The Truth About Stocks and Retirement

What an interesting coincidence that in the same week that I launch the FAILSAFE RETIREMENT™ System, Zvi Bodie is interviewed in Money Magazine. In an article entitled “You Can’t Handle the Truth About Stocks”, Prof Bodie makes the case once again that the risks inherent in equity investing do not decline over time. He sums it up this way:

The standard models that are used to give investment advice to millions of Americans are fundamentally wrong. We’re told that over time, stocks get less risky, but that’s bull. Stocks are always risky — whether in the short or long run. Prices dropped by 37% last year. While improbable, there’s nothing to say they couldn’t drop by that much again next year or the year before you retire. And diversification doesn’t take away that risk. That’s why retirement money belongs in truly safe assets whose value won’t go down — not in stocks.

The article provoked a lot of comments on the CNN/Money site, many of them critical of Bodie’s position. I think many of the criticisms are based on a flawed understanding of what Bodie is trying to tell them. They say that there is risk associated with many aspects of life and that equity investing is just another one of them. Risk is not to be avoided, they say, but carefully embraced.

The assumption of risk is fine in many circumstances but only in when you can recover from a losing bet. If you choose not to insure your car against collision loss, you can probably recover from that. If you choose to gamble $1000 in Las Vegas, you can probably recover from a series of losing bets.

On the other hand, if you choose to work without disability insurance and become permanently disabled, you and you family will more than likely end up a charity case. So it is with retirement income planning. If you put your  retirement income baseline in the hands of the equity markets, there is a real chance that you will lose. Losing means you will not have enough money to support yourself in retirement. This means unretirement or worse, becoming dependent on others.

This is Bodie’s point. Investing for a baseline retirement income should be free from two risks: risk of loss and risk of diminished spending power caused by inflation. Equity investing does not fully address either of those risks, either in the short term or long term.

It is hard for entrenched interests in the investing industry to accept the hard truth in Bodie’s arguments and data. The same goes for investors who have bought into what the retail investing industry has been been selling.

Take care of your essential retirement needs first. Then take your risks in the stock market.