Last week the Dow Jones had a its quickest collapse ever at 1,000 points and a rough day overall dropping 348. Due to the trouble in Greece, political unrest in Thailand and the Icelandic volcanic the markets have been a little rocky lately.
But these reasons don’t really matter and could just be weak attempts to define a ultra complicated stock market full of swings, crashes and runs.
If you’re a passive investor – which 99.7% of people should be – then these crazy swings that periodically happen don’t matter that much. The market will go down, up and sideways but as long as you continually put money into the market every year and gradually get more conservative as you get closer to retirement, then you’ll be alright.
Learning From Those Before Us
During the market collapse of 2008 the Dow plunged 30-40% and every magazine and newspaper posted an article written about people in their 50s, 60s or 70s who were a week away from retirement, but lost 40% of their savings and were unable to retire. They were 1 month away from a new life they had always dreamed about, but back to work they went for who knows how long. These articles often had a picture of the distraught couple on a pier somewhere, half-hugging and looking concerned.
What many of these articles failed to mention was that all of these people had too much of their savings at risk at that point in their lives. When you’re close to retirement (within 5 years) a high percentage of your net worth should be in conservative investments like bonds. When you’re 25, less than 5% of your net worth should be in bonds.
The market’s gone up over time, but the short-term waves of the market are impossible to predict. And by short term, this means anything 5-10 years. So if you have 90% of your net worth in stocks when you’re 65, you’re risking a lot if a market crashes – like it did in 2008.
So why don’t market swings matter?
Well, they do. But the extent that the media covers these swings makes them seem worse than they are – if you’re a passive investor investing in index funds – funds that invest in the entire market and attempt to capture the market’s average.
This is why Target Date Retirement Funds like those at Vanguard or Schwab are so brilliant. They automatically change your savings allocation (the percentage of money in bonds, stocks, etc.) as you get closer to retirement. A lot of people assume they’ll pay more attention to their money when they get older, but why risk it? You’re life will get more complex with a mortgage, job, and kids and having your retirement savings taken care of at a young age is a smart choice for a lot of people.
When you’re young, risk is ok because you have a lot of time before you retire. The swings don’t hurt you as much as they do for a 65 year-old. Every year invest as much as possible (if it’s an IRA, up to $5,000) and let the fund do the work. When you’re 60, a large percentage of your money will be in safe investments and the swings won’t be life-shattering on your savings.
Yes, stock market swings hurt. I’ve been investing for almost 2 years and I still check the market everyday and I still grimace when the market falls 3% one day and my IRA falls $400. But these swings are normal and I’m already slowly getting used to the fact that this insecurity is how the market works. It takes some time though so if you’re frantically checking your IRA the 1st year you invest, you’re fine, and will hopefully get over it.
But do not let these stock market swings and the media blood bath persuade you to not invest and save for retirement. The worst decision is not starting because you lose the benefits of compound interest. Instead, ignore the unpredictable swings and set your money on the right path for life.
How do you handle stock market swings?
Photo: GeekSystem and Vanguard
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I don’t know much about investing but I do know that if you spread across reliable companies over a long period of time your chances of being ok are pretty high….. If your in it for the long term all should be well…
.-= Forest´s last blog ..A Pledge To Never Take Credit Again! =-.
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Austin Reply:
May 21st, 2010 at 4:42 pm
Definitely. Trading and guessing aren’t a good way to spend time with your money.
Thanks for the comment, Forest.
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The views I present here are my own and do not reflect that of my employer:
Well put, Austin. While extremely tactical asset allocation strategies aren’t my strong suit, I am a CPA financial planner at a super-regional financial firm so I have some perspective on this topic.
Unfortunately, most people fail to recognize that the investment horizon should be the primary driver in terms of assuming volatility within a portfolio. Horizon-based volatility-management techniques (e.g., target-dated, age-based, etc.) can be extremely valuable to the 99.7% of investors you speak of. Where I have the option (i.e., IRAs, 529s, etc.; not available in my 401k yet), I utilize such “set-it-and-forget-it” alternatives to avoid chasing returns, which is when many/most investors end up underperforming (net of expenses) for the volatility they assume. See here: https://advisors.vanguard.com/iwe/pdf/timediversification.pdf
In rare moments, a prudent investor may also take advantage of market swings by assuming more risk when others’ emotions wreak havoc on their investment strategy (this last two-year cycle was a good opportunity to do so). So in addition to general horizon-based investing, I may weave between horizon-based options with varying levels of risk. See here: http://www.collegeadvantage.com/otta/userfiles/image/February%2017%202009/Age-of-beneficiary.jpg
If you or your readers have questions on this topic, feel free to contact me via LinkedIn.
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