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Trevor Stone's Journal
Those who can, do. The rest hyperlink.
The Financial Crisis: What Should I Do? 
11th-Oct-2008 12:08 pm
mathnet - to cogitate and to solve
dr_tectonic asks
If I were informed about the situation at more than a casual level, are there actions I could take that would have a substantial impact on my current or future well-being? (I have some retirement funds, they're all TIAA/CREF and not easily accessible to do anything with them, and I'm not really planning on trying to do anything with them for another three decades.)

My current assumption is that the answer is "no", and that this is a situation, much like 9/11, where more information has at best a marginal benefit, and could do significant (emotional) harm by making me all upset about something I really can't affect, and so, like the dangers posed by nearby supernovae, asteroid impacts, random spree killers, rampaging sewer alligators, and the like, it's really best to just ignore it for the most part.
Short Answer:

I think "no" is the correct answer. Retirement plans are kind of like trees: make sure it's planted in a place that will, in general, get the right amount of light and water and then don't worry about it. If you start panicking about a drought and try to micro-manage your tree's growth (like digging it up and moving it to the other side of your house), you've got a good chance of doing more harm than good. Periodically check on your trees to make sure they're growing the way you want, but don't do so when you're panicked. Humans often make good short-term decisions when we panic (like "Oh no, house on fire, grab the cat and run!"), but we rarely make good long-term decisions in a state of panic.

So don't make any rash decisions, but make sure your investment portfolio is aligned with your investment goals, is diversified, and has low management fees.

Long Answer:

If TIAA/CREF works like my 401(k) plan, you've got a dozen or two mutual funds you can distribute a portion of your paycheck to. You can also log on and move money from one fund to another. Broadly, there are three types of funds based on what they invest in: stocks, bonds, and income. You don't know which particular stocks, bonds, or income investments are currently held by a mutual fund, but the prospectus of the fund will often provide a focus like "We will invest about 75% in technology stocks."

Stocks are small bits of ownership in a company, traded on a stock exchange. Stocks are the most volatile of these types of investment. They have the potential to increase value quickly, but they can also drop like a rock. (The Dow Jones Industrial Average, an index of a certain segment of the New York Stock Exchange, dropped to almost 8000 yesterday compared to its high above 14000 last July).

Bonds are less risky. Companies and governments borrow money in exchange for a promise to pay it back at interest over a period of time, typically several years. These aren't likely to suddenly drop half their value like stocks, but they also won't suddenly double in value. A specific bond will be worth nothing if the issuing company goes broke and can't pay it back. The value of a bond fund will drop if there are lots of people who want to buy bonds, driving down the interest rates.

Income investments are generally short-term loans at small interest rates. For instance, the commercial paper market lets companies borrow $1 million to cover payroll. They'll pay it back the next day for $1 million plus $10,000 (1% interest) the next day after they've processed sales.

In the case of retirement funds, like TIAA/CREF and 401(k) plans, paying attention to the current value of your investments is rarely a good idea. Since you and I aren't planning on doing anything with the money in those accounts for 30 years, we've got plenty of time for them to earn back the losses they've made this year and much more. The Dow Jones is the lowest it's been since we invaded Iraq in 2003, but it's still 10 times what it was 30 years ago. So your retirement plan is probably worth less today than it was a year ago. But in another year or five it'll probably be worth quite a bit more than it was a year ago and it will probably get back to that point faster if your money is in high-growth funds (stocks) rather than safer funds.

I've heard that the best approach to take to a retirement fund is to check on it every year or two and make sure you still like the risk/reward situation you're in. As you get close to retirement, you probably want to reduce risk (shifting from stocks into bonds and income funds) so that a big crash on your 65th birthday doesn't take out half your savings. But in your 30s, you can take a big loss and still end up in good shape.

If you'd had perfect foresight, you could have moved your high-growth investments at their peak (perhaps the middle of last year) into something safer (bonds or income) and then switch back once the stocks hit the bottom, assuming you can guess when that is. However, the current financial situation is largely a "credit crisis," meaning banks and investors are very reticent to lend money right now, since they don't trust it will be paid back. This fear is so pronounced that commercial paper trading stopped cold until the Federal Reserve stepped in. If banks are unwilling to lend each other money over night because they think there's a significant chance of failure, I'm not sure any investment is particularly good.

Also note that in addition to gains and losses due to the market, you're charged a significant fee. If the share price of the fund increases slightly, you can actually lose money if there's a large fee associated. If the share price decreases, you'll lose even more money. It can therefore be wise to invest in an index fund (the S&P 500, say) with a 0.1% expense ratio than in a fund with a 1.5% expense. In the latter case, you're hoping the fund managers are good enough to do significantly better than the S&P (which isn't always easy). If you've currently got high-fee mutual funds, now might be a good time to consider moving them to a lower-fee fund with similar risk and potential for growth.

If you have stock in specific companies (rather than through mutual funds), this would be a great time to look into their financial situation. If you're worried the company won't survive the current financial crisis, you might want to sell that stock. If you think it'll make it out, you probably should hold it until the price goes up after investors regain confidence in the market.

Further reading: Is My Money Safe? from the New York Times via TheMoneyMeltdown.com. Gotcha Capitalism, a book about hidden fees by Bob Sullivan.
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