Bracing for another market crash

The markets have made quite a comeback this year. But is it too much too soon?

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By Walter Updegrave, Money Magazine senior editor

Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005)

NEW YORK (Money) -- Question: I'm very worried that we may see another stock market correction. Since the market low of early March, my 401(k)'s value has risen 77%, which seems like an awfully large jump. So last week I moved the majority of my investments into bond and money-market funds, although I did leave 50% of my international holdings intact. Do you think I jumped too soon? --Rick G., Corona, Calif.

Answer: I don't think the question is whether you jumped too soon, but whether you should be jumping at all.

I agree that the magnitude of the market's rebound this year, while preferable to further declines, can also seem a little unsettling. And given the fragile state of the economy's recovery -- we're still losing jobs and the housing market continues to face challenges -- it's certainly possible that we could experience another dip in stock prices in the near future.

That said, I don't think the right way to deal with this uncertainty is to move your money in and out of the market based on a hunch about the direction stock prices may or may not take in the short term.

Why? Quite simply, your chances of being able to make such calls correctly on a consistent basis -- which is what you'd have to do for this approach to work -- are pretty slim. There are just too many constantly shifting variables that go into setting stock values -- corporate earnings prospects, inflation expectations, investor sentiment, etc. -- for you or anyone else to be able to predict short-term market movements with a high degree of accuracy.

I realize that you probably see your decision to move your dough as being well-grounded in fact and reason. But if you step back and examine it more closely, you may find you're not being quite as coolly rational as you think. Just on the basis of the information you provided above, I have at least one question about your reasoning: If it's the sharp rise in stock prices so far this year that's sent you scurrying into bonds and money funds, why did you move only half of your international holdings? After all, foreign stocks, as measured by the MSCI EAFE index, are up about 20 percentage points more so far this year than domestic shares.

In short, far from making informed investing moves, it seems to me that people who shift their money around to capitalize on market upswings or sidestep downturns are really playing a guessing game. And that's no way to invest your retirement savings.

What do I recommend instead?

Well, I say you're better off creating a diversified mix of stocks and bonds within your 401(k) and, aside from periodic rebalancing, largely sticking with it regardless of what the market is doing. This way, the equity portion of your portfolio will allow you to participate in the long-term growth the stock market has to offer, while your bond stake can provide a cushion during downturns.

The key to this strategy is setting an appropriate mix. Generally, that means a higher dose of stocks when you're younger and have more time to rebound from setbacks, and moving more to bonds and cash as you near or enter retirement and have to be more careful about preserving your capital.

To get a better idea of what mix might be suitable for you given your age and tolerance for risk, you can check out the target-date retirement funds offered by Vanguard and T. Rowe Price.

You can also see how different blends of stocks and bonds might perform by going to Morningstar's Asset Allocator tool.

One final note:Diversifying your portfolio among a variety of asset classes won't generate the highest gains or totally immunize you from losses. Over the long term, however, such diversification should allow you to earn returns large enough to grow a decent nest egg, and do so without subjecting you to outsize risk.

If nothing else, you'll definitely be better off than you would be by continuing to engage in the fruitless exercise of trying to exploit the market's ups and downs. To top of page

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