From Stocks to Bonds: Time to Switch?
Exploring how long you can wait before you sell stocks to buy bonds.
March 3, 2009 — -- When's this beating going to end?
That's the question every investor has been asking since fall when the markets began their rapid descent as the nation's financial system began to unravel.
The truth is, no one knows. For a time, it seemed like the worst was behind us with relative stability as the New Year began. But then stock prices resumed their downward spiral in February and continued into March with Monday's dip below 7,000 for the Dow.
There's nobody who can tell you when the economy will rebound or when stock prices will begin to recover. Anybody who says otherwise is either lying or delusional.
Nevertheless, investors are seeking answers to questions like the one posed below.
Q: I sold my business four years ago and retired at a young age (50). Since (the fourth quarter of 2008), I've seen my legacy reduced by 40 percent, with no signs of abatement. I've lost my stomach for stocks and feel sick about what took 22 years to build just disappearing before my very eyes. My financial advisors say now is not the time to bail, but I just can't stand to watch this anymore. If I lose no more net worth, I'll be okay. And growth doesn't concern me. I'd be happy to have the same net worth two years from now as I have today. Any suggestions? Currently I'm in a 60/40 model, stocks vs. bonds and cash.
-- J.G., Green Bay, Wisc.
A: J.G., my first suggestion is to take a close look at the bonds and cash on the conservative side of your portfolio. How much is there, and what kind of income does it produce?
The answers to those questions can help you decide whether to stick with stocks despite their tailspin or move entirely toward conservative investments. A close look at your portfolio and what's in it could help calm your nerves and decide whether you have the capacity to wait for a recovery in stock values.
We all look at the bottom line numbers for our portfolios and then calculate in our minds how much we've lost since early 2008. I've done it myself.
Time to Wait Out the Turmoil
But you need to look at more than the bottom line. Many investors, particularly those at or near retirement, should break down their portfolios into segments that represent what funds are needed over the short, mid and long terms. If there's enough to carry you through the short and mid term, then you may have the capacity to stick with stocks and wait for a recovery over the long term.
Imagine for a moment you rely only on the bonds and cash now in your portfolio to support your expenses. How long could you go before you had to touch your stock holdings?
If the bonds and cash would run out in six months, then clearly your portfolio needs to be readjusted with a more conservative bent. But if you could rely on strictly bonds and cash for five years or more, then chances are better that stock values will be higher than they are now.
Let's assume we're talking about a portfolio now worth $1 million, with $600,000 in stocks and $400,000 in cash and bonds. (If you retired at age 50, then I'm guessing your portfolio was at least that large.)
If the cash and bonds yielded 3.5 percent a year in dividends and interest, you could withdraw $40,000 a year from the portfolio for 13 years before you would need to tap into your stock holdings. Include the dividends paid out on the stocks, and that $40,000-a-year withdrawal will last even longer.
The point is, you may have the time to wait out the turmoil.
Under this scenario, the question to ask yourself is how likely you think it is that stock values will be higher 13 years or more from now. There's no sure answer. But your own individual response can help you decide how much more risk you can stomach and what share of your money you want invested in stocks.
As part of this process, I also would suggest that you study your portfolio in detail and make sure you understand every aspect of it. For instance, are you sure your portfolio, in fact, holds 60 percent stocks and 40 percent bonds and cash, as suggested by your asset allocation model?
Don't Neglect Conservative Investments
With the steep decline in stock prices, the stock portion of most portfolios have fallen well below their original targets. Has your adviser rebalanced by using the cash or bonds to buy additional stocks to return to that 60 percent target for stocks? Or has the state of the markets made you too nervous about doing so? Could you now be at 50-50?
Even if they don't sell their stock holdings, many investors are finding it difficult to bring themselves to buy more.
And when studying your portfolio, pay close attention to the precise kinds of bonds and cash holdings. What kinds of bonds do you own and in what form? Are they individual bonds or bond mutual funds? Corporates or treasuries? Investment grade or high yield (a.k.a. "junk bonds")?
For cash, are you in CDs or money markets?
As we navigate through these turbulent times, it is my belief that investors need to focus as much on the conservative side of their portfolios (bonds and cash) as the riskier side (stocks). It is the conservative side that is supposed to carry us through times like these.
Make sure you know whether your portfolio has that capacity.
This work is the opinion of the columnist and in no way reflects the opinion of ABC News.
David McPherson is founder and principal of Four Ponds Financial Planning in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at david@fourpondsfinancial.com.