Looking for a great book to read this fall? AARP picks 12 notable nonfiction releases.
by Jonathan D. Pond, AARP, June 22, 2009
The following case study offers suggestions for people who sold off many of their stock holdings amidst the stock market meltdown. The first part looks at a pre-retiree’s status, while the second part considers a similar situation for retirees. While everyone’s situation is different, these case studies are designed to show you examples of how to gradually reposition your investment holdings.
Case Study #1: Goal of Retiring in Five-10 Years
Emily Dawson is confronting a double whammy and has sought the counsel of a financial adviser to help her devise a plan to recoup the tremendous losses she has sustained in her investment accounts. Here’s what happened.
Emily got caught up in the bull market and had almost all of her money in stocks. At the urging of a friend who was using an investment adviser with a hot hand, she also used margin to leverage her stock portfolio.
Two years into making easy money in stocks, the market slumped. She asked her friend what her investment adviser was recommending. The response: “Hang in there, the market is poised for a rebound.”
Stocks continued to decline. In a state of near panic after losing over half of her money, she sold all her stocks. “I guess it could be worse,” Emily said. “My friend has lost two-thirds but is still being encouraged to “hang in.”
But Emily’s problem now is deciding what to do with almost all of her savings sitting in money-market funds. She needs a plan to avoid the classic double whammy: abandoning stocks after a steep decline and missing the rebound. She also doesn’t have a lot of time to make up for her losses, since she would like to retire in the next five to 10 years.
Many investors overreact to market conditions and pull out of the stock market completely. While this may bring some peace-of-mind in the short term, unless these investors make changes, the long-term effect may be damaging.
Investors need to balance their fears against the likelihood of achieving a portfolio that meets their far-ranging needs. Often this involves a process of gradually moving the money to a more balanced allocation. While this example focuses on an investor who has abandoned higher-risk securities, the approach also can apply for people who’ve had too much of their money invested in stocks.
1. Investment Objectives. Emily Dawson has moved from an all-stock portfolio to an all-cash portfolio. She realizes that neither extreme will achieve her investment objectives, so she needs a plan to attain a more diversified portfolio. The problem is that the stock market continues to decline, and the economic outlook isn’t favorable to stocks.
2. Timetable to Redeploy the Investment Portfolio. Emily’s adviser realizes that Emily is still frightened about losing more money and therefore recommends a plan to begin very gradually getting back into the stock market. The adviser also recommends a similar approach to bonds, since interest rates on cash are very low. The strategy is to add 1–2 percent per month to stock funds and 2–3 percent to bond funds.
Table 1 shows the results of this strategy after one and two years. Emily is comforted by this approach. “I like this plan, because I’m not making a big move all at once; but after a couple of years, I’ll be where I should be,” she said. “If the stock market continues to decline, I won’t have too much money in stocks. On the other hand, once the stock market starts to rise again, I’ll have at least a bit of money in stocks. Finally, this plan isn’t cast in concrete. I can always make adjustments, like adding a higher percentage to stocks if conditions are improving. But my days of speculating and making big stock-market bets are over.”
One Year Hence
Two Years Hence
Case Study #2: Already Retired
Emily recently described her plight and strategy to her retired aunt and uncle. Her uncle, Roger, remarked that their situation was very similar.
“Most of our retirement income is either fixed or won’t keep up with inflation in the future, so Sarah and I had about one-third of our retirement savings in stocks before this disaster happened,” he reported. “We owned stocks because we needed some growth in our investments to help us keep up with rising living costs.
“But like you, Emily, we couldn’t stand the losses, so we sold off almost all of our stock holdings as well as our bonds. So I guess Sarah and I will need to cut back on our spending, since we no longer have any investments that will grow in the future,” he said. “At least we are protecting what we have, but we fear that if we continue to invest very conservatively, we may fall short later on.”
While they are 20 years apart in age, the strategies that Emily and her aunt and uncle should pursue are not that different.
Sarah and Roger should also gradually begin to return to a more diversified investment position. The table below contains an example of how they might do so.
Adding 1 percent or so per month to their stock and stock-fund holdings and 2 percent or so to their bond and bond funds would get them back to an investment portfolio better positioned to provide the future growth that they and all retirees need.
In the meantime, Sarah and Roger avoid making any single big moves into stocks and bonds, because, as she so aptly noted, “We have no idea when the best time is to move our money out of money-market funds and savings accounts back into stocks and bonds.”
There is no best time, so it’s best to do so gradually.
All the information presented on AARP.org is for educational and resource purposes only. We suggest that you consult with your financial or tax adviser with regard to your individual situation. Use of the information contained in this Web site is at the sole choice and risk of the reader.
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