Stay calm! Panic can hurt your portfolio

DES MOINES, Iowa
It's been a harrowing ride in the stock market lately. So much so that it's prompted scores of investors to pull money out of the market and park it in bonds or other fixed-income assets.

"We feel as human beings that we're supposed to do something," T. Rowe Price financial planner Stuart Ritter said. "But in reality very often the best thing for us to do is to stick right where we are."

As the market fell 9 percent in May, the daily movement of money within 401(k) accounts reached a level unseen since the first quarter of 2009 -- a period when the stock market was in free fall to its March 2009 bottom. Witness that on May 6, when the Dow Jones industrial average fell 3.2 percent, transfers to fixed-income investments were four times the average. Similarly, on May 20 when the market fell 3.6 percent, transfers to fixed income were more than three times normal.

Fearing volatility, 86 percent of the money transferred in 401(k) accounts went into fixed-income investments business consultant Hewitt Associates reports. It's the proper timing of a return to the stock market that's critical for investors.

An analysis of more than 8 million 401(k) accounts during the market collapse that began in 2008, found about 1.6 percent of the investors got scared and pulled all of their money out of stocks. The Fidelity Investments study found that those who didn't get back in the market saw their balance fall an average 6.8 percent, through March 31. Those who kept at least some money in stocks saw their accounts grow an average of 21.8 percent, Fidelity Vice President Beth McHugh said.

Here's a five-step action plan that may keep you from overreacting.

1. Develop a strategy

One of the biggest problems with retirement savings is the failure of investors to have a specific and written asset allocation strategy, said Pam Hess, director of retirement research for Hewitt Associates.

It's best to have a written plan with a specific allocation of stocks, bonds and cash investments. This allocation should be based on how far you are from retirement. Younger workers should have more invested in stocks. As retirement approaches the split should shift more heavily toward safer investments like bonds or money-market accounts.

A savings goal is another factor. For most of us the aim is to preserve our current lifestyle in retirement. If you need more money, you may want to risk more in stocks in exchange for the benefit of gaining more over the long term.

The third factor is how much risk you can tolerate and still sleep at night.

But above all, write down your plan.

2. Weather the storm

A big lesson from this economic downturn is that pulling out of the market at the wrong time is costly.

With cable television channels and investing websites scrolling minute-by-minute results, it's easy to focus on the daily market swings, said Chris Gardner, a financial adviser in East Syracuse, N.Y. He tells clients to shut them off.

He said clients frequently call during a period of market volatility and he reminds them that they have a long-term plan and patience will be rewarded.

3. Understand the market

Part of learning to ignore the swings is understanding that some amount of market volatility is normal. The key is to understand that it can be caused by different factors.

Today's market fluctuation is nothing like 2008 when credit markets were collapsing, banks had little liquidity and the economy was on the verge of a meltdown, said Rose Greene, a Los Angeles financial adviser.

Experienced market watchers know that the volatility caused by underlying economic problems is different from recurring market fluctuations. An influence on volatility during the summer is that people are on vacation, including Wall Street traders. That means fewer people buying and selling, resulting in smaller volume. The fewer shares that change hands, the more volatile the market can be.

4. Get help

If you manage your own 401(k) account, consider using online or call-in advice if offered by your employer. More companies are adding such services, Hewitt's Hess said.

If a target-date fund is an option in your 401(k) plan, consider using one. These funds are focused on the year you plan to retire. They establish your risk, shifting investments toward safety as you approach retirement. They also rebalance your account.

Hewitt's research shows that workers who were in target-date funds, managed accounts or sought advice during the period from 2006 through 2008 outperformed those who didn't get any help by 1.8 percent a year.

5. Rebalance

Rebalance your account at least once a year if you find your allocations have shifted plus or minus 5 percent from your targets. Failure to rebalance creates more risk. For example if a portfolio has 60 percent stocks and 40 percent bonds, a market rally could shift that to 70 percent stocks. This means you've left yourself more at risk than you had planned.

Research has shown that failure to rebalance means you have a 30 percent chance of exceeding your targeted risk level, said Brian Wagenbach, branch manager for Charles Schwab & Co. in Minneapolis.

Many 401(k) plans have an automatic rebalancing feature, while others make it simple to manage online.

If you take these few steps to reassure yourself, you may satisfy your instinctual need to react to the market, but instead of damaging your chances to save enough, you may just help yourself.