MONEY The Economy

The Stock Market Loses a Big Crutch as the Fed Ends ‘Quantitative Easing’

The Fed has concluded its asset-purchasing program thanks to an improving labor market. Here's what QE3 has meant to investors and the economy.

After spending trillions of dollars on bond purchases since the end of the Great Recession — to keep interest rates low to boost spending, lending, and investments — the Federal Reserve ended its stimulus program known as quantitative easing.

The central bank’s decision to stop buying billions of dollars of Treasury and mortgage-related bonds each month comes as the U.S. economy has shown signs of recent improvement.

U.S. gross domestic product grew an impressive 4.6% last quarter. And while growth dropped at the start of this year, thanks to an unusually bad winter, the economy expanded at annual pace of 4.5% and 3.5% in the second half of 2013.

Meanwhile, employers have added an average of 227,000 jobs this year and the unemployment rate rests at a post-recession low of 5.9%. It was at 7.8% in September 2012, when this round of quantitative easing, known as QE3, began.

What this means for interest rates
Even with QE over, the Fed is unlikely to start raising short-term interest rates until next year, at the earliest.

In part due to the strengthening dollar and weakening foreign economies, inflation has failed to pick up despite the Fed’s unprecedented easy monetary policy.

And there remains a decent bit of slack in the labor market. For instance, there are still a large number of Americans who’ve been unemployed for 27 weeks or longer (almost 3 million), and the labor-force participation rate has continued its decade long decline. Even the participation rate of those between 25 to 54 is lower than it was pre-recession.

What this means for investors
For investors, this marks the end of a wild ride that saw equity prices rise, bond yields remain muted, and hand wringing over inflation expectations that never materialized.

S&P 500:
Equities enjoyed an impressive run up after then-Fed Chair Ben Bernanke announced the start of a third round of bond buying in September 2012. Of course the last two times the Fed ended quantitative easing, equities faced sell-offs. From the Wall Street Journal:

The S&P 500 rose 35% during QE1 (Dec. 2008 through March 2010), gained 10% during QE2 (Nov. 2010 through June 2011) and has gained about 30% during QE3 (from Sept. 2012 through this month), according to S&P Dow Jones Indices.

Three months after QE1 ended, the S&P 500 fell 12%. And three months after QE2 concluded, the S&P 500 was down 14%.

 

Stocks

10-year Treasury yields:

As has been the case for much of the post-recession recovery, U.S. borrowing costs have remained low thanks to a lack of strong consumer demand — and the Fed’s bond buying. Many investors paid dearly for betting incorrectly on Treasuries, including the Bill Gross who recently left his perch at Pimco for Janus.

Bonds

10-year breakeven inflation rate:

A sign that inflation failed to take hold despite unconventionally accommodative monetary policy is the so-called 10-year breakeven rate, which measures the difference between the yield on 10-year Treasuries and Treasury Inflation Protected Securities, or TIPS. The higher the gap, the higher the market’s expectation for inflation. As you can see, no such expectation really materialized.

BreakEven

Inflation:

Despite concern that the Fed’s policy would lead to run-away inflation, we remain mired in a low-inflation environment.

fredgraph

Unemployment Rate:

The falling unemployment rate has been a real a bright spot for the economy. If you look at a broader measure of employment, one which takes into account those who’ve just given up looking for a job and part-time workers who want to work full-time, unemployment is elevated, but declining.

unemployment rate

Compared to the economic plight of other developed economies, the U.S. looks to be in reasonable shape. That in part is thanks to bold monetary policy at a time of stagnant growth.

Indeed, many economists now argue that the European Central Bank, faced with an economy that’s teetering on another recession, ought to take a page from the Fed’s playbook and try its own brand of quantitative easing.

MONEY stocks

Why It’s Not Too Late to Buy Apple Stock

Michele Mattana of Sardinia, Italy, poses with an iPhone 6 Plus and an iPhone 6 on the first day of sales at the Fifth Avenue store in Manhattan, New York September 19, 2014.
Adrees Latif—Reuters

Apple could very well have another blowout quarter up its sleeve.

It’s taken 2 years to get back to this point. After peaking in September 2012 at approximately $705 (pre-split), Apple has now climbed all the way back after its prolonged pullback to fresh all-time highs. Shares have now traded over $105, the equivalent of $735 pre-split.

Naturally, with shares back to all-time highs investors are now wondering if it’s too late to get in, or if they can still buy Apple. Let’s take a look.

Word on the Street

For starters, let’s consider the Street’s opinion on Apple. According to Yahoo! Finance, the average price target for Apple is $115, which represents about 10% upside from here. That may not seem like a lot, and it’s also a modest hurdle for the S&P 500 to clear in the next year, which determines if Apple were to outperform or underperform should it hit that average price target.

The high price target is $143. After giving up the Street high target temporarily, Cantor Fitzgerald analyst Brian White is back at the top of the list. White seems to always want to have the Street high price target on Apple, and reclaimed his title from JPM Securities analyst Alex Gauna earlier this month. The low price target is $60, but we’ve already covered how silly that sounds.

For the most part, the Street remains bullish overall, suggesting that it’s not too late to buy.

Apple pays

Re-initiated in 2012 after a 17-year hiatus, Apple’s dividend continues to climb higher as the company remains committed to returning its copious amounts of cash to shareholders. While the majority of Apple’s capital return program is being allocated to share repurchases, its still paying out hefty amounts of cash in the form of dividends.

Apple increased its quarterly payout by 15% in early 2013, following up with an 8% increase earlier this year. The Mac maker usually updates its capital return program in March or April, which is likely when investors will find out more about the next dividend boost.

Importantly, Apple’s dividend is sustainable — its dividend payout ratio has averaged 30% since bringing its dividend back.

Source: SEC filings and author's calculations. Fiscal quarters shown.
Source: SEC filings and author’s calculations. Fiscal quarters shown.

There’s no magic number when it comes to payout ratios, but generally investors prefer a figure in the 30% to 60% range. A payout ratio that’s too low may have investors asking for more, while a ratio that’s too high could potentially suggest that the company is being too generous and a dividend cut could be in the cards.

At current levels, Apple’s dividend represents a 1.8% yield. That’s less than some fellow tech giants like Microsoft and Intel, both of which yield around 2.7% right now, but it’s still a respectable yield nonetheless. There’s something for income investors here too.

Apple buys (itself)

As mentioned, the other aspect of Apple’s capital return is its massive share repurchase authorization, which currently sits at $90 billion. This is where Apple has been focusing most of its capital return efforts, believing shares remain cheap.

It should be telling that Apple just embarked upon its fourth accelerated share repurchase program while shares are at all-time highs. That’s literally Apple telling you that it thinks its shares are cheap at current prices and putting its money where its mouth is — because it’s also repurchasing shares itself. While many companies have rather bad timing with repurchases, it’s hard to argue that Apple is overpaying for itself when it’s trading at just 16 times earnings (a discount to the S&P 500).

Thanks to the resulting earnings accretion, EPS growth has been continuously outpacing net income growth by a healthy margin.

Source: SEC filings. Fiscal quarters shown.

Considering the sheer magnitude of Apple’s repurchase program, it’s also worth noting that share repurchases can drive capital appreciation. As Apple continues to amplify EPS growth through aggressive repurchases, its earnings multiple will contract (all else equal) due to a larger denominator.

If Apple’s earnings multiple contracts, shares look even cheaper, which creates buying interest. If the market is willing to simply maintain Apple’s earnings multiple, then that requires prices to go higher still.

An all-time record quarter is around the corner

Apple’s guidance for the current quarter is mind-boggling. The roughly $14.4 billion that the company expects to make over the holidays is well above what any other company in the S&P 500 is capable of producing, including oil companies. As Apple has just dramatically broadened its addressable market by launching larger iPhones (opening up a whole new world of potential Android switchers), Apple could very well have another blowout quarter up its sleeve. The iPhone and Mac businesses are as strong as ever, and the iPad’s recent woes are possibly temporary hiccups.

When the company releases its fiscal first quarter earnings in January, the figures could potentially be a positive catalyst as the quarter is expected to set new all-time records in both top and bottom lines. Shortly thereafter, Apple Watch will ship, potentially boosting investor confidence (and share prices) further.

Yes, you can still buy Apple.

MONEY stocks

How Arnold Palmer and Yo-Yos Can Help Your Finances

Arnold Palmer, golfer
Meeting your idol on the golf course can end up putting your mind at ease. Jim Young—Reuters

When stocks jump around, ease your worries by distracting yourself and taking the long view.

One of my newer clients, concerned about the latest stock market drop, called me earlier this month. After catching up briefly, she began describing the unsettling nature of the market volatility she was hearing on the news. She was feeling fearful about losing more of her nest egg, since she’s in her mid-60s, has recently retired, and wouldn’t be able to make the money back up by working.

No doubt many other financial advisers have received calls like this in recent weeks.

I responded by validating her thoughts, since our emotions play dirty tricks on us when investing. We all want to sell when fear is strong and buy when things have been hot.

We next spent some time discussing her longer-term financial plan and the idea that when stock prices fall we are then positioned for better future returns going forward.

It was at this point that the conversation went off on a tangent. Earlier this year, while planning for her retirement, we budgeted an annual allotment for golf. My client was planning to join a Thursday morning women’s golfing group and play at different courses around the region.

When I asked her how that was going, she started to gush about the experience she had at the U.S. Open golf tournament over the summer in Pinehurst, N.C. One of her friends had received corporate hospitality tickets, so they were able to access the clubhouse. While having a drink on the patio, she spotted her childhood idol, Arnold Palmer. She immediately walked up to him and asked for a picture, to which he agreed. While chuckling she said, “It took everything I had not to lay one on his cheek during the picture.” She said she hadn’t felt that much like a schoolgirl, since, well, she was a schoolgirl.

By the time she finished, and we had both stopped laughing, she took a breath and said, “Now what were we talking about?”

A saying attributed to Milton Berle is, “Laughter is an instant vacation.” It’s true. Laughter temporarily helps to take the focus off of our fear. But a falling stock market is no laughing matter.

It’s easy to get swept up in the fear that comes from stock market drops, especially after a five-and-a-half year period of gains. In the moment, the fear takes over, making us feel like we should do something to stop our cascading portfolio values.

The key to successfully overcoming this fear is to have expectations aligned before the drop happens. To help our clients truly internalize this concept, we walk through a set of steps to help them digest what a loss may feel like.

  • We begin with a look at the wide range of historical stock return outcomes possible over a one-year period compared to a 10-year period. This helps the client to see the random nature of one-year results and the increasing probability of higher returns for longer-term periods. We often compare it to a person walking up a set of stairs while using a yo-yo. The yo-yo will move up and down with each step but ultimately will make it to the top of the stairs.
  • Reviewing the client’s multi-year plan also calms the urgency to sell when stock prices dip. Because as prices fall, future return assumptions increase. Focusing on hitting income and spending targets, which the client can control, shifts the focus away from the fear. Circling back to important goals or memories the client mentioned when establishing the plan adds perspective and serves as a reminder of why a plan was created in the first place.
  • Running hypothetical examples of a loss in dollars, not percentages, helps to lessen the shock value when it actually becomes reality. Instead, reminding clients (and ourselves) to associate losses with opportunity in the good times makes us better prepared to make stock purchases when prices have fallen. Additionally, reflecting on historical gains that have occurred after certain percentages of losses can build confidence for when things seem extremely bleak.

We all face uncertainty when dealing with decisions surrounding our money. We also all know that stock market drops are inevitable. Removing the element of surprise allows us to be better equipped when the drops come along. Losses will never feel instinctively good, but seeing opportunity instead of being consumed by anxiety will help.

———-

Smith is a certified financial planner, partner, and adviser with Financial Symmetry, a fee-only financial planning and invesment management firm in Raleigh, N.C. He enjoys helping people do more things they enjoy. His biggest priority is that of a husband and a dad to the three lovely ladies in his life. He is an active member of NAPFA, FPA and a proud graduate of North Carolina State University.

MONEY stocks

Should I Be Worried That Stocks Are at Near-Record Highs?

Ritholtz Wealth Management CEO Josh Brown, a.k.a. the Reformed Broker, explains how to look at the market's recent performance.

MONEY retirement planning

Millennials Feel Guilty About This Common Financial Decision—But They Shouldn’t

Sad millennials leaning on desks
Paul Burns—Getty Images

Young adults aren't saving as much as they think they should for retirement. But paying off debts is just as important.

Millennials are pretty stressed out about their long-term finances, according to Bank of America’s latest Merrill Edge Report. Some 80% of millennials say they think about their future whenever they pay bills. Almost two-thirds contemplate their financial security while making daily purchases. And almost a third report that they often ponder their long-term finances even while showering.

What’s eating millennials? Student loan debt. Even the very affluent millennials surveyed by Bank of America feel held back by student debt—and these are 18-to-34 year-olds with $50,000 to $250,000 in assets, or $20,000 to $50,000 in assets and salaries over $50,000. Three-quarters of these financially successful Millennials say they are still paying off their college loans.

Among investors carrying student debt, 65% say they won’t ramp up their retirement savings until they’ve paid off all their loans. But with that choice comes a lot of guilt: 45% say they regret not investing more in 2014.

Contrary to popular wisdom, millennials are committed to investing for retirement. Bank of America found that the millennials surveyed were actually more focused on investing than their elders. More than half of millennials plan to invest more for retirement in 2015. But 73% of millennials define financial success as not having any debt—and by that measure, even relatively wealthy millennials are feeling uneasy.

Fear not, millennial investors. You’re doing just fine. First off, you’re saving more — and earlier — than your parents’ generation did. A recent Transamerica study found that 70% of millennials started saving for retirement at age 22, while the average Baby Boomer didn’t start until age 35. On average, millennials with 401(k)s are contributing 8% of their salaries, and 27% of millennials say they’ve increased their contribution amount in the past year. Even if you can only put away a small amount at first, you can expect to ramp up your savings rate during your peak earning years.

For now, here are your priorities:

Save enough to build up an emergency fund. You could be the biggest threat to your retirement savings. A recent Fidelity survey found that 44% of 20-somethings who change jobs pull money out of their 401(k)s. (That’s partly because some employers require former workers with low 401(k) balances to move their money.) Fidelity estimates that a 30-year-old who withdraws $16,000 from a 401(k) could lose $471 a month in retirement income—and that’s not even considering the taxes and penalties you’d owe for cashing out early. If you have to make the choice between saving and paying off debt, at least save enough to get through several months of unexpected unemployment without draining your retirement accounts.

Pay off any high-interest debt first. When you pay off debt, think of it this way: You’re making an investment with a guaranteed return. Over the long term, you might expect a 8% return in the stock market. But if you have a loan with an interest rate of 10%, you know for certain that you’ll earn 10% by paying it off early.

Save enough to get your employer’s full 401(k) match. The 401(k) match is another investment with a guaranteed return. Invest at least as much as you need to get the match—typically 6%—with the goal of increasing your savings rate once you’ve paid off the rest of your debt.

Related:

MONEY holiday shopping

13 Halloween Costumes for Finance Geeks

Actress Katie Seeley as a bear (left) and Sacha Baron Cohen as a bull (right)
Combine a bear costume (as worn by actress Katie Seeley, left,) and a bull suit (see Sacha Baron Cohen, right) for a punny stock market couples costume. Paul Archuleta/FilmMagic (left);Fotonoticias/WireImage (right)

Look like a million bucks—literally—with these creative costumes.

Still not sure what you’re dressing as for Halloween? Don’t despair. We’ve got a bunch of costume ideas that are right on the money. These finance-themed getups are accessible for a general audience (so you don’t have to spend your evening explaining, “No, the other kind of black swan…”), cheap, and quick to pull together.

For some tried-and-true ideas, you could go as Zombie Lehman Brothers, the London Whale, or characters from Dave Chappelle’s classic “Wu Tang Financial” sketch. Or you can try one of the more timeless 13 suggestions below. Then again, you could just dress up as prerecession government regulations and stay in for the night.

1. Money. Let’s be honest: Dressing as a giant bill or stack of bills is kind of boring. The concept is improved if your homemade costume is a reference to the “made-of-money man” in those Geico ads—or if you are an adorable baby swaddled in a sack of money. (Mom and Dad, throw on a mask and a badge, and voila! A cop-and-robber duo.)

2. A market crash. If Halloween season sneaked up on you like the October stock swoon did on traders, you can craft a “market crash” costume in five minutes by taping a fever line on a t-shirt with some masking or electrical tape. Use light-up accessories, and you’ve got a flash crash. This costume can be modified for a couple or group—just extend the fever line across your torsos—and it pairs nicely with a “broke broker.”

3. The Federal Reserve Chair. Mimic Janet Yellen’s signature white bob with a wig and her go-to outfit with a black blazer over a black dress or pant suit. Don’t forget a gold necklace. If people ask who you’re dressed as, throw fake money at them and yell, “Loose monetary policy!” To turn this into a group costume, grab yourself a Ben Bernanke and Alan Greenspan. Wear matching “chair” shirts for solidarity.

4. Bull & Bear (couples costume). Like salty-sweet snacks and Brangelina, this costume combination is greater than the sum of its parts. Relatively inexpensive store-bought costumes are easy to find, assuming you don’t want to spend hundreds of dollars, or you can always build a DIY ensemble with homemade horns and ears. Hang little signs with upward and downward trending fever lines around your necks for extra clarity. The only hard part will be deciding who gets to be which animal.

5. “Bond” girl. Personify this pun by dressing as your favorite 007 lady-friend and adding a hat, sign, or other accessory that reads “T-Bill” or features an image of a (now-technically-obsolete paper) Treasury bond. Jill Masterson’s “Goldfinger” look might be most recognizable: You can do it with gold spandex or body paint.

6. Wolf of Wall Street. See bull and bear, above. You just need a suit and tie, a wolf mask, and pockets brimming with fake money. And maybe some fake Quaaludes.

7. Cash cow. Unless your name is actually Cash (like this little guy), channel the Daily Show’s Samantha Bee and decorate a cow suit with dollar symbols.

8. A mortgage-backed security. This one might seem a little 2007, but there’s evidence these investment vehicles are coming back in vogue. Start with a shirt that says “security” in front. If you’re handy, you can then turn a small backpack into a “house” and wear that around. If not, just write “mortgage” on your back, and you’re done.

9. Gross domestic product. Just wear a “Made in America” t-shirt covered in dirt and fake blood.

10. Dogs of the Dow (group costume). Grab up to ten of your friends and dress as dogs. Wear tags with ticker symbols for each of the current Dogs of the Dow.

11. Distressed securities. Similar to #8, start with a shirt that reads “securities,” then layer on some dramatic makeup, to make yourself look, well, distressed.

12. Naked position & hedge (couples costume). This idea is pretty inside-baseball, but will be a fun challenge for your finance-savvy friends to guess at. The person dressed as the “naked position” can wear flesh-toned spandex, while his or her partner dresses like a hedge, as in shrubbery. Here are DIY instructions.

13. Spider / SPDR fund family (group costume). This one is pretty easy, since instructions for homemade spider costumes abound. You could go as a solo arachnid, with “ETF” painted across your chest, but dressing up is always more fun with friends. In a group you can each represent different funds; for example, the gold fund spider can wear a big gold chain and the ticker symbol GLD, and the high-yield bond spider can glue candy wrappers and bits of tinfoil all over himself and wear a sign that says JNK.

MONEY Markets

The Dow Moved Triple Digits Today. Here’s What You Should Do.

Arrow cut out of piece of paper
Gregor Schuster—Getty Images

Nothing. You should do absolutely nothing. Here's why.

[Update: The DOW went up 216 points on Oct. 23.]

The Dow Jones Industrial Average has long been held up as the stock market index to follow. Now that the Dow Jones is at such a high level, even moves that are small on a percentage basis allow for attention-grabbing headlines like “Dow Jones Today Skyrockets Over 200 points!” or “Dow Jones Plummets 150 points!”

While these headlines lure in readers, they do nothing to make us better investors. Read on to see why the best investors ignore the daily movements of the DJIA.

Dow Jones today

Do you remember when the Dow jumped 220 points after tensions with Ukraine moderated? How about the 200-point drop after Chinese industrial production slowed, or the 180-point jump following the release of minutes from the secret early-March meeting of the Federal Reserve?

I doubt it.

And don’t get me started on early October. The Dow Jones Industrial average dropped 272 points on a Tuesday — its biggest drop of the year to that point. The next day, the Dow jumped 274 points — the Dow’s biggest gain of the year. Then, on Thursday, the Dow fell 334 points.

114e89f4f5bf149c3b8e810b60149638

The headlines would have you think the world is ending or that you won’t be able to retire because of these market dips. The stock market is one of the few places where, whenever things go on sale, no one wants to buy.

However, these moves only amounted to a 2% drop from the end of the previous week. To put that in an even bigger-picture perspective, the Dow is basically flat year to date.

ee887b6cfb37ef2b441b0ef774201d41

What you should do now?

Nothing. You don’t have to do anything. If your investment strategy changes based on one day’s market movements, you’re doing it wrong. Your focus should be to stick to your plan, constantly educate yourself, and invest for the long term. And if you don’t have a clear strategy, this is your wake-up call.

Research has shown that process is one of the biggest determinants of success in the market over the long term. While your process can yield good or bad results in the short term, those with a proven process do better than the average investor over the long term.

For total beginners, I would first suggest learning about how the market works and how you can do at least as well as the market through index investing. I highly recommend The Little Book of Common Sense Investing by John Bogle as a great place to start.

If you understand the basics of the market as well as index investing, check out The Motley Fool’s 13 Steps to Investing Foolishly, which will teach you the process The Motley Fool has used to consistently beat the markets over the long term.

Everyone can learn from this

For every investor, focusing too much on daily market movements is a mistake. Things happen for no discernible reason. Rather than wasting time wondering why the market is up or down by a percent or two, we should focus on business fundamentals and continue to search for quality stocks trading at bargain prices.

We also must keep calm and not make rash decisions based on short-term market moves. Research has shown that it is far better to focus on minimizing mistakes, rather than overreaching for greatness. As economist Eric Falkenstein wrote: “In expert tennis, 80% of the points are won, while in amateur tennis, 80% are lost. The same is true for wrestling, chess, and investing: Beginners should focus on avoiding mistakes, experts on making great moves.”

And as Warren Buffett’s longtime business partner Charlie Munger said: “We try to profit more from always remembering the obvious than grasping the esoteric. It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”

My Dow Jones Industrial Average prediction for today

The Dow Jones Industrial Average will continue to fluctuate. That’s a given, and we have no control over it. What you can control is your reactions to those fluctuations — and the best reaction is usually no reaction.

Dan Dzombak can be found on Twitter @DanDzombak, on his Facebook page DanDzombak, or on his blog where he writes about investing, happiness, life, and success in life. He has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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MONEY Investing

3 Steps Retirement Investors Must Take Now To Survive This Market

boats trying to ride out rough waves in ocean
Valentin Russanov—Getty Images/Vetta

No one knows if the recent stock market turmoil is over or just beginning. Either way, it's time to re-think your investing strategy.

Is the recent volatility a prelude to worse to come? Or just another scary bump in a near six-year bull market that still has legs? Neither I nor anyone else knows the answer. But I can tell you this: It would be foolish not to take the recent turmoil as an opportunity to re-evaluate your retirement investing strategy.

Stocks have given investors a wild ride lately: one-day swings in value up or down of 1% to 2% (or more) have become frighteningly common. And with both valuations and concerns about slowing global growth running high, we could easily be in for more of the same, if not worse. Or not.

And that’s the point. Since we just don’t know, the best you can do is take a step back, re-evaluate your investing goals and risk and make whatever changes, if any, you must to make sure you’d be comfortable with your portfolio whether the market nosedives from here, or recovers and moves to even higher ground. What follows are three steps that will help you make that assessment.

1. Assess your risk tolerance: If you’ve never completed a risk tolerance questionnaire to gauge your true appetite for risk, don’t put it off any longer. Do it now. If you don’t want to go through the process of completing a questionnaire, then at the very least tote up the value of your stock and bond holdings and estimate what size loss you might be facing if we see another downdraft like the 57% drop from October, 2007 to March, 2009. Should the market take a turn for the worse, you don’t to find that the mix of stocks vs. bonds in your portfolio is out of synch with the drop in the value of your portfolio that you can actually tolerate.

In fact, even if you have assessed your risk tolerance in the past, I recommend you do it again now. Why? Stocks have had a terrific run since it bottomed out during the financial crisis. Even after recent losses, the Standard & Poor’s 500 index was still up some 175% since March, 2009. It’s natural during such extended booms to become complacent. The fear and anxiety we felt during the last big market meltdown fades with time and we fall prey to overconfidence in two ways. First, we may begin to overestimate our real appetite for risk. Second, we begin to underestimate the actual risk we face in the market. Doing either of those alone isn’t good. The combination of both can wreak major havoc with your finances.

2. Bring your portfolio in line with that risk assessment: Once you have a sense of what size loss you can handle without selling in a panic, you can then start making any adjustments, if necessary, to make sure your mix of stocks and bonds reflects the level of loss you can comfortably absorb. For example, if you feel that you would begin to freak out if you had to watch your portfolio decline any more than 20% but five-plus years of stock gains have bulked up the equity portion of your portfolio so that it represents 90% of your holdings while bonds have dwindled to just 10%, then Houston, you have a problem. A 90-10 mix in 2008 would have left you staring at a 33% loss. And that doesn’t count the decline that occurred at the end of 2007 and in the early months of 2009.

If you find that for whatever reason your portfolio is much more aggressive than you are, you need to scale it back—that is, sell off some of your stock holdings and reinvest the proceeds in bonds and/or cash. This sort of adjustment is especially important if you’re nearing retirement or have already retired, as a severe setback can seriously disrupt your retirement plans.

I’m sure you can come up with dozens of reasons to put off doing this. You’ll wait for the market to come back and then rebalance your portfolio. (News flash: The market doesn’t know—or care—that you’re waiting for it rebound.) Or you don’t want to sell because you’ll realize taxable gains. (Oh, you’ll feel better selling later for a smaller gain or even a loss. Besides, to the extent you can shift assets in 401(k)s, IRAs and other tax-advantaged retirement accounts, taxes aren’t an issue.)

Or maybe you’re one of those people who has a “feel” for the market, so you’ll wait until you sense the right vibe before making any adjustments. Fine. But at least check to see how well your ESP worked back in early 2000 when the dot-com era imploded and in late 2007 when stocks went into their prolonged tailspin. Unless your timing was spot on (and you’re willing to risk that you’ll be as lucky again), I suggest you revamp your portfolio so you’ll be able to live its performance in the event of a severe downturn.

3. Take a Xanax: I’m speaking figuratively here. Once you’ve gauged your risk tolerance and assured that your portfolio’s composition is aligned with it, you’ve done pretty much all you can do from an investing standpoint. So try to relax. By all means you can follow the market’s progress (or lack of it). But try not to obsess about the market’s dips and dives (although much of the financial press will do its best to try to get you to do just that).

What you definitely do not want to do, is react emotionally to the latest news (be it good or bad) and undo the changes you made during your re-evaluation. That would be counterproductive and, far from following a well-thought-out strategy, you would be winging it. Which is never a good idea, and a particularly bad one during tumultuous markets. If watching market news on cable TV or reading about the financial markets online makes you so nervous that you feel the need to do something, then step…away…from…the…screen.

If all else fails, comfort yourself with these two thoughts: Market downturns are a natural part of the investing cycle—always have been, always will be. And investment moves driven by emotion and made in haste rarely work out for the best.

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MONEY Investing

Why I Won’t Own Bond Funds in My Retirement Portfolio

Trays of eggs
James Jackson—Alamy

Owning a mix of stocks and bonds is supposed to help protect your portfolio from losses. But bonds aren't the safe asset they once were.

When stocks took a tumble last week, financial pundits were quick to call it a “potent reminder” to investors of the importance of having some bonds in your portfolio for their perceived safety and yield. The classic mix is supposed to contain 60% stocks and 40% bonds, with bonds supposedly cushioning the risk of equities. In the eyes of most investment experts, I would be considered foolish to be 100% in stocks, as I have been ever since I started investing.

But I’m not sure what bonds they’re talking about. Yes, last week the yield on a 10-year U.S. Treasury note surprised everyone by falling sharply to 1.85%, as bond prices soared—when bond prices rise, bond yields fall, and vice versa. Treasury yields edged back up to 2% the next day, as stocks rebounded. Wall Street experts are still trying to determine the reasons behind the 10-year Treasury note’s plunge, which stunned investors and traders.

But that was a one-day event. When you look at the decline in bond yields over the last three decades, I don’t understand how it is mathematically possible for Treasuries—known as the safest bond possible—to protect a stock portfolio against major shocks over the next 20 years.

No question, falling interest rates have been a boon to fixed-income investors over the last three decades. The yield on a 10-year bond has fallen from 14% in 1984 to 8% in 1994 to 4% in 2004 to about 2% today. The decline hasn’t been non-stop—bonds have rallied along the way—but the overall downward trend has most certainly pushed up fixed-income returns. As a result, bond funds have both made money and helped lower risk in a portfolio. This chart created by Vanguard, based on market data between 1926 and 2011, shows the impact of adding bonds to dampen volatility (as measured by standard deviation), while not drastically reducing returns.

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But those conditions, and that steady decline in rates, no longer exist. Today we have an environment where rates have very little room to fall and at some point will go up (we just don’t know when). Once rates finally rise, bond prices will fall, which means investors will lose money. So when someone recommends diversifying one’s portfolio with bonds these days, I wonder: is there some kind of bond that’s immune to interest rate rises that I don’t know about?

Junk, or high-yield, bonds certainly don’t fit the bill as they are also vulnerable to rate hikes. Moreover, there have been warnings that the accumulation of high-risk corporate and emerging markets bonds by mutual fund companies such as Pimco and Franklin Templeton could create a liquidity crisis in the future. Investors have been pouring money into these funds, but shocks could turn into even larger debacles when investors look to liquidate and the large amounts held by fund companies become hard to sell.

Short-duration bond mutual funds might be less affected by rising interest rates. Fidelity has a whole suite of such funds, which the fund group says “can help investors in a low and/or rising rate period.”

There are also mutual funds that “ladder” bonds with staggered durations so that a portion of the portfolio will mature every year. The goal of these laddered bond funds is also to achieve a return with less risk over all interest rate cycles.

The problem for investors saving for retirement is that the returns on such funds are so low that it’s hard to justify allocating anything to them other than savings you will need in three to five years.

I won’t be retiring for another several decades, so at this point, a market crash isn’t really my greatest risk. My greatest risk is not growing my retirement account as much as humanly possible over the next ten to 15 years. To meet that goal, I think I should stick with equities and use any future crashes as buying opportunities. I’m not 100% comfortable with that decision, but I don’t feel I have much choice. I would love to find a bond fund that could be both a safe haven and could provide steady returns, but I just don’t think that exists anymore.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

More on investing:

Should I invest in bonds or bond mutual funds?

What is the right mix of stocks and bonds for me?

How often should I check my retirement investments?

Read next: Why Americans Can’t Answer the Most Basic Retirement Question

MONEY stocks

3 Things to Know About IBM’s Sinking Stock

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Niall Carson—PA Wire/Press Association Images

IBM's shares plunged 7% Monday after a disappointing earnings report. Can tech's ultimate survivor transform itself one more time?

International Business Machines INTERNATIONAL BUSINESS MACHINES CORP. IBM 0.3434% has long enjoyed a unique status on Wall Street — a tech growth powerhouse that investors also see as a reliable blue chip, with steady profit growth and a hefty dividend. But with the rise of new technologies like cloud computing, Big Blue has struggled to maintain that balancing act.

Now investor confidence has suffered a big blow.

On Monday the company announced the results of a pretty lousy quarter. IBM’s third-quarter operating profit was down by nearly one fifth, and the company failed to generate year-over-year revenue growth for the 10th consecutive quarter.

Big Blue also revealed plans to sell-off its struggling semiconductor business, a move that involves taking $4.7 pre-tax billion charge against IBM’s bottom line. Actually, it is paying another company to take this unit off its hand.

While CEO Virginia Rometty acknowledged she was “disappointed” with IBM’s recent performance, she’s also pledged to turn the company around, led in part by IBM’s own foray into the cloud.

Now, you don’t get to be a 103-year-old tech company without learning to adapt. That’s what IBM famously did in the ’90s, when the computer giant started to shift away from profitable PC hardware in favor of consulting and service contracts for businesses.

But Monday’s dismal earnings show just how hard repeating that trick could turn out to be.

Here’s what else you need to know about the stock:

1) You can’t really call IBM a growth company anymore since its sales aren’t rising.

When it comes to revenues, IBM ranks behind only Apple APPLE INC. AAPL 2.4966% and Hewlett-Packard HEWLETT-PACKARD CO. HPQ 3.5638% among U.S. tech companies. On a quarterly basis, though, sales have actually shrunk for 10 periods in a row, including a 4% slide in the third quarter. The big culprit is cloud computing, in which businesses can access computing services remotely via the Internet.

Since the 1990s, IBM’s model has been premised on selling powerful, expensive computers to large businesses, then earning added profits on contracts to help firms run those machines. But the cloud lets companies rent, not buy, this computing power. “You only pay for what you use,” says Janney Montgomery Scott analyst Joseph Foresi. The result: IBM’s hardware revenues sank 15% last quarter.

2) IBM is racing to be a leader in cloud computing, but with mixed results.

The company has identified four alternative areas of growth. One is the cloud, the very technology eating into IBM’s hardware sales. Big Blue has spent more than $7 billion on cloud-related acquisitions. It’s also going after mobile, IT security, and big data, the analysis of information sets that are too large for traditional computers. An example of that is Watson. IBM’s artificial-intelligence project, which won Jeopardy! in 2011, is being marketed to businesses in finance and health care.

These initiatives have promise, but IBM’s size is a curse. For instance, the company’s cloud revenues jumped 69% to $4.4 billion last year, but with nearly $100 billion in overall sales, “it’s hard to move the needle,” says S&P Capital IQ analyst Scott Kessler.

3) The stock is now much cheaper than its tech peers, but it may deserve to be.

Investors willing to wait and see if these moves will transform IBM may take comfort in the fact that the stock looks cheap. What’s more, the shares yield 2.4%, vs. 2% for the broad market. This could make the company look like a good value.

But investors should tread carefully, says Ivan Feinseth, chief investment officer at Tigress Financial Partners. He notes IBM has spent $90 billion on stock buybacks in the past decade, which has kept the P/E low by increasing earnings per share. Yet none of that money was invested for growth, as evidenced by IBM’s sluggish annual growth rate. It is hard to imagine IBM outmuscling Amazon AMAZON.COM INC. AMZN 1.2947% , Cisco CISCO SYSTEMS INC. CSCO 0.8463% , Microsoft MICROSOFT CORP. MSFT 1.2843% , HP HEWLETT-PACKARD CO. HPQ 3.5638% , and Google GOOGLE INC. GOOG 1.9177% in the cloud — and there are better values in tech.

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