Memo to Investors: Don’t Panic

As the stock market continues to fall — the Dow Jones Industrial Average dropped dramatically yesterday, hitting below 10,000 for the first time in five years — investors are wondering if their retirement funds might be safer in a mattress than in a mutual fund. Consumer spending is down, auto industry sales have dropped, and recent Bureau of Labor Statistics data show that workers are staying in their jobs well past age 65.

To find out how investors can weather the storm and still save for retirement, BU Today spoke with Irena Vodenska, a former head trader at the European Consortium of brokerage houses in New York and a past vice president of convertible securities trading at J. C. Bradford & Company. Vodenska is a lecturer in finance at Metropolitan College, where she teaches Investment Analysis and Portfolio Management.

BU Today: The Dow fell below 10,000 yesterday for the first time in five years. What’s the first step for anxious investors?
Vodenska: The first thing that I would say is do not panic — if you react out of panic, you usually make mistakes. Just sit back, look at your portfolio, and think. Do not make any drastic changes just because of the current financial situation.

If you are 10 to 20 years from retirement, this really doesn’t matter for your plan. The savings will go down at this point as the financial crisis unravels, but when you invest for the long term, I recommend doing nothing in the short term — eventually the market, in the long term, will rebound.

If you are a short-term investor, close to retirement, you still should not panic. I would hope that people who are close to retirement by now have a large majority of their assets — over 90 percent — in fixed income. So stick with it. The return will not be that high for the portfolio, but the certainty is there, and that’s what you need. You don’t need to gamble — it’s not the time for that now. Just make sure that you have a certain level of income coming out of your fixed-income portfolio to cover your living expenses.

Can investors take advantage of a market decline?
There is a bright side when the market is down, because usually the macro factors that influence the market take the majority of all the companies down. But in every industry there are better and worse companies. For example, not all the technology companies are created equal — some are better run, and others have bad management teams. The crisis period is really when they will become well differentiated. Even though all of them will slide down, some will do better than others on the rebound. Look at their fundamentals — certainly, there are buying opportunities.

There’s been a lot of talk about failures of risk management at the major firms. How can individuals practice better risk management on their own?
First, diversify. Second, hedge your risk. Third, monitor your portfolio closely. And fourth, rebalance if you feel it’s necessary.

So what do I mean by diversify? Whatever asset classes that people invest in, they should not be investing in one particular fund, or even two particular funds, just because they like them so much and they feel like they know them well. It’s really important to diversify across industries, to diversify even internationally. I highly recommend at least 10 percent of your portfolio be internationally invested. Yes, there is higher risk there, but there is higher potential. And there are some high-growth economies all around the world where we can capture some of the returns, like China and India. So the diversification is really important.

Hedging your risks: if you invest in certain funds that are affected by certain factors, try to find a different type of industry that moves a little bit in the opposite direction, or at least differently from the one that you invested in. In other words, invest in funds with low correlations, and you will be able to lower your risk for the type of return that you’re expecting.

Monitoring: I can’t stress this enough. Be on top of things. You want to monitor your portfolio, see where you’re invested, see the general market conditions, the general financial situation, and think about whether you’re in the right place or you should move to some other area. It’s very important.

Rebalancing: if you feel that a certain area or industry is not that attractive or doesn’t grow at the rate that you expected it to grow, find something else. Find something more attractive and that you believe in — for example, the energy industry. There are different types of energy sources these days, and alternative energy sources have become more popular. If you think that’s the future, find some funds that contain alternative energy sources, and invest in them. You know, if you have 10 to 20 years until retirement, that’s probably a pretty good bet the way things are going right now.

If you’re just getting started investing for retirement, should you be discouraged?
Quite the opposite: people who are just starting should look for opportunities. Try to be more tolerant of risk, because you have a longtime horizon, and many things can happen. There is some value in taking a higher risk, because you will be accumulating higher returns over the years.

It’s just the wise thing to do to be a little bit more aggressive. And even if you’re a person who is very risk-averse, you’re young, so just try to get out of that shell for a little bit. Read some books on retirement, and learn about why you should be very aggressive when you are young. Maybe some resources can get you out of that high-risk aversion shell. There are great opportunities now to invest. By all means, do not be discouraged, because you will not need this money right now, or even in one or two or five years.

What’s the key to getting started on an investment portfolio?
It’s really important to think about your objectives and your constraints. The objectives will be what type of risk you can bear and what type of return you would require. And these really go hand-in-hand. So if you’re more tolerant of risk, you could expect higher returns. And usually thinking about the objectives, you want to think about how to preserve your capital, and then how you appreciate it. You don’t want to deplete your capital, and decrease in value. But at the same time, you don’t want to be overly conservative. And you still want to consider a certain percentage of your portfolio the way you feel comfortable.

Some people would feel more comfortable investing a high percentage of their portfolio in riskier assets, and some people will not. So these are really the questions that every investor should pose and then answer in a policy statement. And once you’re comfortable with that and know how much risk you can bear, you can start thinking about how you want to invest. Once you assess your own style and personality, then you want to look at more concrete constraints: your time horizon, your liquidity needs, and your tax concerns.

Usually, younger people will be highly invested in equities, because the time horizon is longer, and even though there will be higher fluctuations in between, eventually we will see the market going up. People who are closer to retirement will be invested less in equities and more in fixed income. That’s natural.

If you’re afraid of investing now, don’t be. If you want to change your portfolio, don’t do it if it’s not necessary. And if you want to take advantage of the current situation, by all means, search for good deals. It’s a bad time to bear. But it can also be a time of opportunity.

BU faculty and staff can make an appointment with the individual counselors at Fidelity and/or TIAA-CREF to discuss their retirement account. The counselors are on campus at the Human Resources Office once a month based on the following schedule:

Employees interested in scheduling an appointment should call Fidelity at 1-800-642-7131 and TIAA-CREF at 1-866-904-7802 or log on to
www.tiaa-cref.org/moc.

Robin Berghaus can be reached at berghaus@bu.edu.