“Uncertain” is perhaps the best word to describe our current economic climate.  There have been a variety of challenges, from the banking failures and the various mergers and acquisitions, to the big bailouts and severe market fluctuations.  In times of challenge, a sound investment strategy based on a long-term outlook may be more important than ever.  Patient investors that stay the course are most often ultimately rewarded for their fortitude.  Below are a few additional investment fundamentals to keep in mind during these challenging times.  

Don’t Focus on the Short Term

Most of us are inherently emotional about our money.  As a result, it’s all too easy to overact in down markets, moving from higher risk investments into lower risk investments or jumping out of the market altogether.  One of the most difficult things an investor can do is to try and time the market.  Studies show, however, that most of us aren’t able to do this effectively and end up losing in the long run.  

Consider a study done by Standard & Poor’s, which reveals that during the 10-year period from January 1, 1998, through December 31, 2007, the S&P 500 experienced a gain of 5.9%.  For an investor that wasn’t in the market for the top 10 days of positive returns during those 10 years, their return was 1.1%.  An investor that wasn’t in the market for the top 20 days had a return of (2.6)%.  An investor not in the market for the top 30 days had a return of (5.7)%, and an investor not in the market for the top 40 days had a return of (8.4)%.  This shows how detrimental trying to time the market can be.  

The key is to develop a long-term investment strategy that takes most of the short-term market conditions out of the equation. Short-term fluctuations are a given; it’s important to be comfortable with those fluctuations and account for them within your strategy.  

Determine Your Risk Tolerance

It’s important for investors to have a good understanding of their risk tolerance and to be honest with themselves when determining that level of risk.  In determining your investment strategy, you should determine how you will react in good times and bad.  For example, let’s say you determine that you’re an aggressive investor and can handle a market downturn; however, given current conditions, you opt to move from higher risk investments into those with lower risk. Chances are, you’re not an aggressive investor after all.   

In addition to investing based on risk level, investors should factor in the length of time they have until retirement.  In general, the longer one has until retirement, the more aggressively they can invest, since there’s more time to recoup any losses from a down market.  For investors that are closer to retirement, a more conservative investment strategy may be more appropriate.  Therefore, a good strategy for many investors is to have a higher exposure to stock investments in their younger years and slowly shift toward a lower exposure to stock investments as they approach retirement.   

Invest Early

One of the most important investment fundamentals is to start investing early.  The longer one waits to invest, the less time the investments have to grow, which puts pressure on investors to save significantly more than if they’d started saving earlier.  With compounding interest and tax-deferred growth, starting early has a significant impact on the amount of retirement benefits accumulated. 

Rebalance Your Portfolio

If you’re not in an age-based or risk-based portfolio that automatically rebalances, you may want to consider taking the steps necessary to rebalance.  By rebalancing, you maintain the exposure to the various parts of the market that you’ve selected and don’t stray significantly from that exposure.  This helps maintain a level of risk with which you’re comfortable. 

Diversify

You’ve heard the phrase, “Don’t put all your eggs in one basket.”  It’s this philosophy that’s at the heart of diversification.  However, it’s important to note that diversifying doesn’t mean that you need to invest in dozens of mutual funds or stocks.  Instead, the goal is to invest in a calculated number of different asset classes in order to potentially reduce the overall risk with your investments.  By having exposure to multiple asset classes, you’re usually able to reduce the risk that a collapse of one asset class could significantly reduce your overall retirement account.  

What About 401(k)s?

Given today’s environment, many 401(k) participants wonder how safe their contributions are.  While it’s true that 401(k) investments are subject to market gain and/or loss, there may be additional protections beyond what one might have in an FDIC-insured bank account. 

First, contributions that you make to a 401(k) plan are used to buy shares of the investments you select.  These investments are held in a trust account, which isn’t connected to your employer or your company’s creditors.  Therefore, the assets are set aside and cannot be used for any purpose other than your savings as a participant. 

Second, while some financial institutions are struggling and have various problems, understand that your assets held by a financial institution related to the 401(k) plan are kept separate from the assets of the institution.  In other words, the assets aren’t part of the institution’s budget.  Therefore, even if the financial institution holding your 401(k) assets is bought or sold, or requires some type of financial relief, it doesn’t mean that the assets they’re managing for your plan are at the risk of the institution. 

In Conclusion

While we’re experiencing an extraordinary time in the capital markets, it doesn’t mean that we should all stop saving for our retirement.  In fact, these times may present a good time to invest.  Should you have any questions or concerns regarding your retirement plan, consider consulting with a financial advisor to keep focused on your retirement goals.  

Past performance does not guarantee future results. All investments include risk and have the potential for loss as well as gain. 

Data sources for peer group comparisons, returns, and standard statistical data are provided by the sources referenced and are based on data obtained from recognized statistical services or other sources believed to be reliable. However, some or all information has not been verified prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis non-factual in nature constitutes only current opinions, which are subject to change. Benchmarks or indices are included for information purposes only to reflect the current market environment; no index is a directly tradable investment. There may be instances when consultant opinions regarding any fundamental or quantitative analysis may not agree. 

Plante Moran Financial Advisors (PMFA) publishes this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the sectors mentioned herein may not be appropriate for you. You should consult a representative from PMFA for investment advice regarding your own situation.