This is a guest post by Jeff Rose, who is an Illinois Certified Financial Planner(TM) and co-founder of Alliance Investment Planning Group. Jeff is also the author of Good Financial Cents, a financial planning and investment blog. If you like what you see here, please consider subscribing to his RSS feed.
Does anybody feel like the 2008 stock market crash has been one of the worst ever? Unfortunately, the crash in 2008 was the first collision and now 2009 just rear ended you when you thought the wreck was over. If you feel that the the market turmoils are like a severe car wreck, it leads us to wonder how to rehab our way back from such a serious injury.
As you may know, effective rehab is simple and repetitious. The improvements are almost imperceptible, and the real benefit is only recognizable in hindsight. It may take six, twelve, or even more months, but eventually that limp you had will be just a memory.
For those that feel like the recent market crash has left you with more than just a simple limp, here are some pointers that can keep you going as the market attempts to figure itself out.
Continue Funding Your IRA and 401(k)
Yes, I know that sounds insane considering how ugly the market is right now, but you have to have some faith in the U.S. economy. Just because I’m suggesting that you fund your retirement accounts doesn’t mean you have to put in all in the market. You will want to at least fund your retirement accounts to either get the 401(k) match or the tax free savings of the Roth. Even if it’s invested in bonds right now, you’ll be able to transition to stocks later on when you feel more comfortable.
Make Roth Conversions Now or in 2010
If you’ve been wanting to get money into a Roth IRA, now might the opportunity. If your AGI is below $100, 000, you are able to convert traditional IRA’s and old 401k’s this year. If not, you’ll have to wait until the 2010 conversion event. Why is this time to do it? You’ll pay less tax on the conversion because most likely your account balances are down (whose isn’t, right?) and you’ll have less of a tax liability on the amount to convert. If you have to wait until 2010, the one upside is that you’ll be able to spread the tax over a two year period.
Diversify Asset Classes
Is diversifying really dead? There’s no question that even a well-diversified portfolio took a substantial hit over the past 6 months. But what about alternative asset classes? Managed futures returned double digit gains last year, showing that only do we need to diversify with stock and bonds, but we also need to consider non-correlated assets. One thing that you must consider is that although alternative assets classes can reduce risk in a portfolio, that doesn’t mean they decreases volatility (ups and downs of the market). That’s a common misconception with most investors that needs to be known.
Review Your Retirement Plan
Face it, things change and you have to adapt and overcome. If you had a well thought out retirement plan last year, it needs to be revisited. A lot has changed in a short amount of time and you need to act accordingly. It’s not time to panic, but you need to be proactive in what is going on around you. Don’t let an opportunity pass you by that could make a serious impact to your retirement plan.
Put Money to Work
I know that this seems almost impossible nowadays. The stock market loses a hundred points every other day it seems and savings account interest rates are dropping just as fast. But even still, there are opportunities to take advantage of.
If your 401(k) has a match, keep contributing and get your free money. If you have a credit card with a 8.9% APR (just as an example), pay it off and you just made 8.9% on your money. Maybe you have a significant amount in your checking or savings accounts and you’re only earning 0.25% (yes, I’ve seen it that low). If so, consider moving your money to an online savings account (just make sure that they are FDIC insured). It may only pay you 2%, but you’ve still increased your payout by 8 times.
It all sounds simple, but these are the kinds of simple things that we can do to get ourselves back on the road to financial health. What about you? What are you doing to recover from the crash?
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Regarding continuing to fund retirement accounts, I certainly am doing that. But every time I see that deduction on my pay stub, I am reminded of the frightened Cowardly Lion, standing in the Haunted Forest, repeating aloud “I do believe in ghosts. I do believe in ghosts. Oh, I do, I do, I do, I do”
We must continue to believe in our economy, in our recovery, and in dollar-cost-averaging. 😉
LAL: Another thing to consider is that the brackets themselves might change. There are no guarantees that the lowest bracket will remain at 15%. In fact, given recent spending, overall tax rates will almost certainly be going up in the future.
The conversion to a ROTH IRA might not be worth it depending on your tax bracket. You might be solidly in the 15% bracket when you retire and can properly manage your withdrawals from retirement accounts.
You have to consider your tax bracket now and potentially then.
If you are in a high bracket say 28% and this kicks you up to 33% is it really worth it?
Now is the ideal time to invest . . . what’s done is done. Solid advice!
Good idea on the putting money to work, my bank’s APY for checking is 0.0% and Savings is 0.4%.
I move my money out of there and into my online savings as often as I can, even if the interest rate is way down from before.
Thanks for the good points! I always like to hear CFPs since they really study this stuff and work with it every day. Great guest choice.
@ Dylan
Your right in the managed futures. They are a high cost investment and are not right for every person. Nowadays, you can purchase open-end mutual funds as well as the commodity ETF to get some exposure. I’ve been using them as a portion of certain client’s portfolios (5-10% max) for the past several years. I didn’t just jump on the bandwagon. In 2006 and 2007 (more so 2007), clients were wondering why we were in these. 2006 we were up, 2007 futures were down about 4%. My sole reasoning was diversification, not chasing returns. 2008 is another story. We were up over 20% in that portion of our portfolios. (That was the only thing that made money). In meeting with new clients, I never use “return” as a reason for any investment choice. Chasing returns will get you burned as investor (as you stated) and selling them will get you fried as an advisor.
You had me up until the plug for managed futures. (Caution: rant against managed futures coming.) Those are pure bets, not diversification. I’ve heard all the “risk reduction” arguments, and they are all based entirely on past performance, not of an asset or market, but of a trading strategy.
Those funds typically have high fees, usually above 2%, some as high as 8%. Since futures trading is a zero-sum game, once you introduce fees, it’s now negative sum. Long term, odds are greater that you will lose more than you can gain.
The last time managed futures funds were the hot thing was during the last bear market, but eventually luck ran out, many faced huge draw downs, and many went under.
They’re an easy sell based on past performance in a down market, but a lot of the people that made money at the end of the day were the brokers that sold them. Many of these funds pay brokers commissions that are significantly higher than other products. That should be a red flag when a fund feels the need to pay higher than average commissions in order to compete in the marketplace.
I also suspect that many of the people selling these in a retail setting do not actually understand them. Too often, I see people’s money placed with more than one manager that are actually betting against each other. They are essentially paying management fees to both bet on red and black at the same time, a wash.
I’ll admit I’m not a fan of these products (obviously), but the last thing people should be doing right now is chasing past performance.
This is a great post. Sometimes, it’s helpful to ask what you’d think if you hadn’t lost money. What if, for example, the years from 1996 to 2009 had seen a fairly stable Dow going up about 1% per year. By 2009, most stocks would look like screaming bargains, despite the recession.
This is definitely solid advice, though. We won’t pull out of the current slump until people start investing again, and this is an important part of that process.
I wonder if numbers can be run on some sample data to give an idea on the returns?
For instance a 40 year old with 25K in their 401K. Maybe 25% tax bracket.
@ Amy
I think we’ve all studied history and I could inundate you with facts and figures that show the recent market drop does rank as “one of the worst”. Now keep in mind that I am forever the “Bull” and believe the market will come around.
Besides, it wasn’t a statement, it was a question hence the “?” at the end of the sentence. Even if it was a statement, I hardly see it as “irresponsible”. With the market being down 50% from it’s 2007 high, I’m fairly certain that this is up there with the worst of them. But maybe with your studies, you can enlighten us differently?
Does anybody feel like the 2008 stock market crash has been one of the worst ever?
No, because I have studied history. We’d all be a lot less panicked if everyone stopped telling us how terrible everything is. This is not even close to being “one of the worst” financial downturns “ever.” Please stop making irresponsible statements.
@ Neal
The last time I ran some numbers for somebody was the middle of 2007 (including transaction costs, taxes, etc) when the market was still respectable. The person was in their late 20’s and a decently high tax bracket, and after about 20 years is when we saw the advantage of the Roth conversion. It’s hard to run general numbers because there are too many factors at play (tax bracket, time horizon, investment selection, etc.).
The only thing that I can conclude is that with accounts being down as much as they are, the tax bill is obviously much smaller. With all my write off’s from starting my new business, I was able to convert my rollover IRA to a Roth this year. I thought about waiting until 2010, but my optimistic outlook was that my funds would have grown by then and I would be forced to pay more (albeit over the course of two years). So with the lower tax bill, my gut is telling me that the break even would be much shorter for me and anybody else that has time on their side. A 50 year old converting to a Roth has more to consider than I did when I converted.
Not sure about the Roth conversion. Could you run some numbers and examples? The way I figure, it rarely works out.
Thanks for the tip about the 401k conversion. I’ve been meaning to read up on that as I should qualify and that will save me thousands down the road.
To all the readers, do not give up hope on the stock market. Prices are down because so many people have given up on it already. There will be a recovery, patience my friends.