Make no mistake about it: The news for investors is really rotten this quarter. The average stock fund fell 9.1% the past three months.
And it gets worse: A $10,000 investment in the average stock fund has lost $3,789 the past 12 months. You could have had more fun using your money to light the barbecue.
But sooner or later, you're going to have to tiptoe back into the stock market. You can't afford not to, given today's savings rates. If you're terrified, we'll give you three ways to tiptoe back into stocks.
Compared with a 9.1% loss, a money market mutual fund or bank CD looks pretty tempting. But here's the problem: Savings rates are so low that you can't afford to park your money on the sidelines. The average money fund, for example, yields 0.23%, according to iMoneyNet, which tracks the funds. At that rate, you'll double your money in a bit more than 300 years.
How about a bank CD? The average one-year bank CD yields 2.3%. You'll double your money in 31 years at that rate. But even that won't mean much: Inflation and taxes will eat your earnings down to a nub.
So if you have a long-term investment outlook — 10 years or more — then you'll probably earn more in stocks and bonds than you will in money market funds or bank CDs. Ironically, given the losses you may have taken in the past five years, the stock market is probably your best bet at getting even.
Market experts often talk about "reversion to the mean," which means that periods of good or bad performance generally drift back to average. In the 1990s, for example, some analysts warned that ultra-high stock returns would revert to the mean — meaning that, sooner or later, a long period of bad performance would follow, bringing the long-term average back to normal. And that's pretty much what happened.
The stock market's 10-year performance is the worst since the Great Depression, says Ibbotson Associates, a Chicago research group. If there is a reversion to the mean, the next long-term move could be up.
Step 1: Rebalance
If you started the year with a mix of 60% stocks and 40% bonds, your portfolio is probably no longer at the same balance. You probably have a higher percentage of your portfolio in bonds than you did at the start of the year, and a lower percentage in stocks.
When you rebalance, you take money from your winning investments and invest it in your losing ones. The goal is to get back to your target allocation — in this case, 60% stocks and 40% bonds.
Rebalancing every month or quarter usually isn't a great idea. On Wall Street, you're supposed to sell your losers quickly, and hang on to your winners. When you rebalance every month, you're selling your winners too soon. And if you have to pay transaction fees or taxes for buying and selling funds, frequent rebalancing is a loser's game.
You should, however, rebalance when your portfolio is 5 or 10 percentage points away from your goal. In this example, you might rebalance when stocks are 50% of your portfolio.
If you rebalance according to target percentages, you won't have to move money very often. A mix of stocks and bonds is a fairly self-balancing mechanism. Stocks often rise when bonds fall, and vice-versa.
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.
Step 2: Consider a balanced fund