Setting Smart Goals with Your Investment Accounts - What Do I Do if This Is a Recession?

For the past two years, the stock market has performed like a yo-yo. One day, it's up. The next day, it's down. No one agrees on where the economy is headed.

Some people are ready to retire and need to decide how to roll their 401k accounts or pensions. In that case, it is very important that the money last through retirement.

Others want to make sure that their retirement accounts are able to continue to grow so that they can retire. There has been a lot of talk about whether we should be moving our money in an effort to save it from losing any more than it already has.

Since the equity market has been falling, we've heard friends talk pulling out of growth stocks. Some are pulling their money out of value stocks. People are cutting their losses in real estate investments.

There is talk about moving to bonds for less volatility. Others are moving to CDs (certificates of deposit) for safety and stability. Still others are willing to sit tight in the money market or in a basic savings account until things seem to settle down.

So, what is the best thing to do in an economic environment like this? The truth is that, in setting smart goals, you have to do what is best for you and your household. You have to do whatever helps you sleep comfortably at night.

Make an educated decision

However, before making any changes, it is also important that you make an educated decision. Remember that history tends to repeat itself. Therefore, I will share with you some historical trends in the financial world that can help you decide what to do.

Now, historically, equity markets do drop as a recession draws near. However, they do eventually stabilize and then rebound. I'll give you two examples.

When the stock exchange closed in 1914, the initial reaction from investors caused the market to fall about 10%. However, roughly four months later, the market rose approximately 21%.

We all remember the terrorist attacks that occurred on September 11, 2001. Investors' response to those attacks resulted in the market dropping just over 14%. Again, nearly four months later, the market was up almost 25%.

According to Dr. Jerry Webman, a chief economist with OppenheimerFunds, Inc., "the S&P 500 rose 24% on average in the six months following ten of the last eleven recessions. The one outlier year was 2001 where stocks were excessively overvalued heading into the downturn."

The S&P 500 is an index containing 500 large, publicly-held companies. It is considered to represent the U.S. economy.

The most important thing to keep in mind is that the losses you see on your account statements are only paper losses. They are not real losses until you sell the investment.

In selling an investment, you are not only realizing that loss, but also taking yourself out of the market. This is likely to cause you to miss the market's rebound. Let's see another illustration.

Over the last 20 years, the market was up about 9.3% per year, not counting dividends. If your money was not invested on the 20 best days of that entire 20 year span, your average annual return would have been cut almost in half - to 4.8% per year.

We don't know when the best days will occur, and not being ready can significantly affect your returns.

It's hard to beat equities over the long term

As far as bonds and CDs are concerned, neither will give you the returns of the equity market. While they may be a good addition to your portfolio, they cannot replace equities.

While bonds can give you a consistent, fixed interest rate, that return will be lower than the returns you can earn in the stock market. It is also incorrect to believe that CDs are stable investments. CD rates fluctuate constantly. Your rates are very likely to change each time your CD matures.

What makes matters worse is that the low returns that CDs provide are almost wiped out when inflation and taxes are taken in consideration. For example, in 8 of the last 20 years, the rate of return on 6-month CDs has been less than 1% after inflation and taxes. Your money is not growing.

Before making any changes, review your goals. If you have some short term financial goals, it may be best to make some changes. However, if you are truly investing for the long term, you should consider the market volatility only a hiccup. It has happened before, and the market will rise again, just like it has over the last century.