The Goldilocks Strategy for Prudent Investors
By DAVID A. LEVINE
ARE you saving for retirement but worried about how to handle a sudden, unexpected expense? Or already retired and wondering how best to protect yourself against a stock market loss?
Many people with those fears set aside a so-called rainy-day fund, keeping large sums in their bank accounts or money market funds. This is a costly mistake, rivaled only by the excess fees too many investors pay to high-cost money managers.
When I ask people why they do it, they say things like “in case I wreck my car” or “in case my house burns down” or “in case I have a medical emergency.” But problems of this sort require large cash outlays only if you are not insured. And the remedy for this is to make sure you are adequately insured, rather than create a big rainy-day fund that earns vastly inferior rates of return compared with stocks and intermediate-term bonds.
You will need a lot of cash, of course, when you retire or if you join the ranks of the long-term unemployed. Under those circumstances, however, you will need that money over a protracted period of time. There is no reason that the resources to finance this spending stream should take the form of low-interest bank deposits or money market funds, which inevitably will fail to keep up with a rising cost of living, even if inflation remains modest.
Instead, to minimize the real risks we all face in meeting our unknown, long-term financial obligations, you need a different strategy, one that produces reliable, spendable cash flow and superior returns, minimizing the likelihood that the inflation-adjusted value of your portfolio will decline over time.
The best way to achieve those goals is to avoid “perfectly safe” cashlike assets, relying on your savings account or money market funds only for a 30- to 60-day cushion to cover your day-to-day obligations, plus enough extra at times to satisfy those occasional outsize expenses like a child’s college tuition bill that is due in the next few months.
After that, your primary goal is to build wealth. Not surprisingly, equities do best. That’s why most of your money for your retirement should be invested in stocks.