Market pain stirs strange thoughts

PERSONAL FINANCE

August 25, 2002|By EILEEN AMBROSE

BY NOW, the lessons from the bear market are pretty obvious.

Diversify. Don't invest money that you'll need within five years in stocks. Don't hold too much company stock in your 401(k).

But as the stock market appears headed for its third year of negative returns, some financial experts are concerned that investors might begin to take away the wrong lessons.

"People are at a loss for how to really think about their investment plan," said Mary Malgoire, a financial planner in Bethesda. "They are getting bounced like a small sailboat in a storm. They have no idea of what to do."

Not since 1939-1941 has the Dow Jones industrial average lost ground three years in a row. Without having lived through a market like this, investors can draw false conclusions, such as:

Abandon stocks. Michael Martin, a financial planner in Columbia, said some clients seeing stock prices fall have talked about getting out of the market entirely, although he usually manages to persuade them to stay calm and stick with their long-term strategy.

"Our message to them is if you are going to have any stock at all, you will have to put up with some periods like this," Martin said.

And people need stocks, he added.

"If you have an all fixed-income portfolio, your long-term return will have to be lower than if you included some equities," Martin said. "That mantra is still true. Over a long enough period of time, stocks have to return more than bonds."

Forsake the 401(k). Many people became investors through their 401(k), and now with the market in the tank, some are discontinuing contributions.

One of them is Dave Gannon, an evaluation consultant for Allstate Insurance Co. in Pittsburgh, who began investing in a 401(k) in 1987, the year the market crashed. He said he learned from that not to look at his statements too often. But after more than two years of shrinking statements, Gannon suspended his 401(k) contributions this month. He's thinking of buying a hot tub with the money and restarting his contributions at the end of the year.

"You sit there and watch your balance being depleted. I figured in spite of dollar-cost-averaging, it looked like a losing battle at the moment," the 48-year-old said.

Worried workers are better off putting money into their 401(k)'s bond fund or money market fund until things stabilize rather than stopping contributions, said Steve Athanassie, a financial planner in New Port Richey, Fla.

By not contributing, "what they are giving up is accumulating money for retirement, which is a longer-term issue," he said. "But they are also giving up tax benefits today."

Money that goes into a 401(k) is not subject to ordinary income tax until it's withdrawn, which lessens today's tax bill. Also, many companies match workers' contributions, so when employees stop putting in money, so do their employers.

With a 401(k), workers dollar-cost-average, which means they regularly invest the same amount no matter what's going on in the market. That works to their benefit in down markets, experts said, because they are getting more shares for their dollars.

And this steady investing takes the guesswork out of when is the right time to invest.

"Right around the turnaround periods, those are the times the market does go up the fastest. And calling the turnaround is always the hardest part," said James Angel, an associate professor of finance at Georgetown University in Washington.

Buy-and-hold doesn't work. "What's the alternative? Buying and selling and buying and selling?" said Charles Carlson, chief executive of Horizon Investment Services in Indiana.

Many investors confused buy-and-hold with "buy and forget," Carlson said. Rather, investors should look for stocks they want to own for the long haul, continue to monitor the shares and sell if necessary, such as to rebalance a portfolio.

Index investing is dead. Investors in the late 1990s did extremely well investing in index funds, which mimic the holdings and the performance of benchmarks such as the Standard & Poor's 500 index. Now that the indexes are down, some suggest index funds are out.

Not so, said Pat Dorsey, director of stock analysis for Morningstar Inc. in Chicago. "The reason people are saying indexing is dead is that the stock market is no longer a saving account that returns 20 percent a year. Some people are a little annoyed at that," he said.

One of the big advantages of index funds is that their fees are often a fraction of the cost of funds actively managed by professionals. Low fees, for example, have helped the largest index fund, the Vanguard 500 Index Fund, outperform 75 percent of its peers during the past 10 years, reports Morningstar.

"Indexing is still the lowest-cost way to invest," Dorsey said. And if investors are looking at, say, an 8 percent or 9 percent return from the market in the future, then paying a half- or full-percentage point more for an actively managed fund can be significant over time, he said.

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