Tips for Weathering a Stock Market Storm

It’s natural to feel uneasy about the recent ups and downs in the stock market. But it’s also important to remember that investing in stocks can play a significant and valuable role in a successful retirement savings strategy.

When reviewing your most recent State of Maine Deferred Compensation Plan account statement and the updated quarterly investment returns in this newsletter, you should keep the following observations in mind:

• Stock market swings are often unpredictable, but are not unexpected,
• A disciplined approach to investing can help you benefit during short-term market swings, and
• In order to achieve higher returns, you must assume some risk.

Stock market swings are often unpredictable, but are not unexpected.

The stock market is a compilation of common stocks from thousands of companies that are affected by numerous economic factors. Under certain conditions, such as when the economy is struggling, some of these companies may find that their business will slow down and they will not earn the profits they had been anticipating. This can translate into lower stock prices, which in turn may cause an overall market downturn or correction. If the correction lasts long enough, it’s called a bear market.

These market corrections tend to happen every several years as the business cycle runs its normal course. Some of these corrections last for just a few months, while others have lasted for years. Economists and analysts will use various economic indicators such as the Gross Domestic Product (GDP) to judge how well the economy is doing and to estimate how much longer a correction or bear market will last. Interpreting the data can be difficult, and it is very hard to determine or predict when a correction will end or even when it actually began. Some investors attempt to “time” the market ― jumping in and out of stocks in an attempt to sell high and buy low. But timing the market accurately is very difficult. In general, funds invested in a retirement savings plan should be viewed as a long-term investment.

Historically, some of the stock market’s best returns have been achieved in the years closely following a market correction. Through proper diversification, you can help to reduce some of the negative impact on your account balance of these market corrections. Please note that if you are near retirement, you may not have a sufficient time period in which to recover from a market downturn, so your strategy may be different.

You should speak with your financial services organization (FSO) or other financial advisor to determine if you have the appropriate level of diversification in your account, and to determine if the level of your investment in stocks is suitable for your time horizon.

A disciplined approach to investing can help you benefit during short-term market swings.

Dollar Cost Averaging: Making Market Swings Work for You

One of the best ways to purchase stocks or stock funds is through an automatic paycheck contribution, which the Deferred Compensation Plan offers. This systematic approach to investing, commonly called dollar cost averaging, provides you with the opportunity to take advantage of the stock market’s ups and downs. Because you are buying shares on a regular basis, the number of shares (or units) that your Plan contribution buys will vary, depending on the price at the time of investment. That means when share prices are lower, your contribution will buy more shares (or units) of the investment fund, taking advantage of the lower price. In a rising market, that same contribution amount will buy you fewer shares. As a result, short-term stock market swings actually can be an advantage to long-term investors.

Dollar cost averaging does not guarantee a profit or protect you from a loss in a declining market, but it helps to lower the overall cost of your stock purchases.

Rebalancing: Is Your Investment Strategy Still on Track?

Along with the discipline of dollar cost averaging, another investment principle that can be important in volatile markets is rebalancing your portfolio. As part of your investment strategy, you probably decided what percentages of your savings to assign to different investment categories, like stocks and bonds. Depending on your objectives and time horizon, your investment mix (also called a “target asset allocation”) may favor stocks over bonds, or vice versa. For example, if you are still far from retirement, you may have a target asset allocation of 80% stocks and 20% bonds. Over the years, as certain investments outperform others, parts of your portfolio may grow faster than others, causing the original percentages to shift. To maintain your original asset mix, you will need to rebalance your account (move money from one asset class to another) periodically.

Rebalancing becomes even more important in volatile markets. The investment mix has more of a tendency to shift away from the target allocation due to dramatic changes in stock prices. For example, if stocks lose value, you may find that your original 80%/20% asset allocation has shifted to 70% stocks and 30% bonds. To get back to the target mixture, you would need to transfer one third of the money held in bonds to the stock investment funds.

You should speak with your FSO or other financial advisor if you need to set a target asset allocation for your portfolio or if you need help in rebalancing your account.

In order to achieve higher potential returns, you must assume some risk.

A rule of thumb for long-term investing is that an investor must be willing to take on additional risk in the quest for higher potential returns. Conversely, lower-risk investments (such as bonds) generally earn lower returns. In the short term, higher-risk investments (stocks) will not always have the best return. However, historical results show that generally, over a 10 to 20-year holding period, the average annual returns achieved by higher-risk investments are greater than those achieved by lower-risk investments.

The following chart shows the change in value of a hypothetical $100 investment in the mix of stocks represented by the S&P 500 Stock Index and the mix of bonds represented by the Lehman Brothers Aggregate Bond Index, based on the compounding effect of quarterly rates of return over a 15-year period.

Growth of a Unit Value
January 1, 1993 through December 31, 2007

© Russell/Mellon Analytical Services LLC, 1999. All Rights Reserved.

S&P 500 is one of the most commonly used benchmarks for the overall U.S. stock market. It is an unmanaged market-weighted index of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe.

Lehman Brothers Aggregate Bond Index (LB Aggregate) is an unmanaged market-weighted index used by bond funds as a benchmark to measure their relative performance. The index includes government securities, mortgage-backed securities, asset-backed securities and corporate securities to simulate the universe of bonds in the market. The maturities of the bonds in the index are more than one year. The index constructed by Lehman Brothers is considered to be the best total market bond index, as it is used by more than 90% of investors in the United States.

Depending on the period of time, the return on stocks historically has averaged about 10% over longer-term holding periods. Of course, past results are not a guarantee of future returns, and other factors ― such as your time horizon for investing ― may be important in determining if higher risk investments are right for you.

The most recent investment returns for the State of Maine Deferred Compensation Plan are available in this newsletter. The tables provide average annual rates of return for the last five years, three years, one year and year to date. You can contact your FSO to request longer time periods for most of the Plan’s investments.

It may seem difficult to know whether you have the right savings strategy in place today; many things can change between now and your retirement. But planning now for your future is one of the best ways to help ensure that you attain the financial security you seek in retirement. And, participating in the State of Maine Deferred Compensation Plan can be an important part of your overall savings strategy.

Your FSO representative or other financial advisor is available to help you determine if your savings strategy is on track and to help you get the most of the State of Maine’s Deferred Compensation Plan.

Questions to Ask Your FSO Representative or Other Financial Advisor

• Are my Plan assets sufficiently diversified to weather recent (and future) market swings?
• Do I have an appropriate asset allocation for my age and time horizon?
• When combined with my other sources of retirement income, will my Plan account generate enough income during retirement to meet my needs? If not, what adjustments should I make today?
• Does my investment portfolio need any adjustments to help me keep up with cost-of-living increases between now and retirement?