When the economy goes south and the markets get wonky, many people, especially those who are close to retirement, clamor for "safe" investment assets. But what qualifies as a safe investment and are there really any such things out there for people to invest in?
Gone are the days when you could plunk your entire savings into a timed certificate of deposit or a savings account and actually receive interest on your money. Now, no matter where you put your assets, there is going to be some risk attached. The question is which options are the least volatile but still allow you to make money on your money?
See also: Market-Neutral Investing
The first thing individuals must do is acknowledge that risk can't be avoided, says Tom McGuigan, a certified financial planner with Burns Advisory Group in Old Lyme, Conn. "Any time you say you want to get rid of this risk or that risk you are deciding to accept a different one."
McGuigan recently hosted an event for his clients called, "The Risky Side of 'No Risk,'" where he discussed various investment risks and how they can be managed.
One of the things that astonished his clients was how often "safe" investments failed to keep up with inflation. "Forty percent of the time, safe things meant you could only buy a half a loaf of bread instead of a full loaf of bread after 10 to 15 years. I wouldn't consider that safe at all. I would say that is highly risky. …It is actually losing money. By sitting in cash, CDs or short-term fixed annuities, they are actually losing their ability to purchase goods and services. Our whole focus is to make sure they maintain the ability to buy goods and services when they retire," McGuigan said.
One of his strategies is to help clients understand what volatility is and "should we care too much about it. I believe Wall Street loves to play up the notion of volatility. They do that so they can create products with less volatility. Wall Street told [investors] to be afraid of [volatility]. They created the problem and now they have created investments that reduce volatility," he said. "We put volatility in perspective."
He encourages clients to stick with the investments they agreed to in their financial plans. Every time he works with a client, they discuss the risks and market volatility so they won't be surprised when their investments dip down and then go back up.
"Younger clients don't need to worry about volatility if they are not drawing from their portfolio. It is irrelevant. It is a completely different story when they are retired and drawing money out of it. You don't want a portfolio to drop 30 percent and then take money out of it," McGuigan said.
When he builds a client's portfolio, he determines how much money they want to have in retirement and how much they will receive from pensions and Social Security. He then has them set aside a certain number of years' worth of that needed income into an emergency fund he calls the war chest.
The war chest is not invested in stocks. Instead, it is placed in bonds or short-term bonds. The rationale is that when you retire, if the stock market is doing fine, you can pull the income you need from those investments. When the market goes down, clients can draw money from the war chest and use it until the market recovers so they never need to touch their stock investments.
