A Guide to Surviving a Down Stock Market

July 1, 2008 — -- There's just one thing to say about the stock market's recent performance: Ouch.

Last week, the Dow Jones Industrial Average lost 4 percent and now stands about 20 percent below a peak reached in October, while the Standard and Poor's 500 lost 3 percent last week.

Now, as it did in January and March, panic mode is setting in, triggering advice from me and others, advising small investors to resist the urge to do something rash like dumping all your stocks for CDs.

And the panic-stricken will respond, "Easy for you to say. I just lost $20,000."

So, for those to whom "Don't panic" is not enough, let me offer some suggestions on ways to respond constructively to the current bear market. The suggestions are targeted by age category.

Early accumulators (ages 20 to 35): For this group, the advice is easy: Buy more -- stocks just went on sale.

Compared to earnings, stock prices are about the cheapest they've been over the last 10 years. Remember, the first rule of investing is to buy low and sell high, and right now, we're at a low.

So, by making sure you're enrolled in your employer's 401(k), or other retirement savings account, and contributing enough to capture fully any matching contribution, you're buying low. For most, the best bet is to buy on-sale stocks through a mutual fund or exchange-traded fund, rather than individual stocks.

At this stage of your working life, you need not worry about the market's daily ups and downs. The losses sustained this year are minimal, compared to what you should be able to accumulate over the next 30 or 40 years.

Mid-career types (ages 35 to 50): Stick with your game plan, and if you don't have one, get one.

Folks in this age group, you have plenty of time on your side to make up for recent losses, but you can't be fooling around. Before you know it, the time that is the investor's greatest advantage will be gone.

Rather than making any rash investment decisions, you should consider upping your 401(k) contributions if you're not maxed at $15,500 a year. This will allow you also to take advantage of the stocks on sale now.

You also should give a close look at your investment accounts with an eye toward rebalancing. Consider trimming holdings in areas that have done well over the last three years, like emerging markets, commodities, and energy, and could be at risk for serious declines. Plow that money into other portfolio areas that have not done well and may be poised for a rebound. Also look to fill in gaps in your asset allocation.

For this group, I'd also recommend you be sure you hold a decent share of international stocks, somewhere in the range of 15 to 25 percent of your overall portfolio.

Both domestically and internationally, this group cannot afford to be out of the market.

Pre-retirees (ages 50 to 65): It is those of you in this age group that I'm most worried about.

Your portfolios recovered after the 2000-2002 market downturn, and now you could be facing another extended bear market, just as you seriously begin to consider when you might retire. On top of that, the home values you had been counting on as a financial backstop also are in decline.

For pre-retirees, it is critical you pay particular attention to your finances.

But, rather than act in haste, I'd suggest you review your asset allocation to see how much you have in stocks versus cash and bonds, and gauge whether that's the right mix for them.

You should be sure you hold a decent share of bonds to act as a stabilizing counterforce to stocks and provide the potential for higher returns than cash.

For this group, a bond allocation of 25 to 40 percent may be reasonable, depending on your individual circumstances and appetite for risk. Even if you already hold a good percentage of your portfolio in bonds, you might want to consider allocating a portion of those funds to an international bond fund to add further diversification to your portfolio.

For those just a few years from retirement, I'd suggest you prepare yourself for a reduced income in the future by beginning to eliminate unnecessary expenses from your budget now. I'm not suggesting a pauper's lifestyle for those making a decent income. Rather, I'm saying you might be paying for things you don't really need. Why not get rid of them now?

For those thinking about retirement, one sure way to make up for market losses is to hold off on collecting Social Security until at least your full retirement age and not starting at 62, as too many people do. This is particularly true for single women who don't have a spouse's retirement income to rely upon, and you married men who earned significantly more than your wives. The higher benefit amount from waiting will provide an extra layer of security, should your wives outlive you by a significant period.

The retired type (65 plus): Out of necessity, those of you already retired undoubtedly watch your money most closely.

Given recent market events, current retirees should pay close attention to how much you withdraw annually from your portfolios. The general rule of thumb is that you can safely withdraw about 4 percent annually from your nest egg in the early years of retirement and increase that figure slowly over time.

If your portfolio has taken a big hit lately, you're talking about 4 percent of less than you had back last fall, and means you may not be able to withdraw as much this year. And if you're taking 6 or 7 percent from your portfolio in your early retirement years, you need to cut back if you want that money to last.

Even in retirement, folks should still hold a healthy share of stocks to keep pace with inflation. You should not eliminate stocks entirely from your portfolio. You should just be sure you hold bonds and cash to add stability and act as a source for needed short-term funds.

For all age groups, these moves won't eliminate the pain of recent stock market performance, but, hopefully, they will lessen some of the "ouch."

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 (www.fourpondsfinancial.com) 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 david@fourpondsfinancial.com