2008 was a year full of lessons worth learning

January 04, 2009|By EILEEN AMBROSE | EILEEN AMBROSE,eileen.ambrose@baltsun.com

What investor wouldn't like to forget 2008?

It was the worst year for stocks since the 1930s, and there seemed to be no place for you to hide.

But as much as we would like to put last year out of our minds, we should look back once more to see what we can learn from it. It might prevent us from repeating our mistakes.

Among the lessons:

Keep a cash cushion As the economy weakened, T. Rowe Price Associates started noticing an increase in workers asking for hardship withdrawals from the 401(k)s the company administers.

"It didn't take a cataclysmic event" to push them to that point, says Stuart Ritter, a Price financial planner.

In fact, the workers didn't have excessive debt, weren't living beyond their means and didn't have ridiculously big mortgages, he says. But they didn't have an emergency fund either to tide them over during a temporary setback.

The traditional advice is to keep three to six months' worth of living expenses in a savings or other cash-like account in case of emergencies, although some job seekers are finding that it takes longer than that these days to find work.

Colorado financial planner Amy Noel says after last year, she now advises people to set aside a year's worth of living expenses for emergencies or three to five years if they are retired.

Stocks are for long-term money One problem exposed by 2008 is that many people, even retirees, had money in the stock market that they were counting on to spend soon.

When I first started writing this column for The Baltimore Sun nine years ago, the rule of thumb was that money you needed to spend within the next five years should not be in the stock market.

In recent years, I've noticed that many financial advisers are becoming more aggressive in that thinking. Some said money needed in three years shouldn't be in the market. Then it was two years. Then one. Recently, an adviser suggested money should stay in the market up to six months before you need it.

Their reasoning: You need the growth that stocks provide to keep up with inflation, something savings accounts or conservative investments just can't do.

Sure, even retirees need to be in the market, considering that their retirement could last 30 or more years. But again, only money not needed for many years should be in stocks. The five-year rule is a good one.

This raises another lesson: Some older investors kept money in the market too long, hoping higher returns would make up for years of not saving. "You can't count on the market to catch up for you," Noel says.

Trust, but verify In hindsight, plenty of red flags should have warned investors away from Bernard Madoff and his alleged $50 billion Ponzi scheme. The money manager wouldn't disclose to investors how he invested their money. He promised consistent profits. He issued vague financial statements.

New York financial planner Gary Schatsky says an investor showed him a statement from Madoff about a year ago. Schatsky says it didn't make much sense, but the investor trusted Madoff because his father had dealt with Madoff for decades.

"You can't be complacent," Schatsky says. "You can't completely close your eyes."

You must understand what you're invested in. And if a money manager promises unusually rosy returns, you have to wonder, "Why isn't everybody doing it?" Schatsky says.

Past isn't future The impulse is to look at the most recent past and assume that's the wave of the future. That's why investors tend to pour money into the stock or mutual fund that performed the best the year before.

But one year isn't a trend, particularly last year, when even well-diversified portfolios lost money, said Chuck Carlson, chief executive of Horizon Investment Services in Indiana. This could lead investors to wrongly conclude that diversification is dead.

If you have a diversified investment strategy that has worked well for years, don't abandon it "based on a year where nothing worked," Carlson says.

There's always risk Back in the late 1990s, technology stocks appeared to defy gravity - until they crashed. Then it was real estate that went up and up before imploding.

"Nothing always goes up. And there is risk everywhere," Noel says.

Even some money market funds, as it turns out, weren't the staid investments we thought.

Live within your means Easy credit disguised the fact that so many of us were living on the edge. Many consumers also confused a bank's willingness to extend credit "as an indication the lending institution thought they could pay it back," Schatsky says.

Not so. Many mortgage companies, for instance, readily lent to any homebuyer who asked, sometimes not even bothering to verify borrowers' incomes.

The lesson here is to live within your means and not take on debt that you can't afford to shoulder.

As Virginia financial planner Barry Glassman notes, "Frugality is now in vogue."

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