Fighting Investment Risk Aversion

Last week, I had a conversation with one of my friends from graduate school.  She had wanted my advice on what to do with her retirement fund. Although my friend, Sue, had been investing diligently most years through an automatic withdrawal from her paycheck each month, she had also panicked after the market fall in the 2008 market drop and shifted all of her money into a low yielding money market account.  Although her account suffered no further losses of principal, Sue’s portfolio did not recover when equity markets turned up.  Obviously, she did not have exposure to emerging markets, REITs, commodity stocks or other good performers of the past 2 years.  In addition, with concerns that she was losing hard earned money, Sue had scaled back her contributions to the retirement portfolio and was placing excess savings into a bank account.  These were some of the things we discussed:

–Forget about trying to time the market — for most individuals, thinking they can out guess the moves of the market is a sure way to lose money.  Unfortunately, too many of us panic when markets move down and readily invest after they’ve run up substantially, making us susceptible to buying high and selling low.  In Sue’s case, she is better off with automatic withdrawals and a reasonable overall asset allocation that only gradually shifts over time.

–Be aware of investment bubbles — bubbles from an investment perspective are the things that everyone is touting, that have moved up in price in the past few months, and that are generally veered from good valuation metrics.  Currently, the bond market and bond funds are in bubble territory.  While it may be okay to have a percentage of assets in bonds, the shift out of stocks into bonds that many individuals have made in the past year is likely to end poorly.

–The real value of retirement savings is what will hurt most people — one of the dangers of Sue’s portfolio is that her low yield money market account is unlikely to surpass inflation over the long-term.  She needs to plan for retirement costs to include inflation, something many people neglect.

–Pay attention to management fees – previous to shifting her funds into money market accounts, Sue had some very high fee mutual funds and was considering an annuity that charged over 1% annual fee.  Minimizing management and account fees is one way to ensure more of your money gets invested.  With a plethora of index funds, and low fee ETFs, this has become much easier than in the past.

–Reach for help if you need it — in Sue’s case, financial advisors were available through her company retirement plan.  I am wary of advisors that are touting high fee products, but generally, a licensed financial advisor that takes you through a life plan questionnaire can be very helpful.  Just be sure to do your own research and reading.

shared at this week’s Carnival of Personal Finance