How the decline in stocks could help your 401(k)
NEW YORK (AP) — This year's stock market decline has left investors uneasy.
But money managers say take a breath — the downturn could offer opportunities to strengthen your retirement savings for the long run.
Signs of slower growth in China and other emerging-market economies, as well as weak reports on U.S. manufacturing and hiring, have shaken investors' confidence. And while stocks have rallied in recent days, most big indexes in the U.S. are still negative for the year.
There's an upside, though. People making regular, fixed purchases of stocks or bonds through a 401(k) retirement plan can now buy more stocks at cheaper prices. Dropping prices also allow them to shift, or rebalance, their portfolios toward stocks and away from bonds. Falling prices can be viewed as opportunities for those who believe the market will climb over the long haul.
More broadly, a sell-off can be healthy because it resets investors' expectations after big gains, and it stops the market from getting out of line with economic reality.
After the stock market collapse of 2008 and the Great Recession, many investors switched their investments from stocks to bonds, or cash, because the assets were considered less risky.
Those moves paid off for a few years. But with the overall economy looking healthier, many analysts are advising investors to put more money into stocks and cut their exposure to bonds. That's because long-term interest rates are expected to rise as the economy improves and the Federal Reserve reduces a huge bond-buying program.
Rising interest rates in an environment of accelerating growth is good for the stock market, but bad for bonds, says Gerry Paul, chief investment officer for North American Value Equities at Alliance Bernstein. Investors should hold stocks to offset losses they will suffer if interest rates climb.
So far this year, the opposite has happened. Stocks and interest rates have fallen as nervous investors look to buy safer assets. As bond demand and prices rise, their yields fall.
The Standard & Poor's 500 index has fallen 1.6 percent this year. At its worst, the index was down 5.8 percent from a peak of 1,848 reached on Jan. 15.
"Even though they might be scary at the moment, you need stocks," Paul says.
If you believe that the economy and stock market will recover, you should rebalance your portfolio, strategists say. Add to your stock holdings at a lower price, while selling bonds at a higher price.
"Rebalancing is one of the most important tools that investors need to use," says Liz Ann Sonders, chief investment strategist at Charles Schwab & Co. "People don't use it as much as they should during times of volatility."
While it makes sense to buy low and sell high, it still feels risky.
Investors pulled a record $18.8 billion from U.S. stock mutual funds and exchange traded funds in the week that ended Feb. 5, according to data from Lipper. Much of that money appeared to make its way back into bond funds, as taxable bond mutual funds and ETFs saw inflows of $10.7 billion.
As the old adage goes, stocks are the only thing that people don't want when they're on sale.
People can invest in stocks and bonds through 401(k) retirement plans, and they fund these accounts with regular payments, a practice known as dollar-cost averaging.
The advantage of this type of buying, as opposed to investing lump sums now and then, is that investors don't have to worry about timing their entry into the market to buy at low prices or sell at high ones. Those peaks and valleys are hard to predict, even by the most experienced investment professionals.
Investors buying U.S stocks now are getting them at lower prices than they were at the start of the year, and will benefit if prices turn up again.
"You know that at some point the market is going to be up, or the market is going to be down," says Brad McMillan, chief investment officer for Commonwealth Financial, a stock broker and financial adviser. "But you're not betting it all on one single emotional decision."
PULLBACKS CAN STOP BUBBLES
2013's steady advance for stocks was more the exception than the rule, most stock market observers agree.
The gains of nearly 30 percent were the best for the S&P 500 index since 1997. They were also remarkably smooth, as the index climbed in 10 out of 12 months.
While company profits also climbed, much of the market's rise was driven by investors' willingness to pay more for stocks. Using forecast earnings for the next 12 months, the price-earnings ratio for companies in the S&P 500 rose from 12.6 at the start of the year to 15.3 by the end, according to FactSet data.
Stocks weren't quite in bubble territory, but they were getting there, says Commonwealth's McMillan.
Corrections and pullbacks help "to reconnect market values with reality," McMillan says. "It's kind of a reality check."
Bubbles happen when investors ignore economic fundamentals and buy stocks just because they believe they will rise in price. Remember the internet bubble of the late 1990s? Or the housing bubble that led to the financial crisis?
Retirement savings took a big hit when those bubbles burst.