Safe Retirement Investing in Dangerous Times

Posted on October 12, 2012 at 1:56 PM PDT by

Banks on the ropes. Millions out of work. Foreclosures block after block. Yet the stock market has been rising. Safe retirement investing has rarely been more complicated, even for the pros.

We read with interest a recent column by Mohamed El-Erian, the CEO and co-CIO of bond giant PIMCO. El-Erian makes the case, in his usual clear-headed way, the investors have been lulled into a false sense of security.

mee Safe Retirement Investing in Dangerous Times

How? By the U.S. Federal Reserve. The jury is still out on whether the Fed’s strategies will, ultimately, work. But the side effect of artificially low (one might argue negative) interest rates is that investors have been buying stocks.

That is to say, many investors normally focused on safe retirement investing have been rewarded by taking risk, and that has a lot to do with Fed machinations in the background.

That could come crashing to a halt at any time El-Erian warns in a column for CNBC:

There is a limit to how far and how long prices can deviate from fundamentals. This is particularly the case when central banks, acting without the support of other government entities, do not have sufficiently-refined tools to secure good and sustainable economic outcomes.

As argued in Thursday’s column, investors’ romance with the “central bank put” should not be unconditional or everlasting. Moreover, it needs to be accompanied by significant portfolio differentiation, responsive management of overall risk exposures, and positioning that also reflects more durable global themes.

Central banks should be respected. And they can certainly counter air pockets, but not forever.

El-Erian makes an excellent point. Investors should not confuse a rising stock market with a recovery or with safe retirement investing. There’s an argument that stock prices are “efficient,” that they represent an accurate accounting of the value of their underlying companies at all times, but the massive shadow of the Fed is hard to ignore.

The problem, of course, is that it’s essentially impossible to guess when the Fed might pull back. The bank’s rate-setting committee, the FOMC, has forecast zero interest rates to 2015. But that could be undone in a week, or a day, if they so choose.

Arguably, the Fed won’t do much about rates until they see a solid recovery on track. Then, anxious to avoid inflation, they presumably would start to work on cutting the flow of cheap money. Mission accomplished, one hopes.

Meantime, you don’t have to look very hard to find Fed critics and Fed apologists. Each side seems to have deep, personal insights into the inner workings of the committee’s collective mind. Each argues that either inflation is set to roar out of control — or remain tepid and controllable.

Neither outcome is good news for safe retirement investing. High inflation would be a real damper on any recovery, possibly leading to a bout of much-dreaded stagflation, the kind of misery we lived in the 1970s where the economy fails to grow but prices rise just the same.

Very low inflation is a problem, too. Inflation is a natural outcome of economic growth. When central bankers see it shrink and start to disappear, they worry about a stall in growth that can begin to feed on itself. That’s deflation, or falling prices.

If you stayed in stocks through the crisis and stuck to your guns with investing, you are likely in good shape now. But how on earth can anyone do safe retirement investing with so unpredictable a future?

Safe retirement investing in one sentence

Again, El-Erian makes it clear: “Significant portfolio differentiation, responsive management of overall risk exposures, and positioning that also reflects more durable global themes.”

That’s a simple way of explaining asset allocation. Safe retirement investing means you put money into stocks, money into bonds, plus a healthy dose of global exposure, hard assets, and cash. Differentiation protects you from rapid declines. Dividends help you grow your portfolio, then you rebalance over time.

If you rode stocks up from the bottom in 2009, well, that’s great. But now is the time to get smart about safe retirement investing. Taking a one-sided bet on how the world will look after 2015 — either way — is far from safe.




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