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Monday, November 26, 2007
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Sweating details as retirement nears
by Stephen Butler
I'm ashamed to say that I have found myself checking my retirement
plan account balance way too often this month ... sometimes as
often as once a day. How disgusting is this habit? Well, studies
indicate that the more a person checks their investments, the
worse their results will be.
Fundamentally, the theory is that is the "risk premium"
we earn from taking risk is what generates higher investment returns
over time.
For most amateur investors, the best way to come to terms with
risk is to set it and forget it. Constantly checking our account
balance is only reinforcing our fears.
A shift toward lower-risk investments (even cash) is inevitable,
and we have now jeopardized what would have been better long-term
investment gains.
So, remove your retirement accounts from your "favorites"
and "bookmarks." In the old days, when I could see that
the bulk of my 401(k) money was to be deposited sometime in the
future, I never had to worry much about downdrafts in the market.
What little I had didn't matter, and future contributions would
benefit from market plunges. If mutual funds dropped in value,
those inbound contributions of the same regular dollar amounts
were just buying more shares at those lower prices. As goofy as
it sounds, most of us still accumulating should pray that the
market plunges periodically.
Well, that was then. This is now. Looking at less than 10 more
years of work, my current account balance is now far larger than
the projected total value of my future contributions.
A market behaving as erratically as ours has since early November
gets my attention for reasons that never mattered years ago. What
amazes me is the extent to which reputedly smart people can have
such varying views on what lies in store for us as investors.
To take some simple examples, Bob Brinker, the sage of market
timers, continues to be comfortable with a fully invested position.
Richard Young, another respected investment newsletter writer,
also points out a multitude of technical reasons for why the market
continues to be our best investment option and that the recent
volatility offers some buying opportunities. So does the Dow Theory
Forecaster.
Basically, stocks are still a good investment if you assume that
corporate profits will continue to rise. More arcane "bullish"
signs can be counterintuitive. Short-selling (or betting that
the market will drop) is at an all-time high right now, but this
is viewed by technical analysts as being a bullish sign because
short sellers as a group are generally wrong. And so on.
Others such as the Shepherd Investment Strategist cite all the
reasons for why we are staring down the barrel of a gun. For example,
an inverted yield curve (short-term interest higher than long-term
interest) has always been a precursor of a following recession.
Since the market rises on a wall of worry, I find myself building
mine brick by brick. Since none of these financial newsletters
offer the right answer with any degree of certainty, I just need
to build a portfolio that will benefit from, or survive, any market
condition within reason.
A Monte Carlo simulation is a computerized matrix of all financial
events weighted by their probability and the probability that
they will happen simultaneously to varying degrees.
Over the next 10 years, an 80 percent and 20 percent mix of stocks
and bonds respectively has a median expected return of 8.6 percent.
My existing 80/20 account will double in 8.4 years at that rate.
On the downside, there is a 10 percent chance that I could wind
up in 10 years with only 14 percent more money than I have today
(ignoring any future contributions.)
On the bright side, there is also a 10 percent chance that I
could wind up with seven times my current balance.
This would happen if I were lucky enough to experience a 20 percent
average annual return. Sound unlikely? From 1988 to 1999, the
S&P 500 index managed to do just that.
As investors, we need to understand that we're "in the system
-- and the system defies rational thinking." Our only option
is to anticipate the "walls of worry" as delineated
by the simulation and come to terms with a life lead somewhere
within them. The alternative is to live like paupers and stuff
every extra cent into cash -- a likely eventual demand for those
who check their accounts every day.
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