Don't Panic

"In many of the more relaxed civilizations on the Outer Eastern Rim of the Galaxy, the 'Hitchiker's Guide' has already supplanted the great 'Encyclopedia Galactica' as the standard repository of all knowledge and wisdom, for though it has many omissions and contains much that is apocryphal, or at least wildly inaccurate, it scores over the older, more pedestrian work in two important respects. First, it is slightly cheaper; and second, it has the words 'DON'T PANIC' inscribed in large friendly letters on its cover."
--Douglas Adams, The Hitchhiker’s Guide to the Galaxy

I claim no originality in quoting Douglas Adams in reference to the current financial crisis, but then, not everyone reads the same sites I do, and you might have missed it. I think the message is a good one: financial decisions made in a mindset of panic are reactive, emotionally charged, and fraught with danger. (I thought of adding some more dire descriptions, but you get the idea.) The markets are ugly right now, and apt to get uglier regardless of the outcome of any bailout plan. But that doesn’t justify a rush to convert your entire retirement plan to Treasurys. So what to do about it?

Keeping the Faith
In our case, we have at least 30 years until retirement, so we really aren’t adjusting our investment strategy in light of current events. Our active 401K is still set to a drop the lion’s share of contributions into a set of no-load index mutual funds. (What this means is that these funds don’t charge sales commissions, just a small maintenance fee; they can do this because the fund is balanced by computer to hold portions of the companies that make up some of the major US and International stock indexes, so there isn’t some brilliant manager being paid millions to move our money in and out of stocks.)

We believe that the companies that comprise the major stock indexes are fundamentally sound. There is likely to be a period of slower growth, since the finance companies in these index funds will no longer be able to borrow so aggressively to swing their earnings, but the industries overall will continue to grow, and the indexes will track that. Unless there is a dramatic calamity that fundamentally alters the way the industrialized world does business, stocks will continue to go up over time. And if there is a dramatic calamity, say, something that devalues the dollar like a 1932 Deutschmark, the 1.5% we get by parking our retirement in a money market account will only result in a few more dollars in the wheelbarrow we cart down to the soup kitchen to pay for dinner.

Diversifying
So, we will keep chugging along with our index funds and hope the 2040 market is better than the 2008 market. I imagine folks like our parents and other boomer types are somewhat more concerned, enduring the equity haircut but lacking the long horizon to grow it back. My heart goes out to people like the widow profiled in the WSJ who had over 50% of her retirement income from Wachovia Bank dividends. We saw this with those at Enron too, who lost their entire retirement, and also those whose portfolios leaned too heavily toward the tech sector pre-2001. I saw one article asserting that the current crisis had shown that diversification as an investment strategy had failed, since everyone is losing. I think they miss the point. You don’t account for the possibility of 700 billion dollars in bad debt weighing down the economy without taking a system-wide shock. No business I’m aware of can function without borrowing. To paraphrase Churchill, diversification is the worst investment strategy, except for all the others that have been tried. We’ve settled on indexing (along with other allocations) as a low-maintenance, hands-off way to diversify our stock holdings, but there are many other ways to keep your portfolio diverse. If you don’t have a head for this kind of stuff, call your 401K administrator and ask to be enrolled in a preset mix of funds determined by your retirement date. They cost a little bit more but they will save you in the long run, since the guys running the funds will automatically balance your holdings as you get closer to retirement. Then if there’s another doozey market swoon like the current one right before you retire, hopefully most of your holdings will be in bonds rather than stocks.

Playing Defense

Stanley and Danko’s excellent Millionaire Next Door throws a nice sports metaphor into the world of personal finance. They write that people spend a lot of time focusing on offense, that is, bringing in as much money as possible, while neglecting defense, that is, controlling expenses. I’ve seen a few chicken-little articles this week highlighting the uncertain economic times and recommending, among other things:

• Canceling cable television

• Brown-bagging lunch at work

• Eating out less

• Buying generic groceries and health/beauty items

I wrote about implementing some of these practices last year as our adoption expenses loomed and we were in the wonderful world of dual housing payments. Now that we’re back to one housing payment, we see no reason to change any of the frugal habits we evolved to survive Great Financial Squeeze of 2007. (We did blow a fair amount at a recent dinner to a local seafood joint, but it was our first dinner out, sans one year-old, since April, so we felt entitled.) Consumption will rise to match (or exceed) income unless we fight it, one dollar at a time. The best way to play defense is to track expenses religiously, then run down and cross off anything that does not provide lasting value. I don’t mean to imply that anything not made of cast iron should be discarded. Vacations, dinners out, and flowers for the wife most certainly provide lasting value. It’s the battery-powered lawn gnomes and all that other good stuff you hadn’t planned on buying, yet somehow makes it to the Costco register, that needs to be chased down and eliminated.

In the Hitchhiker’s Guide, the protagonist sees the Earth being destroyed to make way for an intergalactic bypass. We clearly aren’t at that point yet, though the news pundits at times do sound like they’re spouting Vogon poetry; you just wish they’d shut up. Hopefully you’ll remember not to panic, even if you didn’t bring your towel.