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Retirement Planning: The Worst May Have Already Happened October 15, 2008

Posted by retirementwithaplan in Uncategorized.
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The idea that panic is viable character trait during an economic crisis has shown up in a wave of redemptions among mutual fund shareholders. Last Friday, over $9 billion worth of funds were sold – ahead of the near thousand point surge that occurred in the Dow on Monday. (Not that Dow Jones Industrial Averages are worth publicizing as a template for whether or not you should stay invested.)

According to Deborah Brewster writing for the Financial Times “US investors pulled a record $65bn out of mutual funds in the week to last Friday, as their losses mounted from failing stock and bond markets.” Three things happen during these types of panic and none of them are beneficial – the the sellers of fund shares and for those who stay to ride out the panic as good long-term investors tend to do.

Even though “Charles Biderman, the chief executive of TrimTabs, said a significant difference between this and previous fund sell-offs was that investors were pulling out of both bond funds and equity funds, as well as from hedge funds, money market funds and bank savings accounts.” Even though this extreme flight to safety seems prudent, the freezing of credit markets doesn’t suggest that the companies held by mutual funds and bonds held by bond funds are failing. (Instead, some companies who have seen significant share losses may be worth less based on market capitalization compared to available cash in their coffers.)

In fact, the opposite may be true. When redemptions occur, you want to have your invested dollars returned to you – and during these types of market downturns, they would do so at a loss. This means that the fund you had invested with no longer has your vote of confidence to do what is right. The fund manager you may have picked for his/her investment savvy no longer has any experience worth tapping. Remember, when you open that statement, the loss is compared with the previous balance – not with how much you invested over the years and the gains you may have made in those preceding years.

Instead, your former fund manager (who is still mine) sells shares to pay for your panic and liquidates positions that, smart investors should (would) be adding to if the markets were cheaper. We have been in a bear market for almost seven years now and many of us made a few dollars during that time. And even though we are recession bound and the bear market will continue bouncing along this bad-news bottom, it won’t last forever.

And now that you have taken your dollars out and put them where you deem them the safest, when will you get back in the game?

If you consider the fat that the hurdle fund managers need to vault to get back to even (as of the end of the third quarter, the S&P 500 was down only 8.4%) is relatively low. Where investors got really hurt was internationally. (“In the three years to the end of 2007, US investors put $500bn into global equity funds – which invest outside the US – and earned a total of 25 per cent from the funds during that period. However, these funds have fallen in value by 60 per cent this year.)

The second not-so-good effect of all of these redemptions is the counterintuitive nature of it. Nowhere, in any investment playbook and I have written a few myself does it suggest that if you are in it for the long-term (heretofore described as any investment that could/should/would be held for more than five years) selling should be done on the way down. Notice any big name investors buying in this market who might have just a little more market savvy (and several billion dollars) than the average Joe?

And lastly, those who stayed will benefit from the capital losses that all this selling generated. By year-end, we will make a few dollars.

Retirement planning, which believe it or not, is where the vast amount of these funds are held is designed to take advantage of these kinds of downturns by allowing you to buy more shares when the markets are down and less when they are up, seems to have been forgotten.

It will take months, if not years for this recovery to take place and when it happens, it will be incremental – not suddenly occurring like last Monday’s run-up. There is an election to be dealt with, a bad economy for the new president to inherit and a whole new preemptive way for the government to intervene (sort of like the Bush Doctrine for Free Markets!).

Stay tuned as we try and ride out this mess – which has been occurring at a lightening quick pace.

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