The Stock Market Continues to Take a Beating, Should You Really Just Stay the Course?
Are you tired of hearing it yet? Most advisors and personal finance gurus continue to urge investors to stay the course, invest for the long run, and everything will be fine. Of course we know this is what history and conventional wisdom tells us, but when you’re seeing your nest egg drop by 5% in a single day, and drop by 30% or more in just a year, it can be quite annoying to keep hearing everyone tell you just to sit tight. Besides, it’s not their money, so what do they care if your account is dropping like a rock?
I’ve been meeting with a ton of people over the past few weeks, and I’ve encountered almost every type of investor you can imagine. I’m working with 25 year olds who are just getting started, to people who have already filed their paperwork to retire in a few weeks. As you can imagine, there is a big difference in priorities when you compare someone with 40 years until retirement with someone who will start drawing their pension and Social Security in a matter of weeks. But even with such different scenarios, the concerns are the same. Where is the market headed?
Everything from Opportunity to Complete Disaster
Depending on who you are and how close you are to retirement, you might view this situation as a great opportunity, or a complete disaster that’s going to force you to delay retirement. I’ve had some people in my office this week recognize the long-term opportunity and increase their contributions to their retirement plan significantly. I’ve also had people in my office that completely break down and start crying because of the impact this is having on their lives.
It’s easy for pundits to say what a tremendous buying opportunity this is, and it is true that if you have a number of years before needing the money, you will be rewarded. But when you’re talking about someone who’s already spent the last 20 or 30 years building up their portfolio, the market declines can far outweigh the benefits of buying a few investments on sale. If you have a $200,000 portfolio that drops 30% in a year, that $60,000 loss looks far greater than the $10,000 you might have contributed during that time. When people look at it that way, it’s easy to see why investors are quick to discount the boring advice of staying the course and continuing to invest.
Many Investors Act Like the Companies We’re Bailing Out
Many people right now would like to see financial company executives dragged into the street to be drawn and quartered after the government bails their companies out when they made bad decisions based on greed. But what most people fail to realize is that they often do the exact same thing when it comes to their own finances.
That’s right, if you’re portfolio is in bad shape right now, there’s a chance it is due to greed. People love to chase returns, and most investors do so not by trying to time the market, but by taking on more risk when times are good, while ignoring the possible downside and getting burned when things reverse course. Just like banks took on excessive risk lending to people, when the money was there, why not? The same is true for many investors. When the stock market is on a roll, people will gladly move out of their comfort zone to take advantage of the market. If the market has been returning 12-15% per year, why not take on a little more risk to grab some better returns?
And then, just like the bell tolled for the banks who took on too much risk, the same thing happens to investors. The market turns sour, and suddenly people who got greedy and tried to take a little more risk in the market are faced with losses they aren’t comfortable with. When you play with fire, you get burned.
Proper Asset Allocation is More Important Than Ever
This is where most people fail and struggle to find answers. I meet with a lot of people who are inside of five years until retirement, yet they come in upset that their 90% stock portfolio took a big hit. Of course, I always ask why they are so heavy in stocks if they are so close to retirement and can’t stomach the losses. The answer is almost always the same. Somewhere between 2003-2005, most people abandoned their recommended asset allocation in favor of holding more stocks because the market was doing well. They talk about how little interest the bond funds and fixed accounts were paying, so they figured it was better to own more stock. They soon found out that doing so creates a case of feast or famine.
That doesn’t mean you can’t be close to retirement and invest heavily in stocks, but for most people who are so shocked about the losses they’re seeing, it’s obviously more risk than they are willing to take. It’s important to remember that if you create a diversified portfolio, you’re probably not going to capture all of the gains in a bull market, but more importantly, you’re also not going to realize all the losses in a bear market. This is exactly what a diversified portfolio is supposed to do, but if you abandon your plan because you get greedy and want to reap the rewards of taking on a little more risk, you have to realize that things can and do change course, and with that risk comes the potential for greater loss.
The Past 20 Years of Investment Returns
You Can’t Time the Market as Well as You Think
People who don’t want to stay the course and bail out of stocks think that they can beat the market. Is it true that if you dumped everything in favor of a money market or fixed account that you can virtually guarantee no future losses? Sure, but who’s to say you’re getting out at the right time? For all we know, the day after you make this decision, the market begins to stabilize and recover, and you’re left holding the bag on a fund with a 3.5% APY while the market made up 10% of its losses in just a week.
The way I see it, is that if you didn’t see the peak of the market back in October of 2007 and it took you a year of losses to make a decision to get out, what is the likelihood that you’ll be able to spot the exact bottom of the market and jump back in so you can recover all of the losses? Very slim. If it takes another six months or longer of a market recovery before you decide to get back in, you just missed the boat, and you’re going to be selling low and buying high.
So What Should You Do?
I can’t tell you what the best thing is to do, but before taking any drastic action you should ask yourself a few questions. Why are you upset over the recent performance? Is it because you’re close to retirement and holding too much in stocks? Is it because you’ve taken on more risk in the past few years and realize it might have been a mistake? Or are you just upset that you’re losing money even though you’re doing everything right?
It doesn’t matter what your situation is, but you need to recognize what is causing you to feel this way so that you can remedy the situation so that it doesn’t happen in the future. This might mean readjusting your portfolio, putting more money into bonds, or even increasing how much you’re investing. If you’re doing all the right things, taking on the appropriate level of risk, and understand the role each investment plays in your financial plan, then staying the course isn’t such a bad thing after all. But if you’re doing the wrong things and are taking more risk than you’re willing to stomach, it might be time for a change. Just make sure you understand the ramifications of the change and that you have all the information necessary to make an informed decision instead of reacting to headlines or sound bites on TV.
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Filed Under: Investing
About the Author: Jeremy Vohwinkle is a Chartered Retirement Planning Counselor® and spent a few years working as a financial planner. Today, he helps people make the most of their money by writing about personal finance here and elsewhere on the web. Jeremy is also Coach at Adaptu and a regular contributor for other publications such as Intuit, and American Express. Be sure to follow Jeremy on Twitter or Google+.