Don’t Let This Nasty Trap Devour Your Nest Egg
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The biggest post-election rally in history has investors and consumers more charged up than I’ve seen since the dot-com rally of the ‘90s.
And it feels so good!
Most analysts agree the optimism is about expected growth from the Trump administration’s promised tax reform, reduced regulation and infrastructure spending.
But behind all the market elation, a subtle and costly trap is developing.
And it’s going to cost income investors and retirees the most… in some cases, all the financial security they have worked so hard to build.
It’s the “safety trap.”
Every person – old and young, rich and poor – has an innate fear of losing what they’ve saved or earned by investing.
The most obvious example? When this fear takes over and drives irrational panic-selling during a market dip. I’m sure we’ve all learned (the hard way) about the damage that can cause.
But as we age, this fear of losing what we have skyrockets.
At first, the increase isn’t noticeable. But by the time we reach the retirement zone (usually around age 60), it explodes into a rabid pursuit for safety and guarantees.
At this age, it’s the exaggerated need for safety (to protect against losses) that’s at the root of the safety trap.
Unfortunately, the losses are always greatest for the one group that can least afford them… retirees.
A Key Rotation Restored
The trap has two distinct parts. The first part is already in motion, and it’s being driven by the Trump rally.
It’s the rotation from Treasurys to stocks – institutional investors moving out of Treasurys and into stocks.
This mechanical rotation function in the markets hasn’t worked properly for the past eight years!
Stocks and Treasurys have both been rising in price since 2008. That wasn’t supposed to happen, but it did.
It’s all changed since the election. The sell-off in Treasurys has driven yields from 1.8% to 2.5% in just weeks.
And as the rotation from Treasurys to stocks continues, Treasury yields will continue to climb. I expect to see the yield on the 10-year rise to the 3% to 4% range by 2018.
Higher rates are at the root of the safety trap.
It seems counterintuitive to think that higher government-guaranteed rates can drive losses, and I’ll get to that in a minute. But first, let’s look at the second part of the trap…
As the pro-growth, pro-business policies of the new administration take hold (barring a black swan event), inflation has to follow.
Why? Because as demand increases, prices for goods and services will rise.
And if Trump’s changes to personal and corporate tax rates, deregulation and infrastructure really catch fire, we could see a big surge in inflation.
But there’s just as much evidence suggesting the likelihood of a more reasonable increase, too. That would put inflation in the manageable 3% to 5% range.
In any event, inflation will increase in the new pro-growth, business-friendly environment, and the Fed will have to raise interest rates to counter its effects.
As it raises rates, returns on savings and CDs will move up, too.
And when these yields reach a number that’s acceptable to most retired folks, the trap will have sprung.
The Guaranteed Way to Lose
The nagging fear of losing your savings combined with the higher rates on Treasurys, CDs and savings will drive fearful investors (primarily retirees) to government guarantees – despite the fact that the institutions and the pros will be doing the exact opposite.
The small, older investor will always chase what he thinks is certainty – or what he sees as a guarantee.
It’s the nature of the beast, and I’ve seen nothing in the past 30 years to convince me otherwise.
But if you check the history of bank and Treasury yields and historic inflation rates, you’ll see that the only guarantees offered by banks and Treasurys are guaranteed losses!
No matter how far you go back (with only a few minor exceptions), after you pay your taxes and inflation takes its bite, these guaranteed holdings always lose money.
The safety trap’s strongest appeal is the extended timeline… the fact that the guarantee will appear to work for years.
Guarantees satisfy our need to feel safe. The income appears to be enough to pay our bills, and things do look good.
That is, until the day we need to replace major appliances, get a new roof or buy a new car… at which point they will cost twice as much as they did (for what will seem like) just a few years ago.
And add this to the equation: We’re now living into our 80s and 90s, which means 20 to 30 years of exposure to inflation in retirement. The problem explodes into a nightmare!
The fear-driven safety shift to CDs, savings and Treasurys has never worked, and it never can.
It doesn’t matter how much they pay – I guarantee that it will always be equal or less than the inflation rate at the time.
But, as always, the lines at the banks will be full of people putting their money into guaranteed losers because it feels so safe.
It’ll lock them into what looks like enough income to finance a 20- or 30-year retirement.
And it’s a nightmare in the making.
Every diversification model requires allocating money to guaranteed assets for cash and emergencies. But if you put all or too much there, then you’re asking for real financial trouble down the road.
The safety trap is the shortest and surest route to waking up broke in your 80s. Don’t be its next victim.