The bear market is no abstract mathematical notation, no mere number on a newspaper page: It's a concrete change in your life, and not a good one, especially if you're saving for retirement.
Consider this: If your 401(k) had $100,000 invested in the average stock mutual fund at the beginning of last year, you've lost $39,500, thanks to the worst year for funds since Lipper began tracking them in 1959. You'll have to earn 66% just to get your account back to where it was a year ago.
Losses like that leave a mark, and not just on your willingness to invest in stocks. They can mean a longer work life. A reduced retirement. Or no retirement at all.
"Will this deter us from an early retirement? Oh, yeah," says Katherine Watson, 53, of Bloomington, Ill. "Will I be likely to gamble on the stock market by purchasing an individual stock? No way."
For most workers, investing for retirement isn't optional. It's something you have to do because you won't get a traditional pension. As you survey the smoking wreckage of your 401(k) retirement plan, you're probably wondering: What should I do now?
There's no one correct answer. But to get past some of last year's devastating financial losses, you'll need to make some adjustments. You'll need to work through the psychological effects of your losses. You'll need to make some adjustments to your portfolio. And you may even want to make a few speculative bets on the stock market's recovery. Just be sure you don't speculate with money you'll need anytime soon.
Taking the hit
The first stage in taking a big loss: denial. "My husband, who has been the major breadwinner the past 35 years, refuses to look at his 401(k) status updates," says Watson.
That's normal, says Meir Statman, professor of finance at Santa Clara University. "People check their balances more often when the market is up than when the market is down."
And when people do check their balances, they're not happy, to put it mildly. "It's a depressing feeling," Statman says. "They say, 'I'm a loser.' It's very hard to make peace with it."
Unfortunately, that's just what you have to do. One way to deal with your losses is to realize that you're not that much worse off than everyone else. The bear market savaged Mr. and Mrs. Jones' 401(k), too. And if Mr. Jones claims he moved to a money market fund just before the bear market started? He was probably lucky. "They will probably be wrong next time," Statman says.
Ultimately, though, you simply have to suck it up and move on. Even though stock returns have been wretched the past 10 years — the Standard & Poor's 500-stock index has lost an average 1.3% a year for a decade — your alternatives aren't great, either. For example, an ultra-safe 10-year Treasury note will return just 2.5% a year. At that rate, it will take 29 years to double your money.
How can you repair some of the damage? A few ways:
•Set a fixed allocation between stocks and bonds, and stick to it. If you have 20 years or more to retirement, you can keep most of your money in stocks. Your losses from last year won't hurt as much in 2029.
Keeping 90% of your money in stocks still gives you a cash reserve in case you sense a buying opportunity. Even an 80% allocation is fairly aggressive.
If you have fewer than 20 years until retirement, consider dialing stocks back to 50% to 70% of your portfolio.
Either way, you also need to take your risk tolerance into account. If you're saving for retirement in 2035 but can't stop sobbing about your losses, you'll simply have to put less money into stocks and more into bonds.
If you're not sure where to begin, several mutual fund companies, such as Vanguard, Fidelity and T. Rowe Price, offer asset-allocation programs online. Financial Engines (www.financialengines.com) and Morningstar (www.morningstar.com) offer relatively low-price, computer-driven guidance. And you also could consult a financial planner to help you put together an asset allocation. You can find fee-only financial planners in your area from the National Association of Personal Financial Advisors at www.napfa.org.
•Rebalance your portfolio. Rebalancing means that you sell shares of your top-performing funds and buy shares of your losing funds until you get back to your target asset allocation.
If you rebalance only when your portfolio is seriously out of whack — as it probably is now — you can reduce your risk and modestly improve your returns. A mix of stocks and bonds is a remarkably self-balancing mechanism. Stocks usually rise when bonds fall, and vice versa. If you rebalance when your portfolio is 10 percentage points out of whack, you'll usually be selling high and buying low.
Using the 10-percentage-point rule, you would have rebalanced three times in the past decade: Once in October 2002, once in January 2007 and once in November 2008.
"I rebalanced about mid-December, selling some of my bond holdings and buying more of my stock fund holdings," says Dan Cobb of Soddy-Daisy, Tenn. "I don't think I sold bonds really high, but I certainly bought stocks low."
Rebalancing isn't a panacea. If you rebalance too frequently, you'll actually reduce your returns. On Wall Street, you're supposed to trim your losers and let your winners run. Rebalance too often, and you'll be selling your winners too early.
•Invest more. The only sure-fire way to get your balances back up quickly is to save more. If you're a 401(k) investor, the increase in savings might not hurt your salary as much as you think. Suppose you take home $5,000 a month in gross pay. If you bump up your contribution from 4% of pay to 5%, you'll decrease your monthly check by just $43, according to Bankrate.com.
The reason: You're paying in pretax dollars, and each dollar you save goes straight to savings. If you were investing in a taxable account and were in the 25% tax bracket, you'd have to earn $1.33 to save $1 after taxes.
The payoff from bumping up your contributions now can be big. Assuming you earned 6% a year on your contributions and your salary stayed at $5,000 a month, you'd have $202,000 in your account if you contributed 4% of your salary for 30 years. At 5%: $252,000.
•Pay less. Any money you pay to someone else is money you won't have when you retire, so look for funds with low expenses. It can make a big difference in the long run. Consider two funds: Expensive Fund, which charges 1.5% a year, and Cheapo Fund, which charges 0.75% a year. Both funds earn 8% a year before expenses.
Invest $10,000 in Expensive Fund A, and you'll have $66,144 in 30 years. Invest $10,000 in Cheapo Fund B, and you'll have $81,643. Simply by investing in a low-cost fund, you've boosted your return by 28%.
You can find out your 401(k) funds' fees through your plan administrator, or through the funds themselves. Many 401(k) plans get lower-cost shares than those sold directly to the public. If you do have some high-cost clunkers, however, your only avenue is to complain to your company management.
Taking small risks
The bulk of your long-term retirement funds should be in broadly diversified funds, such as those that track the S&P 500 or the Russell 3000. But taking a small position — no more than 10% of your portfolio — in a more specialized fund can make investing more interesting.
Normally, investing in downtrodden funds is simply a way to get mediocre returns. Bad returns, like good returns, can last longer than you think. But at the bottom of a bear market, it can pay to invest in the sectors that have been most beaten up in the previous 12 months, says Sam Stovall, chief market strategist for Standard & Poor's.
Stovall looked at the past 10 bear markets, and found that investing in the 10 most beaten-up industries resulted in an average gain of 57%, vs. 36% for the S&P 500.
Assuming that the stock market did indeed bottom in November, the 10 worst industries were aluminum, automakers, casinos and gambling, consumer electronics, diversified metals and mining, industrial real estate investment trusts, investment banking and brokerage, multiline insurance, thrifts and mortgage finance, and tires and rubber. Your 401(k) plan might not offer such specialized funds, but many companies that offer individual retirement accounts do.
Although you won't find a tires-and-rubber fund — yet — you can find funds that specialize in commodities, technology, metals and mining, and several that specialize in financial services.
But use these funds as spices, not as the main course. The most important decision is what portion of your portfolio should be in stocks. Dropping out of the stock market entirely could be a big mistake. "Charlie Brown once said, 'I have a feeling that when my ship comes in, I'll be at the airport,' " says Stovall. If you want to make up for your losses in 2008, don't be at the airport, Stovall says.
TELL US: What do you plan to do with your portfolio? What worked and didn't work for you last year?