What Now?

Now that investment markets have fallen dramatically and remain down, you probably feel like yanking your remaining money out of the market, stashing it under your mattress, and hiding under the covers. After all, you played by the rules. You invested in a diversified portfolio and it didn’t save you.

Declines in 2008 were broad-based and severe, punishing not only domestic and international equities, but also fixed-income securities—from high-quality corporate bonds to municipal bonds.

It may seem that only cash and Treasury bonds have been spared dramatic declines. So retreating to cash might seem like the most prudent course of action, especially if you’re nearing retirement. Yet, while cash and Treasury bonds were king in 2008, stashing all your money in what you may now perceive as your only option is not risk-free over the long term. As you contemplate your next move, keep the following in mind:

• Even in a recession, the long-term case for diversification is still compelling. As brutal as recent months have been, and as volatile as the stock market continues to be, it’s crucial to remember that 2008’s returns for stocks and bonds are not at all typical of the long term. Even with 2008 losses factored in, the S&P 500 index averaged an annual return of about 8.5% over the past two decades (even though this past decade was one of the worst ever on record), and all bond categories outperformed cash over the past 20 years. For the long term, cash significantly lags behind investment-grade bonds and large-cap U.S. stocks. What’s more, returns from different asset classes vary significantly, so it’s a good idea to attempt to temper the impact of a poor year in one asset class by spreading your investments among multiple asset classes. Also, when you invest only in cash equivalents you shoulder the risk that investment performance could be outpaced by inflation, eroding your purchasing power.

• You can’t control the market, but you can tweak your plans. Fear can often lead to hasty, emotional decisions or no decisions at all. Try to block out market noise and consider steps you can take today to gain confidence concerning making your money last through your retirement. For instance, if you’re approaching retirement in the coming months and considered 4% to be a reasonable annual withdrawal rate before the market meltdown, it now may be necessary to plan on a lower annual withdrawal rate. So that retirees don’t have to take scheduled required minimum distributions (RMDs) from IRAs and qualified plans that are under water, the Worker, Retiree, and Employer Recovery Act of 2008 temporarily suspended RMDs for 2009. Those who don’t need that cash to meet expenses might consider leaving their money invested to better position their portfolios for a potential market recovery.

In addition to reducing expenses to offset the downturn, withdrawing from your medical practice gradually by working reduced hours, rather than retiring all at once, could help you cover expenses with earned income, allowing you to preserve your portfolio. For some physicians, it may be wise to delay retirement one or two years. It’s important to know where you stand in this volatile market, so give yourself a financial check-up. You may find your finances aren’t in as bad shape as you’d feared. When you run the numbers, you may discover that if you make some lifestyle changes to accommodate a lower monthly retirement income than you were originally counting on, you may still be on track to retire on schedule.

• Don’t embrace a risky scheme to get even. Keep in mind that if you convert assets to all cash now, your paper losses become real losses. Plummeting stock values may be more a function of fear than fundamentals. While no one knows how much punch this bear market has left, if you cash out now and remain in all cash, you won’t participate in the eventual market rebound, and comparatively lower returns could make running out of money in retirement a real possibility. The flip side, of course, is that it’s imperative to resist the temptation to make back quickly what you lost. Remember, market-beating gains generally are accompanied by oversized risks. In this unprecedented market, additional risk is particularly dangerous. If Bernard Madoff’s Ponzi scheme taught us anything it’s this: “If it sounds too good to be true, it probably is.”

Because we all have different goals, risk tolerances, and stomachs for belt-tightening, no single strategy is right for everyone. Many investors need a plan that combines portfolio moves and lifestyle adjustments to help shore up their financial foundations. Talk to your financial advisor. Together, you can decide on small changes for the short term that could make a big difference over the long term.

Arthur Cooper, a Certified Financial Planner, has been in the financial services industry for over 20 years, and is the founder of Cooper McManus (www.coopermcmanus.com), a financial advisory and wealth management firm based in Irvine, CA. He specializes in comprehensive financial planning, estate planning, and asset management services.