Wealth has been defined thus far as a pool of capital that outpaces inflation. Achieving wealth will not be successful if you do not own equities or, as the author puts it "...committing yourself entirely to bonds, CDs and other debt instruments will prove fatal to wealth as we've defined it."
What should an investor do in retirement? While it may be common to transition from stock ownership to bonds for perceived safety and income as one approaches and moves into retirement, the author and I agree in the rejection of this strategy.
Remember inflation? If you and your spouse live for 30 years, a retirement timeline to be financially prepared for, you will run out of money if you pursue the perceived safety of a portfolio of bonds. Compounded over your 30-year retirement, a 3% annual inflation rate will lead to a 60% erosion of your purchasing power.
Why do so many people, including investment professionals, get this wrong?
1. The author suggests that we may unconsciously assume life expectancies that we have seen historically. If we look to the past we see our parents’ and grandparents’ life expectancies which are likely to be shorter than our own. Current life tables suggest we must plan for retirement money to last into our late 80s or 90s.
2. As previously discussed, our fear of loss is so much greater than our hope for gain, especially in relation to money we have spent a lifetime saving.
3. The author also believes that deep cultural beliefs drive this strategy. For example, today's retirees are children of the Great Depression and they may be scarred from economic suffering and loss. Also any message blasted through an echo chamber enough can begin to appear as the truth. For example if you hear "stocks are too risky for retirement and bonds are safe" enough times you may begin to believe it. I would bet that many people reading this have received that very message and may be struggling with my suggestion that bonds are more unsafe for wealth-building than stocks.
Consider what we have learned thus far and contemplate this quote from the book.
"As we approach retirement, we can't afford to take the risk of speculative investments like stocks. We need to keep our money safe in conservative investments like bonds and CDs. Besides, we need income, and bonds yield more than stocks."
This statement fundamentally misunderstands the meaning of risk, safety, speculative investments, conservative investments, and yield.
You have a choice to make.
"...on which end of your investing lifetime do you want your insecurities so that you can have security on the other end?"
If you choose security here and now you will invest in short-term CDs, treasury bills and maybe high grade corporate bonds. You can sleep well at night knowing that you are not subject to the volatility of stocks and you can enjoy the small amount of current income from these investments. This income will be ruined by inflation and taxes and eventually run out. Security now, disaster later.
Alternatively, by purchasing equities now you elect some insecurities in the near term and you subject your nest egg to assured volatility. There will be some stressful times that you wouldn't have had if you chose the option above but you will also have the rising income and capital to outpace inflation. This is wealth as we've defined it.
Remember, no risk does not exist. Your choice is what to risk and when to risk it.
And finally, if you're wondering whether you should always own 100% stocks in your long-term portfolios the answer is no.
All stock investors, especially those who are retired, should hold meaningful cash reserves.
Do bonds then have a purpose at all? Although irrational for long-term wealth building they are effective tools for managing investor anxiety. They feel good because they feel safe. Here again, emotions are ever present in investor decision-making.