5 ways to protect your nest egg from a volatile stock market

by Jim Sloan

The latest economic news has not been especially good for people who are approaching retirement and moving their money out of the stock market and into "safe investments" like savings accounts, online savings accounts, a certificate of deposit or money market accounts.

Conventional wisdom holds that you should reduce your exposure to stock market volatility as you get closer to retirement by looking for the best cd rates or high yield savings accounts, and moving an increasing percentage of your portfolio into these FDIC-insured safe harbors.

This type of approach protects you from sudden drops in the stock market--such as the slide that occurred after Standard & Poors lowered the United States' debt rating--and keeps your nest egg from shrinking suddenly and forcing you to return to work after retirement.

But since 2008, interest rates on many Cds, and even the best savings accounts, have hovered just over zero percent. And the recent decision by the Federal Reserve to keep interest rates low through 2013 means that savers are being penalized for doing the right thing by putting their investments in money market accounts or savings accounts.

Interest rates are lagging behind inflation

According to USA Today, the average interest rate for a 1-year certificate of deposit is 0.43 percent, and the average money market fund is yielding 0.1 percent.

As the Wall Street Journal recently noted, our bills are going up 5 percent a year or more, so when our savings accounts are earning such low interest rates, we are effectively losing money. When interest rates are kept below inflation rates, economists call in "financial repression"--doesn't sound good.

Some reasonably safe alternatives

So what are you supposed to do? Here are some options:

  1. Ride out the market fluctuations: Although there was a big dip in the market following the Standard & Poors announcement, the market has clawed its way--at least partially--back. USA Today notes that since the Fed's decision on interest rates is aimed at getting people to essentially quit saving and start spending, more and more people are likely to continue investing in the stock market, driving prices back up.
  2. Move out of stocks and into fixed-income funds: According to USA Today, that's what many 401(k) investors have been doing since the first post-S&P plunge.
  3. Purchase Treasury inflation-protected securities, or TIPS: According to the Wall Street Journal, the interest paid on TIPS increases with inflation, which secures the money's purchasing power.
  4. Invest in bond funds that invest in short-term debt: According to the Journal, this option is good for investors who won't need the money for two or three years.
  5. Build up your portfolio of high-quality dividend-paying stocks or exchange-traded funds, which are mutual funds that trade like stocks. According to the Journal, ETFs with high-dividend stocks yield around 3.5 percent.

Regardless of your strategy, it's important to avoid rash, fear-driven decisions based on short-term market fluctuations. According to the McClatchy-Tribune News Service, studies show that stocks bought and sold within a year can lose or gain as much as 40 percent, but stocks that are held for at least 10 years almost always make money.

Reconsider bailing on the stock market

by Jim Sloan

If the recent downturn in the stock market has you worried that your investments need to be in a safer place--such as a certificate of deposit or a high interest savings account--it might be a good idea to take a deep breath and reconsider.

According to Forbes.com, although declining stock values could hurt retirement savings accounts such as your 401(k), the stock market drop also allows you to buy more stock for your money now that prices are low. That's why smart investors don't rush to sell their stocks when prices are down, Forbes said. This phenomenon of maintaining steady, regular investment in stocks despite fluctuations through 401(k) savings account is called "cost averaging."

Time to increase savings rates?

The low price of stocks that accompanied the 634-point drop in the Dow Jones industrials in early August might have been a signal to increase your 401(k) contributions in an effort to capitalize on the bargains, Forbes noted.

Many of us have fresh memories of the pounding our investments took after dot com bust in 2000, and then again in 2008 in the wake of the housing market collapse. According to the Los Angeles Times, American investors in general have become more skeptical about the value of putting investments into a stock market that seems so volatile.

For instance, small investors have pulled $350 billion out of the stock market in the last 5 ½ years, the Times said, and continued to re-channel their money to such things as money market accounts, savings accounts and other options providing the best savings rates even when the stock market was doing well. There are roughly 100 times more Internet searches for "saving" than for "stock investing," the Times reported.

The big drop in the stock market followed Standard & Poor's decision to downgrade the United States' credit rating from AAA to AA+. That decision came on the heels of a Congressional showdown that had lawmakers deciding at the 11th hour to raise the nation's debt ceiling and continue to pay its debts.

The security of bonds

The drop in the bond rating also had many people with investments in bonds concerned about whether their money was safe. According to Kiplinger's Personal Finance, investors should not expect big changes in bond prices and yields in the coming months.

Although bonds' low yields in recent years haven't made them attractive to individuals, Treasury bonds remain a safe place for many banks, governments and insurance companies to park their money, Kiplinger's said.

If you own Treasury bonds, Kiplinger's recommends that you hold onto them until they mature. When that time comes, investors should consider investing in investment-grade quality bonds, such as corporate and municipal debt.

As Forbes.com notes, its important for investors to have the right mix of bonds, considered 'safe' investments, and stocks, which until recently can be counted on over the long haul to increase in value more than the best cd rates or online savings accounts. Selling stocks prematurely locks in your losses

Replenishing your retirement savings account

by Jim Sloan

With the country's unemployment rate stubbornly remaining high, many American consumers may be experiencing gaps in their efforts to build up their retirement savings accounts.

While temporarily halting contributions to a 401(k) plan or some other savings account may be a necessity for some people struggling to pay their monthly bills, those who do should remember that we'll have to play a little catch-up once we resume working and making retirement investments.

Increasing your savings rate

A new study from T. Rowe Price finds that it's easier to get your investments back on track when you're younger because you'll have many more years to bulk up your savings accounts. But even for young people, not doing anything to catch up can be dangerous; all that money you neglected to save may never be compounded and can ultimately leave you short of your retirement goals.

Missing a year or so of retirement investments in your later years may also hurt and could require that you increase your savings rates higher than you would if you were younger. However, not catching up won't hurt your final savings accounts balances as much when you're older.

Either way, if you expect your nest egg to provide half of your retirement income at the age of 65, you will likely have to increase your savings rates after any interruption in your retirement savings.

Breaking down the numbers

If there is a gap in your retirement saving, the question becomes, "How much will I need to save to catch up?"

Assuming you earn $40,000 a year, get a 3 percent raise each year and put 13 percent of your salary - including the employer match - in your retirement savings account, and that those contributions return about 7 percent a year for 40 years, you should be able to retire at 65 with about $500,000, the T. Rowe Price study estimated. But here is what you'll have to do to make up for any gaps in savings:

  • A one-year gap may require you increase your savings rate to 14 percent.
  • A three-year lull might require you boost your savings rate to 15 percent if you're younger than 35, 16 percent if you're 45-55, and 18 percent if you're 55 or older.
  • A five-year hiatus means you should jump to 15 percent if you're 25-35, 17 percent if you're 45-55 and 27 percent if you're older than 55.

Of course, this is all easier said than done, considering that many people who are forced to suspend retirement savings are also forced to dip into their savings--be it a 401(k) account, an online savings account or a certificate of deposit--to pay bills during their unemployment.

T. Rowe Price's numbers are also lofty when you consider that the average worker only contributes 7 to 8 percent to their retirement savings accounts, according to the San Francisco Chronicle.

So it's likely that any boost you give to your savings in an effort to catch up is likely going to have to be combined with other adjustments--working later in life in order to save more, putting off collecting Social Security, and reducing your cost of living, among them.

Another option, the report said, is to establish the best savings rates possible for retirement early on. You can anticipate future gaps early in your career by setting a goal of saving 15 percent of your salary starting at age 25.

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