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sabrinamariI've gotten a series of money management questions from friends and family over the last few days in the wake of the recent stock market plunge. This morning, after receiving an email full of questions from another wise friend, I thought I'd post my thoughts addressing the most common questions I've been getting (and by the way, keep those questions coming---carefully researching and thinking through your options is the best way to prosper during rough times).
******
There is an investing adage that says something like, "Fortunes are enjoyed in bull markets, but they are made in bear markets". I am paraphrasing, but this means that while your portfolio *looks* fat and sassy while the market is up, your real money is made in the form of low-cost stock purchases while the market is down. Right now and over the next few months or even years, equities are on sale. It's like a giant carnival of low prices on stuff you *know* you're going to need later---because unless you die young, you are going to need money to live on when you're too old to work, and your retirement portfolio is there to give you that money.
One of the reasons that the wealthy do so well is that they are the only ones who have enough cash to take advantage of the stock market's fire sales during bear markets, buying up high quality stocks while they are cheap, cheap, cheap. Everyone else is just scrambling to stay alive and can't afford to take advantage of this opportunity.
Later, when the market recovers---and so far, it always has---wealthy investors who bought during bear markets see their portfolio's value rise dramatically---while cash-poor folks who stopped contributing to their 401ks or even sold off their stocks see no rise or show a big, big loss.
Let me give you an example of what I mean. Historically, when the stock market is about to recover, there are a series of "bumps". These bumps have jumped as high as 36% at a time. So wealthy investors who bought lots of stock at bargain basement prices saw big, big jumps in the value of their portfolios when the recovery finally began.
What looked like a dumb move during the bear market (pouring money into a depressed stock market) looked brilliant when the market recovered.
So right now, whenever I get a little extra money, I make extra purchases for my portfolio. The safest way to do it is to buy high quality funds, so the (very real) risk of bankruptcy presented by any single company in a bear market is diffused---and dollar-cost investing is the most consistent and beneficial way to take advantage of this strategy.
A couple of caveats:
This strategy works well as long as you...
* Have a good fat emergency fund in place (most people don't, and so can't take advantage of Wall Street's blow out sales in the first place)
* Have a clear asset-allocation strategy, so you are actually buying what you know you need to strengthen your portfolio
* You buy what's actually on sale (so it's probably too late to buy commodities, for example---they've mostly shot up in price, and they're not a great deal right now)
and
* You buy good quality funds that you would buy anyway as part of your financial strategy even if there wasn't a huge sale on Wall Street.
So, my final thoughts:
Make sure your emergency fund is strong: stock away a 3-6 month minimum reserve---probably closer to six months in a bad economy. If you don't have this in place, consider either:
1. Splitting your savings in half (half going to dollar-costing and half going to your online money market emergency fund), or
2. TEMPORARILY diverting savings to your emergency fund and IMMEDIATELY switching back to dollar cost investing when you reach your emergency fund goal.
If you are comfortable with your emergency fund level, dollar cost right through this market and when you get extra money, make an extra purchase of the funds you are already on target to buy----or, if you REALLY have some extra, spend a little bit on a really cheap, but high quality stock that you strongly believe may go up in value later.
But *be careful* if you do this and understand that at some level, this is a gamble. Don't buy individual stocks with money you can't afford to lose.
My last few thoughts about managing retirement and emergency funds right now:
* If you can, resist the urge to take money OUT of the stock market at this time (in the form of drawing down from your IRA, 401k, etc.). This will make your "paper losses"---theoretical losses in the value of your portfolio---into REAL losses, and will keep you from benefiting from the bump when the market recovers. Bear markets are good times to put money into retirement funds and bad times to take money out of them.
* If you really get stuck and you have to take some money out---and I mean, if you MUST do this to survive----hit your Roth IRA first and your traditional 401k or 403b later. You can withdraw Roth IRA contributions without a penalty---you just can't take out any accrued interest. In general, 401k funds come at a much bigger price: they will cost you a 10% penalty for early withdrawal, and you will pay taxes on the money (for the second time, if you have a Roth 401k) to boot.
* If you can do it, make a plan to add to your emergency fund gradually and pay down debt bit by bit rather than drawing on your retirement funds. In the long term, this is a better strategy because of the reasons I've noted above.
Anyway, good luck! Only you really understand your options and current financial situation, so you must tailor your actions to that understanding. And finally, may you prosper with whatever you choose to do.
******
There is an investing adage that says something like, "Fortunes are enjoyed in bull markets, but they are made in bear markets". I am paraphrasing, but this means that while your portfolio *looks* fat and sassy while the market is up, your real money is made in the form of low-cost stock purchases while the market is down. Right now and over the next few months or even years, equities are on sale. It's like a giant carnival of low prices on stuff you *know* you're going to need later---because unless you die young, you are going to need money to live on when you're too old to work, and your retirement portfolio is there to give you that money.
One of the reasons that the wealthy do so well is that they are the only ones who have enough cash to take advantage of the stock market's fire sales during bear markets, buying up high quality stocks while they are cheap, cheap, cheap. Everyone else is just scrambling to stay alive and can't afford to take advantage of this opportunity.
Later, when the market recovers---and so far, it always has---wealthy investors who bought during bear markets see their portfolio's value rise dramatically---while cash-poor folks who stopped contributing to their 401ks or even sold off their stocks see no rise or show a big, big loss.
Let me give you an example of what I mean. Historically, when the stock market is about to recover, there are a series of "bumps". These bumps have jumped as high as 36% at a time. So wealthy investors who bought lots of stock at bargain basement prices saw big, big jumps in the value of their portfolios when the recovery finally began.
What looked like a dumb move during the bear market (pouring money into a depressed stock market) looked brilliant when the market recovered.
So right now, whenever I get a little extra money, I make extra purchases for my portfolio. The safest way to do it is to buy high quality funds, so the (very real) risk of bankruptcy presented by any single company in a bear market is diffused---and dollar-cost investing is the most consistent and beneficial way to take advantage of this strategy.
A couple of caveats:
This strategy works well as long as you...
* Have a good fat emergency fund in place (most people don't, and so can't take advantage of Wall Street's blow out sales in the first place)
* Have a clear asset-allocation strategy, so you are actually buying what you know you need to strengthen your portfolio
* You buy what's actually on sale (so it's probably too late to buy commodities, for example---they've mostly shot up in price, and they're not a great deal right now)
and
* You buy good quality funds that you would buy anyway as part of your financial strategy even if there wasn't a huge sale on Wall Street.
So, my final thoughts:
Make sure your emergency fund is strong: stock away a 3-6 month minimum reserve---probably closer to six months in a bad economy. If you don't have this in place, consider either:
1. Splitting your savings in half (half going to dollar-costing and half going to your online money market emergency fund), or
2. TEMPORARILY diverting savings to your emergency fund and IMMEDIATELY switching back to dollar cost investing when you reach your emergency fund goal.
If you are comfortable with your emergency fund level, dollar cost right through this market and when you get extra money, make an extra purchase of the funds you are already on target to buy----or, if you REALLY have some extra, spend a little bit on a really cheap, but high quality stock that you strongly believe may go up in value later.
But *be careful* if you do this and understand that at some level, this is a gamble. Don't buy individual stocks with money you can't afford to lose.
My last few thoughts about managing retirement and emergency funds right now:
* If you can, resist the urge to take money OUT of the stock market at this time (in the form of drawing down from your IRA, 401k, etc.). This will make your "paper losses"---theoretical losses in the value of your portfolio---into REAL losses, and will keep you from benefiting from the bump when the market recovers. Bear markets are good times to put money into retirement funds and bad times to take money out of them.
* If you really get stuck and you have to take some money out---and I mean, if you MUST do this to survive----hit your Roth IRA first and your traditional 401k or 403b later. You can withdraw Roth IRA contributions without a penalty---you just can't take out any accrued interest. In general, 401k funds come at a much bigger price: they will cost you a 10% penalty for early withdrawal, and you will pay taxes on the money (for the second time, if you have a Roth 401k) to boot.
* If you can do it, make a plan to add to your emergency fund gradually and pay down debt bit by bit rather than drawing on your retirement funds. In the long term, this is a better strategy because of the reasons I've noted above.
Anyway, good luck! Only you really understand your options and current financial situation, so you must tailor your actions to that understanding. And finally, may you prosper with whatever you choose to do.
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Minor Point
Date: 2008-10-01 02:03 pm (UTC)You would be paying taxes on it for the first time, not 'again', as 401k contributions are pre-tax.
Still sucks, but you're only "losing" the 10% penalty. The tax you'd pay is the same as if you had not invested it at all but took it as pay.
Depending on the managing company, though, they may withhold 30% of it "on your behalf" for taxes.
Re: Minor Point
Date: 2008-10-01 03:43 pm (UTC)But if you are working with a traditional IRA, 401k or 403b, you only pay taxes plus the penalty when you withdraw the money early for a use that's not approved for early withdrawal.
Nice catch!
In other news: I have soemthing of yours that I'd like to return to you. Can you email me your current mailing address? I send hugs to you, your honey flamespirit and your little bunnies {{{methastra}}}.
Re: Minor Point
Date: 2008-10-01 04:19 pm (UTC)Re: Minor Point
Date: 2008-10-01 06:10 pm (UTC)Re: Minor Point
Date: 2008-10-01 03:45 pm (UTC)no subject
Date: 2008-10-01 02:13 pm (UTC)no subject
Date: 2008-10-01 03:44 pm (UTC)no subject
Date: 2008-10-01 03:58 pm (UTC)There are companies on my wish list that are sitting low but I'm reconsidering how and where I put my money now.
Apple & Visa for example seem to be on the cheap but neither of them fit the criteria for what I see as Bear market safe havens.
Right now I'd rather put my eye on companies that provide the basics that people need to live. Food, medicines, basic sundries, etc.
no subject
Date: 2008-10-01 04:19 pm (UTC)So says she...whose only stock are those of JPMC. Um, yeah. It's been fun watching them over the last few weeks or so.
no subject
Date: 2008-10-01 06:09 pm (UTC){{{{flamespirit}}}}
no subject
Date: 2008-10-01 06:50 pm (UTC)I never got past the userpic.
no subject
Date: 2008-10-01 06:55 pm (UTC)no subject
Date: 2008-10-01 06:06 pm (UTC)Sigh. I just get misty-eyed thinking about it.
But...it *is* really rough to know what to buy, especially when you're looking at individual stocks.
It's risky out there, even if you do your research. Fortunately, I'm not in a position to buy individual stocks right now although there are two or three companies I've been pining for...
Because of our dual job insecurity and possible need to move, we need to boost our emergency fund further before doing anything else. So I've lowered my dollar-coat investing (which deeply, truly pains me)and refocused on getting that emergency fund up, up,up.
I can't stop dollar-costing or I'll lose my mind---I can't stand not to buy when things are so cheap! But I can't dollar cost $600 a month anymore until that emergency fund is nice and fat.
Happily, I have a small second source of income designated to fill my Roth IRA, and when the market drops dramatically, I buy a little more of one or two mutual funds with it.
Since I still have asset classes to buy in order to complate my portfolio, this helps dictate what I do and helps keep me from indulging my stock market fantasies.
While I agree that core commodities and basics are a great bet, I won't buy unless there's a sale. A couple of folks around me are excited about silver, gold and that sort of thing. While I wish I'd had a small stake in precious metals going into this bear market, I see no sense in buying in now. for me, the whole point of owning such commodities is to stabilize your portfolio when things get bad---it doesn't help you to buy them during a crisis, when they've gone way up in price.
That's like closing the barn door after the horse is gone.
I also can't buy individual oil stocks or related stocks for the same reason, and I didn't buy them before for ethical reasons. I could only bring myself to buy amongst alternative energy companies, and I am considering an alternative energy fund or ETF for the future.