Jim Lund, a Minneapolis-based senior financial advisor for Ameriprise Financial, says he's hearing from clients who want to pull their money out of the stock market or stop buying stocks regularly through their 401(k) plan. But he thinks that's a bad idea. Instead, he says, consumers might want to consider adding more money at a time when stocks are selling for their lowest prices in years. U.S. News recently spoke with Lund about how to be a smart investor in today's rough market. Excerpts:
What steps should people take to protect their money right now?
The first step is to make sure they know where their money is. Some people don't know how they have their money invested. [After that], so many times you see people wanting to take money out of the stock market. That's usually the worst thing you can do—to overreact to the current circumstances.
But it seems like a lot of people are doing just that.
I just got off the phone with someone with a 401(k). She's thinking, "I don't want to have all my money at risk right now," and yet, she's got 35 years before she's going to retire. There are great buying opportunities out there—it may be the best opportunity she'll have in her lifetime. She's dollar-cost averaging [investing the same amount each period] on each paycheck. This doesn't create gains as the markets decline, but when the market comes back, she'll increase her net worth.
Even though your mind is saying one thing, it's always about the psychological versus financial answer. Psychology usually wins out, unfortunately. As a consumer, you're thinking, 'I'm getting killed—my 401(k) is going down. I should stop investing.' That's the psychological answer. The financial one is, "When share prices are dropping, I should continue to put money in. By dollar-cost averaging, it works out to my advantage.
That mathematical equation works because the market goes up and down, but the trend line is up. If the trend line changed to average down—that has never happened—then we've got a problem. But I don't believe that. Some people say we're in a new economy and it's all negative and we're never coming back, but that's crazy. They sound like the people who in 1999 and 1998 said, 'The world's great, this is a new economy, it's never going down again.' It's the same rhetoric but on the opposite side.
What kind of asset allocation makes sense for someone in their 20s?
Because they have a long time horizon, they probably want an aggressive allocation. That doesn't mean 100 percent equities but maybe 90 percent equities and 10 percent fixed-income.
What about people in their 30s or 40s?
A 30-year-old might want 80 percent equities, 20 percent fixed-income. A 40-year-old might want a 70-30 or 60-40 split, depending on their risk tolerance.
For people close to retirement who just lost a big chunk of their savings, is there anything they can do?
Yes—they can add more money to the system. By dollar-cost averaging, then you can buy more shares at a lower price, so when those shares come back, you've got more value. We also need to be patient. We're all used to seeing things happen so quickly. It will take time for the market to rebound.
How long do you think it will take to make a comeback?
I think it will take three to four years. For the crash of 1987, it took a few days to come into it and about a year to come out. For the 2000 to 2002 drop, it took about three years to come back.
What mistakes are people making right now?
The big one, that I already mentioned, is taking their money out. Related to that, people are not sticking to a plan. Actually, the first mistake is not having a plan. If you're curious about how the current environment has changed your situation, you should update your plan and look at rebalancing your portfolio. There are folks out there saying, 'Now is no time for balancing.' I don't believe that.
What do you mean by rebalancing?
Say you start out with moderate risk-tolerance, with 50 percent in stocks and 50 percent in fixed-income. (Of course, in each of those you have a number of different asset classes, from small to large companies.)
Say because of what happened, equities are down, and I have more like 40 percent in stocks and 60 percent in fixed income. It means now is a good time to rebalance (by buying more stocks), regardless of the market environment. We're not market timers. Even Alan Greenspan can't time the market.