Stocks are in a bear market, inflation is at a 40-year high
and economists are warning about a possible recession on the horizon. For
millions of Americans saving for retirement, the economic turmoil has raised
some big questions: Should they sell investments or stay the route?
First, don't panic, experts say — that can lead to hasty
financial decisions that you might regret later. As you survey the market, It's
important to maintain focus squarely on your personal financial goals.
The S&P 500 is down more than 21% since its most recent
peak in January, which means it has entered a bear market — when stocks fall at
least 20% from their previous peak. In fact, downturns of this scale are fairly
common, with the last one occurring just two years ago when then pandemic shut
down the U.S. economy. Yet younger investors who have never experienced such a
decline and older investors who are closer to retirement might be tempted to
bail or switch strategies.
"Riding out market downturns is a good rule of
thumb," Amy Richardson, a certified financial planner with Schwab
Intelligent Portfolios Premium, told CBS MoneyWatch. "It's nearly
impossible to try and time the markets, so it's important to have a strategy
and remain clear about your personal financial goals."
Having a financial plan "can help you ignore the
day-to-day market noise," she added.
Don't try to time the market
There's a reason why you may have heard this many times:
Investment professionals show that timing the market — or trying to guess when
stocks are at their top or bottom — is nearly impossible. Research has shown
that people who dump stocks during a market downturn are likely to miss the
days when the market rises sharply, and that can make a dent in long-term
returns.
For instance, one study published by the investment
organization CAIA found that a buy-and-hold investor would have an annual
return of almost 10% from 1961 to 2015. But an investor who tried to time the
market and missed the 25 best days during that period would have an annual
return of less than 6%.
To be sure, if an investor managed to avoid the worst 25
days during that period, their annualized return would have been more than 15%.
But predicting both the worst and best days of the market is notoriously
difficult, which is why investment pros recommend sticking with the "buy
and hold" strategy.
Should I move into cash?
Only if you need the money immediately or want to lock in
losses, experts say. Acknowledging that it might be tempting to move into cash
as a defensive measure, Richardson points out that cash's purchasing power
erodes during periods of high inflation.
The Federal Reserve's interest rate hikes are providing
better returns to savings accounts and certificates of deposit (CDs), but they
still trail far behind the rate of inflation. For instance, a one-year CD now
offers a monthly yield of about 1.5%, up from about 0.7% in March, according to
Ken Tumin of DepositAccounts.com. But in May, inflation jumped to 8.6%, which
means that cash invested in a CD would see its buying power eroded by about 7%.
That might still seem more appetizing than the steep
investment losses incurred during a bear market, but you won't have the chance
to make up those losses as you would in the market during periods when stocks
rise. Limiting your exposure to cash during high inflation periods is a good
idea, Richardson noted.
"While it may not seem like it when the markets are
falling, stocks have traditionally outpaced inflation over time," she
said.
Should I stop contributing to my 401(k)?
Research has shown that consistent investing pays off over
time. For instance, Charles Schwab looked at five different investing styles,
ranging from trying to time the market to keeping everything in cash. The best
performing strategy was the investor who managed to perfectly time the market —
an impossibility for most investors, as noted above.
After that, the most effective strategy was one where an
investor socked away money at the start of the year, followed by an approach
called "dollar-cost averaging," or investing a set amount of money on
a regular basis, such as monthly or with each paycheck. In other words, how
most people invest in their 401(k)s.
The worst performer? The investor who stuck with cash,
Schwab found.
"I am a big believer in the adage that time in the
market is more important than timing the market, and that means that any time
you can set aside money to invest is a good time," Richardson noted.
"If you have the ability to put more toward your 401(k) or other
retirement accounts, this is as good a time as any."
Should I change my asset allocation?
This could be a good time to talk with your financial
adviser about your goals and to check whether your portfolio aligns with those
objectives, experts say. That could result in an asset allocation shift if, for
instance, you want to reduce your equity exposure to lower your risk or cut
back on investments in certain sectors, like tech.
"For most investors, the best approach to long-term
success is broad diversification that aligns with their risk tolerance,"
Richardson said. "When you diversify your portfolio, you spread your money
across different assets, understanding that all investments will go up and down
at different times depending on different factors."
People who are close to retirement or already retired may
want to add Treasury Inflation-Protected Securities, or TIPS, to their
portfolio, she added. Investors can buy TIPS directly through the Treasury
Department, or via their bank or broker. But an investor can only buy $10,000
worth of TIPS annually for each account, which limits the amount of inflation
protection they can offer.
"Commodities are also a good offset to inflation,"
Richardson added.
How long does a bear market last?
Since World War II, bear markets on average have taken 13
months to go from peak to trough and 27 months to return to breakeven. The
S&P 500 index plunged an average of 33% during bear markets in that period.
The biggest decline occurred in the 2007-2009 slump, when the S&P 500 fell
57%.
Bear markets tend to have three stages, according to Bank of
America technical research strategist Stephen Suttmeier, who cited Wall Street
legend Bob Farrell's "10 Market Rules to Remember" for investors
anxious about the market downturn.
The first stage is a sharp decline, followed by a rebound,
and then a "drawn-out fundamental downtrend," he noted.
"We are likely in the third stage, with risk to 3800
(20% correction) and even 3500 (27%) on the S&P 500," Suttmeier said
in a research note.
That means the stock market may not have hit bottom, with
the S&P 500 trading at about 3,760 on Monday. But even if markets continue
fading, investors should focus on valuations, given that the price-to-earnings
ratio on the S&P 500 is now below its 25-year average, advised David Kelly,
chief global strategist at JPMorgan Funds.
"Whatever short-term cyclical journey the economy takes
from here, it should, within a few years, resume a brighter path of moderate
growth, low inflation and high profitability," Kelly said in a report.
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