Retirement

NEW YORK Money -- Question: I plan to retire in about two years, but I've lost a lot in my retirement savings account. Currently my money is spread out over small and midcap stocks, growth shares and safe investments. But I'm thinking of moving my balance to an account that tracks the Standard & Poor's 500 index, riding the upswing until the S&P hits 1,100 or 1,200 and then diversifying into something safer. Do you think this is a good plan? --Alan W., Raleigh, North Carolina
Answer: I find that many of the people whose 401(k)s and other retirement accounts got hammered by the stock market's meltdown fall into one of two camps.
The first (and I suspect largest) is what I call the "foxhole" camp. These are the people who, having watched their balances dwindle and fearing even deeper losses, have moved or are contemplating moving their money to investment options that will staunch the bleeding: bonds, stable-value funds, money-market funds, CDs and the like. They plan to hunker down in these secure investments until conditions improve. At that point, they'll consider investing in equities again.
The second group is what I think of as the "Hail Mary" camp. These are the people who, sitting on losses of 20% or more, reckon the best and fastest way to recoup those losses is to throw the investing equivalent of a "Hail Mary" pass into the end zone. They think that by loading up on stocks, they'll catch the market's rebound and get back to even. Assuming that happens, these investors figure they can then return to a more prudent game plan. You are obviously thinking about joining this camp.
I am not an advocate of either of these camps. The problem with entering the first one is that it's hard to know when to leave. Every time stocks make a decent move, you have to wonder whether the rally has legs or it's a bear market trap. Then you've got to ask yourself, as The Clash so famously did in its 1982 album Combat Rock, should I stay or should I go?
Leave too late and you miss the usually explosive early gains of a new bull market. Leave too soon and you get burned, which probably sends you back into the foxhole until you go through the same process again, only this time second-guessing yourself even more.
0:00 /4:54Investing for long-term growth
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My quibble with the second camp is that you open up yourself to much more risk. What if the stock market takes another steep dive from here before it eventually rebounds? By investing far more aggressively in a desperate attempt to recover losses, you could find yourself in a deeper hole that will be even harder to climb out of. And what would you do at that point? Ratchet up the risk even more? Pick up and move to the "foxhole" camp?
So what camp do I think you should be a member of? Well, I guess if I had to put a name to it, I'd call it the "Optimistic But Realistic" camp. I say optimistic because I think people need to feel confident that there are things they can do that will actually improve their finances. Otherwise, what's the point of doing anything?
But you've also got to be realistic enough to know that there are no panaceas. And you've got to understand that some actions have a higher probability for success than others.
If you join this camp, the first thing you would do is take a step back and ask yourself what you're really trying to achieve here. If you mull that question seriously, I think you'll agree that, while limiting further losses over the short-term would certainly be nice, that's not your ultimate aim. Nor is recovering any losses as quickly as possible. Your fundamental goal is to be able to retire and maintain a reasonable standard of living for the rest of your life.
The "rest of your life" part of that goal is important. It means that even though you are approaching retirement, your investing strategy still has to be focused on the long-term. That doesn't mean your investing strategy will be the same as a 20- or 30-year-old's. You don't have as much time as youngsters to bounce back from big declines in the value of your retirement investments.
But just because you're a few years from retirement doesn't mean you should be adopting the same investing strategy as somenone who is investing money for a down payment on a house he or she plans to buy in a few years. That person really does have a short-term planning horizon. Your money, on the other hand, will likely remain invested a good 30 or more years after you leave the workforce.
So essentially you want to adopt an asset allocation strategy that balances the need to protect your nest egg from big hits from which it will be difficult to recover with the need for enough growth to help you maintain your standard of living throughout what could be a very long retirement.
People can disagree on what the appropriate asset allocation for someone in your position should be. But I think a reasonable guideline is a 50-50 mix of stocks and bonds. If you've got lots of other resources to fall back on - a pension, other investments, a nice home equity cushion, cash value in life insurance policies, etc. - you could consider bumping up the stock portion of your portfolio by another five to ten percentage points. Or if you have little in the way of other assets, you might dial back your stock exposure a bit. Whatever stocks-bonds mix you initially settle on, you would then gradually shift more into bonds as you age and require more stability in your portfolio.
The point, though, is that the best way to deal with the inherent uncertainty of the financial markets isn't to engage in a futile guessing game of moving your money around. It's to set an allocation strategy in advance and then, with the possible exception of a few minor tweaks, stick to it.
Diversifying this way won't immunize you against market losses. But if you set your allocation correctly, you'll be much less likely to incur losses so damaging that you'll be tempted to join the "foxhole" or "Hail Mary" camps.