5 tips on recession investing
1. Cut spending, boost saving.
2. Avoid stocks if you need cash within five years.
3. Stay the course with retirement savings.
4. Still too nervous? Invest an IRA in CDs.
5. Younger? Be more aggressive.
With the economy in a recession and most experts predicting that the worst lies ahead, deciding what to do with your money seems overwhelming.
Many market strategists are urging investors to remain cautious with investments, yet there are brave souls suggesting that it is time to start buying stocks in preparation for the inevitable recovery. Historically, the stock market tends to show improvement while the economy remains in a recession because investors start to anticipate better times even while unemployment is growing.
Optimists are betting on government-financed infrastructure projects to put people to work and improve the economy in 2010. Skeptics continue to worry about sickness in the financial system and aren't eager to take risks in the stock market.
Consequently, financial advisers agree on one strategy: Prepare for bad times by cutting spending and saving more. After that, the decisions get more interesting. Hold steady on all longer-term investments? Tinker a bit? A lot?
The answers depend. People often look for the one stock, bond or mutual fund that will help them make the most money or avoid losing money.
Financial advisers look at investing differently. They focus on when you will need your money. Then they have you select a mixture of funds so you aren't injured too badly in a down market but are prepared to make money when stocks start to climb. They know that trying to predict when the ups and downs will come is a fool's game.
A retired person who has enough cash and bonds to cover spending needs for years shouldn't worry if a stock or stock mutual fund has been losing money during the recession, said Lewis Altfest, a New York financial planner.
And a family that needs to be paying for college next year can afford to lose some money in their retirement fund but not in the college savings fund.
The rule of thumb is to keep money out of the stock market if you will need it within five years. But if you're invested, be patient. Typically, when the stock market falls 20 percent or more, in what's called a bear market, investors recover within 21/2 years. But in awful bear markets—like the present one—it often takes longer: 71/2 years after the 1973-74 downturn and 13 years after the Depression-era decline.
If you are saving for retirement: Financial planners are trying to get people to stay the course with retirement savings—stashing money away with every paycheck. But that means staying with a reasoned mixture of funds—maybe 50 percent in stock mutual funds and 40 percent in bond mutual funds and 10 percent in a money market fund if you are close to retirement.
If you are in your 40s, Mark Wilson, a Newport Beach, Calif., financial planner, suggests keeping 60 percent in stocks and 40 percent in bonds. For younger people, he favors 70 percent in stocks to take advantage of their higher threshold for risk.
Although Wilson's not sure the stock market has fallen as low as it will go, he thinks young investors should be positioned in stocks now to make money when the upturn comes. Despite a troubling year ahead, Wilson said young people must be saving diligently for retirement because they are likely to live 30 years past 65. On average, Americans receive about $13,000 a year from Social Security.
Investing in a 401(k) plan or individual retirement account is the best way to accumulate the most money. In a 401(k), an employer often provides free money, called matching money.
Also invest in a 401(k) and traditional IRA because Uncle Sam doesn't tax the money until it's withdrawn. That allows your savings to grow faster than they would in a savings account or mutual fund that could be taxed.
If you are afraid of investing now: You don't have to buy stocks and bonds if the economy is making you too nervous.
You can open an IRA at a bank and invest it all in certificates of deposit, which are insured for at least $100,000 by the FDIC. CDs maturing in five years pay as much as 4.25 percent in interest.
If you have a 401(k), you can leave money that's invested in the mutual funds you have already selected. With new money from each paycheck, you could select a money market fund or stable value fund if you can't bear a loss, a bond fund if you can stomach a little more risk or a balanced fund for additional risk.
A balanced fund typically invests about 60 percent in stocks and 40 percent in bonds. Last year, such funds lost around 29 percent, while the benchmark U.S. stock index lost nearly 40 percent.
Another alternative in a 401(k) plan: a mutual fund with a date in its name. These funds hold stocks and bonds and are geared to get you ready for retirement. So a fund with 2020 in the name would be designed for someone retiring in 2020. The closer to retirement you are, the less risky the fund. If you plan to retire in 2020, but are nervous about the stock market, you could select a 2015 fund and be exposed to fewer stocks.
If you want a modest approach to entering the market: Let's say you have a mixture of stock and bond funds, but now you want to start preparing for a recovery by investing more in stocks.
You could go with a mutual fund or pick large, solid companies that pay dividends. Those dividends are like interest payments, although they aren't guaranteed.
Chicago financial planner Cicily Maton said she prefers exchange-traded funds in the current environment instead of mutual funds. An ETF is like a mutual fund but you can bail out in the middle of the day if the market is crashing and you are afraid you are losing too much money. With a typical mutual fund, you must wait until the end of the day, and can lose a lot of money in the meantime.