The Value in Staying the Course in Your Financial Choices

Don't Let the Economy Disrupt Your Financial Plan

Why you should stay the course in your financial plan

Do you let the economy influence your financial choices – particularly within your retirement accounts and other long-term accounts?

Maybe you shouldn't. Maybe you should stick to a plan, regardless of whether the economy is booming or tanking.

I know, I know – that sounds crazy. But let's explore this idea for a moment.

The stock market changes daily. At the time that you're reading this article, the market might be moving in any given direction.

Maybe the stock market is plummeting again, maybe it’s currently rising, or maybe it’s staying the same.

Regardless of what’s happening right now, there are going to be times when the market takes a downturn or crashes. When that happens, a lot of people see the current market as dangerous.

People prefer not to invest money in a falling market. “Don’t catch a falling knife,” they reason.

That’s not the best method of action. It’s counterintuitive, but contributing to the market every month, no matter what, is one of the best strategies you can use to grow your wealth.

It doesn’t matter whether the market is dropping, rising, or staying the same. Your job is to make the same contribution each month as you always do.

In short, stay the course. Let’s take a step back and explain exactly why this is a good idea.

What Happens When You Stay the Course

Let’s assume you began investing in January 2007 at the height of the stock market bubble.

You bought a broad market Total Stock Market Index Fund from Vanguard at $33 per share. You invested $500, which allowed you to purchase 15 shares. You continued to do this every single month.

By the summer, the price was $37 per share. You continued investing that same $500. At that point, $500 only bought 13.5 shares.

However, the fund price dropped back down to $33 per share in January 2008. That same $500 per month bought you 15 shares once again.

By making the same contribution every month, you bought more shares when prices were cheaper and fewer shares when prices were more expensive.

After 2008, the economy collapsed. In January 2009, this index fund cost only $22 per share. You bought 22 new shares every month as you continued investing $500 per month. As prices decreased, you were able to scoop up additional shares with the same amount of money.

Prices returned to their former levels of $33 per share as we began to come out of the recession in 2011. The same $500 per month was once again buying 15 shares. You’re buying fewer shares now that the prices are higher.

What Happens When You Stop Saving

Let’s contrast that against your neighbor’s strategy. He also purchased shares in 2007 at a cost of $33 to $37 per share.

However, when the prices dropped during the recession, your neighbor got scared and stopped buying more stocks. Never catch a falling knife, right?

When prices rebounded in 2011 back to the $33 per share mark, your neighbor started contributing again. What happened as a result?

Your neighbor missed the opportunity to buy in at $22 per share.

He also missed the subsequent 150% growth in prices by avoiding the market during the time it was low. Your neighbor has actually performed far worse then you have.

How to Manage Risk

There’s a normal human tendency to project the present into the future. When the stock market is declining or weak, we’re tempted to believe this bad news will continue on forever.

In reality, the market rises and falls just like a roller coaster. Your job isn’t to try to time the market. It’s to invest in a mix of stocks and bonds proportionate to your age, timeframe, and risk tolerance.

As a very general rule of thumb, 110 minus your age is the proportion of your portfolio that should be in stocks. The rest should be in bonds or cash equivalents.

For example, if you’re 40, keep 70% of your portfolio in stocks such as stock index funds or ETFs, and keep the remaining 30% in bond funds.

If you want to be a little more conservative, change this equation to 100 minus your age.

There are two key takeaways here.

One is to continue investing every month regardless of what’s happening in the overall market. The second is to adhere to your asset allocation plan. This is your ideal stock and bond portfolio split based on your age and risk tolerance. You shouldn’t base your asset allocation on outside factors beyond your control.