Think 2029, Not 2009
You can afford to take the long view. Remember, you won’t sell your stocks for many years.
Sure, the decade that ended in early March 2009 was the worst for stocks since the Great Depression. But if history is any guide, the decade ahead will be much better. The 10 years ending in September 1974 — the stock market’s second-worst such stretch since the Depression — was followed by a healthy 10-year rally. Over that time, stocks delivered a 5.9 percent average annual return above inflation, according to Morningstar.
Besides, you’re going to hold the stocks or stock funds you buy now for much longer than a decade, well beyond your retirement date. You’ll still be spending that money well into your 70s and 80s, maybe longer. In other words, your investment horizon stretches way into the future.
For anyone with the luxury of time (and the virtue of patience), stocks historically have been a terrific choice. That’s especially true when you can buy them inexpensively, as you can now. A mere $200 put into stocks in 1931 — the Great Depression being the only other time in this century that blue chips were having a more than 50 percent off sale — would have grown to more than $300,000 over the next 70 years. (From 1931 to 2006, the Standard & Poor’s 500 index earned a 10.5 percent average annual return, according to Morningstar.)
With any luck, you are going to live a long, long time. Since stocks are the only asset that has consistently outpaced inflation over long periods, you need them in your portfolio. So repeat after me: “I’m looking to 2029 and beyond. It’s only 2009 and plenty of stocks are on sale. Instead of worrying about whether stocks will be up this week or next, I should be thinking about buying for the long term.”
Hot Tip
Turn off CNBC
Tuning out the minute-to-minute market noise will help you focus on the main event: positioning your portfolio for the long term. So, get a grip. Stop checking your portfolio a dozen times a day. Turn off CNBC. Instead, check out Jon Stewart’s brilliant skewering of CNBC’s hyperbolic self-importance and checkered track record.
Reassure Yourself That
You’re OK Financially
A good cash reserve fund can give you the peace of mind to stick with your plan, even when stock prices plummet.
Some money never belongs in the stock market. That includes whatever you can’t afford to put at risk because you know you’ll need to spend it soon. It also includes a cash reserve that you can tap in an emergency — say, if you’re laid off. That emergency fund keeps you from having to sell stocks to support yourself when stocks are especially beaten down.
Your cash reserve should be enough to meet one to two years’ worth of living expenses. Divide it between a money market fund and a ladder of CDs (see “How to Build a CD Ladder” below). And any lump sum you plan to spend within the next five years ― say, for a college tuition bill ― should be stashed in a CD ladder or a short-term, investment-grade bond fund. You can’t expose that money to market fluctuations either.
Nitty Gritty
How to Build a CD Ladder
CDs make a great safe parking place for money you know you’re going to need within five years. The problem is you have to lock the money up at a specific rate for a specified term, or face early withdrawal penalties. Depending on whether interest rates go up or down over that time, locking your money up can look brilliant or idiotic.
So, instead of buying a single five-year CD, divide the money equally among five CDs of different maturities ― a “ladder” ranging from one to five years. A ladder will give you a higher overall interest rate than a one-year CD, and more flexibility than a five-year CD. If rates rise, you can reinvest each maturing CD at a higher rate. If they fall, at least you’ve locked in a higher rate on your remaining CDs.
Make Sure You Own a Mix of Stocks, Bonds, and Cash
In an unpredictable world, diversification is always your best long-term strategy.
There’s been an outcry that diversification didn’t work last year because stocks were crushed across the board ― U.S. international, emerging markets, big cap, small cap, growth, value, all plummeted. But since when is an all-stock portfolio diversified?
True diversification, which involves bonds and cash (at least) in addition to stocks, actually worked very well last year, says Ron Rog , a Bohemia, New York, financial planner. While the S&P 500 lost 37 percent, Barclay’s Aggregate Bond Index gained 5.2 percent, and U.S. Treasuries delivered a spectacular 25.9 percent.
“In a panic, Treasuries are the asset of choice,” says David Foster, a Cincinnati, Ohio, financial planner. “That’s a good argument for always keeping them as a 15 percent piece of your total fixed-income allocation ― even when they’re overvalued, as they now are.”
For someone with 20 or more years until retirement, Harold Evensky, a Coral Gables, Florida, financial planner, suggests a 70/30 mix of stocks and bonds (in addition to your cash reserve). Does 70 percent in stocks sound too risky for you? Then opt for a 60 percent stock allocation instead.
The important thing is to have a specific plan. In times of stress, that can help you avoid impulsive decisions that turn into costly mistakes.
Voice of Experience
Stay Diversified!
Don’t abandon an asset class when it falls out of favor. You never know when it will rebound.
Stocks can soar even in the middle of a prolonged economic downturn. “2008 was the worst calendar year for stocks since 1931,” says Rog . “But it’s worth remembering that in 1933, the stock market posted a record 54 percent gain.” And in 1933, you’ll remember, the Great Depression still had seven years to go.
What’s more, market recoveries tend to come fast and furious. Had you invested $1,000 in the S&P 500 on New Year’s Eve 1988, it would have been worth $5,023 a decade later, according to an analysis by FactSet Research Systems. Had you missed the 10 best market days during that period, the value of your ending investment would have come to only $2,594. Had you missed the top 20 days, and it would have been only $1,658. Miss the top 40 days, and you’d have wound up with just $784 ― less than your initial investment. In other words, by the time you’re sure a rebound is real, odds are, it’s mostly over. And if you miss those rebounds, there’s no point investing.
Rebalance Your Portfolio
It forces you to buy low and sell high. That works.
Let’s say you take Evensky’s advice and opt for a portfolio that’s 70 percent stocks and 30 percent bonds. If market gyrations have left you with a 50/50 mix of stocks and bonds, you’d rebalance by directing new money into your stock funds, or by transferring money from your bond funds to your stock funds every month until you got back to a 70/30 allocation.
Don’t go nuts with this. You don’t need to rebalance more often than once a year ― and you won’t want to.
Rebalancing is hard because it forces you to sell investments that are performing well and reinvest in underperformers ― exactly the opposite of what your emotions are telling you to do. But then, investing is one area where following your emotions doesn’t work out very well. Your emotions always tell you to buy stocks when they’re very expensive and sell them when they’re very cheap ― a guaranteed way to lose money.
Case Study
Today’s Loser Is Often Tomorrow’s Hot Investment
History shows that rebalancing can pay off dramatically. Think of it as a form of insurance.
In 2002, for example, bonds were the hot investment. They earned 10.3 percent, while international stocks lost 15.9 percent and the S&P 500 lost 22.1 percent.
If you rebalanced out of bonds into stocks, you were rewarded the following year. In 2003, international stocks and the S&P 500 both soared, earning 38.6 percent and 28.7 percent respectively, while bonds returned 4.1 percent.
Likewise, if you had used some of your 2003 and 2004 stock gains to buy bonds, that would have helped cushion your portfolio when stocks tanked in 2008. And so on: if you’d rebalanced early in 2009, you’d have been buying stocks again — just in time for the spring 2009 rally.
Don’t Worry Whether the Bear
Market Is Truly Over
It may not be ― but that’s okay because you’re a buyer, not a seller.
Time is on your side. It doesn’t matter if stock prices fall back this year. What matters is the price you’ll sell them for decades from now.
And decades from now, it’s hard to imagine that stocks will not be higher than they are now. If the events of the past couple of years give you doubts about that, Evensky suggests that you reflect on what equity investing is really about: owning businesses.
“If you have $100,000 in an S&P 500 index fund, for example, what you actually own is $4,000 of Exxon, $2,500 of General Electric, $2,000 of Proctor & Gamble, $1,900 of Johnson & Johnson,” he says. “Do you really think all those companies are going to go bankrupt? What’s the risk that they won’t be worth more down the road than they are today?”
Since you have more than 20 years for stocks to regain their value, you have plenty of reasons to come off that ledge no matter what the market is up to. And once you’re off, put your feet up, and look forward to your future.
