There are a couple of things we know about the stock market, which is still the primary generator of wealth and retirement income. The question is whether you follow what you know or follow what might happen.
First among these facts is that although the price you see quoted at any given moment is based on some expectation of what might occur in the future, it is still something you feel as though you should react to now. The best way to understand this blind obedience is listen to the analysts speak on any one of the business news outlets. Depending on the source, that information has already been built into the price of whatever stock they are talking about and their clients have already decided whether to do something or not.
Second is the information is based on what has happened, called a lagging indicator and any validity concerning the information is just a guess that whatever happened will allow the investor to predict what will happen in the future. Analysts are good at crunching numbers and building expectations. But they do not do a great job at predicting events.
The third is the inevitability of outliers. Analysts build their assumptions based on normal. Normal, something that few of us could recognize if it was standing in front of us, is a continuation of current and past performance that will continue in much of the same fashion for days, months or years. There is always a margin for error in the wrong-headed thinking that change will not happen, that things will always be the same and that what happened in the past – even though the average investor knows all to well the disclaimer about relying on past performance as some indicator of the future – is in fact an indicator of things to come.
Most of us fail to realize that there are only two participants in the marketplace: buyers and sellers. As the markets move up, buyers become fewer (based on the assumption that everyone who wants to own it, already does) and that sellers (those with profits to be taken) are the most likely players left. In order for you to buy something in the marketplace, someone has to sell something.
But few of us question why the sellers are selling. We are just thrilled that we could have made the purchase. When a market surges forward and upward, buyers become fewer. Then some sort of bad news arrives and everyone panics, in unison. The world is going broke, the recession will double dip or a stock or its sector which was once priced for perfection is no longer seen as perfect.
So how should you react if you are planning for retirement? In the current environment, any money in individual stocks should not be counted on for any sort of long-range retirement plan. This doesn’t mean that you should go conservative either. But for the next several years, as this financial crisis plays itself out, a small basket of stocks will be the most vulnerable. Savvy investors know that riding a trend higher is the easy part; finding an exit is another thing altogether.
The easiest solution is to find the exit now. Even with the expenses and jagged performance that actively managed mutual funds are known to have, it will still be the best place to be. Index funds, known for their yearly rebalancing, a process of selling losers and buying winners, will trend sideways during turmoil because of this skewed methodology. ETFs will roil the market further as investors buy in and out at such a rapid pace, no average long-term investor is safe. (Long-term is now more than six months.)
And bonds and the funds that buy them will be pushed to higher prices than they are worth, which makes buying now a pursuit for the top of a trend. As more people flock to this safe haven, they do so in complete ignorance of the maturity wall that many of these securities will hit next year.
So find a good allocation number or percentage and begin to feed these funds in your 401(k), IRA or whatever hybrid of the two you chose, spread across a diverse universe. You may lose money if things get really bad, and the potential is definitely there, but you will avoid much of what the individual investor will experience during the same time frame and you could make more than your conservative cohorts.
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