Many retirees saw the value of their investments plummet in 2008. These steep market plunges have investors questioning their faith in the long-term outlook.
Many retirees saw the value of their investments plummet in 2008. These steep market plunges have investors questioning their faith in the long-term outlook. iStockphoto.com
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Here are some steps financial planners suggest you take to safeguard your financial well-being:
- Create an emergency fund if you don't already have one.
- If you're employed, make sure you have a financial cushion that will provide for your needs for at least three months.
- If you're retired, or on the cusp of retirement, try to set aside enough funds that would last for one — if not two — years.
- If you have substantial debt, take steps to reduce it.
- Continue to contribute to your 401(k) or your other retirement accounts.
- To figure out approximately how much money you should put into stocks versus bonds for your retirement portfolio, subtract your age from 110 and put that percentage in stocks.
- Lower your expectations. The stock market is unlikely to produce double-digit returns anytime soon.
- Rebalance and diversify your portfolio.
The era of double-digit returns may be over, but that hasn't stopped financial planners from counseling people to keep their eye on the long-term horizon. That's of little consolation to anyone who has seen his nest egg plummet in value.
And with unemployment mounting and rising concerns about job security, many consumers are left wondering how they'll ever be able to save for retirement.
No one is really sure how to best allocate investments these days. That's why creating an emergency fund, continuing to contribute to retirement funds, rebalancing and keeping your portfolio diversified are key strategies that haven't lost their appeal.
Unprecedented investment losses are giving those at or near retirement pause about how to proceed. Many retirees saw the value of their investments — whether in 401(k) accounts or other mutual funds — drop by at least 20 percent or more in 2008, according to a November survey by the Consumer Reports National Research Center of 19,000 online subscribers ages 55 to 75.
The Dow Jones industrial average fell by almost 34 percent in 2008. And the S&P 500 dropped 37 percent, the second-worst year since 1926 (in 1931, it declined by 43 percent), according to Morningstar.
Many investors appear to be in "wait-and-see mode," wary of relying on past strategies, says Noreen Perrotta, the money editor for Consumer Reports.
"There's not a lot of optimism at this point about the stock market," she says. "Ultimately, most people expect that it will go up again at some point. It's just when."
So, many people are now turning to Plan B. And that translates into "seizing the reins in every area of our finances over which we have control," Consumer Reports says in its February cover story on rebuilding your nest egg.
Historically, the stock market has "greater potential for growth" than putting money in the bank, says Perrotta. But that doesn't mean people shouldn't sock away some money for contingencies.
Create An Emergency Fund
Whether or not you have a nest egg in place now, financial planners recommend that everyone have an emergency cash fund that can be tapped if things go south with your job or health or should other contingencies arise. That means you won't be left in a situation where you'd have to sell stocks or mutual funds or borrow money to survive.
David Yeske, the managing director for Yeske Buie, a financial planning firm with offices in San Francisco and Vienna, Va., says establishing an emergency fund should be a first priority. The next step, he says, is paying off credit cards to minimize expensive debt.
For people who have relatively stable employment, Yeske recommends having at least three to six months' worth of spending capability as a hedge against short-term disability or a temporary job loss.
For those in retirement, he suggests at least a year's worth of spending reserves — if not a full two years' — to ensure that you're in a position to weather the downturn.
Contribute To 401(k) Funds
Yeske says people who have stopped contributing money to their 401(k) retirement plans are making a huge mistake. He suggests adding cash back into stocks and bonds rather than into money market funds, which aren't offering high interest rates.
Retirement plans, like 401(k)s, allow investors to buy "a constant dollar amount with each paycheck." This practice, known as dollar cost averaging, is most beneficial when stock prices are cheaper (as they are now) because the fixed dollar amount you contribute buys more shares when the market is down.
Do-it-yourself investing can be gratifying, but scary as well for some.
In 2008, investors who paid financial planners said that they were "no more satisfied with their retirement planning" than those who had done their own homework, according to Consumer Reports.
"Conventional wisdom is so upended now," says Perrotta. Deciding how to allocate money to stocks and bonds has also become more complicated in light of periods, like last fall, when all asset classes declined with the exception of gold and long-term Treasury bonds, she says.
Consumer Reports offers this guideline for figuring out how much of your money to put into stocks versus bonds in your retirement savings portfolio: Subtract your age from 110 and put that percentage in stocks. So if you're 65 that would mean you'd invest 45 percent of available funds in stocks.
Russ Roberts, a professor of economics at George Mason University, says investors, regardless of whether they pay someone for investment advice, need to adjust their expectations.
"The single biggest strategic advice you can take is lower your expectations," says Roberts. "We've been spoiled. We're used to double-digit returns from the stock market. Now we've just experienced double-digit losses and we're going to have to get used to a quieter, lower rate of return."
Financial planners like Yeske encourage people to have a plan for how their portfolio is allocated. But after periods when the market rises or falls dramatically, it's important for investors to adjust their portfolios.
Opening a Roth IRA or tapping into an employer's 401(k) plan are good options for people in their 20s and 30s who have their debt under control. These are also beneficial for people of all ages who qualify.
"It's found money," says Perrotta, of 401(k)s. Even if people just invest enough to secure the maximum employer match, then they'll be helping improve their future financial prospects.
"If you have a long-term plan for retirement, it's going to involve regularly investing money," Perrotta says. "If you're young enough to have the time to benefit from a long-range recovery, generally the strategy would be to slowly and incrementally invest money in the stock market. That's a basic strategy, and a lot of people are wary of basic strategies right now because they've failed us."
Saving For College And Beyond
And when it comes to 529 plans, education savings accounts, Perrotta says many people invest in plans that change with the age of the child. When the child is younger, the money is invested more aggressively, mostly in stocks. But as the child gets closer to college age the fund transitions to income-based investing, such as bonds, that is more conservative.
Consumer Reports, however, cautions that people should prioritize by saving for retirement before college. The reason? It's possible to borrow money for college, but not for retirement.
A range of mutual fund companies, including T. Rowe Price, Fidelity and Vanguard, also offer a similar product for retirement investments known as target retirement or lifecycle funds, whereby investors choose a target date close to the time they expect to retire. These portfolios automatically become more conservative as the date nears.
"Traditional diversification works better in some periods than in others, but it's still the only viable strategy in the long run," Yeske says.
Beyond having a diverse mixture of stocks and bonds in one's portfolio, the Consumer Reports survey found that investors who used six or more retirement savings plans including 401(k)s, IRAs, taxable accounts, homeownership, CDs and real estate investments outside of owning a primary residence were "more satisfied" than those who used three or fewer vehicles for saving.
But emotions can be tricky when it comes to investing. Yeske says he strives to help clients set emotions aside: "Markets are always forward-looking, but our emotions are always backward-looking."