The Japanese stock market has entered "correction" territory, down about 11 percent from a five-year high reached on May 22. What's going on there is instructive for U.S. investors.
No one really knows why markets go up and down any given day. But that doesn't stop traders, analysts, journalists and economists from trying to interpret the market's message. Among the reasons given for Japan's market rout are rising bond yields. The central bank is attempting to stoke inflation to shock the Asian giant out of a 15-year economic slump.
So far, investors in U.S. stocks seem more focused on signs of an improving U.S. economy. The housing market is heating up; bank finances are on the mend; state revenues are up, with even California sporting a budget surplus; and consumer confidence is climbing. Yet an underlying worry remains: Is the message in the Japanese market that U.S. stocks also will plunge when U.S. rates start rising?
Many Americans are exposed to the market's manic moods through retirement savings plans like 401(k)s and IRAs. The market drop during the Great Recession mauled retirement accounts. They lost 31 percent, or $2.7 trillion, from the 2007 peak to 2009 bottom.
Four years later, retirement account balances surpassed $10 trillion for the first time in the first quarter of 2013. According to estimates by the Urban Institute, a Washington, D.C.-based think tank, retirement account balances are 16 percent above their 2007 peak in current dollars and 5 percent above their peak after adjusting for inflation. Fidelity Investments reported that the average balance of its 401(k) accounts reached a record high of $80,900 by the end of the first quarter of 2013 — a 75 percent gain from the market low.
How can long-term savers best navigate the turmoil? Odds are that rates eventually will head higher and if the rise reflects a stronger economy, stocks will probably do well. But if the rate hikes are driven more by fears of inflation, stocks are likely to head lower.
Here's one approach: Forget about investing (for the moment). Put aside thoughts about stocks, bonds and asset allocation. Instead, think about what it is you want to be doing with your life in the next year, five years or 10 years. What are your goals? What is your picture of the good life?
When it comes to saving for retirement, the answer of how best to invest doesn't lie in historic market performance and risk correlation charts. No, it's all about you. An approach to managing money that works for a professional adviser, a colleague or a neighbor may not be suited to your temperament or circumstances.
For instance, most financial advisers will recommend a healthy dose of equities in retirement savings. They'll note that stocks are riskier than fixed-income investments like certificates of deposit. But, the adviser will add, investors have been rewarded over time for taking on the greater risks in stocks. Yet the late Nobel laureate Paul Samuelson emphasized that whether you invest in equities depends on your attitude toward risk.
"For my late mother, her level of risk tolerance called for a very small equity share," he said.
My mother never owned equities and never wanted to. She invested mostly in CDs. She did fine financially with little anxiety. This isn't a brief against stocks. It's a plea to understand your own personal capacity to take financial risk.
Chris Farrell is economics editor for "Marketplace Money." His e-mail is email@example.com.