Investors face all kinds of risks in the financial markets.
There is credit risk – the risk that a borrower will default on an obligation.
Liquidity risk – the possibility that you will not be able to convert a security into cash when you need the money. Market risk – the likelihood that the share market will decline in value.
But the biggest risk of all is shortfall risk. This is the risk that you’ll outlive your savings. And it is quite real.Thanks to better lifestyles, improved nutrition and advances in health care, people today are living longer than ever. People retiring at 58, 60 or even 65 face the serious prospect of spending up to three full decades in retirement.That means investors using an ultra-conservative approach, investing in RBI Bonds, Bank FDs, Money market mutual funds, are often taking a bigger gamble with their portfolios – and their retirement lifestyle – than they realize. This is especially true when you consider the thief that robs us all, inflation.
All Signs Point to Higher Inflation
The “headline” consumer price index (CPI) for the year ending in January was up 4.3%, the third consecutive monthly reading above 4%.Of course, the “core” CPI, the one that excludes volatile energy and food prices, shows a 12-month rise of 2.5%. That’s not yet dramatic enough to grab the headlines. But there is likely more bad news on this front dead ahead.
Why? Let’s start with the strong rupee. The gushing in of foreign exchange reduces the cost of imports, and making consumption easy. That’s inflationary. Chidambaram does an Enron with the Indian balance sheet . Yet, transfixed by the credit crisis and the housing slump, the Fed has brought rate down 200 basis points. And stands ready to cut rates further. And then there are banks who are regularly “requested” to reduce interest rates. The gold market is signaling higher inflation, too. Mr. Pranab you will have to clean after the elephant. It is a big mess there.
The “barbarous relic” has been hitting one new all-time high after another lately. And it’s not just a short-term phenomenon. Gold is up more than 225% over the last eight years.Some consumers shrug and say, “What difference does it really make if inflation bumps up another point or two?” Don’t make that mistake.
With a 4% inflation rate, an income of Rs.100,000 is worth only Rs.70,000 after nine years. After 17 years its real worth is cut in half. After 30 years, it only has the purchasing power of Rs.30,000.Investors planning for retirement might be unpleasantly surprised to see the Rs.100,000 investment income they counted on generating only Rs.30,000 worth of purchasing power. And that’s before taxes. And we are talking of inflation of 6%, 8%…as it effects you.
Don’t Bail On Shares – So what do you do? First off, don’t let the bears scare you out of the market. Shares can be nerve-wracking in the short term. And they can always go lower before they go higher. But shares are an incredible wealth-building machine over the long term. For time periods measured over a decade or more, nothing has beaten the returns generated by a diversified portfolio of high-quality shares.
As I’ve been telling FAIDAA (see www.faaida.com) members, internationally junk bonds sport attractive yields now, too. A raw materials fund that tracks the performance of the Commodity Index is not a bad idea, either. And gold-mining shares are another fine hedge against inflation. (Oops, there is only Deccan Gold, listed on the BSE if you are reading this post in India)But don’t bail on your shares portfolio. If you jump out of the market, where will you put all that money to work? In Bank deposits yielding less than 7%? In money markets whose yields drop with every rate cut by the Fed / RBI? Into real estate, which is in a downward spiral? (ok not yet in India, but deals have frozen – just not happening!)
I’m not saying these investments don’t have a place in your portfolio. But you have to maintain a balance – and a decent weighting in equities.In short, if you want your retirement years to be truly “golden,” common shares are still your best protection against shortfall risk, the biggest risk you face as an investor.
Happy retirement, happy investing!
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