Four savvy strategies to cope with crazy markets in a struggling economy
These are times that try savers souls.
Standard & Poor’s decision to downgrade the federal government’s credit rating had a terrible and bizarre effect on our retirement plans and personal portfolios on Monday.
It sent the stock market skidding to its worst loss since the world's banking industry was teetering on the verge of collapse in October 2008.
The three major stock indexes sank between 5% and 7% on Monday, pushing the Dow Jones Industrial Average below 11,000 for the first time since last November.
American stocks have now lost about 15% of their value over the past two weeks thanks to Washington's protracted battle over raising the government's debt ceiling and S&Ps controversial reaction to it.
Yet investors were clearly not buying S&P's new, more pessimistic take on our nation's debt.
They were piling into Treasuries on Monday, pushing prices up and yields down.
The return on the government's popular and closely followed 10-year notes fell from 2.56% on Friday – before S&P announced its downgrade – to 2.34% on Monday, the lowest it's been since January 2009.
So what are the millions of Americans who are just trying to build a nest egg for retirement, to care for elderly parents, or to send their kids to school, supposed to do now?
How can we do the right thing when our savings are under constant assault by one economic crisis or financial calamity after another?
We don’t have any magic solutions to keep your savings safe and growing, but here are four savvy strategies that might help you weather several more volatile weeks.
Savvy strategy 1. Stick with stocks despite the rocky ride.
If you sell the stocks or mutual funds in your retirement plans or personal portfolio’s now, you’ll be selling when prices are already down – and down a lot.
You will be trying to divine when we've reached the bottom of this panic selling, the stock markets are turning around, and it's safe to jump back in and rebuy the equities you just sold.
That's a very difficult thing for even the smartest professional investors to do.
You run the risk of selling when prices are down and buying when prices are up and locking in the very losses you’re trying to avoid.
It’s tough to watch retirement accounts, many of which had just recovered from the 2008 financial crisis and recession caused by the banking industry, swoon again.
But the smart thing for most of us is to endure that volatility, because timing the market is very hard and there’s virtually no way to build wealth without the substantial potential returns only stocks can deliver.
No one can guarantee that you’ll succeed at that, no matter how much, or how wisely, you invest in equities. But it’s a near certainty that you won’t succeed if you don’t take that risk.
This is especially true if you’re young and have another 30 years before you retire.
You can’t worry about what happens this week, this month or even this year. Think decades.
Let’s say you currently have $30,000 in your 401(k) plan, sock away $4,000 per year and earn an average of 7% a year. In 30 years, you’ll have more than $620,000. (You can project how your retirement plan will grow with our 401(k) calculator.)
Now let's say you're scared of the market and decide you're only going to put your money in CDs and money markets.
Even if you put away $5,000 per year and earn an average of 2.5%, you'll have only $287,000 at the end of 30 years.
Savvy strategy 2. Don’t bail on your Treasuries, either.
On one level, we understand why S&P cut the ratings on government bonds.
Its report said the “downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned.”
A shocking number of lawmakers -- primarily Republican lawmakers -- were willing to let the federal government run out of money and potentially default on its debt in pursuit of their political goals.
Negotiating a reduction in the federal deficit is one thing.
Threatening to cut off the money the Treasury Department needs to pay interest on the government’s debt and repay its loans as they come due is a sobering tactic to anyone who owns government bonds.
Yet Treasuries actually rallied last week, even though S&P made no secret about its plans for a downgrade.
And they rallied again on Monday – the first trading day after the downgrade.
The major investors in our nation’s debt -- from mutual funds and pension plans to other governments, such as China – are clearly not rushing to sell.
Why should you?
Hang on to the bond funds in your retirement plans and personal portfolios.
Savvy strategy 3. Find a safe haven for new contributions to your retirement plans.
Holding on to what you have is one thing.
It doesn’t mean that you have to put more of your hard-earned savings in stock right now.
Don’t stop or even reduce automatic contributions to your 401(k) plan. You don’t want to forfeit the tax benefits those retirement accounts provide.
Just ask your plan administrator to direct all of your new contributions into a money market fund -- the safest, closest thing to a savings account that most retirement plans offer.
These funds hold more than a dollar's worth of assets, usually investment grade bonds, for every dollar that investors place in it and pay a guaranteed rate of return.
Take the money market fund at one major administrator of 401(k) plans we just checked. It holds $1.06 worth of assets for every dollar in investments and has established a return of 2.10% through Sept. 30 – not a bad rate of return these days.
Savvy strategy 4. Put new savings outside your retirement funds into cash.
We may not make much off our federally insured bank accounts, but at least we know our principal is not at risk.
So don’t put any more money in personal stock portfolios right now.
Take advantage of our database to find the best CD rates from scores of banks and add to your cash holdings instead.
There’s never been a more pressing need to spread out your money among CDs with varying maturities.
You benefit from the higher interest rates being paid by your long-term CDs while keeping at least some of your savings ready to take advantage of higher interest rates.
The key is to pick the right mix.
One way to go is with a balanced ladder that has your CDs maturing every six months like clockwork. This takes the guesswork out of trying to figure out when rates when will go up.
Another option is to weight your CD ladder heavily toward where the best deals fall. For example, if you find 2-year CDs offer better rates than 30- or 36-month CDs, you forget about balancing the ladder and triple up on the 2-year term.
Either way, your CD ladder is going to give your savings an extra kick. Our CD ladder calculator can help you make all the right decisions.
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