The fear is palpable. I read it in your emails and I see it in your Twitters. The stock market has plunged (as I write this, two days in a row) and your retirement money is getting sucked dry. If you own a house, it’s probably worth less than it was a few years ago. Finally, your debt payments are taking up a large amount of your monthly income. It’s enough to make your head spin!
Given that nearly every class of investment seems to be going down, what is the best way to invest your money (for the long and short term) to buck the trend? In this post, I break down how to invest your money during this downturn, based on how long your investment horizon is.
Long-Term: 10+ Years
The two most likely assets that you will want to hold on to long-term are your house and your retirement account. Let’s examine each of those in more detail:
Housing.
If you own a house: Make sure you are on a fixed-rate mortgage (preferably with a term length of 15 years or less), and that you can afford the payments for months even if you were to lose your job or income. If you are on an adjustable-rate mortgage, call your mortgage company and negotiate to get a fixed-rate mortgage at the lowest rate possible.
If you are on a mortgage and cannot afford the adjusted payments, or you have housing-related debt that will be untenable long-term, this is the time to drop all emotional pretense and admit that you cannot afford the house you are in. Whatever you do, do not pull money out of a retirement account or put money on a credit card to pay your house payment. Your house will be worth less next year than it is right now — there’s no point in throwing good money after bad.
Call your bank and immediately arrange a short sale of your house, and then rent for a few years and save up money. There’s nothing wrong with renting — especially if it frees up hundreds or thousands of dollars a month that you would otherwise be throwing down a drain. Even with a foreclosure or short sale on your record, you will be able to buy a house again later, when your cash position is better and houses are more affordable.
If you rent: Continue renting for at least another year, no matter where you are. I have heard some people say they are planning to buy a house because they are afraid they won’t be able to get a mortgage next year. Do not make one of the largest financial decisions of your life based on fear! If you plan to buy a house, you should be saving money every month toward that house…putting you in a stronger cash position. Also, every year for the next 3-5 years, you will have more cash and houses will be worth less — a win-win proposition. Your patience in continuing to rent will be rewarded.
401(k)/IRA accounts. If you’re investing for the long term, keep your money in an index fund. The stock market may go down short-term, but that means your money buys more. Eventually, the stock market will recover. If you plan to retire in the next few years, you need to adjust your 401(k) and IRA out of the stock market now and put that money into a safe haven such as bonds.
Intermediate-Term: 5-10 Years
Pay down all your credit cards. If you already have debt, especially credit card debt, it’s key to pay it down as soon as possible. Tally up everything you spend money on (I track my expenses to the penny every month.) Really look at those numbers. Where can you cut back?
You may be surprised at what you’re spending money on — I found my boyfriend and I were spending over $1500/month on food. We’ve cut that by 60% since then, and found we enjoy meals out more than we did previously, since it’s no longer a burden to decide where to eat. I also cut my spending on clothes by 80%, cut our cable bill by $57/month by downgrading to basic cable, canceled a business membership I wasn’t using, and changed to a different gym, saving me about $300/month. Overall, I pared my spending by nearly $1000/month, just by tracking what I was spending!
What did I do with the extra money? I paid off all my debt except for my car payment — which should be paid off next year.
Short-Term: 0-5 Years
Cash will be king over the next few years, and you will be able to buy assets as large as houses and as small as electronic gadgets at discount prices.
If you have no high-interest debt such as credit cards, there are a few approaches you can take. Gold recently hit a long-term buy signal, dropping below $850 an ounce on the day the second bailout passed. I noticed this and decided to take the plunge. I pulled money out of my savings account and invested in 10oz. of gold coins. If gold drops below $850 an ounce again, I would recommend picking some up. Gold is an excellent hedge when times are rough and fear rides high.
I plan to sell my gold when it hits $1500-$1700 an ounce, and invest the proceeds into housing. If you currently are in a positive cash flow situation, you can do something similar. There will be a time in a few years when houses make sense again as an investment. That time is not now, but you can put your cash in CDs, high-yield savings accounts, or government bonds and wait patiently for that time. (Stay tuned here, as I will be posting about real estate regularly.)
For you cash savers, ING Direct has a $25 bonus just for signing up for their high-yield savings account. It pays 3% interest at this time. I have one and would recommend it. You can set up auto-deposits to it from your regular checking account, which I would also recommend doing, so you won’t be tempted to spend that money.
You should have several months’ worth of living expenses set aside in a high-yield savings account in case you need cash.
I do not recommend the stock market for short-term investing, unless you are an options trader who enjoys volatility. I have traded options in the past and they are tricky. It’s an easy to lose a lot of money quickly. Only attempt day trading if you really know what you are doing. Ultimately, after spending a month day trading, and having some wins and some losses, I decided it wasn’t for me at this time.
Summary: The Best Way To Invest
Paying down debt with an interest rate higher than 8% will return you far larger amounts of money than pretty much any investment right now. Do that, and get your spending under control, first. Cash will become critically important over the next few years; do what you can now to make sure you have as much cash as possible sitting in a high-yield savings account, CDs, or government bonds.
The stock market is risky for short-term investments. For the short term, consider gold, and stockpile cash to prepare for an eventual investment in housing or other distressed assets at low prices in a few years. Keep your eye open for bargains, but don’t expect too many right now. Next year around this time, there will begin to be some good deals, but don’t spend all your money then, either, as the housing/commercial real estate contagion will continue through 2012-2015.
There will be many chances to get firesale prices on assets in the future, but you must have the cash position to be able to jump on them when you see them. Have patience and do not act when you see the first good deal. Asset prices on everything from real estate to art to wine will decline in real terms over the next few years.
Long-term, keep your existing retirement account in the stock market and continue investing in it now while stock prices are low.
Finally, don’t panic! Focus on what you can control. You can control your spending. You can start a business to make more money. My IRA, like many of yours, is invested in stocks and has fallen 30% this year. I am, however, not concerned, since my IRA is very long-term and I will have many more years to gain that money back. In the meantime, I am happy to stockpile cash, invest in gold below $850, invest in my new business, and patiently wait this crisis out.
“Don’t waste life in doubts and fears; spend yourself on the work before you, well assured that the right performance of this hour’s duties will be the best preparation for the hours and ages that will follow it.” –Ralph Waldo Emerson
Recommended Reading:
- Why You Don’t Save Money, Even Though You Know It’s The Right Thing To Do. Can’t resist buying stuff? I couldn’t either. Learn how I stopped spending myself into oblivion.
- When Will Housing Really Bottom? Charles Hugh Smith wrote the blog post I have had on my mind for months now. Short answer? Expect houses to keep going down in value through 2013 or perhaps even longer. Start preparing for this eventuality now.
- Three Business Ideas That Will Help You Thrive During A Recession. I started my last business in 2001, at the bottom of the dot-com bust. You, too, can start a business that will thrive during a recession. You just have to know which trends to look for.
- One Decision That Can Make Anyone A Millionaire. A decision any of us can make that will make us $1 million.
Bookmark in Del.icio.us
Technorati
Digg This!
Review on StumbleUpon
October 8th, 2008 at 10:06 am
Great ideas Erica! The flip side of all this fear is that it comes with great opportunity.
Brian
October 8th, 2008 at 10:16 am
Great post. For us gold investing rookies…how do you actually go about investing in gold? Is there an online way? Go to a pawn shop?
October 8th, 2008 at 1:52 pm
JJ:
Gold really isn’t a very good investment. Not even as a hedge. Depends too much on timing. However, gold is excellent insurance. You’re too late (by about a week) for coins at reasonable prices from reputable dealers. US Mint isn’t even striking gold coin until further notice. If you can purchase in 10 oz lots, you can *some* coin (probably not US Eagles) from some dealers at 3-6% over spot. Your alternative is eBay.
Say what you want about the economy… about how gold is a lousy investment… how it’s overpriced… now go try and buy some.
Erica:
I agree with almost everything you write except staying in securities. I got out in October 2007, totally, all in cash. I risk losing a year or so of gains if I’m wrong. If I’m right, I save a 75-90% loss of value in my portfolio.
Yes. Think Dow at 3000.
Laugh if you want.
If I’m wrong, I don’t lose. I just don’t gain.
If I’m right, I won’t really need to work for a few years, given my current graduate-school-level frugality.
I don’t give financial advice.
What I will say to anyone is that if you need to “do something, anything,” do something that makes you feel better, and won’t hurt you in the long term. For me, that was moving to cash at market peak.
The forecast is the financial equivalent Cat 5 hurricane. It may dissipate. What if it doesn’t? It may not make landfall. But what if does?
If this thing does actually land, expect an entire generation or two that will be keeping 10-15% (at least) in cash in reserve, and possible a fair fraction of that in coin in safety deposit boxes, in heavy jewelry, etc. Think about that, think about a permanent capital reduction by 10-15%. This is what loss of trust means, and why Wall Street is petrified. Cash in a safety deposit box can’t be leveraged. And *gains* value in deflationary regimes.
BTW, prices on entertainment are going down.
October 8th, 2008 at 3:31 pm
BTW, just to be clear, I’m a huge gold bug! Love the stuff. And I do expect gold to increase in value, possibly radically, but my primary emotionally-driven motivation is gold for insurance rather than gold for investment.
October 8th, 2008 at 3:40 pm
Erica,
Overall, you’ve given solid advice EXCEPT for the advice on buying gold. Buying gold with money that is intended for the 0-5 year range is foolish. Gold is volatile and highly speculative, especially in this environment of fear when strong demand is driving up the price. The primary goal for this money should be safety. Safety trumps yield. A high yield, FDIC-insured savings account fits the bill, as you mentioned.
Dave:
I have to chuckle at your response since you’re the 3rd person I’ve seen today claim that they got completely out of the market at the peak last year. But what the heck, let’s assume you are telling the truth (maybe you can post copies of your account statements as proof). Your problem now is that you need to be right AGAIN - you have to predict exactly when the market bottoms so you can get back in the market. Picking the bottom is a highly unlikely event.
The market lost 45% of its value in the 2000-2002 dot com bust. Many folks were fearful and fed up back then and eventually decided to sell. Well, you know what happened? The market returned 30% in 2003 and most of those who sold missed the beginning of this run, further compounding their problems.
How about another example from the Great Depression: Say you decided to invest in a 60% stock, 40% bond portfolio beginning January 1929 and held this portfolio for 10 years, until December 1938. Your average annual rate of return would have been 5.9%. Not the greatest return in the world, but still decent. If you take into account that there was an average annual price deflation of about 2%, your nominal return would have been 7.9%. Contrast this with staying in 1-month T-Bills for these 10 years, which produced an avg. annual return of 3.0%.
Bottom line is that market timing does not work. Having a reasonable asset allocation, good diversification, and an eye on your long-term goals is what will work best for average investors.
Last piece of evident: What is the smart money doing now? Is Warren Buffett buying or selling? Discuss amongst yourselves.
October 8th, 2008 at 6:58 pm
Hi all,
Thank you for your excellent comments!
J.J., I bought my gold through Monex. You can check them out at http://monex.com — but you have to place an order on the phone. I bought 10 Vienna Philharmonic gold coins. They charge a small commission on top of the regular price, but their commission is far lower than other places. After you buy the coins, you will need to wire transfer Monex the money. I have done so and received confirmation today that they had gotten my wire and were in the middle of processing my order.
Gold is definitely in the middle of a boom, but I think the upside potential ($1500/oz) far outweighs the downside potential ($550/oz). If I’m wrong, I will happily hold onto it longer-term.
Brent, interesting comments. I sold my business on September 7, 2007, and said to many that I felt I had sold at the economic peak. The stock market peaked a month after I sold my business. I shifted my portfolio in December ‘07 from tech-heavy NASDAQ to a series of more balanced international funds, but unfortunately that wasn’t enough to stem the losses. So I bought gold.
Warren Buffett is in a buying mood, provided he can get the right terms. He’s a smart guy, having sat mostly on the sidelines over the past few years. I didn’t agree with his thesis that the bailout was needed, but I also don’t own a multi-billion-dollar share of Goldman Sachs purchased pre-bailout.
Keep the comments coming!
-Erica
October 8th, 2008 at 7:46 pm
brent:
Buffet doesn’t “follow the market.” By his own admission, he buys entire companies when it makes sense for him to do so. For example, he bought a lot of companies during the 70s, when the market sucked. I remember the 70s. They sucked. They sucked real bad. They sucked so bad that I eventually stuck out my thumb and hitch hiked out of the Rust Belt.
Another comment with respect to Buffet: the market cannot gain 5% per year, for 50 years. Do the math. Start from DJIA at, say, 8000. Or 10,000. Doesn’t really matter. Won’t work.
Getting out in October of 2007: I am very glad to hear many more people did the same. If you are really that interested in my personal finances, feel free to contact Mr. Blair Martin at SmithBarney’s San Rafael office (Lindaro Drive). I’ll be happy to provide anyone with his office number, and he will be happy to tell you that I did as well or better than any of his other clients in 2007. Including full out in October 2007 (modulo 9 shares of FLSCX so that I could buy back in case Soveiro [he's good, possibly really good] closes the fund, and 200 shares of ELSR, again, a highly speculative lottery ticket gamble, not at all what I consider an investment. These total < 1% of my “portfolio.”).
Picking a bottom: I never said I was going back in. I have no need to “pick a bottom.” I have no need to “right.” Like I said, if I am wrong, I lose, what, 10-20-30% gain in a year? Whoopee do. If I’m right, I won’t lose anything at all, while the people all around me too hesitant to make a decision lose another 50% of their portfolio. I know people right now that have lost 50% of their 401k. Friends even. Sucks.
This is what I want to see before I purchase securities, of any sort:
* Real financial statements with absolutely no “off-balance-sheet” holdings. I don’t mind me gambling with my money, but why should I allow someone else to gamble with my money? Especially when the current, unregulated gambles are intertwined to the tune of, what, 62 terabucks now? Freezing up credit so bad that foolish companies have their payroll at risk? Ridiculous. Since I cannot evaluate my risk in any rational way without accurate public financial statements, I’m not interested.
* Housing nationwide selling at historically viable prices (3x gross income), at supportable underwriting standards (20% down, 35% max DTI), without an excess of supply (3-4 months max).
* Political meddling is greatly reduced. Won’t consider buying anything until Congress finds something else to do rather than “fixing the economy.”
* Stock/securities ownership falls below perhaps 25% of general public. Way too many people in USA own stock or securities based on stock. Something like 75%. That’s too many. Who is left to buy? No more Greater Fools.
* Unemployment in the 6% range, or the U6 under about 10-11%.
* The USA comes up with a rational plan for dealing with $70 trillion in entitlements liabilities. By the time I graduated high school in 1978, I knew the odds of me getting social security were laughably low.
When the economy is fundamentally sound again, I’ll consider “investing.” But not until then. What the Dow Jones Industrial Index, or NASDAQ, or S&P, or whatever does between now and then is totally irrelevant to me. Until then, in a deflationary economy, cash is king. CDs work just fine. I’ll even take 5% per year guaranteed if I can get it. 5% per year with $20k per year contribution is $1M in 21-22 years. Guaranteed.
You are making the assumption that the economy is going to function next year, and the year after, as it did last year. You are making the assumption that the last 25 years of credit explosion at the expense of real wage gain is supportable. That basing 70% of an economy on consumer spending, with most of the remaining based on the so-called “FIRE industry” (an oxymoron if ever there was one), is supportable.
I am not convinced this is true.
Fact of the matter is, the economy is getting downright crappy. We’re overbuilt, unemployment is rising, personal indebtedness is at record highs, exports are falling. Nothing here indicates a sound and growing economy. Since I don’t have Buffet’s wherewithal, I see no advantage to me to purchase shares in someone else’s enterprise. I prefer to use that money to grow my own enterprise.
If I’m wrong, I stand to “lose huge gains.” If I’m right, I don’t lose anything at all.
Do you know what your risk is?
What if you’re wrong?
October 8th, 2008 at 7:56 pm
Erica:
It’s very telling that everyone says “gold is a terrible investment”… but when you actually go to try and buy some, “What Ho?” it’s pretty hard to find.
I’m in for ~10% net worth in coin, more or less buying and selling to maintain that ratio. It makes me feel good.
October 9th, 2008 at 4:40 am
Erica,
My investment strategy for the short-term is to invest in my online businesses. I have already seen a much higher rate of return than I could get elsewhere.
My advice is to start a side business during these uncertain times to improve your financial situation. You’ll emerge from the recession in a strong position.
October 9th, 2008 at 6:30 am
Maybe I’m crazy, but I haven’t changed a single thing in my entire investment strategy. Not only that, I haven’t even looked at my accounts since January this year, and I might take a look January ‘09.
I have 30+ years until retirement. I’m buying investment units every 2 weeks and enjoying these low buys. With dollar cost averaging I’m reaping the benefits the whole time.
I always learned to buy and hold for long term to build wealth. Admittedly I have the ability to sit this market event out, so I don’t know what I would do if I was close to retirement. But for all those people that have 10-15+ years to go. Don’t sweat it.
October 9th, 2008 at 7:52 am
Erica,
Your advice regarding a 15 year mortgage is not sound. If you are able to make the increased payments required by a 15 year mortgage, a 30 year mortgage is still a more prudent position provided the mortgage has no pre-payment penalties. One should NEVER take out a mortgage that has pre-payment penalties anyway. Then you can make the same monthly payment as you would for a 15 year mortgage but have the downside protection of a lower monthly payment should you lose your job or have any other financial setback. If you do make larger than required payments on your mortgage, the excess reduces the principal owed. Then for each subsequent payment, a greater portion of your manadatory payment goes towards the principal. This is a good strategy to have as an alternative way to save, while giving you options on how to use your cash.
October 9th, 2008 at 8:49 am
Be prepared to wait along time for those index funds to payoff.
It took the stock market until 1954 to return to the highs of 1929. If you factor inflation in it was even longer to return to parity.
NASDAQ closed at 5,000 in 2001. It is now 1,700. It will most likely take at least another 10 years to reach 5,000 again (ignoring inflation).
Most people have never known a bear market, but now is not the time to have money in stocks.
Commodities will be king for the next 15 years.
October 9th, 2008 at 11:24 pm
Personally, I’m not sure why you ranked the paying off of high interest credit cards so far down the road. I know that there is quite an addiction ( and for some a sense of security ) with credit cards, but within th realm of finances, they can be deadly.
That being said, it was interesting to read about using gold as a hedge. I’m not a huge fan of gold, but if I was more inclined I would likely use an ETF or mutual fund. Keeping all those gold dublooms around makes me feel too much like a pirate !
October 9th, 2008 at 11:58 pm
Hi all,
Great comments!
Gail, I would agree with you if interest rates were the same for 15- and 30-year mortgages. But interest rates are significantly lower for 15-year mortgages, making it an advantage to have one.
I would agree with having plenty of money in reserve, but I’d do it with a 15-year mortgage…which is one of the reasons I’m still renting.
@Steve: I’m enjoying the ride. I hedged with gold — so I agree with you — but I’m many years away from retiring, so my IRA balance is not that significant to my daily life right now.
@Joshua: I consider paying off credit cards one of the most important things you can do. Better yet, get out of the “can I afford the payments?” mentality and into the “Can I buy this with cash, NOW?” mentality. It will be a tough switch for most Americans to make…
Thank you again for taking the time to comment!
-Erica
October 18th, 2008 at 8:23 pm
“…Gold recently hit a long-term buy signal, dropping below $850 an ounce on the day the second bailout passed.”
Why is $850 a long term buy signal?
“…There will be many chances to get firesale prices on assets in the future, but you must have the cash position to be able to jump on them when you see them”
If you advocate keeping money in cash, why invest money in a commodity like gold? If gold has long-term investment potential I would think it should generally be due to monetary inflation, not deflation.
For that mater, for those suggesting investing in gold, why not just buy shares of the GLD ETF? (Is its expense ratio higher than buying/selling coins from a dealer?)
October 20th, 2008 at 8:44 pm
@Mike: I was watching several different newsletters that had mentioned if gold went back under $850 to buy it. Of course, it is at about $800 now…still a buy signal.
I am keeping money and cash AND in gold.
-Erica
October 24th, 2008 at 7:15 am
And now it’s $680 an ounce. Still a buy signal? Personally, I think cash is king right now.
October 24th, 2008 at 10:01 pm
Hi Andy,
The newsletter I am reading says: “Gold broke important support at 740 and could now fall to as low as 550.” I did say there was a downside risk to gold in the $550 range. If it does get down to $550, I may consider buying more. I didn’t buy to flip, however — I’m comfortable waiting a year, or two, or more with mine.
-Erica
October 27th, 2008 at 12:38 pm
Gold is good for speculation only. Long term has and will always stink as an investment (10-20 years). History has always shown this.
Short term investment is another story.
Gold is going to go lower (as most other commodities because of the deflationary pressures) but in the next 1-5 years will increase because of the issue of inflation or hyper-inflation. The US Govt is pumping soo much cash, that it will eventually happen. Buying an ETF like GLD or IAU is a much easier option than buying actual gold.
As a value investor who does not time the market IMHO buying stocks is a much wiser long term choice, especially those will loads of cash and/or good dividends. P/E of some companies are at historic lows.
December 4th, 2008 at 6:54 am
There were many people making lots of money by buying in the stock at low price or value investing. But I find it a bit too risky to do so in this economic downturn because it seems that there the effect of this financial crisis is too great and it may take really a long long time to recover. So, I think we will need to follow the trend and doing some shorting in the market as the best way to invest money.