Money Obedience

The Sage of Omaha, Warren Buffet, has written in the New York Times that he is putting his own money into the market now. He oughtto know what he is talking about. He is the best investor alive, which happens also to have made him the richest man of the world. Aside from all that, he offers what sounds to me like a sound opinion that could also bring profits to the average investor. His comments made me feel better, that's for sure. As I have written in a recent blog and in part 2 my wife and I have decided to stick with our current investments and to keep making contributions to our 401k retirement plans. So, we have been following, if not anticipating, Buffet’s advice.

When investors are as frightened as they are now, there is a good chance that the sell-off in the stock market has run its course – at least for the time being. I believe the decline isn't even done yet, and still, I think it is a good idea to keep adding to one’s investments, and to keep making 401k contributions or regular payments to an IRA. I know that I am likely unable to catch the lowest prices during this market decline, but I also know that by adding money to my investments I will own some pretty cheap stocks in the long run. Sure, I'll own some expensive ones I acquired in previous purchases, but I'll also own a bunch of cheap ones. Does it make sense for me not to buy cheap when I already have bought them at the time when they were expensive?

Sure, things look pretty bad in the economy, and in the stock market, too. But it is not like every stock will go to zero. Some companies may go bankrupt and send their stock values to zero. To protect myself here, I buy index funds that put together many stocks. It would not matter all that much if a few of them went under, because a large majority of the stocks in an index fund will always have a value. And that value will rise when the economy turns around. That could be a year from now, two years from now, or even ten years from now. I'm neither clairvoyant nor smart enough to know when this turn-around will happen. I only know that as sure as an economy hits a recession once in a while, it will also expand again, at some point. We have been privileged enough to have lived in a time of extraordinary economic growth (during the last 20+ years). But let's take care not to be spoiled and unrealistic with our expectations. The economy, the stock market, and, well, life itself, all have their ups and downs. We have to be ready to face both the ups and the downs. In fact, I'd say that life's ups and downs are the things that add spice to our lives.

Sometimes I blog, and after I post my comments I think further on the things I wrote about. I’m no different than other thinking people - the uncertainties surrounding life and personal finance can only be captured by continuously challenging ourselves and our assumptions. So, I try to keep my mind open. In fact, I quite enjoy stretching the use of my little noggin now and then. This time, I was focused on 401 contributions and our 401k investments. So, here we go with a follow-up.

As I said in the previous post, my wife and I plan to stick to our plan to save for retirement. While we will leave our basic plan alone, we do plan to make some adjustments when necessary. And we will retire and no matter how much we’ve saved by then, we still plan to enjoy each other’s company in old age. That is, no matter what happens, we will not allow the market turmoil to suspend our retirement indefinitely.

As I told you, I reviewed our various investments – some have gone down in value more than others, but not enough to warrant shifting our money around, yet. (We just received the statements for our 401k plans.) When we do make a shift (or “rebalance our portfolio”), the strategy we will use is one that will add to the funds that have fallen the most relative to other investments. These I will sell to raise money for new stock purchases. When I am done with these transactions, our relative exposure to the various investments will be the same as before the market rout started. In other words, by shifting things around a little, we balance to make our portfolio look like what it did before all the market ballyhoo started. That is, our strategy is to make sure that the market turmoil is not changing our investment allocation too much.

There’s another way to think about why one might want to rebalance – at times like this, when we buy stocks we get to add to our investments at relatively lower prices, while we get to sell investments at relatively higher prices. The stocks bought at lower prices (like nowadays) will rebound eventually. This technique is called “dollar cost averaging.” It works because buying low and selling high is always a good way to make money.

Let me explain how it works. Let’s say you started investing in 1925, 4 years before Black Monday, the Great Depression. You’d face a lackluster stock market for the better of the next 20 years. But if you left your money in stocks, even through those bad times, you really would be okay by the time you wanted to retire, as long as you kept adding to your investments. The same way of thinking works today.

There is only one problem with this technique. If you lose your job during bad economic times, you will not be able to contribute to the retirement account exactly at the time, when it is needed the most. Staying employed and staying a stock investment contributor is key! So let’s all keep our fingers crossed that we can keep our jobs and incomes at a relatively stable level, if not improving, even through the bad times. On this, I wish good luck to us all!

Many people have been wondering about the future of their retirement savings recently. Perhaps you’re nagged by worries – I know my wife is. She recently joked that she should cash in her 401K and stuff the money in the mattress to ride out the world’s financial turmoil. Do these questions pop into your head also: Should I continue contributing to my 401K plan? Should I lower my 401K contributions to have more cash on hand? What do I do about the investments I have already? Can I still enjoy a comfortable retirement even with things looking as bad as they do right now?

I certainly agree that the whole idea of holding 401k savings in today’s market is a little frightening. Lately, these hard-earned savings have gone down in value, and there may be worse to come. Our anxiety about retirement increases as the value of our retirement savings decreases. What do we do about this?

First, take a big, long, deep breath. That’s so you can think about this with a little less emotion, a little more clarity. Okay – first of all, we’re all still going to retire someday, right? Right. (We might have to change that date on our calendar, but that day will come!) Okay, well if we’re going to retire, we still have to plan for it, right? Right. Is having a 401k the best way to plan? For most people, the answer is an absolute yes. As I told my wife, we are saving in our 401k accounts because we want to use that money for retirement. We still plan to retire. So we still should plan to contribute to our 401k accounts. Sure, we may have to adjust our plans a little bit like work a little longer, but we are fully aware that our plan was never set in stone to begin with. (Hey, you’ve got to expect promotions, or changing jobs, or all kinds of things.) Since the plan was never a sure thing, changing the plan should not be such a big deal for us.

The same thing holds true for the allocation of our 401K funds into different investment accounts. We own certain funds in our 401k accounts because we think that in the long-run these investments will give us the best return considering how much risk we are willing to accept. When we invested in stock funds, rather than in the mattress account, we made the decision to accept the risk of declining stock prices in the hopes that we would fight against the impact of inflation. It’s just that we now happen to be experiencing the downside of this risk. But that does not change the generally accepted idea that investing in stocks is the best option for ensuring long-term savings plans work out in our favor.

I’m not trying to belittle the impact of the financial and economic situation we’re all facing during this roller coaster ride on the global economy. Neither my wife nor I are happy about seeing our savings go down in value. (Aren’t saving supposed to go up continuously over time?) But we also saw our savings go up in value quite a bit over the years, more than what we had expected when we first started saving. Nevertheless, the important lesson for us is this. We will continue saving money for our retirement and we will continue to invest in various funds that we believe support our long-term goals. It’s only when we decide that investments are far riskier than we are willing to accept that we will make a change.