Lately during in-service training and court appearances, conversations have inevitably turned to the stock market. Last fall, as many of you painfully remember, the market collapsed. Depending on how you were invested, you could have lost 40 to 50% of your investment value. I don't know if that is technically called a collapse, but it sure qualifies as one in my book!
Fortunately, most of us invest in either a 457 or 401K to defer some of our compensation and plan for a nicer retirement. Unfortunately, that means that most of us were caught in the collapse. Some people sold, moving into less volatile investments; some people have stayed, despite their natural instincts to flee; a few just cried. So, what did you do? What should you do?
Reality
First things first; the market crashed. There is no better way to phrase it. If you owned any stock, or mutual funds that owned stock, you saw your investment lose roughly 45% in the past year. We won't try to put lipstick on that pig; it's a major hit to anyone's finances.
Second: these terrible losses are just paper losses, unless you sell! Investments regularly gain or lose money every day. You don't pay any taxes or collect any additional earnings from these movements unless you sell the investment. That means the profits and losses are just theoretical, or on paper. They are not actual gains or losses until you lock them in by selling.
Third: historically, the stock market returns 7 to 8 percent per year. This ratio is essentially consistent over any 40-50 year period in the past 200 years. Nothing, including gold, government bonds, banks and corporate bonds has equaled the performance. Gold is almost flat and bonds average about 3%. Sure, history is no guarantee for the future. But when it comes to this extensive, consistent and repetitive of a performance, it's tough to argue the future will be much different.
[The Social Security Administration published an article in 2000 addressing the very issue of market performance; it's also where I verified my long-held beliefs. If you want to understand how economists think, and how much deep analysis goes into very basic decisions, I encourage you to read it at the link provided below. Don't read it before work or during a 3rd shift lunch break; it isn't exciting. But it does offer insight. Interestingly, the article was written in 1999, at the height of the Dot-com hysteria in the market. The assessment that there would have to be a fall in prices turned out to be pretty much dead-on.]
So What?
Good question - so what? The market collapsed and you lost a bundle, right? Smart people sold their stocks, went to bonds or money market accounts and said, The heck with stocks! Right? Well, maybe.
Yes, the people who sold their mutual funds and stocks have stopped bleeding. They cannot lose any more money in the stock market. However, they have guaranteed their market losses. What used to be a paper loss is now a real loss; they cannot get that lost money back - ever. And that is a good move for some people, but it is a stupid move for most of us.
The real answer on what to do now depends on where you are in life. Remember, the market returns 7-8% per year on average. That means that the losses over the past year should be made up in the next 9 to 11 years. That sounds like a long time, but if you put your money into money market accounts paying 1-2% interest, you're looking at roughly 36 to 72 years to recoup your money. Yes, THIRTY-SIX to SEVENTY-TWO years. Big, painful difference, huh?
So, if you have a while before you plan to use your retirement funds, my personal recommendation is leave it alone. If you have 20 or more years until you plan to access your 401K/457, then let time rebuild your lost money. I don't mean 20 years to retirement, I mean 20 years before you plan to start taking your deferred compensation. Many people plan on a second job after retiring, so they don't need the money in the near future. Even if the market has not hit rock bottom (personally, I think it basically has), you still have plenty of time to make up your losses.
If you have 10-20 years before you will start accessing your retirement reserves, you should look at moving some money into stable investments (money markets, government bonds). The amount depends on three things: time to retirement, adversity to risk, and confidence in the economy. Time can be your friend or your enemy; more time is always better to make up the paper losses. If seeing your 401K/457 plummet 45% gave you a coronary, you probably have a lower risk tolerance. If you shrugged during the collapse, figuring it just meant another four years of putting bad guys in jail, you probably have a higher risk tolerance. That's a personal issue you have to address on your own.
The last issue is your confidence in the economy. That may seem like a stupid statement given the current crush of negative press everywhere, but it really requires you to think. Do you really think that five years from now, GM and Chrysler will be closed and sold off, Citibank will be bankrupt and houses that used to cost $500,000 will be available for $98,000? Or do you think things will level off then start to rebound? If you believe the rebound is just a few years off, leave some money in stocks to regain those paper losses. If you think the world is on the brink of disaster, then give up on stocks.
The toughest one is people who are less than 10 years from using their retirement funds. Time is not on your side, even if the stock market rebounds immediately. You need to do some soul-searching on two levels. First, what is retirement like without any of your 401K/457 money? Second, what level of risk are you willing to take to rebuild your retirement money? If you have a great pension on the horizon, one that you can live on comfortably, and your 401K/457 money was just going to buy nicer vacations, then maybe you gamble. If the pension is just so-so, then locking in your losses to avoid any more losses might make the most sense. I can't offer you a great answer; you need to evaluate your own position.
Conclusion
This market collapse has caused a lot of pain, but you can use it to your advantage. If you have a long time before you need your money, keep investing; you are actually buying many companies at really low prices, which means you'll make a lot of money over time. Also, if you have a long time, in about 10-15 years, remember the year 2008. Remember how all the old-heads forgot to move out of stocks the closer they got to retiring, and how they lost so much money. When you become an old-head, start moving your money out of stocks because you don't have time to make up losses.
If you are close to retirement, there is no magical suggestion here. You need to balance your time, risk tolerance and overall situation as to how much of your stock holdings you move to stable, low-paying investments. Just remember, when you move out of stocks, you are locking in your losses and you are moving to investments that pay, currently, less than 2%.
Keep in mind, I'm just a cop - not a professional investment advisor. If you want serious guidance, talk to your deferred comp people or a good financial advisor (I can give you my brother-in-law's contact info, if you want, or First Responders.com, founded by a former NYC fireman, specializes in cops and firefighters). Until you talk to them, don't panic. The worst decisions ALWAYS are made in a panic.
Jonathan Bastian
Jonathan Bastian is a police officer in Lexington, Kentucky. He is a noted author on thermal imaging technology, but has a passion for personal finance and helping people spend money wisely. He has a bachelor's degree in business economics and international relations (commerce emphasis), and paid for several Spring Break trips by "buying low and selling high." He is still a cop by trade, so his suggestions and comments are not intended as formal tax, financial or accounting advice. Consult paid professionals if you need formal guidance.
