How to Invest When Everything is Losing Value

How to Invest When Everything is Down

By John H. Robinson (6/18/2022)

* Cryptocurrency is technically not an asset class since has no fundamental underpinnings/backing.

Although the term “bear market,” tends to be associated with a downturn in the stock market, 2022 has produced a bear market in everything. Nearly all broad asset classes are trending lower. The table above is intended to provide a quick cheat sheet to help FPH clients understand the tools that are available to address the various threats to their financial security.  More detailed insight along with articles to support my perspective are provided below.

CASH

Many consumers perceive cash to be a safe, liquid store of value. In times of low or no inflation, it is.  However, inflation as measured by the consumer price index (CPI)for the past six months rose by more than 9% (annualized), the largest increase since the 1960s.  To make this tangible, if you had $100,000 in a 0% checking account a year ago, it would take $109,000 today to buy the same amount of goods and services today. 

The easiest way to fight back against the insidious creep of inflation without putting your principal at risk and without tying up your money for too long is to put your cash to work in safe, short term interest-bearing instruments such as FDIC insured online banks, short term CDs, and treasury bills.  While interest rates on these instruments have been rising quickly this year, current yields are still far below the inflation rate. If you are fortunate enough to find a safe place to earn 3% on your money over the next 12 months,  your real return will still be a 6% loss of purchasing power if inflation remains at 9%.  

One way to fight back more effectively may be to shift money from cash into other asset classes and investment types such as Series I savings bonds, treasury inflation-protected securities or even rising dividend stocks, but these alternatives require the buyer to give up some near-term liquidity and/or be comfortable with some price volatility.  For people who have been holding cash waiting for rates to rise, such moves may be timely now.  For regular emergency reserve money and money needed for paying near-term bills, these alternatives may be less suitable.

Bear Market Tips for Retirees: Stay Invested, Buy Dividend Stocks, and Bank Online (Barron’s)

Stop Stretching for Yield. Consider These 2 Investments Now (Barron’s)

8 best short-term investments in June 2022 (Bankrate.com)

Treasury Securities (Bankrate.com)

Best Savings Accounts for Your Emergency Fund (MyBankTracker.com)

BONDS

Bonds are a bit of a sticky wicket as they are generally mispresented to consumers, particularly in 401(k), 403(b) and 457(b) plans.  Specifically, they have historically been presented as the “safe” portion of consumer portfolios – the part that adds stability to counter the inherent volatility of the stock market.  “Shift money from risky stocks to conservative bonds as you approach retirement,” says much of the retirement planning literature.  This guidance has been sound for much of the last 40 years as interest rates steadily declined from their lofty inflation driven peaks of the late 1970s and early 1980s to historic lows by the end of 2021. Falling interest rates on new bonds beget higher bond prices for previously issued bonds. However, when interest rates rise, as they have just begun to do, the opposite occurs - the values of existing bonds fall.  What this means to investors who hold bond mutual funds, including balanced funds, “conservative” and “moderate” asset allocation funds, and target-date funds with near term dates, is that they may see much sharper negative returns from the so-called “safe” parts of their retirement account than they may have anticipated.

Why many investment pundits appear to have been taken by surprise by this is baffling to me.  Unlike stock market volatility, which is both unpredictable and unavoidable, the threat of rising interest rates could be seen a mile away. When interest rates T-bills actually turned negative briefly and 30 year treasury yields dipped below 2%, there was really on one direct for interest rates to go.  I have been warning about the inevitability of the changing bond paradigm for years both in my newsletter and to clients directly. 

Now that it is actually happening, some financial journalists have suggested that consumers who own bond mutual funds should just wait it out, I vehemently disagree.  Interest rates have only just begun to rise and, as we have seen after 40 years of steadily declining yields, interest rate cycles may be decades long.  The downward bond price volatility that occurs when rates rise can be sidestepped by selling bond mutual funds and purchasing individual treasury securities and CDs which, unlike bond mutual funds and ETFs, are guaranteed to return principal and interest if held to maturity.   In today’s interest rate environment, the yield curve is nearly flat, meaning consumers purchasing the shorter maturities captures nearly all of the yield curve with almost none of the price volatility.

With rates just beginning to rise, in my professional opinion, it makes little sense to lock in maturities much longer than 12 months, but the 12-month rates rise to 4-5% it may make sense to begin laddering maturities to 3-5 years and extending the ladder still further if rates continue to creep higher.  At current interest rate and inflation levels, consumers will still suffer negative real (inflation-adjusted) returns, but laddering may eventually allow investors to make up some of those losses by locking higher long-term rates when inflation begins to abide.  Last week, Federal Reserve Chairman Jerome Powell said it was the Fed’s goal to try to curb inflation to the point where interest rates on treasury securities provide positive real returns.

In the near term, Series I Savings bonds and treasury inflation protected securities provide a direct hedge against inflation, since the value of these investments is adjusted in 1:1 proportion to the CPI.  For example, consumers who purchase 6-month I-bonds between now and the end of October will earn 4.81% (9.62% annualized) for the first six months that they own them.  This exactly matches the CPI-Urban Price Index. The rate for the next 6 months is reset every May 1 and November 1.  The current rate is much higher than comparable bank deposit rates and promises to deliver a whopping 0% real return instead of a negative real return.  With TIPs, the interest rate on the bonds is set at the time of issue and the principal on which the interest is paid is adjusted for inflation twice per year when the interest is paid.  

While I-bonds and TIPs represent the most direct way to counter inflation, both have considerable warts that consumers should consider before buying.  For example, I-bonds must be held for a minimum of 12 months and a 3-month interest penalty is applied for redemptions in less than 5 years.  There is also a $10,000 annual purchase limit per person, and the bonds may only be purchased through the TreasuryDirect.gov website, which can be a nightmare to navigate.  Investors in TIPS should be aware that the principal value may be reduced in deflationary environments and that federal income tax on accrued principal on TIPS held in taxable accounts is due each year even though it is not paid out to the consumer.  Because of tax reporting complexity, I only recommend TIPS in retirement accounts.  I also recommend consumers purchase only shorter-term TIPS and avoid TIPS mutual funds. Here again, consumers should be aware that individual TIPS provide principal return guarantees at maturity that are absent in TIPS mutual funds.  To drive this point home, the Bloomberg U.S. Treasury Inflation Protected Securities Index is down more than 8% for the year-to-date through 6/16/2022!

The 9.62% Opportunity in I Bonds (Podcast with Prof. Zvi Bodie)

When Bonds Do Not Hedge Stocks (Morningstar)

Why Are Bonds Down?  (Forbes)

How Bad Can This Bond Crash Get? (US News)

TIPS vs. I-Bonds (Morningstar)

Individual TIPS vs. TIPS Funds (Oblivious Investor)

STOCKS

As of this writing, the S&P 500 Index is down more than 22% from its January 2022 peak while the NASDAQ Composite Index, a popular large-cap technology stock index benchmark, is down more than 31% from its previous high water mark.  Most consumers invest in the stock market for long term wealth accumulation, and this asset class has historically produced significant nominal and real returns.  Most consumers know (or should know) that there may also be periods of time when stock prices decline.  However, it is one thing to understand the concept and quite another to see the reality reflected in one’s real-world portfolio values. 

To manage stock market downturns, investors need to come to terms with two issues -  (1) understanding that the depth and duration of the stock market downturn is unknowable and (2) determining the degree to which their investment portfolios may be exposed to permanent losses as opposed to temporary declines.  The 35% one-month decline in the U.S. stock market in February and March 2020 was a useful learning experience for many younger investors who had never seen real market volatility.  However, the value of that “teaching moment” may have been limited, as the downturn only lasted a few months.  While it is true that the overall stock market has recovered 100% of the time from all previous bear markets, investors need to know that two downturns of more than 50% occurred in the 2000s.  Both declines lasted nearly three years and the recoveries took just as long.  Simply put, short term money, which I define as funds you might need to spend within the next 5-7 years, probably should not be invested in the stock market. 

In terms of assessing the risk of permanent loss, there is a long list of formerly “hot” VC-funded “unicorn” startups with brilliant ideas but no proven path to profitability.  Many of these companies are already trading down 70-90% from their former peaks.  Investors in these companies should realize that there is a very real possibility that many of these companies may not survive now that they have burned through their capital and are still far from profitable.  We saw this with the dotcom stocks when the internet bubble burst in early 2000.  We saw this to a degree with the cannabis stocks a few years ago too.  Even investors who “diversified” by owning baskets of these companies in sector ETFs are not safe from permanent losses.  Most of the red-hot Internet funds of the 1990s either never recovered or were merged out of existence.

That is not to say that the stock market is all doom and gloom.  Investors who are saving for retirement in their IRAs and/or retirement plans and who are investing on a truly broadly diversified basis using investments such as broader market index funds/ETFs should view market downturns as opportunities and should even hope that the stock market stays down for an extended period of time.  The knee-jerk reaction among 401(k) plan participants is often to cash out of stocks and stop contributing when bear markets occur.  Sadly, that is exactly the opposite course that most should take.  Downturns in the stock market are only problematic if you are forced to sell to meet expense needs when it is down.  For long term investors it is a golden opportunity to buy when the stock market is on sale.

For people who are already retired, the advice is only slightly different.  Ideally (i.e., if properly planned in advance), those approaching retirement and those who are already retired should have at least 5-7 years of retirement savings in safe, liquid investments with no exposure to market risk so that they are not forced to sell stocks when they may be down.   To the extent that retirees have money available to invest in healthy companies that pay dividends and have a demonstrated proclivity for raising their dividends at or above the rate of inflation, rising dividend stocks may offer down market opportunities as well.  At this time, there are many companies that are more than 20% off their previous highs, with current yields in the 2-4% range that have consistently grown revenues, earnings, and dividends.  Consumers should understand that investing in these companies is not risk-free and that they are obviously not immune to volatility.  Nonetheless, investing in a diversified (by industry sector) mix of 15-20 or more of these companies can be a reliable source of inflation-resistant passive income while offering appreciation potential over time as well.   Qualified dividends are also tax-favored relative to ordinary income.

Some more seasoned investors who have been through previous downturns may be wondering if now is the time to double down and load up on stocks with prices of many great companies down 20% or more.  My advice is that it is fine to continue to add, but not to be overly aggressive in diving into the market.  Keep in mind that the downturn only began a few months ago and there is no way to tell how long it will last or how much more it may decline.  Measured, consistent investing throughout is just fine.

How to invest during a bear market (NY Times)

How to Stand Up to a Bear Market (Wall Street Journal)

Help beat inflation with dividend stocks (Fidelity)

The End of the Millennial Lifestyle Subsidy (The Atlantic)

The Unraveling of Robinhood’s Fairy Tale (Robinhood)

Many Unicorn Startups Could Become Zombies (Axios)

REAL ESTATE

Like stocks, real estate has historically been a wonderful way to accumulate wealth over time.  In fact, the $500,000 capital gains tax exclusion for married couples ($250,000 for single people) on the sale of one’s personal residence makes homeownership a uniquely attractive investment.  However, there is a perception among some consumers that real estate is a superior investment because it always holds its value.  In truth, the risk profile for real estate is not all that different from stocks.  Real estate investors and speculators/flippers in many parts of the country (most notably California and Florida) got a very real taste of that when the sub-prime mortgage market collapsed in 2008.  Foreclosure rates soared and home prices plummeted in many areas of the country.  In Hawaii, prices largely held firm through that period.  The last major real estate bubble in our island paradise occurred with the Japanese real estate bubble burst in the early 1990s.  It took more than a decade for some properties in Hawaii to recover from that event.  

In the past 6 months, 30-year mortgage rates have risen from under 3% to over 6% in some parts of the United States.  Given that each 1% rise in interest rates raises the lifetime cost of homeownership by roughly 10%, it is difficult to imagine how inflated real estate prices can be sustained. With fewer borrowers able to afford homeownership, it stands to reason that the resultant decrease in demand will ultimately lead to falling home prices and increased inventory.

In this environment, consumers who purchased homes, even at inflated prices can take comfort in knowing that they financed the purchases at historic low interest that may never be seen again in their lifetimes. My message to them is, “Enjoy your homes and your remarkably low monthly mortgage payments that are mostly comprised of principal.”  My message to would-be buyers, especially those with cash, is that prices may be much lower a year or two from now.  Sellers who may be nervous would be wise to consider lowering their prices sooner rather than later.  Would-be sellers who are holding out for prices set when mortgage rates were lower run the risk of holding onto their properties much longer than they may desire. 

What about the Rent vs. Buy decision and does it make sense for homeowners who sold to rent for a while before repurchasing? In a recent article, Paul Owers, a housing researcher and longtime journalist covering the Florida real estate market states, “Despite rapidly rising rents, prospective buyers in many U.S. markets could build long term wealth faster by renting a similar single-family property and investing the money that otherwise would have been spent on owning.” Later in the article, Ken H. Johnson, Ph.D, a real estate economist at Florida Atlantic University is quoted as follows, “Buying near the peak of a real estate market is never a good investment strategy. Even though rents are high right now and rising, renting becomes a hedge against locking in a home price that is too far above a market’s long-term pricing trend.”

Home Prices Have Begun Falling: Here Are the Cities Where They’re Down the Most (Realtor.com)

Mortgage rates hit 6.3%—the real cost to buy a house has officially spiked over 50% in just 6 months (Fortune)

A 1% Rate Increase will Decrease Your Buying Power by 11% (Mortgage Insider)

Is it Better to Rent or Buy in a Hot Housing Market? (Wall Street Journal)

Housing Index Shows Why More Consumers Should Rent Rather Than Own (FAU News Desk)

CRYPTOCURRENCY

Cryptocurrency is an odd duck in the investment world, and I have traditionally been reticent to discuss it my communications.  The reason is that it is not really an asset class.  That is to say that there are no underlying fundamentals that could be considered to attempt to forecast its future.  A counter argument to that – and the central thesis for crypto’s raison d’etre – is that it should be treated as a non-sovereign currency.  However, all sovereign currencies have a central government behind them that is the basis for their relative valuations.  For instance, there are sound fundamental reasons why Venezuela’s bolivar is viewed as less stable and weaker than the U.S. dollar.  With crypto currencies, one can argue that it is valuable asset for nefarious individuals, corporations, and rogue nations to store and transact ill-gotten wealth, but I am not sure that is enough to build a credible investment thesis.   At the same time, crypto is in the news so much that it is difficult to ignore.

As a financial planner, my approach to clients who inquire about crypto is to treat it as I would an “idea stock” - a much-hyped company with a novel but unproven investment thesis that is still far from generating revenues or profits.  This would apply to many of the recent “unicorn” startups over the past several years.  In this vein, I never advise clients to avoid crypto, as I certainly don’t want to be the person who kept you from getting rich if its hypothetical future value becomes reality.  However, I caution investors not to underestimate the speculative risk and to find the balance between investing enough to change your lifestyle if it really hits big, but not so much that it will permanently jeopardize your financial security in the more likely event that it fails.

Currently, the cryptocurrency market space is in turmoil. My sense from having been through other mania stock bubbles bursting is that the bloom is off the rose and that there is growing widespread skepticism over the future of cryptocurrencies and the myriad derivative cryptocurrency trading platforms that have sprung up.  In speaking at a technology conference last week, Bill Gates described cryptocurrency valuations as being driven solely by “Greater Fool Theory” – the notion that pricing is determined solely by the hope that someone will be willing to pay more than you did rather than having any meaningful fundamental valuation.  Similarly, economist and NY Times columnist Paul Krugman last week likened the cryptocurrency market to a Ponzi Scheme.

Further contributing to the changing perceptions are the invalidation of two primary selling points that crypto proponents have touted as reasons to be bullish on the market’s future – (1) that crypto is valuable as an inflation hedge and (2) that it is safe and secure. The former claim was the source of Krugman’s ridicule (see article link below).  With respect to security, within the last 12 months there have been three separate hacking events in which security flaws were exploited to extract $325 million, $540 million, and $611 million.  That is not chump change and there have been countless other large-scale hacks as well.  There is no FDIC to give victims their money back.  As one of the article links below stated, “Experts say cryptocurrency is increasingly being seen as low hanging fruit by hackers…Crypto transactions are irreversible, so if a hacker can get their hands on it, it’s very difficult for anyone to retrieve it.”  These high profile heists obviously cast a huge pall over consumer sentiment, but hacking is not the only fraud threat.  The unregulated nature of the crypto ecosystem lends itself well to a wide variety of fraudulent behavior including rampant pump and dump schemes. The failure of these crypto mantras are undoubtedly also contributing to the decision by legions of scorned consumers to abandon crypto trading, most likely for good.

Count me among the crowd that believes “investing” in crypto is akin to buying a box of air.  In full disclosure, I do not own, nor have I ever owned any form of crypto currency.   I do not proclaim to be an expert in cryptocurrency investing, so I discourage any consumer from using my opinion alone to avoid buying it.  However, I am an expert in financial planning, and, on that score, I encourage all investors to be judicious in the amount of capital they commit if they do decide to board the Crypto Crazy Train.  If you are already in and down big and you invested more of your savings than you should have, I have no idea how to advise you.  The same applies to people overloaded with unicorn idea stocks.  Once the bloom comes off the rose, it rarely blossoms again.

Wasn’t Bitcoin Supposed to Be a Hedge Against Inflation? (NY Times)

Bill Gates says crypto and NFTs are 100% based on greater fool theory (CNBC)

The Crypto Party is Over (Wall Street Journal)

Trillion-dollar crypto collapse sparks flurry of US lawsuits – Who’s to blame? (The Guardian)

The Crypto Firms that Bought Those Superbowl Ads aren’t so Super Anymore (Wall Street Journal)

What a $600 Million Hack Says About the State o Crypto (BBC News)

How Crypto Investors Can Avoid the Scam That Captured $2.8 Billion in 2021 (NextAdvisor.com)

John H. Robinson is the owner/founder of Financial Planning Hawaii, Fee-Only Planning Hawaii, and Paraplanning Hawaii.  He is also a co-founder of fintech software-maker Nest Egg Guru.

DISCLOSURES

Securities offered through J.W. Cole Financial, Inc. (JWC) member FINRA/SIPC. Advisory services offered through Financial Planning Hawaii and J.W. Cole Advisors, Inc. (JWCA). Financial Planning Hawaii and JWC/JWCA are unaffiliated entities 

Fee-only financial planning services are provided through Financial Planning Hawaii, Inc. DBA Fee-Only Planning Hawaii, a separate state of Hawaii Registered Investment Advisory firm. Financial Planning Hawaii does not take custody of client assets nor do its advisers take discretionary authority over client accounts.

The information contained herein is general in nature. Neither Financial Planning Hawaii nor J.W. Cole provides client-specific tax or legal advice. All readers should consult with their tax and/or legal advisors for such guidance in advance of making investment or financial planning decisions with tax or legal implications