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Will the European debt crisis affect my retirement account?

Is there anything I can do to protect my 401k? I'm about 12 years from retirement.

Apr 23, 2012 by Phoebe from Norwalk, CT in  |  Flag
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13 votes


What a question, huh?

Most economists are predicting that the European zone will suffer a period of slower than usual growth - or even short periods of shallow recession - as they try to work their way out of the debt crisis that they are currently in. Since we are, in reality, a global economy, this means that markets both here and abroad will likely be volatile and moderately stagnant for the next several years. It may well feel like we take 3 steps forward in the market, only to be followed by 2 steps backwards - for a while.

Morgan Stanley did a wonderful study called "The Aftermath of Secular Bear Markets" in which the authors of the study tracked the 19 major bear markets over the last century (only 4 were in the US). All major bear market corrections (defined as a market drop of 47% or greater) were followed by a rebound rally, (2009) then a mid-cycle correction (2010 & possibly 2011), followed by a period of 5-6 years of volatile, sideways behavior, before a new bull market started. So, based upon that historical precedent - we are about 2 years into the sideways part. (if you Google this study, you can read it directly. Here is a link to see it visually: http://www.tradersnarrative.com/the-aftermath-of-secular-bear-markets-2893.html).

The sideways part is the period of time where the economy heals itself, and goverments try to "unscrew" what went awry in the first place. Likely you see daily evidence of this natural process - Democrats and Republicans squabbling over policy but not really changing anything, the Fed printing money, banks hoarding cash and trying to get their books in order, finger-pointing, governmental gridlocks, and daily predictions of great bull markets or terrible bear markets. While difficult to live through - this is actually part of the NATURAL healing process of a free-market economy. Once you realize where you are in the cycle, then it becomes much easier and far less confusing to stay the course.

So - to answer your question - the secret to being an investor in exactly YOUR case would come in 2 separate parts:

1) Build your portfolio to a risk tolerance that even if the market drops 20 or 30%, you will NOT freak out and will NOT stop investing. That means you may have to have 30%, 50%, or even 70% of your money in the "safer" investments like government bond funds, or even cash. A good rule of thumb is - whatever percent of your portfolio you have in the stock market - that is the percent that it will go down when the market corrects. So - if the market drops 20% (which it does every 3 years) - and 50% of your money is in stock funds - then your portfolio will drop by about 10%. (50% of 20% is 10%.) If you can hang through a drop like that - but no more - and keep investing, then that's your risk tolerance threshold (limit). If your personal limit is more like 20%, you can build your portfolio more aggressively - like 70% stock funds, or maybe even a little bit more. With 12 years to retirement, you've got plenty of time to make it up, so you can afford to be more aggressive.

2) KEEP INVESTING. When the market goes down - and your portfolio goes down - but you keep investing - you are buying up shares of the funds ON SALE. If you see a sale at a store - you don't throw away everything you bought previously, would you? Then why do people do this with stocks or mutual funds? If they are on sale - buy more!! Keep buying over time - during that volatile period that I mentioned above - and when the steady bull markets DO come back (they will - we just don't know when) then you will likely be extremely pleased with your investments.

Jon Castle http://wealthguards.com

1 Comment   |  Flag   |  Apr 24, 2012 from Jacksonville, FL
Jonathan N. Castle, MSFS, CFP®

The link to the chart I mentioned above has changed. Here is a fresh link. We are 3 years to the right of the "we are here" marker. http://www.ritholtz.com/blog/wp-content/uploads/2009/08/secular-bear-markets.png

Flag |  Apr 24, 2012 near Jacksonville, FL

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12 votes

I have no idea and doubt anyone esle does, including economists - at least not in the short term. When it comes to complex systems like economics and politics, trying to predict the short term future is almost - if not completely - immposible. There is too much randomness. This creates an inherint conflict: As human beings, we are hard wired to want to predict what will happen next- it gives us comfort, partcularly with our retirement accounts! But we rarely can, which is why I like Jonathans 1) and 2) solutions at the end of his answer but dont care for the first part about " What most economists are predicting". Best of luck! Evan

Comment   |  Flag   |  Apr 24, 2012 from Port Washington, NY

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10 votes

Passive investing involves buying and holding market components, whereas an active investor or fund manager tries to pick the next winning stock or time where the market is headed next.

A passive approach offers these major benefits:

  1. By holding entire market components, one maximizes the benefits of diversification.
  2. By “tilting” the portfolio to riskier or less risky components, the investor can expect to capture the highest market return given his or her risk tolerance.
  3. The investor maintains control over his or her own portfolio’s components (by avoiding active funds’ tendency to style drift without the investor’s knowledge).
  4. Expenses can be minimized.
  5. Tax efficiency can be maximized.

Thus, build a globally diversified portfolio that is adjusted to your risk appetite, rebalance your portfolio within certain parameters and keep on maximizing your 401(k) deduction and company match, if offered. Turn off the news and go outside and play with your children or grandchildren.

Comment   |  Flag   |  Apr 24, 2012 from Lititz, PA

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5 votes
Ryan Level 19

Here's a whack at addressing this: yes, the European issues will impact your retirement just like issues here in the United States will impact your retirement. Whether the current topics surround the debt crisis in Europe, the emerging debt crisis here at home, rising interest rates, or many of the economic and political issues that fall in between these themes, your retirement planning should be built to withstand the current, future, and unexpected twists and turns that economic cycles will always produce. Dollar cost averaging is one key, not overreacting is another, and having a portfolio that you understand are some basics. By understanding, you should have a clear understanding of how and why each mutual fund, ETF, stock, etc are held in your account. You can probably start to work with (if you haven't already) a local advisor in your area who can help make sure your 12 year retirement time frame matches up with your current strategy.

And I agree wholeheartedly that the news right now is selling a lot of fear thus drawing in more and more viewers... which is good for their advertising sales but not our own peace of mind. Leave the worrying to your advisors... it is part of what we get paid to do!

Comment   |  Flag   |  Apr 25, 2012 from Gettysburg, PA

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