Reader Question: Bear Market Worries, What About My Roth IRA?

Earlier this week I got a very good question from a reader:

Last week I decided to take your advice and invest $4,000 in a Roth IRA. My Roth IRA holds only one fund: Vanguard Target Retirement 2050, which holds 90% stocks and 10% bonds. Unfortunately, my timing was terrible: in a mere 3 days, my initial $4,000 investment has already fallen to $3,800, and there seems to be no end in sight. I keep reading all of these pessimistic forecasts about a looming bear market, so I’m very worried about losing my $4,000 investment.

My question for you is: Am I overreacting, or is there something I should do to protect my investment? I don’t need this money now; I invested it knowing fully well that I wouldn’t reap the benefits of it for another 40+ years. If the market keeps going south, however, I’m worried that I’m going to lose most of my $4,000 investment. Do you think I should try to withdraw my remaining money from the Vanguard 2050 fund and invest it in something less risky? I know that you’re generally opposed to attempts to “time” the markets, but I can’t help feeling foolish for investing $4,000 in a fund containing 90% stocks without taking into account the current market conditions.

I think everyone from time to time will question their investments. Again, I’m not a financial professional, but here is what I call “brotherly advice” – as in it’s the same thing I would tell you if you were my family.

1) There is virtually zero chance you will lose your $4,000. That’s part of the benefit of having a widely diversified mutual fund. An individual company, even a huge company like Enron, MCI Worldcom, or E-Trade has the possibility of going bankrupt and becoming worthless. For a Vanguard Target Retirement fund to go to zero, we’d be in Stone Age 2.0 and your primary concerns would probably be food, shelter, and guns.

2) Remember your time horizon. You chose the 2050 fund, which theoretically means you won’t need to withdraw for 43 years, and it seems like you’re okay with that. So then the question is – do you think you will end up higher or lower than $4,000 in 40 years? Because that’s what matters. If you think it will end up higher, then who cares what it’s worth today, or next week, or even the next decade? If you haven’t already, check out this chart.

3) Stop looking at your account. I’m a money geek, but I only look at my IRA accounts once a month to do my net worth updates. Honest! I have zero clue how I’ve done so far this month.

4) Risk = Reward. I know $200 seems like a big loss now, but really it’s just part of the deal. If there was no ups and downs, there would be no extra gain. No risk = bank savings account. You want the ups and downs! Adjusting risk tolerance is a very tricky thing – people tend to have low risk tolerance when the markets go down, and high risk tolerance when the market is hot. Not good. I think the gradual decreasing of risk provided by the Target Retirement fund is a better way to avoid such conflicts.

If 2050 is truly your time horizon, I say stay put. I could go on and on about the behavioral reasons against market timing and pull fancy stats from historical studies, but the above simple reasons are how I convince myself to step back and keep calm. I’ve lost way more than $200 over the last few months, and I haven’t sold a thing. If I do, I’ll let you know. Don’t hold your breath though. ;)

Comments

  1. well said. I had to stop looking at my long term investments. It was driving me to bing manic. One day your up, the next your scared, the next your angry. If you are in a good fund then just relax and keep at it. Over any ten year period the stock market has gone up 100% of the time.

  2. My Roth is down for the year, over all. I know this because it is my first year funding and thus far I have put in 3900, and i have less than that.

    It’s a little disappointing, but I do realize it is a long term investment and I shouldn’t worry about it.

  3. Independent George says:

    Heh.

    In February 2007, I brilliantly decided to re-balance to put $5000 of my Roth IRA into the Vanguard REIT index (roughly 10% of my total retirement portfolio) to diversify my risks. One year later, it’s down a little over 20%.

    I’m leaving it as-is, though; it still yields good dividends each quarter, and I can’t lose more than I put in. I still like my target portfolio allocation (50% US, 30% Int’l 10% REIT), which I still think will pay off in about 30 years. I still check my account daily because I’m a glutton for punishment, but I haven’t lost my nerve yet, and don’t expect to.

  4. I don’t mean to sound rude, but if seeing your broadly diversified mutual fund drop is making you question your investment, you really shouldn’t be buying stocks. Not that that is a bad thing, we all have our own levels of comfort with risk and your comfort level is what helps you determine where your money should be invested.

    You just need to know that stocks change frequently based on nothing more than emotion and you can’t let the daily or weekly fluctuations bother you. Bond funds will fluctuate a lot less and T-bills or cash even less so. Find the investment that lets you sleep well at night and go with that.

  5. Why put all $4,000 in one shot? The minimum initial contribution for Vanguard is like $2,000, why not put in $2,000 and then spread out the remaining $2,000 over a few weeks or months if the market is volatile?

    By the way, it’s ok for the fund to be down WHEN the market is also down. The right question to ask is “does the fund still outperform the market?”

  6. Consider yourself lucky. Many people lose 5% just on the load and another 1%+ on yearly fees. Your expense ratio is 0.21%. You’re doing well on the only factors you can control.

    However, “without taking into account the current market conditions” reeks of market timing and the notion that you would somehow know when the market is under or overpriced. I can’t think of a time since 1999 (perhaps even back to 1996′s “irrational exuberance”) when “current market conditions” weren’t worrisome for some reason. If you waited or continue to wait for perfect market conditions, you’ll be stuck in cash indefinitely. Your won’t ever have a dip, but your returns will be much lower.

    Comments like “Do you think I should try to withdraw my remaining money…?” make me feel bullish. This is like the opposite of Joe Kennedy’s stocktip for a shoeshine boy. It’s amazing that people sometimes appear to follow the reverse supply and demand effects. Prices go up, people want more — prices go down, people want none.

  7. Seems as good a time as any to remind everyone of one disadvantage with Roth IRAs – while you are not taxed on your gains you also cannot write off your losses. Ride out the ups and downs because no matter what, once that money is in a retirement fund it’s as good as gone for the near future.

  8. I have the Vanguard Target Retirement 2048 and have had it since October 2006. It has been about a year now, and I’ve yielded a profit of around $800+ based on my contributions of $6,000. I know, I need to add 2k more for the 2007 year to max it out. Remember, we can only contribute 4,000 a year. But each year the limit increases, right?

  9. First, congrats. You took your first step toward building a nest egg for your retirement (in 40+ years from now). Sometimes it can be difficult for someone to save any money, let alone put $4000 in the retirement account.

    Second, do some research on DCA ($ Cost averaging). Since you have funded $4K in year ’07, it is time for you to look ahead and find a way to fund your Roth IRA for year ’08 and beyond. Starting ’08, you can make contribution to $5k. Yeah~

    I know one thing for sure when it comes to stock market, and I’ve been right 100% of the time. I can predict what will happen to the stock market in 2008 as well. Do you want to know?

    My crystal ball tells me…market will go up and market will go down. Last time I checked the market history for last 80 years, same thing every single year. So don’t worry too much about what the market is doing NOW.

    Now, like FinanceandFat said, if this market is making you lose sleep at night (or losing $200 or so in past couple of weeks), then maybe you need to invest in something else other than stock market. Open up a savings account for next year, then see how your Roth IRA compares to your savings account in, let say 10 years.

    Remember this, you have 40 years of time horizon. 40 years! I wish I had 40 years of time. We all can’t predict the future, but knowing what I know, I feel very comfortable that stock market will do just fine.

    Good luck

    Anyhow, good luck

  10. Grad Student says:

    aa,

    The minimum for most Vanguard funds is $3000, except for the STAR Fund. So with $4000 available, putting it all in one shot is really the only option if you want to stick with mutual funds.

    I’m no expert, but in my opinion TR 2050 is just about as good as you can do with $4000. In fact, I’m 25 and I’ve got all of my Roth (~$4500) in there too. (and I’m not going anywhere with it)

  11. I agree! Yes, most definitely remember that it is a Retirement Account. It’s not a regular brokerage account that may one day be used for a down payment for a house – it is a Retirement Account. Your time horizon should be decades, not a mere week.

    I don’t even look at my retirement account balance that much anymore. I just tweak the portfolio on occasion but it’s not something that needs to be tracked on a daily basis. -R

  12. I would tell the guy who wrote the email to calm down and try not to worry so much. My wife’s 401k went down more than $200 from yesterday to today, and she’s only been contributing for less than 2 years. It’s the long-term horizon you need to look at. If it helps, just don’t look at the account at all. Maybe twice a year to make sure it’s still there =p

  13. I should also add, the two $4000 contributions ($8000 total) to her Roth IRA is only worth $7,852.40 today. The money was put into one of those Vanguard or T Rowe Price 2040 target date funds too. So over the course of the past YEAR it lost value. Am I worried? Nope…

  14. These market ups and downs will be little blips on a chart in 43 years. When the S&P goes from 1,450 to 44,000 by then you won’t even notice these 100 point fluctuations. (8.5% a year for 43 years from 1,450 is 44,608)

    So although spreading out your 4k intial investment could mitigate some risk of entering at a short term high in the market, the difference it makes will be quite minimal in the long term. The critical thing that will determine your return in the long term is what you own!

  15. Never make decisions on a long term investment based on short term market movements. I have seen a lot of people lose money re-allocating their portfolios (like moving into technology in ’99).

    Dollar cost averaging is a great way to offset short-term down turns, once you invest your initial minimum, most companies will allow you to invest as little as $25 per month. Some even allow for bi-weekly contributions. Mutual funds shouldn’t be purchased with large lump sums, if you are trying to guess the market, or if you think you have market skills, you might as well buy stocks.

  16. FatAndFinance said: “I don?t mean to sound rude, but if seeing your broadly diversified mutual fund drop is making you question your investment, you really shouldn?t be buying stocks. Not that that is a bad thing, we all have our own levels of comfort with risk and your comfort level is what helps you determine where your money should be invested.”

    I disagree. You either shouldn’t be buying stocks, or you should be asking around and getting informed. It would be better to learn an appropriate level of comfort and invest wisely than to stick to something safe with a terrible return. The author appears to be attempting to do the smart thing.

    It probably only seems terrible because of lack of experience. By next year or the year after, I bet everything will seem different for the (more informed and more experienced) author.

  17. VFIFX has been outperforming S&P 500 on 1-month, 3-month, 6-month, YTD, and 1-year charts.

    If people want to make money when the market goes down, they should instead buy a bear fund!

  18. I think a lot of people are way too unrealistic about the current situation about the U.S. economy. This slide in the stock market is like I said in the past, a “train wreck” created by U.S. consumers and their incredible spending habits.

    I would not be too worried about your Vanguard fund. You have a lot of time. However, you should keep yourself abreast of what is happening in the U.S. economy. It is not pessimism but realism in the market. Reality has finally caught up witho U.S. consumers. If you talk to people in the financial services industry local and overseas, a lot of them will say that unrelenting spending and borrowing of consumers from their home equity along with the country’s $10 trillion budget deficit is causing some of this initial turbulence.

    I had to put this disclaimer because sometimes people paint a very rosy picture on Jonathan’s blog about the macro and micro events occurring in the U.S. economy.

  19. >>> MO-HA-HA

    I laughed so hard because it is so true and MY T Rowe Price Real Estate Fund in 401 (k) too loosing like crazy every day … I try not to look because I only had $2000 in it now it like $1670.

    Who else is loosing? Let’s have a LOSER FEST. LOL…

    Oh, I feel so much better now after reading all these posts. Thank you, Jonathan.

  20. Ted Valentine says:

    No need to worry for the person that asked the question*. Just keep putting the money in and you’ll do find.

    Larry Swedroe wrote the following in his book, The Only Guide to a Winning Investment Strategy:

    “If you had invested the same amount on January 1 of every year for 30 years beginning in 1965, your return would have been 11 percent per annum. If you had been unlucky enough to have invested the same dollar amount each year on the day that the S&P 500 Index hit its peak for that year, your return would still have been 10.6 percent per annum. That is less than a 0.5 percent per annum difference in returns. And no one is that unlucky. If, on the other hand, you were lucky enough to have chosen the market’s low for the year, each year, then your return would have only increased to 11.7 percent per annum. That is an incremental return of just over 0.5 percent per annum. And no one is that lucky. If that does not qualify as much ado about nothing, I do not know what would. ”

    * PS – I hope you didn’t follow the advice of using the ROTH as your emergency funds, too.

  21. Does anyone here have some retirement money in Berkshire Hathaway B? I read so much good stuff about it and so wonder why it isn’t mentioned much on this blog (except for the ShareBuilder posts).

    Thanks.

  22. I actually had almost the exact same experience with a Roth IRA earlier this fall, and also with a target 2050 fund (different company).

    I kind of panicked at first. After a little while I realized I was planning on taking my money out in 2050 so the whole point was to have lots of risk now…

  23. Good to see some differing views. I forgot – my first Roth IRA purchase was Janus Mercury… AFTER it was a really hot fund. That went splat. So I started out even worse than this fellow.

    Pat – I used walk past it every day (to tutor at the SLC) ;)

  24. Hey My Money Blog,

    I love the picture of the bear. I went to Cal and I know exactly where that bear is, on lower sproul. I don’t even know if you went there or just found a random picture of a bear (a Golden Bear!) Haha..brought back good memories. Great blog, I love it. Best regards,

    And go bears!

  25. I’ll agree with some of what others have said- that is you really must find what your risk tolerance is. And if you’re willing to accept the ups and downs of the market and you’re in it for the long term then only look at your balance periodically. I’ve personally left a chunk of change in my RRSP in Canada (think of an IRA) over 5 years ago when I moved south. I check it annually which suits me fine since I’ll never touch it for at least another 25 years. I think the target retirement funds are a great place to start for beginner investing. Good luck.

  26. While I agree with the majority of the comments in that the reader shouldn’t worry about the short term changes, after all this is a retirement fund he’s invested in but in the same respect I feel where the reader is coming from.

    I have read that its “not timing the market, but time in the market” (or something like that) but in the same respect why start out on the wrong foot? I find myself feeling the same disappointment when I invest in a stock or fund only to see it dip in price the same day, I can’t help but think “why didn’t I wait until tomorrow”. Maybe this is a typical feeling of a beginning investor like myself.

  27. In a three day period last week my 401k balance dropped from $103,000 to $94,000but it does not worry me in the slightest. In fact, the ups and downs of the market will make you money in the long run. When it goes down you get more shares, and when it goes back up your value increases.

    My asset mix right now is 30% large cap, 40% small/mid cap, and about 30% international. In the past two years the value of my account has increased by $42,000, which consists of $13,000 in contributions from me and the rest is appreciation.

  28. I’m a market timer, and unashamed to admit it. Though I’d actually advise most people against it. If you’re investing in for the long haul, getting out of the market means you need to get back into the market. It’s hard enough time one event, and twice as hard to time two different events. As I said I do readjust my porfolio based on macro events in the market. My macro moves have been much better than my individual stock picks. I would never consider moving money completely out of the market, but I think when there are changing economic realties making rebalancing can make sense. But if you have no plan of action about what you’re looking to do then it’s better just stay investsted.

  29. Whew! Glad to see this article. I have been wondering the same thing lately. I just started my ROTH this year and maxed out for 2006 and am about to max out for 2007. But I check it too often and I’m getting anxious and thought about stopping contributions for awhile since they are doing so ‘poorly’. But you’re right, 40 years to go and things will improve.

    Also the minimum for Vanguard is $3,000 (except for the STAR fund) but once you have that set up you can DCA through automatic investments into that same fund.

    Go Bears! I like your blog even more now =P

  30. Just wanted to point out that “Risk” doesn’t necessarily equal to “Reward”.

  31. No offense but this is one of those ‘no duhs’ out there.

    Go ahead, buy high, sell low. jeeez.

  32. After a decade of contributions, $200 will look like nothing. Then you’ll be going “OMG, I JUST LOST $5000 TODAY!!!” And then 10 years after that, you’ll be going “WTF, I JUST LOST $50,000 TODAY!!!”

  33. Just a reminder, we can take out I think 6K from the IRA ROth for use on home downpayment without any penalties.

  34. I started my IRA when I was 18, and I’m 20 now.. and you know what I keep telling myself? COMPOUNDING. You and I have sooooooooo far to go. It’s great that we’re starting now because we have a lot over most other people. So calm yourself– read up on the market (I think one guy said it best “the market will go up and down and up and down”) and sit back and enjoy the compounding.

  35. Mkt timing is a beaotch sometimes. I consider myself lucky not smart when I loaded up big time in the dip of august in FNORX fund and sold right at my 90 days of holding with a 23% gain. Since then it’s down from 53 bucks to 49 / sh and the market is going south for a while from here. Just my guess. 5% cash for me for the rest of this year and then paying off the house with a nice lump sum and relo package from my new job which is buying our house for what we paid back in 05. Its a lot of luck but at the same time knowing when to sieze opportunity.

  36. Now’s the time to buy. Jake mentioned dollar cost averaging in a previous comment. Buy a little every week and while the price is going down, you’ll be buying more shares. Even if your existing investment continues to fall, you don’t lose the shares. Research first, but buy and hold.

  37. Jonathan,

    Ahh, yes, the SLC. What did you tutor there? I always walked by there because it was on the way to BRH (the band rehearsal hall).

    Anyways, I started my Roth this year too and have been contributing $333.33 a month to max it out at the end of the year. I do bad habits checking it everyday, but I do know that no matter what happens in the market today, i got 40+ years left till I will (or am supposed to) touch that money so I got time on my side. I should really stop checking the numbers.

    Anyways, GO BEARS!

    (poor game against the Huskies though) =(

  38. Justing – it’s called hindsight bias and it’s easy to succumb to. You bought that stock and the next day it went down. Say you did wait that that extra day to buy, what would prevent that stock from declining even further? Or, on the opposite side of the spectrum say you sell after a 10% gain and the next day it’s up another 5%. In hindsight you wish you would have held on to it longer. But in reality, there’s really no way to know what that stock is going to do in the short term.

  39. Jerad Gardner says:

    The way I see it, I feel good when my holdings are green, because I’m making money. But when they are red, I get excited because I hope that some great stock is going on sale (like google’s recent performance, although it’s still not cheap enough for me). This way, I have taught myself to be happy about the market regardless of what it does (except when it doesn’t move much, which is disappointing).

  40. Ah…this post makes me feel a lot better for some reason.

    Thanks for the “brotherly advice.” I think I finally know what to expect regarding ups and downs and be prepared to lose some but gain a lot in the long run.

    Damn it: I’m just not going to check it daily!

  41. Another Berkeley student says:

    I’ve enjoyed your blog for a while now and am much happier to associate it with Berkeley instead of say, the current inhabitants of the tree in front of Wheeler Hall. (Yes, there’s another protest; however their message is, as usual, completely incoherent.)

    I’m a grad student with a measley stipend, but I do manage to sock away about 10K a year and live off the remaining 13K. I dutifully deposit $417 / mo in my Roth (JAOSX), rain or shine – er, bull or bear, a chunk into WaMu (4% APYDB (a new metric: annual percentage yield despite Bernanke)) for a house down payment in ~ 5 years, and the remainder in solid low annual expense mutual funds.

    Bottom line: Not worried – I love bargains!

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