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The Financial Crisis And You: Impact on Your Investments

Tim Hanson
Investment Analyst, The Motley Fool
Thursday, October 16, 2008 12:00 PM

Motley Fool analyst Tim Hanson will be online Thursday, Oct. 16 at noon ET to take your questions and comments about what the tumultuous times on Wall Street mean for your investments.

A transcript follows.

Tim Hanson is a senior analyst for The Motley Fool, and a contributor for Motley Fool Hidden Gems, a service that uncovers stocks that are underfollowed, undervalued and under Wall Street's radar. A graduate of Georgetown University, Tim specializes in the energy industry, following trends in oil, gas and alternative energy investments, as well as financial companies, retail businesses and restaurants.

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Arlington, Va.: Not really a question about investments, but rather timing. It seems that many big stock market crashes (1929, 1987, 2008) occur in October. Any particular reason why October? End of fiscal year? Start of school year, and end of summer vacations? Cool weather leads to pessimism? Any ideas?

Tim Hanson: Good question. I don't know.

The summer is usually pretty slow in the market because Wall Street -- and lots of us -- tend to be on vacation/not paying attention. Perhaps the problem with October is that it's about the time that everybody's gotten back in the office and had a few weeks to figure out just how bad it's gotten since they were last paying attention in May.

The market's a pretty insane and illogical place, though. Remembering that during times like these offers some comfort (to me, at least).

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Tim Hanson: Hello from Fool Global HQ in Alexandria, VA. We're celebrating our 15th anniversary this week, and it's interesting to look back at all of the financial crises we've dealth with since then. There was the Asian Contagion of 1997, the dot com bust of 2000, September 11th, and now the current global financial credit calamity. These are certainly interesting times, but it's important to remember that our system is periodically stressed and that we'll get through this eventually. In the meantime, let's see if we can help more investors deal with current market conditions and -- hopefully -- come out stronger on the other side.

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Washington, D.C.: Hi Tim - with all of the market volatility, I'm feeling like I should be moving some of my 401K investment money from small cap funds into mid- or large cap funds. Is this a smart move in general?

Tim Hanson: It looks like we're going to get a lot of asset allocation questions this afternoon. The general answer to all of them is that it depends on your investment timeline. The general rules of thumb are that if you're more than 10 years from retirement, you want to be 80% to 90% in stocks. If you're 3 to 10 years from retirement, you want to be 60% to 70% in stocks. And if you're nearing or in retirement, you want to be about 50% in stocks and 50% in bonds and principal-protecting treasuries.

As for the small cap/large cap question, that, too, depends on your timeline. Small caps are going to be more volatile than large caps generally, but as these past few weeks prove, large caps are not immune from swings. I'm partial to the small-cap sector myself (being a Hidden Gems employee), and if you have more than 10 years to retirement, I'd stick with a healthy small cap allocation since the sector historically offers the best returns.

But you need to do what's right for you. If you're fretting the current volatility, by all means do some reallocating. If there's a silver lining to the current crisis, it's that lots of sectors have gotten cheap at once. That gives long-term investors the opportunity to really perfect their portfolios by making sure we have exposure to all market caps, all countries, and all industries...because you're not paying a valuation premium to move around.

I'd also encourage folks who are looking to reallocate their 401(k)s to look hard at international options. Most Americans are underexposed to foreign stocks, and while these too will be volatile, the value/growth opportunity surrounding China, Brazil, and few other markets today is compelling.

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Great Falls, Va.: The financial crisis has just confirmed that the average american can no longer sit on the sidelines and hope their 401K investments will bail them out when they retire. Beyond the company match, why bother? Did you know during the last bull market 75 percent of mutual fund managers couldn't beat the S&P 500? We need to look beyond the mutual fund industry and wall street which has trapped so many Americans into thinking this is the only way to save. Investments in private equity like your own business, partnerships, commercial real estate, or other hard assets need to be considered.

Tim Hanson: I disagree with the premise here. If you're a young person with a 401(k), you need to keep contributing. If you have 20 to 30 years until you retire, your 401(k) is going to be much bigger then than it is today. The key, though, is to make sure your 401(k) is properly allocated relative to your timeline. If 401(k) participants near retirement were had a healthy allocation of bonds, they would have been spared a lot of pain these last few weeks. Young folks who have lost money shouldn't really care that much (but they should remember this when they're tempted to leave their money in stocks as they near retirement).

I read the other day that Congress held a hearing on abolishing 401(k) plans. I agree they're imperfect as currently constructed (let's give people more options and lower fees), but they're a powerful long-term savings vehicle. I hope that the next Congress doesn't use a few months of Wall Street chaos to limit the ability of Americans to own shares of the world's great businesses.

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Houston: Are small caps the place to be right now? What percent of your portfolio would you weight to small caps at this time?

Tim Hanson: I enjoy following small companies and am particularly partial to the micro caps (and specialize in studying them). That's because I think they're generally underfollowed by Wall Street and thus give investors the rare opportunity to gain and informational advantage over the market when it comes to valuing them.

But as I said earlier, these guys can be excrutiatingly volatile. They've been sold off en masse by risk-averse investors recently, and I think there are a number of very compelling micro cap opportunities right (indeed, I've bought a few). But if you want to invest, do your homework and buy a basket of them in the position size that you would normally allocate to one large cap.

If you don't want to research individual stocks, there are some good small cap funds out there run by Bridgeway and Royce.

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Rockville, Md.: Tim, Can you explain why gas prices are still a lot higher than they were the last time oil was at this price? Also why is it that when I went by a Shell gas station on Monday, gas was selling there for $3.70. At the BP gas station right next door, it was selling for $3.29! Is this an example of price gouging by the oil companies?

Tim Hanson: Retail gas prices are influenced by a lot of things. It could be that the folks at Shell don't change their signs until Tuesday.

I know lots of folks suspect that energy companies are gouging them, but it's not true. These guys are selling a product into the marketplace at a going rate. What's more, they operate in a cyclical and capital intenstive industry that can see violent boom and bust cycles (and they don't get a lot of sympathy when they're busting).

This is not to say that I'm a Big Oil apologist, but if you find yourself getting angry at gas prices, consider buying shares of some energy companies instead. It's a worthwhile business to be in.

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London: Could it be a good idea to leverage slightly now that we are nearing a possible bottom? Say, 10 percent leverage on top of a diversified portfolio?

Obviously, this is not money I need for the next few year...

Tim Hanson: We're not in the business of calling bottoms, and I think we still have some way to fall given the need for housing prices to come down a bit more to return to historically normal levels.

Moreover, given the crazy volatility we've seen recently (check out the VIX), I don't think leverage is a good idea. After all, as Aubrey McClendon of Chesapeake Energy learned this week, margin calls can come at very inopportune times.

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Manassas, Va.: Hi, my TSP (government retirement savings plan)value dropped about 20 percent since the stock market tanked. About 90 percent of my TSP is in stocks with a mixture of small caps, international stocks, and common stock.

Although this drop makes me nervous, I decided to stay put and not reallocate my investment funds into more secure funds such as those guaranteed by government. I plan to retire in about 20 years.

Good idea, or should I shift to more bonds and less stocks?

Thanks!

Tim Hanson: If you've got 20 years to retirement, I wouldn't worry about what your balance is today. Sounds like you're heeding the general asset allocation guidelines I outlined above.

In times like this, lots of investors feel the need to get out of stocks and into safety. That's the fault of their brains. A recent book by Jason Zweig called Your Money & Your Brain showed that we're hardwired to hate losing money, and that we actually feel physically pain when we do.

But if you find yourself buying stocks after the market has had a great run and selling them when the market is tanking, then you're buying high and selling low, which is a very quick way to incinerate cash.

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Virginia Beach, Va.: We finally opened a Roth IRA for 2008 and maxed out about two months ago. While we know we're in it for the long term, we've watched it dwindle by almost $1K already.

For 2009, should we save up the money and dump into the account after we know things have stabilized a bit? Or do the monthly contributions throughout the year? FYI -- we're in our early 30s and already contribute to our TSPs. Thanks!

Tim Hanson: What you're talking about is something called dollar-cost averaging, and for most individual investors, I think it's a pretty sound idea.

After all, I don't know where the bottom will be in this market. But if you average in, you can get more bang for your buck as the market drops.

The flip side is that if the market rises, you won't do as well, but if you're clairvoyant about this market, then you should be doing this chat...not me!

One thing to keep in mind is to make sure you invest in chunks that are big enough to keep transaction costs to less than 1% or 2% of your investment. Otherwise, you're putting yourself in a hole when it comes to making money. Thankfully, transaction costs are pretty low nowadays, which is another reason to embrace dollar cost averaging.

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21771: Last week, getting nervous, I moved about one-third of my 401K in to government bonds. And all future contributions too. My thinking was to protect some of the funds against more loss and to leave some funds there for eventual recovery (when the market rises). Thoughts?

Tim Hanson: Again, it depends on your age. There is no perfect investment strategy. Rather, everyone needs to figure out the investment strategy/asset allocation strategy that's perfect for them.

If you're in/near retirement, you want to be protecting your principal and moving into bonds. If not, you should be sticking with stocks...and not quoting them daily (that's a good way to lose some hair as I'm fast finding out).

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Los Angeles: Reports that Americans' retirement plans lost $2 trillion in the past 15 months due to the stock market plunge should forever lay rest to Bush's Social Security restructuring scheme calling for private investment accounts. Prominent Republicans including McCain backed Bush's scheme. Doesn't the recent mortgage mess and decline in value of mortgage backed securities show that private investment accounts was another bad Bush idea, and that equity markets are too risky and unpredictable as a panacea for restructuring the Social Security program? McCain recommends an up or down congressional vote on Social Security reforms recommendations by a commission. Doesn't appear to be much leadership (mavericky or otherwise).

Tim Hanson: I've heard that statistic, and I think it's a little intellectually dishonest. Again, the state of your retirement savings depends entirely on how close you are to retirement. If $1.9999 trillion of that was lost by people 40 and under, then I'm not concerned. If $1.9999 trillion of that was lost by 65-year-old retirees, then I'm very concerned about the lack of education we're giving to investors.

Given my profession, you can probably guess that I'm pretty in favor of helping more Americans learn how to invest in the stock market. But in order to do so, we need to make sure there are learning resources out there. That's one of the reasons why I'm a proud Fool.

In all, stocks can be very mavericky over short periods of time, but they're pretty reliable over timespans that are measured in decades. That's why it's important to get investors started early, to teach them about asset allocation, and to help folks understand that times like this -- for long-term investors -- are opportunities, not disasters.

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Evanston, Ill.: What does the Motley Fool think of Hyman Minsky?

Tim Hanson: That's a sweet sweater vest in that picture.

Obviously, debt can be a very big problem, and the American economy has probably been living on cheap, borrowed money for too long. We're feeling the consequences of that today.

The takeaway for investors is to make sure you diversify outside of the U.S. China, for example, has an enormous budget surplus and a high national savings rate that should both help them weather a global economic downturn.

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Washington, DC: I'm 41, have a stable job, no serious debt, etc. I've been putting about 15 percent of my salary into stock index funds for the last year. Bad timing, obviously! (Most of my previous savings were put in -- and stayed -- in CDs and such. Poor returns, but I'm not much of a risk taker.)

I'm not planning on taking the money I put into index funds out -- why make the paper losses real? But, do you think I should reduce the amount I put into those funds every month? I.e., put a higher percentage into CDs and less into indexes?

Or, just keep with the habit and take the opportunity to buy stocks while they are low, even if I'm not likely to see any return for 5 years or more?

Thanks!

Tim Hanson: There's a relevant apocryphal investing aphorism/truism that can help here:

It's not timing the market that matters, but time in the market.

I'm not a registered investment advisor, so I can't give you specific advice, but remember the general rule that if you have more than 10 years to retirement, then stocks are your friend. And index funds are a great choice. They're generally low-cost, broadly diversified, and offer returns that most well-paid active mutual fund managers can't beat.

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New Orleans: Should Obama be elected and subsequently raise tax rates on capital gains and dividends, how might you adjust your portfolio? Would any sectors actually benefit under such a scenario?

Tim Hanson: This is fascinating question. Historically, the stock market has performed better under Democrat administrations than Republican ones, which seems slightly counterintuitive given tax issues.

But I don't think there's a clear cause & effect scenario here. (Cause & effect is extremely hard to pin down in a place that is as dynamic and chaotic as the stock market.)

That said, while there are certainly some policy implications depending on who wins the election (industries such as healthcare and energy may see their tax rates or profit margins affected), the longest an presidential administration can last is 8 years and the cynic in me would say that there will only be 2 functionally consequential years where things get done.

As for sectors that *might* benefit, alt energy and infrastructure seem like two industries Senator Obama has been talking up.

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NY: I'm wondering what effect all of this mass selling is having on the amount of now taxable capital gains accumulating in my mutual fund accounts? Is it possible that I will have lost 40 percent and still end up paying a big tax bill??

Tim Hanson: This is a very real possibility. That's why I chuckled the other day when Senator Obama mocked Senator McCain for wanting to lower cap gains rates. He said something like, "No one -- not even the smartest investors -- have capital gains today." That's an example of being too clever by half.

In fact, with all of the selling going on, mutual fund investors might get a pretty hefty year-end tax bill. You can offset some of those cap gains by selling companies you've lost faith in a realize capital losses, but the details will vary with your individual situation.

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Albany, N.Y.: I have about 20K money in my emergency fund. You know, in case I lose my job or need a new roof. I have kept it in a money market account with a decent return that keeps it fairly liquid. I am getting a little nervous about money markets these days. Where is the best place for your liquid assets these days?

Tim Hanson: If that 20K is in an FDIC-insured account, you are well below the government threshold for guaranteeing those funds. And kudos for having an emergency fund. It's something every needs to have.

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Abolishing 401k plans?!: How on earth could they do that? Would the investment companies have to payout every fund to its owner? That's an especially stupid move to consider in a down market, when our fund values are scraping the bottom of the barrel.

Another topic - I have my 401k completely invested in one of those lifeband products - my target retirement date is 2040-ish. How will the health of those automatically recalibrated funds pull through this?

Tim Hanson: I'm shocked as well and don't think it's a good idea. This was the relvant hearing in the House: http://edlabor.house.gov/hearings/fc-2008-10-07.shtml

Target retirement funds are a great option for folks who just want to set and forget their 401(k)s. You keep contributing, and they'll keep reallocating for you. I hope more folks catch onto and employ these Target Retirment options.

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Sacramento, Calif.: Is now a good time to sell stock and rebalance my portfolio because of the reduced capital gains?

Tim Hanson: I said earlier that this is a great time to be rebalancing because so many sectors are cheap. Normally in the market, one or two sectors will get cheap at a time. A lawsuit against Merck might cause pharma to fall, for example. Decreased consumer spending could hurt retail.

But right now, there are lots of bargains out there. I think everyone should take a look at their portfolio and figure out what you have and what you don't have. And I'll say it for a third time, look abroad. Most Amercians are underexposed to foreign economies and currencies and would do well to get some exposure to Brazil, China, India, Europe, and the like.

After all, if you live here in the USA, you are likely invested in US stocks, own US assets, have a US job, and have all of your savings denominated in dollars. When something goes haywire, that makes you dangerously concentrated in one specific geographic region.

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Anonymous: I have a hard time explaining to my wife that any losses I show due to the market downtown are largely losses only if I sell now (there are, of course, lower dividends), and I plan on holding on to my investments (mainly mutual bonds and bonds such as Fannie Mae and Freddie Mac and Pepsi Bottling) for at least 5 years so we don't yet have to panic. When SHOULD I panic?

Tim Hanson: You're not panicking yet???

Just kidding.

I've talked about this stuff so much with my wife, that she now tells me when she thinks there's a buying opportunity to be had. As for your question, there are times when there is a permanent impairment of value. Given what's happened at Fannie and Freddie, and the government involvement that now seems to dictate their fates, those may be stocks that are not coming back whether you sell them or not. Generally speaking, if you own an index fund, that's going to be so broadly diversified that owners have no reason to panic.

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Aldie, Va.: Huge cash infusion by governments = inflation, right? I understand the short-term liquidity needs, but long-term doesn't this have a large negative impact on savings?

Tim Hanson: Yes, there will be significant long-term effects, but this was a case where the alternative was looking pretty awful. We heard from some of our contacts in China that the Chinese and Japanese governments were on the verge of selling our treasuries into the open market unless our government stood up and stabilized this mess. Such a scenario would have diminished the government's ability to borrow money, crushed the dollar, and likely caused a crisis of confidence that would have caused capital to flee our markets like no other. Not good.

There is never a free lunch, but without these injections, I think we were staring down a far worse scenario.

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Germantown, Md.: I know I am not the only one, but I feel lost. I used up much of my 401K with the dot com bust, and more to provide nursing home care for my mother before she died. I was left with $365K in my Wachovia 401K, which is now down to $150K. I will be 60 on Monday, and don't think that staying with Wachovia Securities will do much for me at this point. I am open to suggestions as to where I could invest what little I have left.

Tim Hanson: This is a very sad story.

If your 401k was administered by Wachovia, that doesn't mean you were invested in Wachovia stock. That's a crucial distinction. You can stick with your administrator now that Wachovia has been acquired.

As for what to do, the general guidelines for people who are in retirement is that they need to be invested in principal protecting bonds and treasuries.

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State College, Pa.: We have heard a lot about the banking system being stressed due to a lack of trust, with ramifications rippling through other sectors that depend on banks. My question is, do you see other areas of the economy that similarly do business based on trust and so might be expected to freeze up? How about the stock market itself? It seems to me that a disappearance of liquidity might cause stock market declines that are not related to intrinsic value or even investor psychology. Who maintains the liquidity in the stock markets and are they affected by today's tight credit environment?

Tim Hanson: I'll close here with the famous quote from Warren Buffett's teacher Ben Graham:

In the short-term, the stock market is a voting machine. In the long-term, it's a weighing machine.

That means that over short periods of time, the stock market will often respond violently and irrationally to news. Just look at the crazy volatility we've seen these past few weeks corresponding to moves and non-moves by the government.

Over the long-term, however, stocks are much more predictable, and if you focus on diversification, smart allocation, and companies with strong brands, balance sheets, and good management teams, you can be a successful long-term investor.

The current credit market issues are going to mean low, no, or negative growth this year and possible next. The stock market may fall further. But don't let that dissuade you from pursuing your investment goals. Good companies will attain to their intrinsic/fundamental values over the long term.

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Tim Hanson: We're out of time. I didn't get to all the questions, but I hope folks found this interesting and helpful.

Stay Foolish and come visit us on Fool.com for more stock market talk, asset allocation guidance, and investment ideas.

And let's go Hoyas. We're only a few days away from Midnight Madness.

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