How to Save Yourself When Market Turns Cruel
The stock market has turned cruel, probably leaving you with losses in your 401(k), IRA and college savings.
What should you do?
If you want to know how far this downturn will go, be skeptical of any answer you receive. When a downturn is in motion, top analysts cannot determine whether it’s going to be a 10 to 19 percent decline, known as a “correction,” or a scary “bear market,” which inflicts losses of 20 percent or more over several months. So far, the Dow Jones industrial average has gone into a correction.
A correction isn’t surprising. Stocks have been overpriced — especially for a global economy that is deteriorating. And whenever stocks get pricey, they eventually fall. Once the decline has made stock prices a better buy, investors will buy them, and the stock market will climb again.
Since you can’t know the future, now is the time to examine your investments, instead of bailing out of everything or hoping for the best.
Thinking now can save you from making the mistake many made in the last bear market between 2007 and 2009. People who bailed out at the worst point in 2009 lost about half of their money, and they will probably never get back to even if they’ve kept it in a savings account. People who didn’t bail regained all they had lost in about three years and are well ahead now.
To put this into dollars: A person who had $10,000 in the stock market (Standard & Poor’s 500) when the downturn began in 2007 had only $5,400 left at the worst point in early 2009. If they left the paltry sum in the stock market, by March 2012 they were back to even, and at the end of this June had about $16,000.
Here’s what to consider now:
■ Will you need to get your hands on cash soon?
If you are saving for a house, a car, or anything else that requires cash soon, don’t keep that money in any stock or stock fund. That’s true when stocks are soaring or falling, because you never know when a tough period will hit.
On average, the stock market falls 20 percent or more every five years and then recovers. So the rule of thumb: Put no money in the stock market that you will need within three to five years.
Instead, keep the money in savings accounts or CDs. Make sure the penalty isn’t too great for yanking the money before the CD matures. Losing three months of interest isn’t bad.
■ Are your children in college or about to attend?
Apply the five-year rule of thumb: Anything you will need to pay for college during the next five years should not be in stocks, stock mutual funds or stock exchange-traded funds, known as ETFs. If you are saving money in a 529 college savings plan, you probably have some stock mutual funds. Try a safer plan.
Deerfield, Ill.-based financial planner Sue Stevens uses this approach: When a child starts college, there’s nothing in the stock market. When the child is a year away from starting college, only 25 percent is in the market. When the child is two years from starting, no more than 50 percent is in the stock market.
■ Are you retired or about to retire?
Major downturns in the stock market just before retirement can destroy your plans because you will need to start withdrawing some of your savings to cover living expenses in retirement. If you can tap savings accounts, CDs and bond interest for living expenses while the stock market is falling, you should be fine. The idea is to let stocks and stock funds sit while the bear market is eating away at those investments and then let them heal completely before tapping them for living expenses. The average bear market lasts 19 months, according to the Leuthold Group.
Because the bear can be fierce, advisers get people to insulate themselves before stocks turn cruel. They typically have retirees cut back on stocks and increase the bonds in their nest eggs as they get close to retirement. Near retirement, that often means keeping about 60 percent in stocks and 40 percent in bonds. At retirement, it’s often a 50-50 split, or 40 percent in stocks and 60 percent in bonds.
If you are nervous and work with an adviser, ask how long your cash and bonds will carry you if the stock market stays down for a year, two years or various scenarios. Once you see that you will have enough money to cover living expenses for a lengthy period, you may relax.
When Stevens or one of her clients is worried about the future, she will shave down stock exposure rather than bail out completely. A person who would normally have 55 percent in stocks could reduce it to perhaps 45 percent.
■ Are your investments too risky?
Some financial advisers have been worried that normally cautious retirees have been taking too much risk with their stock investments lately. For example, Jack Ablin, chief investment officer of BMO Private Bank, recently advised his clients to cut back on emerging market stock funds, or funds that invest in areas such as Asia and Latin America. Many countries are hurting because China has cut back purchases — especially oil and basic materials. Oil dropped below $40 Friday, a level not seen since the U.S. financial crisis.
Ablin also had clients reduce small-cap stocks, from about 15 to 20 percent of their stock portfolios to 5 percent. Small-company stocks have been expensive, and therefore vulnerable to a fall.
■ Are you years away from retirement?
If you are saving for retirement in a 401(k) plan and won’t retire for 10 years or more, you probably are fine with your usual target date fund. But these are loaded with stocks for people in their 20s and 30s. Want fewer stocks? Pick a fund with the 2020 retirement date in the name.
Gail MarksJarvis is a personal finance columnist for the Chicago Tribune and author of Saving for Retirement Without Living Like a Pauper or Winning the Lottery . Readers may send her email at gmarksjarvistribune.com.