Retirement Investing In Times of Financial Crisis

Times like these aren’t easy for retirement investors. Every day, it seems, brings unsettling news and commentary. This bank failed. That stock tanked. A bailout is necessary. A bailout would be a reward for those who caused the problem. And so on.

The news is accompanied by increased volatility in the financial marketplace. Sudden drops in value of stocks and bonds are followed by equally unpredictable rallies. Investments are starting to look less like piggy banks and more like lottery tickets.

What’s a future retiree who doesn’t want to gamble, but merely to safely build a nest egg, to do?

AAFR offers these guidelines for investing during troubled times:

• Don’t make “knee-jerk” decisions. When you learn that a stock in your portfolio has dropped 50%, it’s easy to conclude that “the sky is falling” and that you’d better run for cover. To be sure, sudden financial loss can cause a lot of pain. But that pain isn’t a good guide to decision making. When you learn of a heavy loss, it’s unfortunately too late to do anything about it. Such a loss may be an indicator that even worse drops in value are ahead. But it can just as easily trigger an upswing. It has never been possible to predict which way the markets are headed. It still isn’t.
• Do follow sound asset allocation principles. Asset allocation means systematically spreading your total available investment money over several different forms of investments. For example, a 30 year old investor with a long time horizon might put 80% of his money into stock mutual funds and the rest into bonds. A 60 year old might go with 50% in stock funds, 30% in bond funds, and 20% in a money market fund. The older you get, the more money you should put in more stable investments, for two reasons. First, you have a shorter timeframe in which to recoup if your investments go down. Second, you are more likely to have to make withdrawals soon, and you could be forced to sell assets when they are at their lows. If you’re younger, you’re better off with stocks because even though they are less stable, they generally give better returns over long time periods.
• Avoid specific stock risk. This principle always holds true, but even more so during times of financial troubles. As a rule of thumb, you should never hold more than 5% of your total portfolio in any single stock, with 10% being the absolute maximum. This is because any company’s stock can drop suddenly if the company faces unexpected troubles such as a major lawsuit, unexpected competition, bad publicity, or whatever. It’s particularly unwise to put your money into the stock of the company you work for: if bad times hit, you may lose both your job and your investment. If you’re top-heavy in any company’s stock, consider selling it off gradually over a period of several months to avoid the possibility of selling everything at the worst possible moment.
• Keep some of your money in very safe investments. Earmark a portion of your portfolio for safety, and make safety your prime concern for these investments. Buy either bank CDs, government bonds, or other risk-free investments. Get the best return that you can, but don’t sacrifice safety to do so.
• Don’t forget about inflation. Inflation is the great enemy of the future retiree. You may be tempted to put all of your money into ultra-safe investments. But remember that such investments generally barely keep pace with inflation. The taxable portion of your portfolio may even lose ground when you factor in the tax on interest income. Especially in tax-sheltered accounts such as IRAs, inflation-protected government bonds provide a good combination of safety and inflation protection.

These guidelines make sense in any investment environment. Does this mean that you should ignore the financial crisis? Not entirely. While you shouldn’t try to guess what the future will bring for this stock or that fund, you should evaluate whether the risk/reward ratio for various investments has changed. You may decide, for example, that the stock market has become more risky than before, and that you would therefore be wise to trim your stock market holdings in favor of FDIC-insured CDs. While panic selling generally isn’t a wise move, such a well-considered shift in asset allocation may well be.

To sum up: the basic principles of retirement investing haven’t changed, but some risks have become greater than they were before. This means that you shouldn’t make radical changes to your investment strategy, but you might want to become a little more conservative. Remember the old saying: tough times don’t last, but tough people do.