You can go home again, but will you?

Posted by on June 1, 2009 @ 8:18 am in Investing

Federal Reserve data indicate that between January and early May, bank savings deposits rose by almost $170 billion. At the current rate, new deposits for 2009 will exceed those in 2008, which totaled almost $330 billion.

Clearly, you’re voting with your money. While many of you have stayed invested, others have either withdrawn from the market or stopped committing new investment to the market—and, in some circumstances, both.

The main factors behind the rising U.S. savings rate are lower consumer spending and deleveraging by households. So, it’s probably likely that savings deposits are increasing over previous years not only because Americans are retreating from the markets, but also because they’re saving more.

What I’m wondering is whether you and your money will come back to the market at some point, or if there will be a fundamental shift in how you invest. Will you allocate more to cash in bank deposits and money markets?

My initial feeling is that investors always come back after the worst of a cycle is over and the market is recovering. This is our tenth bear market since 1958, and, while causes and durations varied, all of the previous bear markets ended eventually. That certainly was the case after the dot-com bubble burst and recovery occurred. You followed the market.

Most likely, when the stock market recovers, its returns will beat the 2% interest rates currently available for savings deposits. Will that be enough to bring the majority of your discretionary income and cash balances back to stocks? Or do you plan to continue weighting your asset allocation more heavily toward cash and bonds?

Research by Vanguard’s Don Bennyhoff says you might err on the side of caution. He explores the concept of “emotional circuit breakers” and equity implementation plans. He acknowledges the stiff emotional hurdles facing anyone who’s even thinking about reentering the market. The fear of losing more money by investing in an asset class that spectacularly underperformed in the current bear market is likely to give any investor significant pause, whether he or she left the market or not.

While many investors are staying with their allocations during this recession, legions of others have abandoned their strategic equity allocations. For them, reentry involves a myriad of emotionally charged decisions. The first is whether to reenter the market in the first place. The next might be on what basis and with what asset allocation? Next would be timing—at what point will they be ready and willing to consider reentry?

Don makes the case that reentering the market in stages defined by your own “equity implementation plan” could help emotionally distance you from the decisions you need to make. The very act of putting this kind of plan together can give you the opportunity to assess how you want to go forward and give you something to react to—and to test out, to see if it makes sense. You might come back with the same asset allocation, or you might develop a very different one, matched to a changed view of your personal risk tolerance.

Some lessons are in front of us with stark clarity. The need for enough liquidity to cover expenses and emergencies for a reasonable period of time is one of them. Periodically rebalancing to keep your asset allocation within your risk tolerance is another. Keeping track of your changing circumstances—since this could very likely have an effect upon your tolerance for market volatility—is yet another. (Diversification first, last, and always.)

The first step in an equity implementation plan may be one Don hasn’t identified: A clear savings strategy as part of your overall financial strategy. With a savings plan in place, putting together the timing and steps of an equity investment plan could go forward more easily.

Notes:

• All investments are subject to risk. Past performance is no guarantee of future results. The link to FederalReserve.gov will open a new browser window. Vanguard accepts no responsibility for content on third-party websites.

We invite your comments on this Vanguard Blog entry. Comments will be monitored and published at Vanguard’s discretion. Comments received prior to July 7, 2009 will not be published.

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