Last night, I saw a couple on the news tearfully describing the recent loss of a substantial part of their retirement savings in the stock market. They are apparently only a few years from retirement and now have accounts that might support them for three or four years, instead of ten or twenty years. As I watched this tragedy unfold, two thoughts occurred to me:
1) If they are only a few years away from retirement, why is so much of their money in the stock market?
Pretty much every retirement strategy says you should move your investments out of more volatile areas (stocks, mostly) and into more stable areas (bonds, mostly) as you get closer to retirement. What kind of planning were these people doing? Did they have a financial advisor? (If so, they are clearly due a refund of any advisory fees.) Even if your retirement accounts are run through your place of employment, you should still get some say over where your money goes. Start thinking, reading and planning about what kind of lifestyle you want to have in retirement, and when you want to retire, and structure your accounts accordingly.
2) Technically, have they actually lost any money?
Most people forget (or don't realize to begin with) that any money invested in the stock market is only real at two points: when you put it in, and when you take it out. What happens in between those two points is all virtual.
Let me explain. The day the Dow dropped 778 points, I was riding the bus home from work. The bus driver struck up a conversation with me, and he mentioned the Dow drop. I replied, "Yes, they say it erased about $1.2 trillion worth of value."
"Really?" he replied. "Where did that money go?"
I answered him without even thinking about it. 'Well, nowhere," I said. "It wasn't really there to begin with."
(Now, I am looking at this from the perspective of a stockholder, so save your comments about market capitalization and quarterly reports, etc. etc.)
You buy 10 shares of Company X at $10 per share. Three months later, you sell your ten shares at $15 per share. You make a $50 profit. What happened during the three months in between?
It doesn't matter.
Let's say that at the end of month 1, the stock was down to $8 per share. But you didn't sell any.
At the end of month 2, the company announced that it was merging with another company and the stock went up to $18 per share. Again, you decided not to sell any.
Then at the end of month 3, the stock was at $15 and you decided to sell for a profit.
Whether the stock goes up or down in the intervening period, all that really matters is what you put in and what you take out.
You could have sold at $18 per share and made a nicer profit. Or you could have panicked, sold at $8 per share, and lost money. But you didn't.
The value of the stock you buy doesn't matter until it's time to sell it.
Tax-wise, profits and losses are recognized when you sell, not before. So panicking and selling at a loss when your stocks are low only makes those losses real, as opposed to being losses "on paper". Also, you need to consider exactly how much real money you put in to start with. You have only lost money if you end up with less than that amount after you sell.
Just some food for thought...
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