coming next.

Don’t Assume that “Riding It Out” is the Best Strategy
I’ve heard many financial advisors and columnists all say that everyone is better off just letting their investments stay put in the various stock and bond mutual funds … because “it will come back” over time.   I personally think that is horrible advice because you can sell your shares immediately, and re-allocate into something at least reasonably safe with several mouse clicks today.   Why suffer a 40% (or more) loss, and then have to wait X number of years for it to come back to where it was when you can very easily sell now?

A counter argument to what I’m saying is that if you don’t keep your money parked in those stock-oriented mutual funds, then you will miss the recovery.  In other words, if you sell now – they say you will be locking in the losses you have already experienced.   Well that could be true – but what if everything drops ANOTHER 40% from here?  Then you will really be kicking yourself for not selling right now.  My take is – the credit crisis has only started to seriously screw up this economy … and I think we are a long way off from experiencing any sort of sustained recovery in terms of stocks and real estate.   I plan to keep as much of my 401K and non-401K assets in the safest possible types of accounts until there is at least three to six months worth of positive growth.  Sure – I will likely miss out on a big short-term price bounce upward … but I won’t be risking a huge loss by possibly jumping back in too soon.

Focus on Capital Preservation
In my opinion, the safest bet currently is to focus on capital preservation – just hang on to what you have.  And the absolute safest way to do that is keep everything in cash or near-cash.  This means FDIC-insured accounts.  All FDIC-insured accounts are now insured up to $250,000 (versus $100,000 previously) – so find the highest interest rate paying CDs or Money Market accounts, make certain they are FDIC insured, and deposit your money there.   You can use to find the highest paying banks and accounts.   I suggest not locking your money into any time-constrained CD for anything more than maybe 6 to 12 months … because a lot can change between now and then.  I typically prefer the highest interest paying savings accounts which do not require you to keep your money there for any particular length of time.  This allows me to move money around when I do find a bargain – such as what I describe in the next paragraph.

Sometimes capital preservation can mean buying short-term bonds or notes, and holding them to maturity.  I confess that I had not done this previously – up until this past week when I ran across the State of California RANS 8-month note offering described here

       California Brings $4B of RANS Bonds to Market  

These are essentially state-issued short-term bonds that pay 4.25% … but that 4.25% is tax-free so its yield is effectively 4.25 ÷ (1 - <your combined federal & state tax rates>).   For example, if you are in the 33% federal tax bracket, and the 9.3% California state tax bracket … then the effective yield of these notes is 4.25 ÷ (1 – (0.33 + 0.093)) = 4.25 ÷ 0.577 = 7.36% … which is outstanding.   The only risk involved is if the State of California declares bankruptcy … and that does not appear likely to happen.   Regardless, just in case – I only committed roughly 8.3% of the cash component of my portfolio to that bond issue … as diversity is still very important to minimize overall risk.

On the subject of bonds – I have seen some commercial paper (bonds offered by individual companies) that pays very high interest rates.  Be very careful with those – as the higher the interest rate that a company is paying, the greater the risk of default by that company.  Personally, I will only touch government-issued bonds right now.

What about Gold?
There is an excellent discussion about gold in our Midlife Forum – so I’ll simply point you there:

      Ways to Hold Gold in your Portfolio - discussion thread in the Midlife Forum

I go back and forth every week about whether or not to put some percentage of my cash holdings into gold.   I have not done so yet – and if I eventually do, I won’t commit more than maybe 5% of my cash to gold.  Oh – and I won’t actually keep gold at my home … I would hold an exchange traded fund (ETF) like GLD, for example.   My problem with gold today is – even it has been dropping in value the last week or so, as central banks have been selling it to raise their own cash.   Longer-term, many people believe that gold is a safer way to preserve wealth than cash … because cash is subject to things like inflation or even hyper-inflation due to over-monetization by the federal government, etc.   While I agree that cash is a poor way to guard against inflation, I think that TODAY cash or near-cash is the safest way to preserve what you have.   My take TODAY is that anything that is volatile in terms of its price is probably not the safest way to hold your money … and the price of gold has been fairly volatile the past several weeks.

Silver is another precious metal that can also be used as an inflation hedge to protect or preserve the value of your money. Just like with gold, there is an ETF that tracks silver - its symbol is SLV. You can also buy and hold the commodity itself - although you may not want to personally hang onto the physical commodity (since it can be stolen, etc.). Here is a good tutorial on how to buy gold and silver as commodities.

Next Page - What about Stocks and Mutual Funds? >>>

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