Money Power: Protect against risk in your investments
BY KIPLINGER'S Money Power
Saturday, April 28, 2012
4/28/12 at 5:04 AM
Stocks have always been the core plank in the Wall Street framework for retirement investing. According to this strategy, stocks are superior long-term investments compared with any other asset class.
The real risk with retirement savings, the thinking goes, is being too cautious with your money and earning a meager return.
The "stocks for the long haul" mantra has become somewhat muted now that bonds have trounced stocks in the total-return sweepstakes for a considerable period. But the concept of managing personal finances with a goal of maximizing returns by owning stocks is still dominant.
The insurance framework for managing money didn't get much attention until the Great Recession. Its proponents preach that rather than reaching for riches, you should first put money into safe investments to limit the downside. In fact, they say, stocks are too risky to be the average person's core investment, even if held for the long term.
Extreme proponents of this insurance perspective favor Treasury inflation-protected securities. U.S. Treasuries are the world's most creditworthy securities, and TIPS offer the advantage of hedging against inflation by offering interest payments tied to changes in the consumer price index.
The purpose of putting your money in safe assets, such as TIPS, Treasury bills, FDIC-insured certificates of deposit and the like, is to have the minimal sum of money you need when it comes time to pay the bills.
Proponents recommend putting money into two pots: safe savings, to cover your minimum needs, and riskier investments, such as stocks, for wants.
I basically buy into the protect-against-downside-risk philosophy, but its proponents often seem to underestimate how difficult it is to accomplish. Many of the investments on which this approach is based are difficult to understand and analyze. It also seems to be getting harder to project income accurately over the next couple of years, let alone a lifetime.
Put it this way: How confident are you about your income projections, considering corporate America's relentless drive to downsize, right-size, restructure, re-engineer and outsource jobs? No one plans on getting divorced, but many couples part ways, with a devastating effect on their finances. Stuff happens.
You can't escape risk. And there's no magic number that solves the equation about "how much savings will I need to age gracefully?" Individuals should focus on setting aside enough money in safe savings so that a setback around retirement doesn't turn into a financial catastrophe.
Original Print Headline: Protect against risk in your investments
Chris Farrell is a contributing columnist to Kiplinger.com.
