Time the Market at Your Peril

by Laura Rowley

Stocks have been fluctuating sharply since the Japan earthquake, tsunami and subsequent nuclear crisis. As Peter Cardillo, chief market economist at Avalon Partners, told the Associated Press Tuesday: "It's a situation where you sell, and you ask questions later," he said. That's why it may be helpful to look at what happened to investors who bailed out during the last sharp market decline.

T. Rowe Price recently did an analysis of investor returns based on the financial crisis in the fall of 2008. On Oct. 6, a well-known television commentator (unnamed in the analysis) advised viewers to take any money out of the stock market they might need in the next five years and put it into safe-haven investments. The analysis assumed investors who heeded this advice on that day shifted their money in short-term Treasury bills. T. Rowe Price then compared those returns to stocks and a diversified portfolio through Dec. 31, 2010.

U.S. stocks indeed continued to fall for the next six months before sharply rebounding. Between Oct. 6, 2008 and Dec. 31, 2010, short-term Treasury bills returned 0.4 percent; U.S. stocks (invested in the S&P 500 Index), 25.3 percent; and a diversified portfolio, 13.4 percent. The diversified portfolio contained 20 percent stocks (S&P 500); 50 percent bonds (Barclays Capital U.S. Aggregate Index); and 30 percent cash (Barclays Capital 1-3 month T-Bill Index).

Although the fluctuations of the past week provoke a discomforting sense of déjà vu, "you can't evaluate your strategy based on what happened in 2008," says Stuart Ritter, a T. Rowe Price financial planner. "Imagine I asked you to randomly pull a card from a deck and guess if it's a two or not. You would likely guess that it's not a two — that makes logical sense — but the two's are still in the deck, and once in a while they come out. That doesn't change every card in the deck to a two. Prior to 2008, investors had to decide to make a plan based on a huge bear market or not a huge bear market — and if you look historically most of the time we have not had a huge bear market. But they're out there."

But what about the Wall Street traders I knew who started shifting their funds to cash in the spring of 2008, before the market meltdown? They may have been right, Ritter says, but the consequences of not getting the timing just right can wreak havoc on a portfolio. Many investors who tried to time the market bailed after the greater part of the decline and missed out on a substantial rebound.

"The asset allocation in your portfolio gives you a balance between lots of growth and short-term stability," he says. "There's a direct tradeoff between the two. If you want more growth, you'll have less stability and vice versa. The way to determine the appropriate balance is by looking at the time horizon. If it's 15 years or more, you should have most of your money in equities because the biggest risk is not having enough money to pay for your goal."

Ritter recommends that people who need their assets in five years allocate their money in line with the diversified portfolio described above, and shift into cash two years before the money is needed. More conservative investors can substitute additional savings for market exposure. "It's not about how much you can make in the market — it's about the goal," he says. "If you need a $30,000 down payment to buy that house in five years, and you're able to save the money in two, you're done" and can shift the money to cash if the market gives you jitters. "It's not about putting your chips back on the color red and letting it ride."

I have to admit that after covering the stock market's twists and turns for 15 years — including the Asian market meltdown in 1998, the bursting of the Internet bubble in 2001 and the 2008 freefall — I've become more conservative. Just two-thirds of my retirement portfolio is invested in stocks, although I won't need the money for 20 years. I've compensated for that conservative approach by maxing out my retirement savings each year.

As Ritter puts it, "The more money you have saved and the sooner you have it saved the more options you have. You're not depending on someone else to come through with something; you're not as worried about the things you can't control."

I agree with Ritter, which is why I found the recent advice of one of his colleagues profoundly dangerous. T. Rowe Price senior financial planner Christine Fahlund suggested baby boomers could stop saving so much for retirement and indulge more on vacations, home renovations and the like right now. The tradeoff: They have to work until age 70, instead of retiring at age 62 when they become eligible for Social Security.

Fahlund's plan has two big flaws: You have to stay healthy, and you have to stay employed — certainly not a guarantee for most people these days. A 2010 survey of retirees by the Employee Benefit Research Institute (EBRI) found that 41 percent of respondents left the workforce sooner than they had expected. Of that group, more than one in four cited changes at their companies, including downsizing or closure.

Separately, the Department of Health and Human Services reported in December that more than one-quarter of Americans have two or more chronic conditions that require continuing medical care and limit their abilities. They include conditions such as heart disease, diabetes, high blood pressure and arthritis. Among Americans over 65, two-thirds have multiple chronic conditions. They are not likely the best candidates for full-time work. In fact, in 2010, just 16 percent of that population worked at all — with about half, or 8 percent, working full time.

Last year EBRI found that more than 40 percent of baby boomers are at risk of not being able to meet "basic" retirement expenses and uninsured health care costs. People don't need another excuse to avoid saving for retirement. To achieve long-term wealth, stick with the fundamentals: Save consistently, allocate appropriately and don't try to time the market.


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