FiLife

Ron, congrats on both your fortunate timing and– much more important–on retaining the discipline to follow through with a sound (if evolving) investment plan. The biggest obstacle many of us face is not that our their investment plans aren’t good, but that we never make them in the first place, or we find them too difficult to stick with when greed, fear, or confusion gets in the way.

You asked us to comment if we “believe that stocks are permanently on the decline”, since otherwise the only “sensible thing for retirement investors our age to do at a time like this” would be to “just keep buying regularly “.

Well, like you, I have no idea “when the stock market has reached the top or the bottom or the middle.” (I wish I did, as that would be profitable knowledge to have!) And, like you, I don’t believe that “stocks are permanently on the decline”.

And yet, I haven’t been buying US stocks for some time now. The reason is that my own investment plan–imperfect as it is, and still evolving (like yours)–counsels me to buy more domestic stock funds only under certain conditions. Since those conditions aren’t currently present, I’m investing elsewhere until those circumstances exist once again.

Again, I think the key point is that one saves and invests not via hunch, guess, or fear, but in accordance with a simple, clear plan supported by sound reasoning. It’s OK if the exact details of one person’s plan differ from those of another’s, as those tend to be of secondary importance.

For example, while I probably wouldn’t advise it myself, a plan consisting of “maxing out” 401k contributions, then using all proceeds to regularly purchasing stock index funds, might work very nicely for many younger workers like us. Over the long run, such a plan will almost certainly offer far greater returns than the more typical 401k saver will likely ever see.

But whether it does or not, I’m confident that simply following a disciplined plan it will perform much better than the alternative of simply making investment decisions “on the fly” as we go along. Among other problems, such “gut-based investing” leaves us too vulnerable to feelings of fear, greed, and confusion in volatile weeks like this. And researchers have proven quite convincingly that such feelings are quite hazardous to our wealth.

Dave: great response. As personal finance noob I am really struggling or craving for someone to just tell me what to do. This however seems impossible as no one plan fits all. Or can it?

Take for example your statement: “For example, while I probably wouldn’t advise it myself, a plan consisting of “maxing out” 401k contributions, then using all proceeds to regularly purchasing stock index funds, might work very nicely for many younger workers like us. Over the long run, such a plan will almost certainly offer far greater returns than the more typical 401k saver will likely ever see. ”

When I read this I ask myself “OMG… maybe I should not have made a New Years resolution to max out my 401K this year” But then again, it sounds like you are saying in the end I will probably be OK with this strategy.

Not sure if that counts as an actual question as much as a general statement about the frustrations associated with being a finance noob.

- Paul

Ron-

I am just a tad older than you (40) and like you I really don’t know what financial advice to folllow. I am also like you in that I am actively manipulating my 401K to maximize my retirement money.

Unfortunately, unlike you, I have not formulated a long-term plan and so I am probably reactionary and much more prone to making moves based on fear than you are. The first commentator summed it up best when he said “‘gut-based investing” leaves us too vulnerable to feelings of fear, greed, and confusion in volatile weeks like this. And researchers have proven quite convincingly that such feelings are quite hazardous to our wealth.”

That being said, I moved most of my 401K money into (1) foreign markets and small caps (40%), (2) a T Rowe Price Lifecycle Fund (25%), and then (3) the bond market (35%).

The Lifecycle fund is something new (as of 1/1/08) that is offered by my 401K and I am testing it out to see how it performs. I have no problem yanking my money out of it if they seem clueless, but since the managers of that fund are a whole lot smarter than me about this stuff I will probably wait a VERY long time before I pull the trigger.

I put money into the bond market based on Mondays collapse of the foreign markets. Since the US market was on holiday that day this was purely reactionary and probably not a good idea in retrospect. The effects of the Fed cuts and congressional stimulus package haven’t really sorted themselves out, yet, so I will let that ride for a little while.

Overall, I think that investing in the overseas, gold, and real estate markets is a really good short-term strategy until the market bounces back a little bit. But I too am a noob when it comes to this stuff and I may have learned just enough to be dangerous.

I know that buying low is the mantra, but I just don’t know how low things will go in the next 12 months and I have already lost 15% or so of the value of my 401K in the last 6 months.

I am able to make changes (for free) daily if I want to and I pay attention to the market moves so, hopefully I can switch things back to stocks once an upturn begins.

I applaud your discipline and your long-term planning and I think that overall you will be fine. I cannot fault your reasoning that this is a temporary hiccup in the market and that staying the course is a sound philosphy. Sadly, I am afraid that this is a HUGE hiccup and I am all about minimizing my losses so I will pay closer attention and remain active with switching around my investments until things settle down a little bit.

Hi Paul,

Thanks for your reply. There are at least two different issues here: saving levels and asset allocation. My reservations were directed solely at the latter, not the former.

I think that your NY Resolution to maxing out your 401K is a GREAT idea. For what it’s worth, I think most younger people are best off with the following sequence:

1) Contributing to 401k up to the maximum level of matching contributions, if offered;

2) Fully contributing to a Roth IRA, if your income is below the eligible cutoff (see http://fairmark.com/refrence/ for an excellent table on this). This means up to $4K for 2007 for you and a spouse–you have until April 15 of 2008 for this–and $5K apiece for 2008.

3) Additional contributions to the 401K, assuming your fund choices are decent (and at FiLife, they’d better be!). Finally,

4) Any additional savings in Education accounts like 529s and Coverdells, or in regular accounts, depending on your situation.

Note that if your income is just over limit for a Roth contribution (2 above), you can often squeeze under if by upping the deductable 401k contributions (1 and 3).

As for asset allocation, that’s really beyond the scope of a comment here at FiLife. I reckon Ron will want to arrange some longer pieces about this soon. But one good reason to have a plan for asset allocation is illustrated by PTRoy’s comment.

PT, I think you are to be admired for your frankness here. Virtually everyone faces the kind of investment anxities you sketched in your comment, but most people are too embarrassed or insecure to detail them.

It sounds like you see the benefit to developing a plan. Hopefully FiLife can help you think about this in the coming months. For now, let me just make a pitch for having a diversified portfolio of “noncorrelated assets”–that is, investments that don’t move in lockstep with each other.

One reason is the academic research suggesting that such a strategy can massively reduce the risk and risk and volatility in one’s portfolio without significantly reducing overall returns (and it may even increase them!) But another reason is reduction in our “fear factor”. It’s much easier to get through periods like last week if some of your assets aren’t so affected by the wild swings.

For example, even as domestic stocks were getting creamed last week, government bonds increasing in value as the markets jumped to them in what commentators like to call a “flight to quality”.

One should also pay close attention to special investment categories that a 401K may offer. For example, as a former processor, I have access to the impressive TIAA/Cref Real Estate Annuity (see data at http://www.tiaa-cref.org/performance/retirement/profiles/1009.html ). A chunk of my retirement money stays here. Also, one of my credit unions offered an impressive 2-year, 8% CD last year (the offer has since expired). Normally, someone my age probably shouldn’t invest in “cash” for the long term. But in this environment, with a rate that much higher than normal, it made sense not to pass that offer up.

You won’t ever see options like these mentioned in standard discussions of “asset allocations for beginners”. And that’s understandable, because options like these aren’t open to most. But MANY more options are available in a standard IRA than was the case even five years ago. FiLife will be a fun place for us to think about them together.

How do you like Schwab’s website? I am thinking of moving my Roth IRA to them.

Really well written, Ron. As I read your entry and the thoughtful comments that followed, I found myself feeling bitter (again) about the maddening tendency afoot among some of our biggest and farthest reaching mass media brands to reduce really important events, such as a market adjustment/correction, into 90 seconds of broadcast time. The result, not surprisingly, has been lack of insight in favor of sound bites. I therefore wonder if you see an appetite for a thoughtful dialogue growing among those who are similarly dissatisfied with what 24-news is shoveling. Keep up the great work.