To Stay Safe, Sell Stocks?

While most financial planners are still extolling the virtues of stocks—even in the midst of a recession—Zvi Bodie is telling retirement-age investors to run the other way. The Boston University and Massachusetts Institute of Technology finance and economics professor, who is coauthor of Worry-Free Investing: A Safe Approach to Achieving Your Lifetime Financial Goals, says any investor who doesn't have the heart of a high-stakes gambler should pull his or her nest egg out of the stock market and shift retirement money into inflation-protected government bonds. Continuing to invest retirement money in stocks, according to Bodie, is similar to trying to win money back from a Las Vegas casino. U.S. News

asked Bodie to explain his conservative investing strategy. Excerpts:

Should ordinary investors with 401(k)'s keep a certain percentage of stocks in their portfolio?

Right now, the conventional advice basically hinges on how old you are. The two additional factors that I think are way more important than your age are your level of income and wealth and the riskiness of your job. For most ordinary people during most of their lifetime, the most important asset they have is their earning power. If you have a job that is very secure—like a tenured professor at a university—you can sort of look at your human capital as a safe asset. Assuming you are buying the proper kinds of insurance against disability, then there is nothing wrong with exposing yourself to the risk in the stock market in your investment portfolio.

[See How Much Should Retirees Allocate to Stocks?]

Isn't it the conventional wisdom right now that retirees should hold some stocks to provide growth and protect against inflation?

That, I think, is about the worst advice you can give people who are retiring if they are people of modest means. The claim that the only way you can protect yourself against inflation is by investing in the stock market is a lie. If you want to beat inflation, what you want are TIPS [treasury inflation-protected securities] and I bonds. Diversification is certainly a valid way to reduce risk, but the only thing that can protect your nest egg is investing in safe assets. As we have seen in the current market, risky assets all tend to go down. What people of modest means need is additional Social Security income. They need inflation-protected, very secure income that will last as long as they live. [An example is] immediate annuities that are inflation protected. The rule of thumb is that once you reach retirement, you should only take out 4 percent of your retirement savings every year to live on if you want it to last and be inflation protected. You can get much more than 4 percent, even with inflation protection, if you convert it to an immediate life income annuity. And equities, as we have just seen, are anything but a reliable inflation hedge. If you had your money in equities, you just saw 40 percent of it disappear in one year.

Wouldn't leaving the stock market right now be locking in your losses?

That is exactly right. You want to make sure you don't lose more. Suppose you thought that equities were going to protect you against inflation in retirement. All of a sudden, you had this rude awakening when you saw 40 percent of your portfolio evaporate before your eyes. You can draw two conclusions from that. You can say, "Oh, my God, I didn't realize how risky these things are. I am going to switch all my money into something that is safer. I may even have to go back to work part time to make up for what I have lost, but at least I know that what I have is secure." The other route is "I only have part of what I had before, but I am going to stick it out in the hope that maybe now it will be safer." Which of these two paths seems more rational to you? I view this downturn in the market as a wake-up call to investors to question the conventional wisdom they have been fed over the year by everyone in the investment industry. It is not true now, and it was never true. Equities are risky in the short run and in the long run. If you can afford to take that risk, you should take it, but recognize that there is a big downside.

What if you have time to hold stocks over the long term?

The view that stocks are almost safe in the long run is just plain fallacious. It's been proven many times over that stocks are risky in the long run as well as in the short run. If it were true that stocks are really safe if you hold them for a long time, then shouldn't the investment company that is trying to convince you to invest in stocks for the long term be willing to offer you a guarantee? What if I am willing to commit to holding stocks for 25 years? Will you guarantee me that at the end of 25 years that I will have at least as much as if I had invested in TIPS or some other safe security? I think you will find that the answer is no unless the company wants to go bankrupt. If it is true, then who should be taking that risk: investment companies or individuals who don't know the first thing about it?