Somewhere in America, someone may have been immune from the recent economic turmoil that rocked the housing market, the stock market, the job market, and every market in-between. That someone has yet to be found.
Few — amateurs and financial professionals alike — anticipated anything like the 57 percent drop in the Standard & Poor’s 500-stock index over the 17 months prior to this March. No one can be sure if the worst is over. But out of this greatest sag in our economy since the Depression, some important lessons can be gleaned.
Here are a few tips from the pros to help you recover — and then some — in the years ahead.
Be True to Yourself
“It’s one thing to say you can stand to lose, say, 25 percent of your portfolio; it’s quite another to actually see it disappear,” says Matthew D. Gelfand, Ph.D., CFA, CFP®, managing director and chief investment officer of Lynx Investment Advisory in Washington, D.C. “Many investors discovered that they weren’t quite as able to handle risk in reality as they were in the abstract.” Gelfand suggests that moving forward, you seriously question how much volatility you can truly stomach. “Put market risk into very concrete terms. If your portfolio today is worth $300,000 and you have two-thirds in stocks and the stock market again tumbles by half (assuming the worst-case scenario), you will be left with $200,000. How exactly will that affect your current lifestyle and your retirement plans? Could you live with that?”
Diversify Your Portfolio Intelligently
As you know from just about any other investment article you’ve ever read, diversification is all-important. But a lot of people who thought they were well-diversified before the recent debacle really weren’t. “It’s still important to diversify within your stock holdings, but as we’ve seen, you should pay much more attention to making sure you divide your portfolio into stocks, bonds, and cash,” says Christine Benz, director of personal finance at Morningstar, a leading provider of independent investment research. Stocks offer the potential for highest return, but also position you for potential loss. Although getting the optimal mix of stocks, bonds, and cash involves many factors, a good rule of thumb, says Benz, is to not invest any money in the stock market that you might need in the next seven to 10 years. “Prior to the recent collapse, most financial professionals were saying five years, but that clearly isn’t long enough,” she says.
Trust in Uncle Sam
Within the bond side of your portfolio, diversification is also key. During the dark days of 2008, when stocks were sinking fast, corporate bonds surprisingly sank, too. U.S. Treasury bonds, in contrast, soared by nearly 14 percent. “Corporate bonds were overestimated to hold up during the financial crisis, and the diversification power of U.S. Treasuries was underestimated,” says Benz. She suggests that a good portion of your bond holdings, at least one-fourth, should be in bonds that hold the full backing of the U.S. government and tend to rally in times of financial worry. Treasury bonds come in two basic flavors — conventional and inflation-adjusted, otherwise known as TIPS. You can buy both kinds directly from the U.S. Department of the Treasury at treasurydirect.gov, or you can purchase them in fund form through a company, such as Vanguard (vanguard.com) or iShares (ishares.com), that offers various Treasury fund options at very low cost.
Don’t Lose Faith
You don’t want to go overboard and invest all of your money in the safest securities such as Treasuries or CDs, warns Frank Armstrong III, CLU, CFP®, AIFA®, founder and principal of Investor Solutions in south Florida and coauthor of Save Your Retirement. In order to recoup whatever you lost in the recent downturn, you’re going to need the growth power of stocks. “The stock market has seen serious slides in the past and has always come back to recover nicely,” says Armstrong, who has more than 35 years experience in the securities and financial services industry. “Stocks, over the long-run, have far outperformed bonds and CDs in the past, and will very likely continue to do so in the future,” he says. In only two months after the stock market’s low on March 9, the Standard & Poor’s 500-stock index soared approximately 35 percent — in the absence of any good economic news. Armstrong sees that as a sign of the stock market’s resilience. He recommends that you invest in stocks through low-cost index mutual funds or exchange-traded funds that track large segments of the market. Consider such fund options from Vanguard, Tiaa-Cref (tiaa-cref.org), or State Street Global Advisors (spdrs.com).
Destroy Your Debt
Perhaps one of the biggest lessons learned from the economic turmoil of late is the peril of debt, says Morningstar’s Benz. “The whole crisis, which started with our financial institutions’ overindulgence in debt, carries a strong lesson for individual households,” she says. “We all need to look at our personal balance sheets and make certain that debt doesn’t drown us.” Start by trimming your credit card use and then perhaps begin to chip away at the principal of your mortgage, suggests Benz. “As you near retirement, one of your goals should be to enter that phase of life with as little debt as possible.”