Oct 21 2014
“Ugh! Another boring investment article, right?” If only it wasn’t so important to your future wealth and quality of life. First a little set-up before getting to my real points which are strategies for your use.
The media are all over the “the next correction” in the stock market (“correction” equals a significant drop). After all, it’s been up since 2009; surely it has to pop sometime soon. “So what”, you ask. Word of these stock market events spreads eventually causing us investors to act in silly and costly ways.
To recap, the stock market hit a bottom in March 2009 and began the rebound. There was a correction (drop) in 2010 of about 13%. Again in 2011 of about 15%. In 2012 there was an 8% dip. But the big picture is a solid up since March 2009.
Besides the stock market correction is the inevitable inflation and interest rate hikes that will drive down bond prices. Meaning, if you hold bond funds in your 401k/TSP, their value will drop. Between the sluggish economy and the resulting government actions to fix it, we have economic conditions that are ripe for inflation. Inflation leads to higher interest rates. Higher interest rates lead to decreased bond values.
Example: You buy a bond for $1000 that pays 3% interest. Say interest rates rise to 4%. You want 4% so you decide to sell your 3% bond. No one wants your 3% bond when they can buy a 4% bond. You have to drop your price to sell your bond. Voila! Bond values decrease in a rising interest rate environment.
Finally, the real points.
What is a 401k/TSP/IRA investor to do? The financial journals are all over the map on opinions. Simplify the discussion.
We boil down the types of investors into two pots: wealth accumulators and soon-to-be retirees seeking preservation of assets but also requiring some growth to stay ahead of taxes and inflation. While there are other types of investors with rather specific or sophisticated needs, the majority of you fall in the wealth accumulator category.
Wealth accumulators require a down market to accumulate the maximum shares of ownership (mutual fund shares in retirement accounts). Ownership equals wealth. “What?!”
You read me right. Wealth accumulators need the stock market to go down. Only in a down market will your regular payroll contributions have a chance to buy enough ownership to build wealth.
Here’s the rule of the game; s/he who retires with the most shares wins! Stop judging your success on your account value. Account value is a by-product of ownership.
Wealth accumulators shouldn’t worry about market corrections. In fact, they should welcome it. They should be dollar cost averaging and have an allocation that leans heavily to stock funds. Rebalance your portfolio after your allocation is off by more than 5% (these bolded strategies are explained in the articles linked below).
Soon-to-be retirees should have an allocation that won’t follow the market all the way down. Say, a portfolio of no more than 30 or 40% stocks. This is a proportion of stocks recognized as being able to maintain enough growth to offset taxes and inflation without too much risk.
From September 2008 to March 2009, the stock market dropped 48%. A portfolio of 80% stocks dropped 38%. For wealth accumulators, that’s great. You are raking in ownership at bargain basement prices. A portfolio of 40% stocks went down 18%. If closing in on retirement, you can survive that reasonable drop in portfolio values to ultimately catch the rebound in stocks.
Details are missing in this article. For more go to:
- Don’t be a Scaredy Cat; 4 Ways to Manage Your Stock Market Risk
- Investing Doesn’t Have to be That Complicated
- Millennial?—4 Steps Into Simple Financial Planning