Certainty Isn’t Safe
Harold Evensky (HE): Kirin, good to see you. Where’s Autumn?
Kirin (K): She’s out shopping. I wanted to see you alone. I’m very upset and concerned about my investments; I don’t want her to know and get worried.
HE: Kirin, what’s worrying you?
K: Well, as you know, most of my money is in a series of large, one-year CDs that I’ve been rolling over every year. A few years ago, I was getting almost 9 percent. It’s been going down every year, and now I’m facing rolling them into CDs that are paying only 1 percent! Harold, we can’t live on 1 percent.
HE: I hear you and, indeed, rates have come down significantly. We might find a bank paying a tad more, but it would be a small increase. Let’s talk about repositioning at least some money into a balanced portfolio.
K: A balanced portfolio? That sounds like it has stocks?
HE: Indeed, the idea is to balance your investments between stocks and bonds—probably somewhere in the range of 50 percent bonds and 50 percent stock.
K: Harold, forget it! The market’s too risky. No way am I buying stock.
HE: Okay, Kirin, let’s talk about designing a laddered bond portfolio.
K: What’s that?
HE: Well, we would buy a series of high-quality bonds maturing each year during a period of time. If you invested $100,000, we might buy ten bonds, one maturing in one year, the next in two years, and so on until the last $10,000 was invested in a ten-year bond. That way, if interest rates go up in a year, you’ll have the money from the maturing bond to invest at the new higher, ten-year rate, and if rates go down, you’ll have most of your money invested in bonds paying a higher return than the current market.
K: Sounds cleaver, but forget it. No way am I tying up my money that long.
HE: Okay, Kirin, I give up. Stop buying your one-year CDs and buy five-year CDs. At least they pay a little bit more.
K: Harold, no way. Long-term to me is a green banana.
HE: [By now, I was more than a little frustrated.] Kirin, go ahead make my day—die. [Normally, I wouldn’t be so blunt, but Kirin was not only a client but also a long-time friend and I thought he needed a significant wake-up call, so I went on.] If you really did die, I would be distraught because you’re a good friend, but what keeps me awake at night and should keep you awake at night is not dying and having no financial assets to support your lifestyle. As my friend Nick Murray would say, your problem is confusing safety and certainty.
CDs are certain in that you can have confidence that you will receive the interest payments promised and your full principal back at maturity. In the real world, the friction of taxes and inflation is likely to result in your certain payments buying less and less. That means your standard of living will gradually be eroded. That is not safe. The moral? Don’t confuse certainty and safety. A safe investment portfolio has a high probability of allowing you to maintain your standard of living. For most of us, that means investing in both bonds and stocks.
This blog is a chapter from Harold Evensky’s “Hello Harold: A Veteran Financial Advisor Shares Stories to Help Make You Be a Better Investor”. Available for purchase on Amazon.