When the leaves begin to turn red and yellow near my home in central North Carolina, I love to watch the squirrels literally “go nuts” in my front yard. I can see them from my living room window as they scurry on their urgent mission to collect every acorn and hickory nut in the yard and stuff it somewhere. They are, of course, stockpiling food for the winter. Watching this, I am convinced that when God made squirrels and gave them this quirky food-gathering habit, he did so to teach us humans a lesson about industry, thrift and planning for the future.
Biologists call this behavior scatter hoarding. These little bushy-tailed critters bury their nuts and seeds in hundreds of different locations, so if they lose track of one hiding place they have plenty of others. Diversification at work! You know that little munching thing squirrels do with a nut between their paws? Surprisingly, they’re not eating. They’re cleaning the little morsel, leaving a scent that will lead them back to their hoard when the snow is on the ground.
Financially, we go through three phases during our lives:
Hopefully, during your accumulation years, you were like those busy squirrels and stashed every dollar you could from your paychecks. No? I didn’t either – at least not at first. My first paycheck job was from the Young Men’s Shop in Durham, North Carolina when I was 16. I felt as if I had finally joined the adult world. I knew where every dime of that paycheck was going to go. Back then, I got my first lesson in adult economics. When they handed me my paycheck, part of it was missing! There was only $63.64 on the line where $82.25 should have been. When I went to talk to the boss about the error, I learned quickly that the store’s payroll people had made no errors in calculating my pay. This wasn’t a mistake; the money went to taxes and something called withholding.
“What’s FICA?” I asked my young boss. He didn’t know. It was just something I had to pay. No, I was not a saver. That impulse would come later in life.
When you are a young investor, you can do no wrong if you are patient and consistent. Time is on your side. You are protected by dollar-cost averaging. The stock market can be a dangerous place if you are a one-time investor or if you are approaching retirement, but the volatility of the stock market actually works to the advantage of younger workers. Let’s say that you have a 401(k). The money you contribute to a 401(k) usually goes into an investment account where a custodian uses the money to buy as many shares of XYZ mutual fund as that amount of money can buy. If XYZ mutual fund shares increase in value, that’s great! Your account value just went up. If XYZ mutual fund shares decrease in value, that’s also great! Your contribution just bought more shares. Those XYZ shares will fatten up some day, and because time is on your side, you can afford to wait. This is not the case with older individuals.
The preservation phase is generally when we are still working, but we are approaching retirement and begin thinking in terms of protecting what we have accumulated. It would be a shame to work and save for all those years then, because of some sudden change in the economic climate, lose half of it because you had too much exposure in the stock market. That happened to a lot of people during the 2008 market crash. Why? They didn’t sense what time it was, financially speaking. If time is on your side, you can recover from market corrections and even benefit from them. If time is not on your side (and it isn’t for those who are in or approaching retirement), you could get caught with your pants down and lose your shirt. (Please pardon the apparel metaphors, but it’s true.)
Bear markets are defined by financial research giant Standard and Poor’s as a 20% or greater decline in the stock market. This is something that happens every 4.8 years. According to S&P, the average decline of a bear market is 38.24%, the average duration is 17 months and the average time it takes for an investor to recover from one is 17 months. It doesn’t take into consideration the “opportunity cost” of lost time and lost interest. See why time is important if you are an older investor?
That’s why I like the investing Rule of 100 for retirees and those approaching retirement. Take your age and put a percent beside it. That’s how much of your fortune you want to keep absolutely safe from loss. It’s more of a guideline than a rule, but once you have your retirement savings preserved, you can get a little risky with the rest.
Ironically, the bubble-wrap of dollar-cost averaging that protected you when you were a young investor could now put the squeeze on you when you get older. You could be the victim of reverse dollar-cost averaging. Here’s how that works:
Let’s say you are in full retirement. When you stopped working, you also stopped contributing to that tax-deferred 401(k) retirement plan as well. Now, the money river starts to flow the other way. Instead of contributing to that fund, you must now draw from it. Those withdrawals are made with the same regularity as your earlier deposits were made only the withdrawals are much more, since they must replace what your entire paycheck would have been. Now, instead of buying shares, you are selling shares. When the price of those shares fluctuate, which they will always do, you still write yourself the same paycheck each month from your retirement account. If the share prices go up, you sell fewer shares. If the share prices go down, you sell more shares. Either way, you are withdrawing the same amount. If a market crash occurs and the value of your account goes down dramatically, those losses will be real and earnest. Since you are no longer contributing to the account, you are no longer buying shares on the cheap to replace those losses. Factor in that you are depleting the account at a faster rate and every share you sell is one less share that will be working for you in the account.
Take a lesson from the squirrels.
- Work hard and save diligently when the time is right for it. There will come a time when the nuts are no longer falling from the trees.
- Don’t store all your assets in the same hollow of the same tree. Diversify.
- Understand what financial season you are in and adjust your saving and spending behavior accordingly.