We continue to believe that the market will turn around and that it could happen fairly quickly. By waiting for a sign that it's safe to get back in, you risk missing out on the biggest gains; and missing just a few of the highest return days can reduce your overall returns quite dramatically.
Our prescription: Think about how much of the money in your investment portfolio you will need to pay for expenditures in the next three to five years, then set that amount aside in a money market fund or CDs. What's left in your account should be long-term money -- funds you will not be drawing upon for five or more years. This money should be invested in a diversified portfolio incorporating a moderate level of risk that allows it to outpace inflation but still lets you to sleep at night. If you are not planning to draw upon your investments for five or more years and have the ability to contribute to your accounts, it makes sense to continue to do so and to buy securities at what will in the long run probably look like bargain prices.
We've been repeating this mantra since the downturn began and stand by it as the most sensible course of action. But, many people have reached the point where they don't want to hear it anymore. Adding to accounts that seem to shrink on a daily basis is more than they can stomach. They are accumulating cash -- building their checking, savings and money market funds rather than put any more money into the bottomless pit the market has become.
If you find yourself in that camp, here are some ways to make good use of your excess cash until you feel safe getting back into the market:
- Accelerate your mortgage payments. Paying extra principal will reduce the time it takes to retire your loan and yields a guaranteed rate of return -- the interest rate on your loan minus the value of tax deductions (for interest you will not pay in the future) you are forgoing. Reducing your debt increases your overall net worth just as much as increasing your assets -- and it's a sure thing.
- Prepay tuition. Check with your child's college or private school to see if they will allow you to prepay for one or two years of tuition. Tuition increases have outpaced general inflation for years, and if you believe the market will continue to drop it makes sense to pay future tuition bills now rather than waiting for your education fund to shrink further. Our caveat on this -- don't pay too far ahead -- especially if your child is starting at a new school or not entirely happy with the school she attends.
- If you definitely plan to purchase a house, remodel, buy a car or other big-ticket item in the near future, it might make sense to dive in now. You'll have great bargaining power in markets that are starved for buyers.
- Invest in yourself. If you've been thinking of going back to school to improve your job skills or train for a new career, use some of your cash-on-hand to cover the cost.
- Remember to look for opportunities to harvest lossses in your taxable accounts. Sell losing securities to capture the losses (up to $3,000 each year can be deducted from income, the remainder can offset realized gains this year or in years to come). Invest in another, similar fund if you want to be positioned to participate when the market rallies, or keep the proceeds in money market or other stable asset classes if you can't bear the risk. Just remember that you're locking in losses when you sell in a down market and don't reinvest in equities or stocks.
And a final reminder: you should always keep enough cash on hand to cover at least six months of living expenses, more if your income is at risk or irregular. These suggestions are only for investors who have a reliable income source that leaves you with excess cash you would normally be adding to your retirement or investment portfolio. We are not endorsing an irrational spending spree or depleting your cash reserves to pursue the ideas above.
Above all else, be sensible and plan to return to regular saving and investing as soon as possible.
Copyright 2009 Money Dames
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