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Almost two months back, I made, for me, the highly unusual case that the stock market would drop. Reaction, pro and con, was swift and pointed. Dan Solin, a best-selling investing author, called my arguments sound but questioned timing the market.
Today the market’s down a bit. My portfolio’s not — I took my advice. My original concerns remain, and the Fed’s ongoing rate hikes strengthen my view.
I’ve also looked closely at the business aspects of the House Republican tax plan. If implemented, it can significantly boost the economy. But the Senate seems poised to undermine key provisions. Moreover, the personal tax reforms could greatly expand the federal deficit at a time when our country is in horrific long-term fiscal shape.
For those still in the market, let me suggest how you can play the market with no downside risk to your basic living standard. I call this trick “upside investing.” The idea is simple: Treat investing in the stock market like playing the casino.
Most people take cash, not the rest of their wallets, into the casino. Their cash is their play money, all of which they expect to lose and usually do. They gamble with peace of mind knowing they can’t endanger their basic living standard.
Now think of your stocks and the money you’ll add to the market as your gambling money. Whether you temporarily pull it out in extreme circumstances (as I think we’re in), treat it as lost money and fuhgeddaboudit.
Then, based on your remaining finances, establish a lifetime spending and saving plan that entails maintaining your discretionary spending through time. This is your living standard floor.
This living standard floor is akin to the wallet you leave behind when gambling. To keep your floor safe, invest all assets, apart from those “lost” stocks, safely.
The safest assets for this purpose are called TIPS — Treasury Inflation-Protected Securities. TIPS are Treasury bonds that fully adjust for inflation. If prices rise by 10 percent, the money you get paid — the periodic coupon and final principal payments — rises 10 percent as well.
The longest-term TIP is a 30-year bond. It’s currently yielding 1 percent real — that’s 1 percent before the government’s adjustment of the payments for inflation. TIPS have two downsides. The inflation as well as the real component of their return is subject to taxation. Also, Uncle Sam could default on his debt, although that’s unlikely.
But if you too are wary of putting too many eggs in one basket, look for other safe investments.
One example is a fully inflation-indexed annuity issued by a highly rated insurance company. Another is short-term corporate and municipal bonds (short term so they can’t lose much money from unexpected increases in inflation). A third is real estate that you are quite sure will retain value. Whatever you choose as safe assets, use them to secure your living standard floor.
Installing a floor
How do you set your living standard floor?
First, assume that all money in or going in the market is entirely lost. Second, create a living standard floor, ignoring all stocks and assuming a safe return on other assets. Third, consider the potential increases in your living standard once you start leaving the market, assuming you leave with something positive.
Worst case? Your stocks tank and your living standard is fixed at its floor value. Best case? Your stocks pay off and your living standard goes up. This is investing in stocks at no risk to your basic living standard.
You can also ask your financial planner to do the calculations or use a commercial tool like ESPlannerPlus at esplanner.com. This tool from my company (from which I take no salary) costs $199 the first year and $70 a year after that for updates.
It’s a simple trick, though: Treat your stocks as entirely lost until you’ve sold them and converted them to safe assets. Don’t count on their making you a single penny. If they do, great. If not, your living standard won’t fall.
Laurence Kotlikoff is a Boston University economist and co-author of Get What’s Yours. His company markets maximizemysocialsecurity.com. Readers can email questions to firstname.lastname@example.org.