Recently the Wall Street Journal highlighted how the Federal Reserve’s policy of keeping interest rates low to spur economic growth has hurt retiree’s who rely on interest rates to maintain their lifestyle. In the article Fed’s Low Interest Rates Crack Retiree’s Nest Eggs, they highlight residents within the Port Charlotte area of Florida and how many of them are coping with little help coming from their CD’s and Money Market accounts.
Unfortunately, this highlights that an all cash portfolio may not last a lifetime. You will never lose principal and you don’t face the same risks as you do with the stock market. But an all cash portfolio can provide as much risk of running out of money during your lifetime as stocks or other investments. Here are my thoughts on cash and the retirement portfolio:
1.) Obsolete Core Holding for Many: Cash in the past used to be a great and logical core holding for retirees. However the forces of longevity and inflation make it very hard for people to continue to maintain their purchasing power over the long term (especially after taxes are considered). In my experience, the few who could afford an all cash portfolio usually had rich pensions (which are diminishing as well) and Social Security coupled with disciplined frugality.
2.) "Don’t Touch the Principal" is Outdated: It is very difficult to have a sustainable retirement cash flow strategy without having to touch the principal. The great draw for risk adverse people towards cash is the interest is consistently spun off without principal. But this limits your alternatives. When you have a diversified portfolio of other asset classes with varying traits, you may be able to touch the principal and still have a better chance of not outliving your money. With a diversified portfolio you can harvest cash flow from investments which are doing well and ripe for the picking while leaving your under-performers in the garden to mature. Dividends, interest, capital gains, principal redemption, it is all money.
3.) Where Are The Bonds? The most interesting thing that I see is most investors have a “barbell” portfolio approach where the decision is either stocks or cash. Where are the bonds? Bonds over the past decade have done quite well as interest rates bottomed out. I suspect that if some of the people highlighted in the WSJ article had part of their nest egg in bond funds over the past decade, they may not be facing the same predicament they are in now.
4.) Cash Has Its Place: Cash is great for expenses needed within the short term, usually within the next 3-5 years. Bad market cycles for stocks usually take three years to recover. By having cash on hand, you avoid the sequence risk of having to sell stocks at lows and instead you can use cash to allow these investments the time to recover their losses.
5.) Excessive Risk Taking May Set In: Chasing yield or going outside the norm usually suggests a tipping point with the retiree who relies on cash and is frustrated with low yields. The real estate bubble was spurred on by mortgage backed securities that were leveraged to provide that higher yield than other interest deriving vehicles. Reverse mortgages or insurance products with implicit “guarantees” start looking attractive. A 70 year old person in the article had 80% of his portfolio in stocks. Why so high? He was quoted as saying, “That’s why most of us are in the stock market, because there is no place to go.”
6.) Problem Appears When It Is Too Late: In retirement planning, usually the problem of having too much cash appears later in life. Even if the person is presented with this projection with time to fix it, many people don’t take action or make change. Why? Human nature tends to discount delayed gratification and provide a premium for today. But for a lot of these people, small changes made a decade ago would have gone a long way. Now the choices are few without taking on excessive risk.
7.) Where’s the Planning? This is where a little financial planning would have gone a long way. A financial planner could have helped these people determine if they had a sustainable lifestyle, addressed the risk of having all cash, and could have helped developed a strategy to balance the needs of today with those of tomorrow. In the article, it discusses one person who turned primarily to cash after the stock market crash of 1987. Unfortunately I suspect a lot of damage may have been done with that one move.
Unfortunately relying on interest rates is something that is out of your control. In the end, I am a firm believer that financial education is a 21st century survival skill and that people need to work with things they can actually influence. The above illustrates that there is a large need for this as I suspect we will see more of these stories as the Baby Boomers enter their retirement years.