Seniors, boomers: Going to cash has never looked so good

Warren Buffett recently said that if interest rates stay as low as they are for the next 10 years, then stocks will have proved to be very cheap today. If interest rates go higher, then they will have proved to be expensive. So, what to do?

Yield-seeking investors who have binged on stocks in sectors that have historically been considered stable, dividend plays should sell. As a financial advisor this is high on the list of things I never want to say, but it's time to be happy to earn nothing on (at least some of) your money.

Going to cash can actually be a good thing.

Dollars cash
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Investing is often about earning the highest return relative to other investment options. And in an investment climate that hasn't seen the Federal Reserve hike short term interests in about 9 years and has held short term rates at near zero since 2008, just about everything has looked better than good old fashioned cash equivalents like CDs and savings accounts.

That also means the stable, dividend stock sectors have risen to valuations that are more like high P/E growth stocks than value stocks. This is what we pros mean when we say that low interest rates have caused market distortions. Virtually any stock with a half-way decent dividend yield attracted investors' cash.

For several reasons, I see danger in all of this—dangers that are making a move to cash with some stocks look really attractive.

"It takes an entire year to earn a 4.5 percent dividend payout, but only a day for the stock to lose that much or more."

If you're a baby boomer or a senior, this conversation is very familiar to you: "I can't live off zero percent interest rates in my savings account, but I don't want to take undue risk and lose my principal if the stock market takes a big hit."

This is nothing new, by the way, and you aren't alone in saying this. I have this conversation with my clients almost daily. I'll share with you now what I always say to them: Nothing with a big yield is safe, and nothing safe pays a big yield.

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So what do you do now that the Federal Reserve is getting ready to end the zero-bound short-term interest-rate environment? Regardless of exactly when the Fed moves—be it later this year or sometime next year—investors need to reset their stock expectations starting now.

Consumer staples, utilities and telecom are among the sectors that have been embraced by investors as bond replacements. The only problem with this, which is major, is that these are still stocks.

If the Fed's raising of short-term interest rates causes long-term rates to move higher, then these sectors are at serious risk of being marked down. The ones with the highest P/E ratios are the ones that could see the most acute selloff. Remember, it takes an entire year to earn a 4.5 percent dividend payout, but only a day for the stock to lose that much or more.

The answer to Warren Buffett's rate riddle

If interest rates have bottomed, then time may not necessarily bail investors out of paper losses, since interest rates would need to go all the way back to new lows.

Professional money managers, who do not have the same loyalty to stocks that individual investors have, would be very quick to sell these blue-chip stocks. Then there is something called regression to the mean—stocks typically revert back to their longtime P/E ratios. The 12-month forward earnings for each of the S&P 500 sectors shows that forward P/E ratios are at cyclical highs for every sector with the exception of telecom, according to Yardeni Research. Since these sectors are currently way above their long-term P/Es, a regression to the mean would mean lower stock prices.

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For my boomer and senior clients, I would rather take profits and spend down some principal on living expenses than risk losing a lot of principal due to the above arguments, which I believe are very compelling. In other words, earning nothing on cash is OK for now, for a bigger chunk of your portfolio. I am not suggesting a wholesale "sell everything!" Simply, reducing exposure to these sectors after such a mighty run-up is prudent. One may certainly reallocate to other sectors, depending on one's age, risk tolerance and goals.

I'll end this article this way. There is an acronym that is very popular these days: T.I.N.A. It stands for "There Is No Alternative" to stocks since interest rates are so low, so investors have to keep plowing their money into the same dividend-paying stocks regardless of how much they have risen in price. Well, I'm here to tell you that there is an alternative: cash. This may be heresy for professional money managers, but at this time, it makes total sense for individual investors who are of boomer and senior age.

By Mitch Goldberg, president of ClientFirst Strategy, an investing firm @Mitch_Goldberg

Read more from Mitch Goldberg on the markets and investing.