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A Wall Street Sell-Off, Yet Again

New plunge rattles investors, but analysts say 'hold tight'

Investors are bracing for another turbulent ride on Wall Street Friday after a series of dismal economic reports and the financial turmoil in Europe sent the U.S. stock market tumbling yet again on Thursday, renewing concerns among Americans over how to best protect their retirement plans.

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The market's extreme swings in the last two weeks — the Dow closed down 420 points Thursday — have caused many investors to question the soundness of the often repeated recommendation by financial advisers to stay the course.

Fidelity Investments released a report on Thursday showing that in the erratic swings of 2008 and 2009, people who stayed with stocks are better off today than those who didn't. The study compared three groups:

  • Investors who got out of equities completely between Oct. 1, 2008, and March 31, 2009, the lowest months of the market downturn, and maintained no stocks in their portfolios through June 30 of this year, saw an average increase of only 2 percent in their account balances.
  • People who dropped their equity holdings completely but then later got back in at some level saw an average account balance increase of 25 percent.
  • Investors who held on to all their equities through the downturn saw an average account balance increase of 50 percent during the same period, the study found.

"Our analysis reinforces that during extreme market swings, it's essential for investors not to overreact and remember that investing for retirement requires a long-term view, regardless of their investment horizons," James M. MacDonald, president of workplace investing at Fidelity Investments, said in a statement.

Older investors, in particular, feel vulnerable to market gyrations because they have less time to make up for shrinking nest eggs.

Diversify, economize, save — and don't panic

Economists and advisers generally say the foundation of solid investment planning hasn't changed — diversify your holdings and gradually decrease your equities as you age, live beneath your means, lower your debt and save for retirement.

Above all, don't sell your equities in a panic when they drop.

"Investors must be very cautious before taking drastic steps" to alter their portfolios, says Bernard Baumohl, chief economist at the Economic Outlook Group. "I recommend at this moment to stay the course. The smart money will wait until the fall, when … there's greater clarity over where the U.S. economy and Europe will be headed to solve the debt crisis."

Next: Get used to the economic roller-coaster ride. >>

Kevin Cook, senior stock strategist at Zacks Investment Research in Chicago, suggests a different approach. He says investors should take advantage of lower stock prices by buying up equities in a down market.

"I think investors who plan to keep their money in the market for three years or more should sit tight and be looking for good stocks to buy on sale whenever the market dips like this," he says.

"While the probability of staying out of recession is still on our side, and the Federal Reserve is still backstopping the economy [by keeping interest rates low until 2013], stocks and earnings can still grow even if GDP stays below 2 percent" annual growth, says Cook.

Global gloom

The outlook for economic growth got more reason for gloom Thursday after reports showed first-time jobless claims in the United States rose above 400,000 and existing home sales hit an eight-month low in July.

And two Wall Street giants, Morgan Stanley and Goldman Sachs, issued pessimistic forecasts Thursday concerning the global economy. Calling the United States and the 17 European countries that use the euro currency "dangerously close to recession," Morgan Stanley downgraded its global growth projection for 2011 to 3.9 percent from 4.2 percent.

The S&P 500 stock index, now at about 1,100, reached a high of about 1,400 in mid-2008. It fell by half in early 2009 to about 700, rebounded to about 1,200 in the latter part of 2010, then reached about 1,350 before the latest round of declines.

"This whole picture reflects the weakening global economy, particularly in Europe and in the United States," says Sophia Kopeckyj, managing director at Moody's Analytics. She says Moody's downgraded its outlook for economic growth for the second half of the year and increased the probability of recession to a 1-in-3 risk.

She says Americans might as well get used to the roller-coaster ride; she doesn't expect the volatility to end anytime soon.

"People who've seen their nest eggs contract will be working longer," she says. "They'll be more conservative in their spending. And then you have a lot of people who've lost their jobs, so even if they get new jobs, they're likely to be getting paid less."

As a result, Kopeckyj says, consumer spending won't be solid enough to boost the recovery, which has typically gotten the economy moving again after previous recessions. This time, business spending, expansion and exports are expected to fuel the recovery.

Also of interest: 5 common money mistakes. >>

Carole Fleck is a senior editor at the AARP Bulletin.

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