Dealing With a Down Market

Boomers on the verge of retiring face some tough investing choices.

Retirement Guide 2008

Stocks are a great long-term investment, except sometimes the "long term" can be very long, indeed. For most of the past decade, stocks and mutual funds, the primary investment vehicle for most Americans, have been bogged down. The S&P 500 is up less than 1 percent over the past nine years. The index is off about 7.5 percent so far this year, even after a healthy bounce from March lows. Some on Wall Street have dubbed the crash after the tech bubble a "lost decade," a period of subpar returns similar to the 1930s Great Depression and the inflation-addled 1970s. "The fact that the market hasn't done well is just repeating many instances in history after the run-up we had in the 1990s," says Richard Sylla, a market historian at New York University.

Now maybe the worst is over and stocks are ready to roll. But maybe not. In the last extended bear market, from 1966 to 1982, annualized returns for the Dow Jones industrial average fell 7.9 percent, adjusted for inflation. The current drop between 2000 and May 2008 is 1.6 percent, according to Ned Davis Research.

Certainly, recessions and bear markets have been shallower and shorter in the past 25 years than during most of the 20th century, thanks to smarter economic policy and a more vigilant Federal Reserve. So the current big slump in stocks may not last as long as the previous one. Yet there seems like plenty of trouble ahead that could keep stocks on their heels. Home prices are still falling and gas prices are still rising, both crimping the spending power and net worth of American consumers.

That puts the coming "silver tsunami" of American retirees in an awkward position as 78 million baby boomers born between 1946 and 1964 start relying on 401(k), pension, and other retirement plans that are heavily invested in equities.

So what to do if your last day at work is fast approaching (or has recently passed)?

Stay calm. The first step is not to panic. With luck, you've already taken the usual litany of retirement investing advice to heart: Diversify, mix stocks and bonds, write a long-term plan for living on your retirement assets, budget for healthcare, and so on. That goes for retiring in any market.

In the current one, Craig Carnick, who runs Carnick & Co. in Colorado Springs, Colo., says raising a buffer of cash ahead of time is the easiest way to keep a portfolio intact during uncertain times. "The key to overcoming volatility is that you're not in a position where you're forced to sell at a loss," he says. That means keeping up to 20 percent of a portfolio in cash or cash equivalents, or enough for two to three years' worth of income, plus a mix of bonds with varying maturities set to expire over seven to eight years to replenish that money.

Still, a cushion of cash can't defeat the other great long-term enemy of every retiree nest egg: inflation. Soaring prices for food and energy today have Americans on edge, and some economists, including former Federal Reserve Chairman Alan Greenspan, have warned that this century will be one where prices climb at a higher rate than they have in recent memory. Not only are energy prices unlikely to fall substantially from current levels as global demand continues to rise, but rising labor costs in Asia may translate into higher import costs in America.

Dean Barber, a financial planner and founder of Barber Financial Group, is particularly risk averse. Barber says allocating as much as 30 percent of a portfolio to treasuryinflation-protected securities, or tips, isn't unreasonable, given shaky markets and rising price pressures. He recommends filling out a portfolio with exposure to commodities, cash, and foreign stocks, adding that no more than 30 percent of any retirement portfolio should be in domestic stocks. A few years ago, the allocation would have been 60 percent. That's just too risky now, Barber says. "Retirement is not like golf. There are no mulligans. If you mess it up, you go back to work for 20 years. People can't afford to get it wrong," he says. "The portfolio we have today is more defensive."