Q: My 22-year-old daughter inherited about $20,000 last year. I’d like to put it into a retirement account. … Given the volatility of the stock market now is there some other investment to consider?
A: Before I get to your question, I want to touch on investing in turbulent times. Bear markets are part of investing. You can’t get rid of the risk.
A bear market is defined as a decline of at least 20% from the market’s peak to its low during the sell-off. On average, there has been a bear market about once every six years with an average loss of almost 40% and, again, on average it takes some 22 months to rebound.
What to do? The answer lies in the favorite aphorism of Laurence Siegel, director of research at the CFA Institute Research Foundation: “Don’t just do something, stand there.” A couple of techniques help the typical retirement saver to “stand still” smartly until the market revives, whenever that may be in the future.
First, the hope is the portfolio is well diversified, with money invested in different assets such as equities, bonds and cash. Diversification is a classic risk-reduction approach. Second is automatically rebalancing your diversified portfolio. The providers of tax-sheltered retirement plans typically offer participants the option. While market timing is hazardous, periodic rebalancing returns you to your original asset allocation. There are no tax consequences in a tax-sheltered retirement savings plan.
“Rebalancing, or selling a portfolio’s best performers to buy the worst performers periodically, is one of the best ways to protect against market movements altering a portfolio’s risk profile,” wrote Adam Millson and Jason Kephart for the analytics firm Morningstar.
Last, continue to contribute to your retirement-savings plan and dollar-cost averaging into the market, meaning putting the same amount of money into the portfolio on a regular basis. Dollar-cost averaging takes emotion — fear, greed and panic — out of the investment equation. Again, this assumes you don’t need the money to pay your basic household bills next month.
Now, to your question. The inheritance can’t go into a retirement account since contributions must be earned income. I like the idea of investing it in a low-fee broad-based equity index fund for the long haul in a taxable account. Investments in funds like that come with relatively small annual tax levy and the money will compound over time. However, if she needs the money at this turbulent time, cash remains king.
Chris Farrell is senior economics contributor for “Marketplace” and a commentator for Minnesota Public Radio.