Yesterday, USA Today published a piece describing how you should invest in a bad economy. Though the market is in shambles, the authors write, it’s no time to panic:
Enough. The stock market — and your savings — have gone down steadily, day after day, for more than a year. You’ve lost thousands this month alone. It’s time to do something. But…what? Should you shift more money into stocks? Put it all into a savings account? Pay off your mortgage? Hop a freight and become a hobo?
The authors talked to top financial advisers from around the nation. Here’s a summary of the experts’ advice. (For details, please read the entire article.)
- If you’re in your 20s, take comfort in the fact that time is on your side. You probably haven’t lost much, and you have decades to make up the difference. Now’s a good time to focus on paying off your high-interest debt.
- If you’re in your 30s, prioritize retirement savings. “Don’t let fear squander your opportunity,” says one expert. Protect yourself from unemployment by maintaining an adequate emergency fund. Be cautious about moving money out of the stock market, but be open to diversifying with new contributions.
- If you’re in your 40s, prioritize saving “even if it means cutting back on spending.” Don’t abandon the stock market. One financial planner tells USA Today that “nervous investors who stash all their savings in certificates of deposit and money market funds ‘are committing financial suicide’.” Still, stay diversified, and don’t take unnecessary risks.
- If you’re in your 50s, don’t do anything rash. Keep your investments balanced. Continue to save. In fact, the article suggests that you should look for “any way you have to boost your savings, no matter how small.”
- If you’re 60 or older, your position is tougher. You don’t have as much time to recover from the market downturn, but you’re not without options. Put off Social Security as long as possible. (This is a strategy advocated by Scott Burns when I interviewed him last summer.) Take a part-time job. Adjust your expectations.
It seems to me that the advice to every age group (except the last one) is essentially the same: Don’t panic. Diversify. Cut spending. Boost savings. Or, in other words, do the things that we’ve been talking about here at Get Rich Slowly for the past 2-1/2 years!
In a related note, Daniel Gross writes in the latest issue of Newsweek, “Don’t get depressed — it’s not 1929!” Also see this past post at GRS: Why it pays to ignore financial news.
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I am in my late 30s. I transferred out of stocks where I could in early October. This left me with about 16% of my retirement and savings in stocks. Since then I have been buying 70% stocks and 30% bonds within my 401K only. Outside of my 401K I am only storing cash. Why did I try to leave stocks?
The main reason is the uncertainty in the market. There is too much uncertainty. This market is new to us. I would rather keep my hard earned savings and miss out on some gains then risk further loss eating into my principle. For now I am sitting in bonds and cash; I am pacing myself back into stocks. This will limit my down side. Although I can not predict the return of the stock market, I don’t believe we are going to maintain any real gains anytime soon. There has been a lot of value lost between the stock market and the housing market that it will soon be seen in earnings. Once the housing and credit markets stabilize, I believe we will begin seeing real returns in the stock and housing market. I will use my cash to invest where the fundamentals makes since.
The rule of thumb of “buy and hold” would work if value is never lost and only transferred. However, value is lost and being smart with money is how we get rich. Not knowing how to invest, the rule of thumbs are probably all you have to go on.
This is only my opinion.
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@Dave: You ask some good questions, but at the end of the day there are mathematical proofs based on historical “what if” scenarios that show that a fixed asset allocation approach comes out ahead in almost every type of market. Obsessive week-by-week or month-by-month dollar cost averaging is for those who cannot spend the time following the economy. Year-by-year dollar cost averaging, however, is largely unavoidable due to the nature of tax-shelter account contribution limits.
@Mike: Buy and hold also works as long as the economy continues to advance and become more efficient. We are in a situation now with globalization where developing economies are pushing more advanced economies up the value chain until we get to the top, the US. We have nowhere to push, so we simply feel greater competition, lower price elasticity, and yet fixed costs like health care and energy are increasing. At the end of the day that means fewer jobs and lower wages and lower profit margins.
Stocks never were a profit center. It is simply a piece of a diversified savings vehicle. The people who believed they could invest in stocks and profit are hopefully beginning to realize that isn’t the way it works. If not, they soon will.
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Actually anybody who is bearish on the future of the American economy has an unprecedented investment opportunity on their hands because they can buy securities in China or whatever countries they think will outperform the American stock market over the long term.
If you think the gap between America’s wealth and rest of the world will widen over the long term, then you can keep buying USA index funds.
The great thing about investing is that you decide where to put your money based on your own outlook, and you can profit from basically any scenario as long as you correctly predict it.
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I always jump in on the conversations too late, oh well. I feel that some one in their 20s should use the next few months (perhaps years) to really establish themselves in the world. Meaning that now is a perfect chance to do many things:
1. Stay in school longer, if you are worried about finding work then why not upgrade your education.
2. Learn from the mistakes of people older than you.
3. Invest in real estate. If you have been able to save some money then why not invest it in real estate that is at really low prices in your area.
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Be careful with real estate. Government is taking action to prop up prices and keep them from falling more. That implies that the true market value of the real estate is still lower than the current pricing. Additionally, the depressed interest rates are already propping up real estate prices. Yes, prices have fallen dramatically, but that does not mean that we’ve hit the bottom. Some believe there’s still quite a ways to go to un-bubble the real estate market.
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Probably not. It is much more likely that when you have over $100,000 saved you are earning more than you spend and have no immediate use for the extra money you are saving. You can afford to be patient.
The problem with investment experts is that they always say the same thing – now is a good time to invest in the stock market. Followed by generalizations about risk and returns. You pull the chain on the doll and you get that response. Its programmed in.
Don’t panic is always good advice. We may all wish that our financial and political leaders had taken it. But there are good reasons for people to be alarmed and to act differently than they have in the past. What is happening now has never happened before. It probably is not 1929 – but it might be worse.
The truth is no one knows what is going to happen. Predictions are all over the board from deflation, to hyper-inflation. There is no safe harbor. There is risk in whatever you do or don’t do.
So what should you do?
The first thing you need to do is mourn. Because that money you lost, its never coming back. Its gone and whatever plans you had for spending it are gone with it for now.
Which is the second thing you need to do. Decide realistic goals for the future based on your remaining resources and make a plan for how you will use them. For instance, if you are unwilling to reduce your retirement goals, then you will have to save money somewhere else in order to increase your retirement savings.
And don’t ignore your non-financial assets. How secure is your job, how valuable will your job skills be going forward? If you have doubts, your best investment for the future may be in getting different training and/or education.
The third thing to realize, is that market slide may not be done and the market may not get back to its previous levels in your lifetime. As I said, No one really knows what is going to happen next.
Some of that uncertainty, read risk, is built into the current market prices. But there is a lot of information that the market just doesn’t have to make credible valuations of stock. What’s GM stock worth. It will be more than it is priced at now or nothing at all.
Which bring us to the largest uncertainty in investments. The administration has now explicitly put the full faith and credit of the US government behind CitiGroup’s risky investments in credit default swaps and other derivatives. They have essentially guaranteed its survival. Six months ago that was something the regulators hesitated to do even for Fannie Mae and Fannie Mac. And they were created as quasi-governmental companies. What is certain is that whatever traditional evaluations there have been of risk, they no longer hold.
With the government choosing winners and losers, its not at all clear what impact those huge injections of cash will have on the returns for private investors. For companies too big to fail, the government has become investor of last resort when private investors demand too high a return.
If you still have extra money to put into savings for long-term goals such as retirement, then you really shouldn’t change your approach for that money. Keep investing in index funds that match your chosen investment mix. If you aren’t going to fiddle a lot with your investments (and you probably shouldn’t) a good way to do that is to put the money into a balanced index fund (Vanguard has one that is called that). Most of those are 60-40 stock to bond splits and they take care of the rebalancing to keep that split.
The real question, if your money isn’t already in a balanced fund, is to decide what to do with the money you have left from your previous investments. The traditional answer is to rebalance, as has been suggested by many people above. That means buying stock. If you are lucky, you will be buying low.
On the other hand, if you are convinced the market is going to continue to slide, then you should take your money out of the stocks. You can decide how much to take out based on how convinced you are. But you should immediately start to cost average that money back into stocks.
Don’t try to wait until you think the market has reached bottom. Decide that in advance and then cost-average your money back into the market based on having it all invested when you expect the market to have returned to its current level.
You are essentially gambling that you are right about the direction of the market. You don’t know where or when the market will bottom so don’t add that to your gamble. By cost averaging, you may miss part of the market upturn.
Just a reminder, the bottom of the market after the 1929 crash came in 1932. The market may come back in the “long term”, but as someone pointed out above that is 30-40 years from now. By that standard, there aren’t very many long term investors out there.
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At some point in the future we will look back at today as a pivotal point in our past. We will either regret not taking action, or point to this time as the impetus of a significant net worth increase.
Best Wishes,
D4L
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J.D. says, granting too much:
You’re right: if the decline of the American economy is here to stay, then investing all of your money in the stock market is financial suicide. I don’t think anyone argues with that.
I’ll argue. If a time-traveller gave me a history book from the year 2500 with a chapter titled “The End of the USA [2000 - 2100]” so that I knew for certain that the American economy was doomed forever, I could still find plenty of companies (and even index funds) that would make good long-term investments. Most of the world’s companies, after all, aren’t even American. A significant portion of my investments are in Vanguard’s international index funds right now. If America descends into doom, some other country or countries will ascend.
Further, as an example, it’s unlikely that Spain will ever be the world-dominating colossus that it was during the days of the conquistadors. Something tells me that not everyone with money in Bolsa de Madrid is a chump, however. Smart people still invest in Spain, it turns out.
On the other hand, if one thinks that the economic system is on the brink of long-term failure, then he would be a fool to save or invest money at all. Spend it on women and booze (or guns and canned goods) while it’s still worth something.
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@Ross,
Nice post. I think you are dead-on with the government intervention and no one really knowing what that’s going to mean long-term or even short-term. How do you value an asset if tomorrow the government might buy it at 125% or 200% current market price? It’s hard enough to determine the current market price!
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A significant portion of my investments are in Vanguard’s international index funds right now. If America descends into doom, some other country or countries will ascend.
And if other country’s descent into doom, you may or may not be invested in the right companies in the right country. Some people win when they put money on 00 on the roulette table, that doesn’t make it a wise investment or even a good gamble. The fundamental issue here is whether putting money in the stock market is a wise investment, or a bad gamble.
Given the size of the US economy, a lot of the most successful international companies are the ones most closely tied to the US market. Being diversified internationally has some benefits, but immunity to the current economic crisis isn’t one of them. Its not even really a very good hedge.
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As an old bat in her 60s and looking at rumored layoffs, I would not advise declining Social Security if you’re in a position where you’re going to be unemployed. Here’s the deal: if you take the lower SS before you reach “full retirement” age, you can pay back that amount when you do hit that age (66 for me) and then reset your payments at the “full” amount.
This feature allows you take out something to support you without raping your savings while the market is tanked. If we are lucky and things start to improve in a couple of years, you can then start your drawdown at a time when you rejigger your SS at a higher rate. The higher amount you get is far and away more than the 4% you would draw down from the amount you have to return to the government to do this.
Although I’ve lost a large part of my shirt, I’m not without some resources. If I’m canned in December, as predicted, I will draw $30,160 in reduced Social Security payments before I reach age 66. I’ve got that much in cash, so even if the market continues to drop, I’ll have enough to increase my fixed income at that time.
Since it’s extremely unlikely that a woman my age will get a job — certainly not in the present market! — my plan is to go into poverty mode for a couple of years. I will have to limit my freelance income to $13,500 (the amount you can earn without having SS taken away from you, if you’re under 66), meaning I will have to live on less than $26,000. At 66, my income will increase to $38,628, plus whatever I can safely take out of savings (if anything), plus whatever more than $13,500 I can earn by freelancing or working.
It’s going to be a rough two years, but I think it can be done. When I reach the age where I no longer can generate freelance income (no one can work forever, after all), then…well, tomorrow is another day.
I do not believe the stock market (read: “my investments”) will recover during my lifetime. I’m just hoping I don’t have to use everything I have left — which is far now less than I had saved to support myself in retirement — before I die. The prospect of facing my 90s with no money is a bit scary. I’m not panicked. I’m just pessimistic.
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Michael @26:
Your calculation presumes that the amount of interest paid over the life of the loan is fixed. In reality, the additional interest you will pay is calculated using the current principle balance. If you make an extra payment to reduce that balance, all future payments will reflect the change. Since most loans have an agreed fixed payment, the reduction comes at the “end of the loan” by eliminating future payments. This elimination, though, is much more than if you simply were making a future payment today. For instance, on a $100,000, 7% loan, an extra payment of $100 per month will knock 113 months off the loan term. If those payments were simply used to pay what was owed in the future, the reduction would be much less.
This link will allow you to calculate the affect of a prepayments:
http://www.mtgprofessor.com/mpcalculators/ExtraPaymentsCalculator/ExtraPayments1.asp
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Couldn’t help but notice that none of the age groups, not even the 20-somethings, were advised to invest in the market now while stock prices are dirt cheap. I genuinely wonder why.
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