If you’ve been paying attention to financial and economic news lately—or any other news, really—you’ve heard about the fiscal cliff.
The million-dollar question: how did you react?
What did you do way back in the summer when you first heard whispers of some fiscal cliff? When pundits tried to turn it into an election issue? When we marched through December listening to ongoing updates about the lack of progress? When we found out it was less of a cliff and more of a series of mountain ranges?
I hope you were rational and didn't allow your 401(k) investment strategy to be decided by the fiscal cliff talks. I hope you did a little reading to learn what the fiscal cliff was really about. I hope you paid attention to the news in deciding whether you agreed with the numerous proposals, and I hope you noted how various outcomes could affect you.
The whole debacle has been a perfect example of a news event that sent some retirement investors into fits of stress and angst partially because it was constantly in the news. That’s why it’s also a perfect example of a news event that caused retirement investors to react without reason or logic.
There were people out there who may have made major changes to retirement investments in response to short-term volatility. The lesson to remember is that allowing emotions to affect your investing decisions is a bad idea, whether you’re feeling fear and panic or exhilaration and confidence.
Emotional, reactionary investing can lead people to reduce risk or withdraw from the market after a drop; conversely, people may tend to disproportionately increase risk when the market is hot. This behavior is effectively buying high and selling low—the opposite of what you want to do.
Instead, if you remain steadily invested during down times, you’re better positioned to take advantage of a recovery. Contributions you make as the market bottoms and then begins to recover are the equivalent of buying low.
Intellectually, this sounds good. But when emotions run high, it’s tough to behave rationally. That’s why you need to create a personalized retirement investing strategy.
Start by establishing your tolerance for risk, always remembering it will be tested and shouldn't be based on short-term market conditions. Use your risk tolerance, your retirement and investing time lines, your retirement goals and the overarching economic climate to set an appropriate allocation. Only make allocation changes when any of those criteria change. Along the way, rebalance quarterly and continue to research investments to ensure you've selected optimal funds to represent each asset class in your allocation.
With a strategy in place, you needn't spend a lot of time stressing out about short-term volatility caused by world events.
Your strategy allows you to sidestep emotional investing. The most appropriate reactionary behavior you could adopt related to the fiscal cliff is to tweak your long-term retirement strategy based on the tax changes that have come out of the January 1, 2013 legislation. While major events may cause you to want to make changes to your long-term strategy, it’s important to remember how that may affect your overall investment plan.
Whether it’s a tsunami or a foreign monetary crisis, a hurricane or a war, an overthrown dictator or a congressional budgetary debate, news events will have economic implications. And economic events will make the news. One could spend hours contemplating the short- and long-term implications of each. For the average investor, though, that only leads to overblown emotions and panic. Relax a little and rest knowing you have a retirement strategy built based on sturdy economic principles, not a 401(k) investment strategy decided by the uncertainty of events.
Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.