The COVID-19 virus. The drop in the stock market. The presidential elections. Alarmist news reports and “expert” predictions about the economic impacts of each. No wonder investors are feeling fearful.
When our brains perceive that our survival is threatened, rational thinking goes out the window. This was the case during the 2008 recession. It may be even more true today, given the combination of financial and medical uncertainty.
If you are feeling an urge to get out of the markets, it may help to ask yourself this: If you cash out, what will you do with the money?
Let’s say you are retired, with $1,000,000 in a diversified portfolio (60% in stocks, REITS, and commodities and 40% in bonds and cash). Such a portfolio has generated a total return around 6% annually since 2009. But given the frightening and uncertain future, you’re getting scared and think maybe you’d better preserve what you have.
You need your invested funds to generate an income of $36,000 a year. What are your options?
Might you put cash in a money market fund or your bank? Yet if we are on the verge of a catastrophe, is your bank really safe? And since anything over $250,000 is not FDIC guaranteed, you would need to put your money in four different banks.
Treasury bills, backed by the US government, would be a safer alternative. However, the very best bank money markets and T-bills are currently paying about 1.5%, which generates only about $15,000 a year. Bank CDs pay a little more, around 2.0%, or $20,000 annually, but give no protection against inflation.
A better option might be Treasury Inflation Protected Securities (TIPS). These 30-year government bonds index your principal to inflation and pay about 0.25% over the inflation rate, which is currently around 2.5%. This could be a better income alternative, especially if inflation increases, but would still net only $27,500 a year. AAA rated corporate bonds are yielding 2.13%, which still would fall short of your long-term income needs. All of these options will require you to begin depleting your principal. You really need to be earning 3% to 4%, plus some growth to hit your cash flow needs.
Are there other higher return options? High yield bonds would produce your desired return of around 4% to 5%, but they have a three-fold higher risk over AAA bonds. The biggest risks of corporate bonds, however, are that the company may fail or inflation may erode the buying power in the future since the rate isn’t indexed to inflation.
To guard against inflation, you could add some real estate investment trusts (REITS). Many of those are yielding 3% to 5% and would produce close to the income needed, plus real estate usually appreciates with inflation. You could even add some dividend-paying stocks, which are yielding 2% to 3% plus some probable appreciation that may produce a total return of 5% to 7% over the long term.
The best option might be to add a little bit of each. Altogether, you would get close enough to provide the income you needed, with a little left over to increase the portfolio.
But wait. That’s exactly the type of portfolio you already own—the one your fear is urging you to sell.
It’s easy to panic if you focus on alarming news reports and predictions. Instead, try focusing on your present condition and the options you have today to generate income and recover from potential losses. Look at your current portfolio amount as if it were cash. Then ask yourself, “If all I had today was cash, what would I do with it to generate the income I need?”