For savers brave enough to review their recent investment statements, it has been a lost decade. With the booms and busts we have all lived through, money you invested in the stock market has earned you nothing, or less, in the past ten years. If it were not for the tax benefit you receive when investing in your 401k or 403b, many would have been better off keeping their money under their mattresses.
If we treated financial assets as we do other goods, we would sell them when they are expensive and buy them when they are cheap. In fact, we do the opposite. We couldn’t get enough of the stock market in 1999-2000, at the peak, and are piling out of it now. Studying how investors react to these boom and bust cycles and the decisions we make as a result has spawned a field of study called behavioral finance. The definition of behavioral finance translates to the nexus of your emotions and your money and the decisions you make as a result of how you’re feeling. With nerves rattled as bad as they are now, fear will usually trump logic. This is where the benefit of having a long term strategic approach to your investment strategy can help prevent you from making decisions based purely on fear.
In a recent issue of The Economist, the term “careless caution” was used to describe the behavior many people are applying to their current long term investment strategy. Caution is understandable after the trauma of this year. Stock prices could still fall farther, especially as the news on the economy seems to get worse week by week. But yet think how strange it is that investors were happy to buy stocks nine years ago when the ratio of shares prices to profits was three times what it is today and are now determined to keep their money in cash and bonds.
That approach will be terribly inadequate for those who need to build a decent nest egg when they stop working for money. Most people are on their own in terms of investing and making sure they save enough money to last for a lifetime. I would advise to take the time you need to recover from the dizzying roller coaster ride the stock market has taken us on this year and then, crunch your numbers and start planning for your secure future.
In Chapter nine, I offer some specific choices for investors willing to put some of their savings in the stock market. Depending on your risk tolerance and time horizon, one of the Vanguard LifeStrategy Funds as recommended in the chapter could work well for you. But you will need to do your homework first before deciding which fund suits you best.
With money market accounts and savings accounts currently earning less than 2%, this option offers a safe harbor for the short term. But over the long term, needing to accumulate enough capital to stop working for money will require a higher return than 2%. So do your research on the investment options presented in Chapter nine, fully understand the choices you have available, review the risks and rewards, plan accordingly and set sail for FI.