Sept. 19--Q: Due to a job relocation, for the past 18 months I have had funds from the sale of my old house and my old 401(k) sitting in a savings account. I did some research and saw the potential for a stock market downturn and a bond downturn happening together. I am risk averse and would rather avoid risk and give up some yield. I'm close to retirement. But it's probably not wise to keep this huge sum of money in a savings account. What should a cash-rich person do? -- E. B., Chicago
A: Your concerns about a downturn in the stock and bond markets have been widespread for months. But if the markets have taught people anything recently, it's that popular expectations can fail to materialize ... sometimes for months, sometimes for years.
And it can be painful. Simply parking money in a savings account for years carries risks that people sometimes fail to appreciate. That money doesn't disappear, but it doesn't grow. And given the fact that people at age 65 can expect to live until their late 80s or even 90s, letting all your money stagnate in a savings account carries the risk that you will run out of money too early in retirement.
That does not mean that concerns about stocks and bonds have been invalid. Stocks have become pricey and may have a way to fall if a weak global economy hurts corporate profits. The stock market has declined about 8 percent since the beginning of the year and some analysts think it could be on its way to more than a 20 percent decline. U.S. Treasury bonds and bond funds have been OK, but they will become losers when the Federal Reserve starts raising interest rates.
But when will that happen? People have been afraid for years that the Federal Reserve would raise interest rates and bonds would become losers. And it hasn't happened. Predicting interest rates is complicated and the smartest brains on Wall Street get it wrong. Consider that half of economists were sure last week that the Fed would raise interest rates, and then the Fed didn't do it.
Now analysts wonder if rates will finally go up in December and cause bond funds to become losers. Or will it be in 2016 or 2017, as some economists think will happen? Retirees who have been risk averse and tried to protect their money in savings accounts are growing desperate for income.
Rather than taking the risk of earning nothing while you wait for the Fed to finally make its move, you could consider a moderate-risk approach that would hedge your bets somewhat.
You could put half, or maybe 40 percent if nervous, in a Standard Poor's 500 index fund and the rest in FDIC-insured bank CDs, with maybe half of the CDs maturing in five years and the others in 10 years. If you search sites such as Fidelity, Schwab or Bankrate.com you will probably find CDs that pay between 2.25 and 3 percent interest.
I'm suggesting CDs rather than bond funds because you won't lose any money in the CDs if you hold onto them until they mature. This is not the case with bond funds, which do lose money when interest rates climb. And because you will have some CDs maturing in five years and others maturing longer than that, you hedge your bets. If interest rates start climbing, in five years you will have cash from some of your CDs available and then you can buy more CDs. In a rising interest rate period, the new CDs you buy will pay you more interest than current CDs are paying. Of course, if interest rates don't rise, you will have the security of a safe investment that will be paying a dependable 2.25 to 3 percent interest.
Meanwhile, with that security, you can put some money into the stock market through a Standard Poor's 500 index fund. If the stock market falls, you will lose money in that fund during the decline in the market. But the loss might not be as severe as your nightmares suggest.
For example, let's say that during the next year the stock market goes into a tough bear market, with a downturn of 30 percent. You might be afraid to trust money in the stock market if you assume you are losing 30 percent. But you won't be losing 30 percent of all your money. Remember, you divided your money, half in stocks and half in CDs.
So only half of your money is losing. Overall, your loss in the combination of stocks and CDs is about 15 percent. Actually, it will be less than 15 percent. Remember, you are earning interest on your CDs and about a 1.1 percent dividend yield from the stock market index. So when you blend the losses and gains together, your loss for the year will be only about 12.5 percent.
Such a loss is no fun. But it's not nearly as severe as the 30 percent that might be paralyzing you.
gmarksjarvis@tribpub.com
