Bailout

Why invest retirement funds in stocks?

By Felix Salmon

I love Eddy Elfenbein’s response to Scott Adams, who thinks that a good simple retirement portfolio can be wholly made up of just two ETFs, one domestic and one emerging-market.

Elfenbein responds with a great question: why not just invest the whole thing in Treasury bonds? After all, I’m pretty sure that Scott Adams doesn’t have a great degree of certainty about the magnitude of the equity premium over the next decade or three, and the first priority when it comes to retirement funds is that you don’t lose them. Right now, with a eurozone crisis looming, it’s entirely conceivable that we could see a rerun of the stock-market panic we had in 2008 and a return to Dow 7,000 — or even lower, if the U.S. and European authorities find themselves without the fiscal and monetary ammunition that they had last time around. In any case, the point is that we’ve been there before and we can be there again, and if that’s a possibility that’s unacceptable to you, then you shouldn’t invest in a 100%-stocks strategy.

Of course, there are risks to government bonds as well, especially long-dated ones, as Jim Chanos loves to explain. But if Treasuries take a tumble, you need to be a very nimble investor indeed to outperform in some other asset class.

My feeling is that if you’ve got a nest egg which you want to keep safe for retirement, then investing it in the highest-yielding TIPS you can find is probably as good a strategy as any. You won’t get rich that way, but at least you’ll be protected against stock-market losses and against inflation. On the other hand, if you don’t have enough money for retirement and you need serious positive returns on your investment, then you’re going to have to start speculating. Either that or going out and earning more money.

Most people, I think, overestimate their risk appetite, and only realize when it’s too late that they really couldn’t afford to lose that money after all. Which is why right now in many ways is a better time to sell stocks for retirement and put the proceeds in something safe like TIPS, than it is to buy stocks for retirement. If you were sickened when the stock market was at its lows and promised yourself that you would be much more cautious in future, then now’s probably as good a time as any to take advantage of the big run-up that we’ve seen in stocks and rotate into something which allows you to sleep well at night. Unless you enjoy investing — and few of us do — I see no great reason to jump with both feet, Scott Adams style, into this increasingly unpredictable and senseless market.

Full post as published by Macroprudential on May 06, 2010 (boomark / email).