As the Dow plummeted in September and October, alarm skyrocketed. Many seniors fear their livelihood, lifestyle, and retirement are in serious jeopardy – but that doesn’t have to be the case. Let’s take a look at what happened on Wall Street, some points for your consideration as an investor, and what you can do to protect your assets.
What happened?
As a culmination of the year-long crisis among financial markets, the events of October are unprecedented in their impact on the structure of Wall Street investment banks. Investment banks are being forced to merge with commercial banks to take advantage of a more stable deposit base and the greater investor security that comes with tighter regulation. This transition is occurring more rapidly than many had expected, exposing the market to a web of interconnected liabilities and complexities. At this point, there is great uncertainty about the ultimate ramifications of these events, and it is important for all of us to acknowledge this uncertainty. However, it is also important for investors to keep these events in perspective.
Are we facing a second Depression?
The bankruptcy filing by one of the oldest investment firms on Wall Street, along with the forced merger of another, will remind people of other times of Wall Street turmoil such as October 1929 or March 2000. But while the worries are the same, the economy and markets are different.
This is not the economy of October 1929. Structurally, it is a far more stable economy, prone to fewer and shallower recessions. Cyclically, with home-building, vehicle sales and inventories already at very low levels, there is some potential for stronger economic growth in 2009. The commercial banking system is protected by FDIC insurance and is heavily regulated. Both the Treasury Department and the Federal Reserve are more engaged and have far more tools at their disposal than they did 80 year ago.
Nor is this the stock market of March 2000. Back at the turn of the millennium, technology stocks had been bid up to levels that could not be justified by any conventional measure of valuation. By sharp contrast, the stock market today is at a lower level, despite significantly higher profits, particularly outside of financials, with much higher dividend yields, much lower long-term interest rates, and lower taxes on dividends and capital gains. By the numbers and assuming a moderately growing economy, the stock market was expensive in March 2000. By the same numbers and under the same assumption, it is cheap today.
Key points for investors to consider
Having said all of this, this is a very uncertain time in financial markets and it is a time when investors need balanced advice more than ever. In providing that advice, some points can be made which are particularly timely right now:
First, Economy Matters. Remember that this is an economy of long summers and short winters. American economic expansions have been getting longer over the decades while recessions have been getting shorter. While the events of October are shocking, they most likely will not prevent the economy from resuming a path of moderate expansion.
Second, valuation matters. The Markets are always most dangerous when investors are complacent and valuations are extended. But this simply isn’t the case right now with the earnings yield on stocks actually above the yield on 10-year Treasury bonds, and the net value of the assets of non-financial firms significantly exceeding their stock prices.
Third, Diversification matters*. Many stock markets around the world are closely correlated and all are suffering from the turmoil of the last year. That is why it is important to have a mix of suitable investments in a balanced portfolio.
Fourth, Discipline matters. Consider annualized returns achieved in different asset classes in the 20 years from 1988 to 2007. Despite recessions, wars, hurricanes, 9/11, and political change, stocks, real estate and bonds all provided the potential for good long-term returns. However, the average investor didn’t wait it out long enough to realize those returns. Why? Largely because they got in when they felt comfortable and got out when they felt uncomfortable – which is just another way of saying they bought high and sold low.
What can seniors do to protect their finances?
For many seniors, preservation of capital is a big concern, as well as generating enough income to sustain their lifestyles. The Fed will keep interest rates low to stimulate the economy – including interest rates on money market accounts, CDs**, T-Bills, and other fixed income securities, which many seniors rely on for income. As a result, many will have to dip into their principal to sustain their lifestyle.
At Prospera Wealth Management, we advise our clients to keep three different “buckets” of assets:
Shannon Wood
Editor
Senior Living Strategies
If you have any questions, concerns or comments regarding these topics, or you would like to suggest another topic of interest, please e-mail Shannon at shannonw@lawtonprinting.com.