June 9, 2009 -- Mr. Panicked wants to know if it's "safe" to jump back into the market.
You may remember Mr. Panicked. I introduced him in September as hell broke loose in the financial markets and advisors like me warned about the dangers of selling low and buying high.
Back then, the Standard & Poor's 500 Index stood at 1,188, the starting point for a horrific 54 percent fall down to 677 on March 9. So those who panicked back in September and dumped stocks may have come out ahead -- for now.
But did those same folks know on March 9 -- or even April 9 -- that might have been the perfect time to jump back into stocks, that stock prices as measured by the S&P 500 would climb 39 percent in less than two months?
I doubt it. That's why Mr. Panicked and many other investors who ditched stocks during the downturn are asking: Is it safe now to invest in stocks again?
The truth is no; it's never safe to invest in stocks. That is if you mean safe compared to an FDIC-insured certificate of deposit or a U.S. Treasury bond held to maturity.
There will always be an element of risk of investing in stocks. That's why historically they earn more for investors than banks CDs. With any investment, investors are rewarded for their willingness to take risk. Eliminate risk and you eliminate the potential rewards. That's just the way it works.
So given that reality is it safe to invest in the stock market again?
No, but that doesn't mean you shouldn't consider a return to stocks. Even though many investors missed out on the quick gains realized since the stock market's low point on March 9, there's still a long way to go to get back to where we were in September or even at the start of 2008.
We're still down 20 percent from where the S&P 500 stood in late September and 36 percent down from it where opened 2008. That means there's still plenty of recovery to go. We just don't know long it will take. It could take 12 months … or 12 years.
That's why if you're thinking it's time to return to the market, I'd suggest the following steps:
Take a Balanced Approach: Even if your confidence in the stock market is fully restored, do not move all your assets into stocks. If the recent crisis taught us anything, it should be that we all need of mix of holdings: stocks, bonds and cash. Within each category, you can divvy up things even further from exchange-traded funds investing in narrow sectors to bank CDs bought through a brokerage firm.
As I've written before, investing is not an all-or-nothing endeavor. Seldom would I suggest an all-stock, all-bond or all-cash portfolio. Finding the right mix for you is the trick. If you're not sure where to start, why not consider one-third of each major category? Then adjust as you go along.
One Step At a Time: If you are someone who rushed out of the market in recent months, then it's probably best you not rush back in. You can make a sound academic argument for making sure an individual is fully invested at all times according to an optimized asset-allocation plan.
However, I believe you also need to take into account human nature and the fragile state of investor psyches. That's why to many investors I recommend buying back into stocks in a series of several steps.
Think you're ready to invest in stocks again but remain nervous? Then take whatever amount you've decided should to be allocated to stocks (and bonds) and break down the purchases into three, four or even five steps.
I'm not talking market timing here. Rather, I'm talking confidence building.
Auto-Pilot Investing: I remain convinced there's one group of investors that will emerge in terrific shape from the recent market turmoil. They are those who turned on the auto pilot in their retirement savings vehicle of choice and kept it on that course all through the financial crisis.
They didn't stop contributing to a 401(k) or direct everything to a money market fund; rather they bought stocks in small bites at cheap prices that in 10, 20 or 30 years will provide them with marvelous gains.
If you're not in this category, then join it by bumping up your weekly contribution or redirecting it to a broadly diversified, low-cost stock fund.
Even if the $100 you contributed to this week falls to $75 next week, your $100 contribution next week will buy you one-third more shares in a given investment.
Following these three steps can't guarantee it's safe to invest in stocks now, but they will reduce your risk and improve your chances for success.
This work is the opinion of the columnist and in no way reflects the opinion of ABC News.
David McPherson is founder and principal of Four Ponds Financial Planning in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at email@example.com.