Monday, December 14, 2009

Monday question: Why not just savings account?

On Mondays, we answer a question from a reader. If you have a question for us, post it in the comments section or DM us on Twitter @family_finances.

QUESTION: My wife and I are retired, both of us in our mid-70s. We lost a good bit of our retirement account in the past two years. Given the problems with the stock market, does a savings account paying 3 percent sound like a good place for our money? We find it difficult emotionally to stay in the market, and my wife especially is losing sleep over it. We have less than $100,000 in retirement savings.

ANSWER FROM DAN DANFORD: Well, I'll eat my hat if you can find a saving account paying 3 percent today! Even CDs - where you "lock up" your money for a lengthy period - aren't that high. This is a very unique investment period, and the only redeeming value of cash or bank accounts is that you won't lose money. In the long run, of course, you will because money rates are insufficient to offset inflation. That's why most advisors recommend a diversified retirement portfolio.

The past several years, indeed the past decade, have been very tough on investors. Remember, though, most folks don't buy stocks because they want to, they buy them because the need to. Simply, no other asset class has the demonstrated potential to beat inflation over time. Retired people (you are a great example) must look forward to several decades of future life expectancy, and "keeping money in the bank" hasn't historically fared well against that scenario.

There is a middle ground, though. We advise clients to maintain diversification at a tolerable level. In other words, keeping just 30 to 50 percent in stock market mutual funds is enough for a solid inflation hedge. It's tolerable for most families because the downside risk is mitigated. If the stock market falls by 40 percent, and you've limited your portfolio to 50 percent in stock funds, then you maximum exposure is a 20 percent slip in total portfolio value. Most people can tolerate a temporary dip like that to maintain buying power throughout their investment period.

In investing, you must focus on future goals and needs. Turn off the television market pundits because they yap about the next 15 minutes or 15 weeks. And they don't know anyway. Sleep comes easier when you ignore all the bad news. I've been doing this now for 30 years and there has never been a moment when the doomsayers were quiet! In thirty years. It's not rocket science, but it's not Armageddon, either.

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