What you must know in case of a new crisis
Recent news has been conjuring images of 401(k) and college savings risks again – this time with a financial crisis in Europe rather than the U.S. housing mess.
The stock market has been anything but calm as elections in Greece, a housing bubble in Spain and banking problems in Europe threaten to unleash problems for the U.S. economy and the stock market. And people with retirement and college savings are asking themselves once again if they will be OK.
Seeking answers from the news is not likely to be reassuring. Much of what happens in Europe depends on leaders in 17 countries who have had trouble agreeing on plans to bail out banks and financially troubled countries such as Greece. So there’s zero chance of finding an expert who can accurately predict what will happen to your 401(k), IRA or 529 college fund investments.
But here’s what you can do to get a sense of whether you will be OK.
Are you set up for immediate expenses and emergencies? One clear lesson of the past four years has been that counting on a job or investments to be there when you need the money is less certain than people imagined. Everyone needs an emergency fund, with money that is completely accessible on quick notice. A rule of thumb: Don’t put money you will need within five years into risky investments – stocks, high-yield bonds or gold, all of which can be volatile.
Is your child on the way to college? Make sure you are not taking risks with college funds if you will be paying tuition within the next couple of years. If you have a 529 college fund that invests money based on when your child starts college, take a look at how that fund is investing. Some take greater risks than others. Close to college, you want little or no exposure to stocks or risky bonds. For example, if your child is 15, you will need most but not all of your college savings within five years. Some financial planners still suggest a small stock exposure, maybe 30 percent, at that point to help grow your money for the last year of college. Stocks are not the only risky investment that ends up in 529 plans. If the economy grows weaker, you will not want a large exposure to risky corporate bonds and especially high yield or junk bonds. They can be mixed into your bond fund. How do you know? The safest bonds are rated AAA. Then come AA and next A. When bonds are rated BB, B or C, they are junk.
Are you saving for a home? Like the college saver, if you are planning to buy a home within five years, you should not be taking risks with stocks, stock funds or bond funds that invest in risky corporate bonds. Savings accounts, money market funds or CDs are more appropriate.
Are you saving for retirement? If you are in your 20s, 30s and 40s, you probably will come through any downturn within plenty of time to recover your retirement savings and earn more — even if you invest most of your 401(k) in stock funds or target-date funds with heavy stock-market exposure. The 2008-09 market crash helps you envision what can happen to your money during an awful period. People who were 100 percent invested in stocks have not recovered everything they lost when the market dropped 57 percent. But people who combined stocks and bonds have recovered. Take a look at $10,000 invested 80 percent in stocks and 20 percent in long term U.S. Treasury bonds just before the crash.
At the worst point in the crash in March 2009, that person would have had just $5,980 remaining. But three years later, they would have recovered and been making money again, with about $11,100.
If the thought of losing half your money temporarily is frightening, hold fewer stocks. A $10,000 investment half in stocks and half in bonds dipped to $7,800 in the 2008-09 crash. But three years after the worst point, an investor had $12,900. Financial planners often suggest 50-50 mixtures for people close to retirement age because they can survive the damage and recover later. Of course, the future might be different than the past.
Gail MarksJarvis is a personal finance columnist for the Chicago Tribune and author of “Saving for Retirement Without Living Like a Pauper or Winning the Lottery.” Readers may send her email at firstname.lastname@example.org.