Rebuilding A Nest Egg After The Great Recession

First of a three-part series

Retired members of the United Auto Workers attend a benefits meeting. i i

Retired members of the United Auto Workers (UAW) listen to details of their retirement accounts while they attend a monthly benefits meeting in Detroit in 2008. Investment experts say people make the mistake of not adjusting the balance of stocks and bonds in their portfolios after making their initial investment. Spencer Platt/Getty Images hide caption

itoggle caption Spencer Platt/Getty Images
Retired members of the United Auto Workers attend a benefits meeting.

Retired members of the United Auto Workers (UAW) listen to details of their retirement accounts while they attend a monthly benefits meeting in Detroit in 2008. Investment experts say people make the mistake of not adjusting the balance of stocks and bonds in their portfolios after making their initial investment.

Spencer Platt/Getty Images

The stock market plunge caused by the financial crisis blew a big hole in lots of retirement accounts.

When stock indexes hit bottom last March those accounts had lost half their value. Since then, stocks have gained back a lot of ground, but the market remains about 30-percent below its peak.

After months of opening their mutual fund statements with great trepidation, have Americans regained confidence that investing can bring them retirement security?

There's no question it's been financially and emotionally devastating — not as devastating as losing your job and income as millions of American have, but difficult nonetheless. After all, when we hit bottom the value of American retirement savings in 401(k) accounts and IRAs had shrunk by $2 trillion.

In a survey done for the Center for Retirement Research at Boston College, some people said the collapse in their retirement savings was equal to the stress they felt after the Sept. 11 attacks.

U.S. Private-Sector Retirement Plan Trends, 1979-2008

In recent deades, the number of private-sector employees who have a traditional pension plan (defined benefit) has declined dramatically. Participation in 401(k) and other defined contribution plans is up sharply over the same period.

Chart: Participation in defined benefit versus defined contribution retirement plans (1979-2008)

Changing One's Approach

Victoria Banales and her husband lost 40 percent of their retirement savings in the crash.

"It was really frustrating and we discussed, well should we stop investing and invest all the money in a vacation home," says Banales, an educator from Idaho.

She lost confidence in the market: "I distrust it, but on the other hand I also keep investing, hoping somehow we'll find some kind of combination that will still help us save for retirement."

Steve Meier says he and his wife lost close to 30 percent — a typical loss for 401(k) investors during the crash.

"It was scary and then from there you didn't know what was going to happen," Meier says.

Meier, 46, who works in Silicon Valley, says he and his wife may delay retirement because of their losses.

"Hopefully the market will come back, and otherwise we can adjust our spending both now and in retirement," Meier says.

Working longer to make up for losses was one of the most common strategies cited in the Retirement Research Center survey.

Slow To Adjust

But, given the shock investors absorbed, a surprisingly small number of people moved out of stocks after the plunge.

"I think people were paralyzed with fear," says Alicia Munnell, the center's director.

"Remarkably little movement occurred," Munnell says. "On net, there was a slight movement out of stocks. But most people stayed pat."

After people start investing, they hardly ever make adjustments in their 401(k) accounts, Munnell says. That meant that when the crash came lots of Americans nearing retirement were over-invested in stocks, because of the big market gains in the 1980s and 1990s.

"If you're approaching retirement you really don't want to have 65 percent of your assets in equities," Munnell says.

But what is the right balance of stocks and bonds, risk and safety in a retirement portfolio? And did the financial crisis change the rules?

John Bogle, who founded the Vanguard Group, says no.

"The real message, I think is, you know, we're going to get big rises and big declines in the stock market, and if you keep investing through them you will build yourself a terrific retirement account," Bogle says.

The Quest For Balance

Bogle has seen a lot of market ups and downs during almost 60 years in the investment business. He says even in this uncertain time, the principle remains the same.

"I'm a great believer in balanced investing," Bogle says.

And that philosophy is evident in one of Vanguard's flagship funds, the Wellington Fund, which invests two-thirds in stocks and one-third in bonds.

Bogle has this simple investment advice: Own stocks for opportunity and bonds for safety. Buy them in low-cost index funds — a product he invented. They allow investors to own a broad array of assets like all the stocks in the S&P 500 Index, for instance.

Age-Appropriate Investing

And Bogle has long told Americans that the percentage of bonds in a retirement portfolio should be roughly equal to your age. That way your investment gets safer as you approach retirement. So, if you're 60 years old your nest egg should be 60 percent in bonds.

But here's something that might surprise people who've heard Bogle give that advice before. He says you should count the value of your Social Security benefit when you calculate your bond position. And, for the average American the value of Social Security equals about $300,000 worth of bonds.

"If you accept that $300,000 is the value of Social Security and you had $200,000, that could all be in stocks," Bogle says.

Since most Americans have much less than $200,000 in retirement savings, that suggests most retirement portfolios should be very heavily invested in stocks. But that's hard advice to follow after the crash, especially if you're close to retirement.

Going International?

What about international stocks? Bogle is cautious. First, he says, many big American companies have global exposure. And, he argues, in the past 15 years when U.S. stocks have fallen, international stocks have dropped, too — only further.

"International diversification lets us down just when we need it the most," Bogle says. "So it's no panacea in any way, shape or form."

But Nathan Gendelman, investment director of The Family Firm, a financial planning company in Bethesda, Md., says international investments are very important. The point, he says, is not to have all your investments concentrated in the dollar.

"Should the dollar take a very sharp decline, it would hurt quite a few of our other investments," Gendelman says. "It would hurt our standard of living, quite frankly. And it would be extremely valuable to have investments that were appreciating."

In addition to international stocks, Gendelman suggests buying a variety of foreign government bonds. There are mutual funds that allow you to do that.

Saving And Reducing Fees

But in the new post-bubble, slower-growth environment that economists are predicting, if you want to make sure your retirement funds grow you're going to have to do it yourself by saving more, Gendelman says. The reason? Because no one can control the returns the market will give.

"[Federal Reserve Chairman Ben] Bernanke can't control it, [President] Obama can't control it and we can't control it," Gendelman says. "But what we can control is how much to spend and how much we save."

The other thing you can control is the fees you're charged. They can have a huge effect. An annual management fee of just 1 percent, for instance, can reduce your accumulation by 20 percent by the time you get to retirement.

But even adopting some of these pretty straightforward approaches to retirement investing can be difficult for a lot of us. We're busy with work and family and we're not confident in our ability to make the right decisions.

In Part 2: Lifecycle or target-date funds are mutual funds designed to automatically reduce the level of risk in your fund as your retirement date approaches. What are the benefits and drawbacks?

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