If you poll investment experts, there is no consensus about a perfect mix of stock, bonds and cash. There never is. But there is probably an answer that is right for you, as long as you know how comfortable you are with the possibility of losing some money and have thought through every detail of what you’re willing to sacrifice if you do.
Figuring out how low your portfolio’s value might drop ought to be much easier than it is. In a perfect world, every brokerage firm and 529 college savings account administrator would have two buttons on their web pages.
The first, a “What if?” button, would let you see how much portfolio pain you’d be in for if your stock investments fell by 10 or 20 percent — or some more apocalyptic amount — and if bonds earned nothing over some period. The second, a “What are the chances?” button, would let you input the portfolio percentage decline of your choosing and then set the site to work estimating the odds of anything like that happening based on what has happened in the past.
If you don’t have access to anything like that, you can at least approximate the “what if” math yourself if you know what’s in your portfolio. (With the age-based funds that some people put their 529 money into, it can take a little digging to figure out what percentage of the investments are in stocks.)
A good financial adviser will put the numbers in front of you and demand that you reckon with them. Paul V. Sydlansky, a financial planner in Binghamton, N.Y., recently went through this exercise with a couple who hope to buy a home in Spain in two to four years. And because it could indeed take 48 months, they don’t want to leave their money in cash, earning very little, for that long.
So Mr. Sydlansky put it to them this way: If they have $180,000 split equally between stocks and bonds, a 30 percent stock market decline would leave them with $153,000. How would that feel if the perfect house came along? Not good, they decided, and they elected to have just 30 percent of their money in stocks.
This conversation probably gets harder if you’re a first-time homeowner. Sure, you could hope that housing prices in your area would fall as much as your portfolio, but there is rarely precise alignment in the choreography of market corrections and crashes.
So, would you be comfortable passing up the perfect property if your down payment account had fallen by 10 or 20 percent? How would it feel to sacrifice the dream of buying your “forever” home and settle for a starter one? What about buying the bigger house in the second-choice suburb? And let’s say you have a spouse. Better be sure that you two are on the same page. Have you asked?
Or perhaps you would just borrow more. Easy, right? But could you afford it, if interest rates are a point or two higher then? That could happen. And how much would all that extra interest cost you over time? Or would the bank even lend you that much?
And don’t forget this possibility either: How much would you kick yourself over the lost stock market gains if the market continues to rise? If you have all of your down payment money in cash for years while the housing market outruns you, as it has for many people in expensive coastal markets this decade, it wouldn’t feel so good.
Now, consider a college savings account, perhaps for a middle-school student. You’re reasonably sure that there will be some kind of stock market calamity between now and when the kiddo leaves home. How bad might things get?
It’s tempting to consider how you reacted to the stock market declines at the end of the last decade in figuring out how you might react in the future. If you had decent nerves back then when your child was in preschool, perhaps you were betting that you were buying stocks on sale.
That’s how I consoled myself in 2009, at least. But now that my 11-year-old is seven years away from college (or eight if she takes a gap year), riding another market wave like the one we all rode in 2008 and 2009 seems like a sure path to stomach ulcers.
How bad could things get over the next 10 years? Given how rough things got last time, I asked Howard Silverblatt, senior index analyst at Standard & Poor’s Dow Jones Indices, to calculate what people might have seen if they’d been looking back at total S.&P. 500 returns (including reinvested dividends) over a previous 10-year period. Any decade ending between January 2009 and September 2010 would have been negative, he said. In the first four months of 2009, you would have been facing a decade-long decline between 21 and 29 percent.
You’d hope that few with children about to start college were invested entirely in large United States stocks then. One benefit of diversification, as Preeti Shah, an accountant and financial planner in Matawan, N.J., reminded me this week, is that even over the four years of college, you can pull from the investments that aren’t hurting as much (say, the bond or cash portion of your portfolio) during the first year or two. Then, you cross your fingers that the stocks will recover during the latter part of your child’s undergraduate years. Indeed, stocks nearly doubled from their March 2009 lows within two years.
This summer, what felt right in my household was to cut the stock allocation in our 529 account by about 10 percentage points. That put us about halfway between what Vanguard does in its aggressive 529 account and what it does in its moderate one for people with children the same age as my daughter.
But something more conservative may be better for you. Again come the pressing questions, perhaps even more emotion-laden since they involve your son or daughter: How much more could you pay out of pocket if your college savings portfolio suffered a big loss? What if your employer cast your aging self off during the recession that might come with a big stock market decline?
Perhaps you attended a private college and hope to give your child a shot at the same thing. Would you insist upon the state university where you live — and nothing else more expensive — if your aggressive portfolio took a big dive? Or have you made a promise to your overachieving teenager about ye olde alma mater that you couldn’t bear to break? Would you want to borrow? What could you do now to limit the debt in that event?
Again, none of the answers dictate a precise asset allocation. And sure, some people could address any potential losses by earning more, saving more or spending less.
But many of us aren’t that lucky. An untimely stock market decline could hurt, badly. A bear market will emerge eventually, so imagining the pain of its severe bite is one of the healthiest things you can do for your finances when the stock market continues to seem so sunny.