Unless you are extremely well off ($10 million or more in liquid assets for individuals or families), fight the urge to retire in this era of great financial uncertainty. The United States and much of the world has embarked on an unprecedented venture to absolve the financial sins of the current and immediate past generations with promises that future generations will pay our bills. As I have written frequently on my site, that strategy is not only financially irresponsible but profoundly immoral.
Whether from a recognition of the financial folly or from pangs of conscience, increasing numbers of Americans are turning their backs on the concept of further bailouts. The latest polls show that a majority in this country want the Fed to discontinue its stimulus efforts.
The largest and most aggressive bailout program in world history put at least a temporary floor under a plunging economy. The recovery it stimulated, however, has been one of the weakest on record. Recent economic readings increasingly point to the growing potential for a renewed slowdown or even a double dip recession.
The Fed acknowledged in its recent statements that it has been surprised and disappointed with the recovery’s lack of progress. Chairman Bernanke has expressed concern about the unusually uncertain economic outlook. It is that uncertainty and the still precarious economic condition that prompt my strong suggestion that you maintain your employment income stream.
A great many people retired over the last decade with a million to several million dollars in investments, fully expecting that their various retirement income sources would allow them to live their “golden years” as planned. The behavior of the financial markets over that most recent decade, however, has introduced unexpected speed bumps and has turned many golden dreams to dust.
I have vivid recollections of non-clients coming to our office in 2002-03 somewhat in shock, having seen as much as half or more of their nest-eggs disappear in the market decline that followed the bursting of the dot.com bubble. Several were literally in tears as they evaluated their economic alternatives.
Although we made money for clients in each of those difficult early years in the new century, we remained cautious. We warned listeners that the economic and market excesses had not been solved by the largesse of the Greenspan Fed, which brought interest rates down to 70-year lows. Those historically low rates furthered the real estate boom and precipitated the bubble from which we still suffer. Unfortunately, we lost some clients at that time who decided our cautiousness was out of touch with new era opportunities in both residential and commercial real estate. We readily admitted that we had no real estate expertise. Nonetheless, we repeatedly warned that leverage in real estate was extreme and that, notwithstanding recent experience, real estate was a cyclical commodity. When any financial commodity is overleveraged at a historical price extreme, the danger is serious. Unfortunately, the risk was realized, and latecomers to the real estate party were punished severely.
Whether because of the collapse of the real estate bubble or merely coincident to it, common stocks were again battered from 2007 to 2009. Despite the price rally into the end of the decade, stocks lost money over the full span of this century’s first ten years. Because of the historically typical tendency for investors to buy high and sell low, most investors in equities did far less well than did the weak stock market indexes themselves.
So far bonds have proven to be the new century’s most profitable securities investments, largely because government rescue efforts directly lowered short-term interest rates and because the Fed purchased well over $1 trillion of fixed income securities. Once the Fed effectively promised not to let financial institutions fail or hurt investors, bonds of all types leaped in price. Junk bonds, rated barely above default levels, returned over 100% in their first twelve months of recovery. As is typical of investors in every era, they project recent results into the indefinite future. Because bonds have beaten stocks and cash over the past decade, investors are pouring money into bonds, notwithstanding interest rates at or near historic lows.
Bonds, at least Treasury bonds, could continue to be profitable if the economy remains weak and especially if deflationary tendencies become more dominant, which looks increasingly probable in the short run. Corporate or municipal bonds, however, are likely to be good investments only if rates stay low, yet we skirt deflation or a significant recession. Should deflation or a significant recession occur, prices of municipals and all but the most secure corporates would likely be hurt by the threat of default.
Whatever is left in retiree portfolios after this difficult decade is now earning precious little. The Fed has pushed risk-free rates virtually to zero. If you’re willing to lend the U.S. Government money for two years, you’ll receive an annualized return of just about one-half of one percent. You will receive about 2.7% per year from a ten year U.S. Treasury bond. If retirees choose to avoid risk, their investment income is far below what they had anticipated.
Retirees face difficult choices. They can seek higher returns in equities that continue to face strong headwinds. The problems that led us into the unprofitable last decade remain: excessive debt and excessive speculation. Those problems have been compounded by severe unemployment and an extremely weak real estate market. The potential long term success of government rescue efforts is unknown but increasingly questionable.
The retiree can stretch for yield in corporate or municipal bonds but assumes the risks listed earlier. On a risk/reward basis, there is far more room for rates to rise and hurt bondholders than to fall and provide benefit.
The safest approach for those for whom this is an option is to stay employed and keep the stream of income flowing. It broadens the scope of future options.
Should deflation take hold, even for as little as a year, it could leave a deep scar on the psyches of consumers. Once people begin to expect lower prices, they defer purchases and the economy slows. That can easily become a self-reinforcing cycle.
Fed Chairman Bernanke has vowed that he will not allow the economy to fall into deflation. But should it begin, he may not be able to control it. He has already poured an unprecedented amount of money into the banking system, but there it remains. For a variety of reasons it is not being loaned out. More money does the economy no good if it just sits. It is only of benefit if it circulates, and the Fed Chairman can’t force that to happen. On the other hand, Carmen Reinhart and Ken Rogoff pointed out in This Time Is Different that over the past 800 years, inflation is the normal response to excess debt and monetary crises. Government almost invariably tries to print away excessive indebtedness. Whether deflation affects us initially or not, it is a relatively safe bet that inflation, possibly even virulent inflation, lies somewhere in our future.
As inflation and deflation battle one another, investing will continue to be a complex and difficult endeavor. Should inflation become severe, it will likely do serious damage to the assets of retirees heavily dependant on fixed income. Employment incomes rise over time to compensate for inflation. For most people, having that regular paycheck is likely to be the safest defense against uncertain conditions. Keep your job.
Disclosure: No positions