Your Funds

Investors have a lot of reason to think they should avoid the stock market these days.

“I’m making so much in my certificates of deposit” is not one of them.

And yet, I have met a number of seniors recently who worried their way onto the sidelines for much of the long-lasting bull market, and who are now content to live with savings accounts that are finally paying them a little better than a piggy bank.

The market’s downturn last fall and its steep drop in December has investors — but particularly senior savers — scared. Sure, stocks snapped back quickly from their 20 percent meltdown, but it still felt like a validation for the adage that the market rides the escalator up but takes the elevator down.

And with the rebound happening so quickly, no one figures that there isn’t some future trip that passes the lobby and goes all the way to the basement.

Intuitively, these savers can know that bull markets don’t die of old age, but that can be balanced against the fact that every market cycle comes to an end.

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This one will too, though no one can know when.

With typical investors fearing loss more than they covet gains, nervous investors would rather stick to the sidelines than be in the market when that time comes.

What is changing now is that the motivation for some comes from bank products.

I recently met a woman named Bella from Quincy, Massachusetts, a 70-something retiree who has a small teacher’s pension, supplemented by Social Security and a reasonable amount of savings. All of her liquid assets are parked at the bank.

She is excited that rates on certificates of deposit are rising, because “I’m not willing to gamble in the stock market; I’ll take all the risk I want when I visit Las Vegas.”

It’s safe to assume that Bella is not wagering big at the gaming tables, but she is betting her entire financial future on bank yields, and it’s a lot riskier than it seems.

Yes, yields are up.

Bankrate.com currently shows the top rates for online savings accounts nationally at roughly 2.5 percent. The top rates on one-year CDs are slightly higher, with two-year deposits topping out at 3 percent.

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Those returns are spectacular compared to what was available for most of the last decade, when interest rates near zero meant that savings instruments were more like parking instruments. In fact, with inflation factored in, most bank savings were losing ground when it came to purchasing power.

Today, savers are at least able to generate a real return, though not much of one.

With inflation running at 2.4 percent in 2018, only the top bank accounts are able to deliver above that level.

“Erosion of buying power has been the norm for the last decade, but at least now a bank account can preserve your capital and buying power,” said Greg McBride, chief analyst at Bankrate.com. “It’s not going to grow either your capital or your buying power if you leave it there over the long haul.”

That said, Bella — and the friends who were with her when we met at an investment seminar — isn’t using the top-yielding savings vehicles. She’s in whatever was available at her local bank, so her money is treading water, at best.

She wants to look for better savings accounts, because she can’t get comfortable with buying other investments.

Her reasons for discomfort aren’t all bad.

The biggest reason is that she believes she has enough in savings to not outlive her money, and she doesn’t want to mess it up.

“I think it’s OK if I don’t grow it, and if I am spending some of it,” she said, “but if I were to lose money, that might leave me below the level I need.”

Her two friends at the meeting were not in the same boat, as they are more worried about falling short and having to depend on others to get by because they don’t have enough to live comfortably in retirement.

Ultimately, they all misunderstand risk, thinking that avoiding the stock market makes them risk-free, when in fact it subjects all of their money to inflation risk. The avoid volatility and principal risk, but they are overweight on the potential for their purchasing power gets eroded.

Moreover, their reasons for not wanting to buy simple, diversified mutual funds are wrong.

“They’re expensive,” said Bella’s friend Evelyn. “They’re risky,” said Sally, the third friend. “And from what I heard today, they don’t beat the market very often,” Bella said.

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That thinking is wrong because these savers need funds to beat the bank accounts, rather than the market. The “expense” argument is incorrect because the average expense ratio doesn’t stop the typical conservative-allocation fund from doing significantly better than the typical two-year CD.

It would not be hard to find age- and risk-appropriate investments — a life-cycle fund, a conservative bond fund, a dividend-paying stock fund — that could improve returns and diversify risk so that there is some protection against inflation.

“People are feeling better about savings rates and feel like they are protecting themselves against a market downturn, but if the economy slumps and rates go down again — which it could — they could be reinvesting when rates are down again,” said McBride. “Yes, savings rates are better now than they have been in a long time, but not so much better that people should think a bank account is really going to protect them.

“If you want that to work, you had better be protecting all the money you are ever going to need.”

Extreme risks seldom work, and using only banking vehicles is an extreme in its own right. Don’t let a few pennies of extra yield fool you into making that mistake.