What, Me Worry About a Meltdown? [Retiree Portfolios] April 10, 2000

Retiree Portfolio What, Me Worry About a Meltdown?

By David Braze (TMF Pixy)
April 10, 2000

Last Monday I traveled to The United States Military Academy at West Point. I went there at the invitation of the USMA Investment Club, a group of mostly cadets and some faculty. It seems the club has many Fool devotees. Instead of David or Tom Gardner, they had asked me to address their group. I was flattered by their request, thinking they had either heard of my superb speaking skills or had been wowed by my Foolish writings. "Hoo boy," I thought. "I'm finally getting noted for my talents." That smugness lasted until I learned they had extended their invitation to me for two distinctly different reasons. First, unlike those of my famous leaders, my talks are free. I just request payment of my travel expenses. (Note to self: Could this be a way to supplement my retirement income? Maybe the Gardner brothers are on to something here.) And second, my official biography notes that I'm a retired Regular Army officer, so they assumed I would relate better to the needs of a military audience. (Take that, Tom and David. I may be cheap, but I relate better.)

While my ego may have been deflated some on learning the real reasons for my invitation, I nevertheless had a marvelous time. I attended a finance class, toured the campus, watched a parade drill, ate with the cadets in the dining hall, and made my talk that evening to an attentive audience. And in the process I had many stimulating conversations and questions from some astute young men and women. Are they the nation's brightest and finest? You bet! I envy the knowledge, enthusiasm, and awareness these young folks exhibited about the investment world and the economy. Had I possessed just half of the insight they possess at the same age, then I would be far wealthier than I am today.

One question, though, stood out from all others. It dealt with the Nasdaq meltdown that had started on the previous Friday and continued through the market close on that Monday. The questioner asked how I, as a retiree, would react to seeing such a decline in my portfolio and how he, as a young long-term investor, should react to the same decline in his portfolio. I suspect the young man already knew the answer and was merely testing me. Still, I was pleased to answer for it gave me the opportunity to once again expound on one of my favorite Foolish tenets. I've practiced it for years, and did so long before Tom, David, and the Fool appeared on anyone's radar screen.

Before I tell you what I believe, though, let me ask you: How did you react to the news last week? When the market closed on Monday, April 3, the Nasdaq was down some 17.7% from its high. The bubble had apparently burst; the airwaves were filled with pundits saying the high-flying, overvalued tech stocks driving the stock market's advance were finally getting their comeuppance; and rumors abounded of failed day traders. That's certainly not the kind of news that warms the cockles of a retiree's heart. Instead, it's the type of tidings that can easily cause one's stomach to churn as if riding in a tossing ship in the midst of a force-ten gale. I'm sure many lost sleep that night, but I hope most sincerely you were not part of that group.

I answered the cadet by saying, "The Nasdaq is down again, huh? Well, that's the stock market for ya." That's the reaction I have to all stock market declines. They do not bother me in the least. Why? Because I have no intention of using any part of my stock portfolio at that moment. Further, I don't have to. My current living expenses come from elsewhere, not the stock market. We say repeatedly in Fooldom that no money you know you will need to spend within the next three to five years should ever be invested in stocks. I'm partial to the five-year period myself. Once I have that five-year cushion of living expenses set aside, my remaining stash gets dedicated to the stock market.

Where does the five-year stash go? Into things like money market funds, treasury bills, certificates of deposit, and short- to mid-term bonds where it can still earn interest but avoid most of the volatility found in the stock market. By doing that, I don't need to cash in stocks at a low point, which would deplete my lifetime stash far quicker than I desire. In down years, my living expenses can come from the five-year pot. I replenish that pot only when stocks have gained for the year. So when it comes to fluctuations in the stock market, I note them merely as interesting events. In fact, I pay little attention to what's happening to my stocks from day to day because I don't care about today. I care only when I need to take money from my stock portfolio, and that happens only once a year when I want to replenish my five-year cushion. At best, I look at my stock portfolio quarterly. Does that shock you? If so, all I can say is it's a system that works just fine for me. I've got better things to do from day to day than track my holdings.

I picked the five-year living expense period for my non-stock money based on the market's history over the last 50 years. It wasn't a number plucked at random from a spinning wheel. Since 1950, there have been nine periods that could be classified as bear markets, that is, nine times the market has fallen some 20% from its peak. From peak to trough and back to peak, the average bear market lasted about 20.7 months. The shortest time to recovery was the drop in 1990, which lasted four months. The longest was the bear market of 1973-1974, which required 69 months to regain the previous high. That 69 months convinced me that I needed to keep five-years' worth of expenses out of the market. Whether such history will repeat itself or not is anyone's guess. It could be even worse next time. But, at least to me, the odds don't indicate that. Hence, five years seems appropriately conservative for my willingness to take risk with my retirement money. Others may take more risk, and some less. That's an individual choice. The only thing I know for sure is that keeping three to five years' worth of living expenses out of the stock market does much to preclude a nervous stomach when the market inevitably falls, and fall it will. In my opinion, it's an approach that will work reasonably well for any investor, retired or not.

As for the cadet and his portfolio, I allowed that if he was happy with his stock choices and saw no long-term changes in the business prospects of those companies, then he, too, should ignore the blip we saw last week. Lord knows at his age he has far longer to recover from a disaster than I do, right?

See you next week. In the meantime, post away on the Retired Fools board.

Best to all... Pixy