What a question, huh? This question seems to be on the minds of many investors these days.
Most economists are predicting that the European zone will suffer a period of slower than usual growth – or even short periods of shallow recession – as they try to work their way out of the debt crisis that they are currently in. Since we are, in reality, a global economy, this means that markets both here and abroad will likely be volatile and moderately stagnant for the next several years. It may well feel like we take 3 steps forward in the market, only to be followed by 2 steps backwards – for a while.
Morgan Stanley did a wonderful study called “The Aftermath of Secular Bear Markets” in which the authors of the study tracked the 19 major bear markets over the last century (only 4 were in the US). All major bear market corrections (defined as a market drop of 47% or greater) were followed by a rebound rally, (2009) then a mid-cycle correction (2010 & possibly 2011), followed by a period of 5-6 years of volatile, sideways behavior, before a new bull market started. So, based upon that historical precedent – we are about 2 years into the sideways part. (if you Google this study, you can read about it directly. Here is a link to see it visually: Trading Range. Note that the chart on this link was published in 2009, so the “we are here” mark is has moved 3 years to the right . It was right on as far as predicting the mid-cycle correction(s) in 2010 and 2011.
The sideways part (the trading range of 5.6 years, on average) is the period of time where the economy heals itself, and goverments try to “unscrew” what went awry in the first place. This is where we are now. Likely you see daily evidence of this natural process – Democrats and Republicans squabbling over policy but not really changing anything, the Fed printing money, banks hoarding cash and trying to get their books in order, finger-pointing, governmental gridlocks, and daily predictions of great bull markets or terrible bear markets. While difficult to live through – this is actually part of the NATURAL healing process of a free-market economy. Once you realize where you are in the cycle, then it becomes much easier and far less confusing to stay the course.
So – to answer thequestion – the secret to being a successful 401(k) or other retirement plan investor in which you have to save money over time, and have, say, 10 or 12 or more years to retirement, would be:
1) Build your portfolio to a risk tolerance that even if the market drops 20 or 30%, you will NOT freak out and will NOT stop investing. That means you may have to have 30%, 50%, or even 70% of your money in the “safer” investments like government bond funds, or even cash. A good rule of thumb is – whatever percent of your portfolio you have in the stock market – that is the percent that it will go down when the market corrects. So – if the market drops 20% (which it does every 3 years) – and 50% of your money is in stock funds – then your portfolio will drop by about 10%. (50% of 20% is 10%.) If you can hang through a drop like that – but no more – and keep investing, then that’s your risk tolerance threshold (limit). If your personal limit is more like 20%, you can build your portfolio more aggressively – like 70% stock funds, or maybe even a little bit more. With 10 or 12 years to retirement, you’ve got plenty of time to make it up, so you can afford to be more aggressive.
2) KEEP INVESTING. When the market goes down – and your portfolio goes down – but you keep investing – you are buying up shares of the funds ON SALE. If you see a sale at a store – you wouldn’t throw away everything you bought previously, would you? Then why do people do this with stocks or mutual funds? If they are on sale – buy more!! Keep buying over time – during that volatile period that I mentioned above – and when the steady bull markets DO come back (they will – we just don’t know when) then you will likely be extremely pleased with your investments.
This blog post is not personal investment, financial, or tax advice. Please consult your financial professional for personal, specific information. Indexes mentioned are a general barometer of the stock or bond market they represent. You cannot invest directly in an index. Past performance is no guarantee of future results.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Investment advisory services offered by Paragon Wealth Strategies LLC, a registered investment adviser.