Fleeing the Market

Some of these sentiments may sound familiar.

“I’m panic stricken. The company is in trouble. The market’s falling ...”

“It’s so scary ...”

“Wow! What happened today? I want all my money ...”

As the economic downturn deepened, lots of workers—especially those closest to retirement—panicked and snatched their money out of the stock market.

“We can’t stand it any more,” I heard from one friend only weeks before the market bottomed out. She and her husband joined the tide of investors turning to safe but low-earning alternatives such as money market accounts.

Unfortunately, according to Ken Fine and Wei-Yin Hu of the retirement investment advice firm Financial Engines, your instincts often are not right. Many investors fled the market when prices were at or near record lows.

According to Hewitt Associates 401(k) Index, a total of $6.3 billion was moved out of stocks and stock funds in 2008, most of it put into conservative investments equivalent to cash, which protect principal but don’t promise much in the way of earnings.

Problem with fleeing the market

“We saw a lot of people move to all cash,” Hu said. “It’s a natural response, but, on average, it does more harm.”

The problem with fleeing the stock market is twofold: The first is the drawback of selling low. The second is that, once you’re out of the stock market, you miss the good days once the recovery begins.

Stock prices increased by nearly 40 percent after what may have been the bottom of the market in early March. There’s been some give and take in prices since then, but if you stayed in the market instead of fleeing, you’re probably better off than those who sold at the low.

Consider this scenario: Someone who invested $1,000 in a Dow Jones industrial average index fund when the Dow hit its high point of 14,164 in October 2007 sells it all in March 2009, when the index reached its recent low of 6,547 last March. That investor would have gotten only $462 of his original stake back. If he had let it ride, his investment would already have recovered to a value of $582, based on the Dow’s value in the first week of July.

Recovering from losses

Financial Engines looked at the impact of moving investments to cash equivalents—what it would mean for an investor’s ability to recover from losses and get back on track for retirement. The results weren’t pretty.

Financial Engines found that it would take at least an extra year on the job for investors who stayed in age-appropriate diversified portfolios to recover from the market declines of 2008. For investors who jumped to cash-equivalent portfolios, it would take up to four years of delayed retirement to get back on track.

The setbacks for those who moved to cash point to a much larger problem with our current system of retirement finance—its dependence on individuals to find the right investments and set aside enough money. Most of us, and this is certainly true of me, are not financial experts. We don’t have the expertise needed to decide how to allocate our investments. Sure, we understand that we are supposed to diversify our portfolios. We just don’t know what that really means.