Sharply falling stock market and home values have created an extremely treacherous period. It's in just this sort of tough economic environment that your future financial security is won or lost.
How you handle your money in these tough times is going to play a huge role in whether you reach your long-term financial goals. Unfortunately, I'm seeing far too many people focused on making moves that might bring some short-term relief without fully recognizing the long-term damage they're doing to their bottom line.
It's Too Early to Hibernate
The stock market has officially fallen into bear market territory, with the Dow Jones Industrial Average sinking 20 percent below its October 2007 high. Watching your portfolio take a big hit probably has you seriously considering making a beeline for the nearest exit, but please slow down and think this through.
Emotionally, it makes perfect sense to want to bail on the stock market. But emotions are what keep individuals from making smart investing decisions. Look no further than the ever-growing cadre of behavioral economists who make a living by studying how we cheat ourselves with misguided money moves.
Heading into investing hibernation right now is one of those moves. I'm not predicting that the market has absolutely bottomed, but to bail out now puts you at odds with the immutable law of successful investing: Buy low, sell high.
Many Unhappy Returns
Selling now also plays right into the timing trap that's thwarted so many individual investors. We need to look no further than the data provided by Dalbar Inc., which takes a look at how fund investors have historically fared when compared to the performance of the S&P 500 stock index.
History Rewards the Long-Term Investor
That brings us back to today. If you're a long-term investor -- that is, if you expect to leave your money invested for at least 10 years -- the evidence is pretty clear that sticking it out as a buy-and-hold investor is going to be your best (non-) move. That's especially true if you're investing via a 401(k).
Your money buys you more shares today -- given lower stock values -- than it would if you bought at higher valuations. Invest $250 per paycheck in your 401(k) in funds that have a share price of $25 and you get 10 shares. Invest when those shares fall to $20 and your $250 buys you 12.5 shares. Fast-forward 10 years and the shares that have bobbed both up and down but are now worth, say, $30. If you had 10 shares your account is worth $300. With 12.5 shares you have $375.
What are your alternatives anyway? Don't tell me the 3 percent or so you can get at the bank or the 4 percent in a Treasury bond is a good, safe investment. There's nothing safe about having money you need to grow earn a guaranteed rate of return that's well below the rate of inflation.
Homing in on Reality
The slide in home values is creating another "timing" issue for many individuals. In addition to the few million homeowners who are already in or close to foreclosure, some economists are now projecting that another 2 to 3 million could find themselves in serious trouble over the coming year or so if home values continue to falter and a weak economy causes unemployment rate to rise.
The typical response to being in mortgage stress is to pull out all the financial stops to stay in the home. That includes raiding retirement savings, running up huge credit card debt, and borrowing from any and every family member or friend to come up with the cash to cover their rising mortgage costs. Again, emotionally this makes perfect sense -- the desire to stay in homes we ostensibly "own" is profound. But if the only way you can afford your home is to ruin the rest of your financial life, what have you really achieved?
It's very sad to say, but I think many homeowners need to seriously consider "folding" if the reality is that they have no way of being able to afford the higher mortgage payments in the long term.
Know When to Fold 'Em
Can you afford it today, without running your savings dry and your credit cards into the stratosphere?
If the answer is no, then you need to look at the big picture. It makes little sense to throw good money (what savings you have) at a bad situation you know you can't afford long-term. As painful as it is to consider selling, or going through foreclosure now, it can be the smarter move than trying to "hold on" for another six months, or year, or two years, until you have no more money to raid.
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