Q: My firm offers a wide range of 401(k) investments. I currently have my money in a bond fund, a stock fund, and a balanced fund, but with everything that’s happening in the economy and the financial markets, I’ve taken a substantial hit and I’m afraid of losing more. Among the other available options is a money market fund, which at least offers some stability in this volatile market. Do you think it would be wise for me to transfer the money from any or all of these three funds into the money market fund, at least temporarily? DW via email
A: Don't transfer everything into the money market fund.
Your instinct is a natural one in this turbulent market, not unlike the desire to pile into stocks when they're soaring. Unfortunately, investors who follow their instincts invariably buy stocks when they're most expensive and sell them for less – a long-term recipe for disaster.
What you really need is that Holy Grail of investing: a combination of stocks, bonds, and cash you can stick with even when the market is going crazy. A money market fund can indeed play an important role in that mix. It's a stable investment to focus on while your stocks and bonds are being battered, helping you resist the temptation to bail out of your riskier investments at the bottom of the market.
The right mix of stocks, bonds and cash depends on both your time frame and your temperament.
Your 401(k) plan time frame is long even if you plan to retire next week, because you’ll spend your retirement money gradually, over many years. (Don’t underestimate your life expectancy. A healthy 65 year old is now likely live another two or three decades, or even longer. Last year, the Census Bureau estimates there were 70,490 Americans over age 100. In 1950, it counted just 2,300.)
Stocks have been a good long-term investment because historically, they’ve outpaced inflation better than anything else. 'Long-term' means stocks are for money you won't need to spend for at least seven years. Money that you’ll need sooner belongs in short-to-intermediate bond funds and/or money market funds.
But of course, stocks' long-term return is meaningless if you can't wait for it. And that brings us to temperament: How much pain can you take? These are unquestionably bad economic times, and the financial markets are likely to remain very skittish at best for quite awhile.
That's why sitting temporarily on the sidelines sounds great. But how do you know when to come back? The market doesn't alert you when it's about to turn -- and it can turn very fast. One Consumer Reports study found that if you'd fled stocks during the March 2000 to October 2002 bear market (in which stocks dropped a stomach-churning 49%) and returned to them only after the carnage was clearly over, you would have missed one-third of the gain of the following five year bull market.
The fact is that if you sell in a down market, and don't reinvest until stocks prices have been climbing long enough to restore your confidence, you''ll be selling low and buying high. That's a money-losing proposition.
It makes greater financial and emotional sense to revise your retirement portfolio to a mix you believe you'd keep even in the worst-case market scenario. Let's assume that the worst is an an additional 40% stock market drop, for example. If you currently have $150,000 in stocks, a 40% drop would temporarily reduce its value to $90,000. If you think you'd bail at that point instead of hanging tough, you need a smaller stock allocation.
You don't give your age, but let's say you're 60. A conservative portfolio for you would be 50% in stocks, 30% in short-to-intermediate term bonds, and 20% in a money market fund. The stock allocation should be in broadly diversified mutual funds, divided between U.S. blue chips (30%) and international stocks (20%). If you're less conservative, or younger, you can boost your stock allocation to 60% and you still won't have an aggressive portfolio.
Please send your questions to [email protected]. I'm sorry I can't respond personally to every email. Questions are only addressed online.
(c) Lynn Brenner, All Rights Reserved.
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