Two years after the collapse of Lehman Brothers (LEHMQ) sent stocks into one of the worst bear markets since the Great Depression, the stock market has turned volatile again. If you are worried about another downturn, you’re not alone. While no one knows for sure which way stocks are headed, you can learn important lessons from the experience of investors during the last market drop.

According to a March 2010 Fidelity study of more than 11 million 401(k) participants, investors who stuck with their plans and kept making regular contributions to their 401(k) and maintained an allocation to stock investments fared significantly better two years later than those who bailed out of stocks or stopped making contributions.

A look back

The stock market reached a low point on March 9, 2009, in the wake of a precipitous fall in U.S. housing prices, credit problems around the world, and a rise in unemployment. Meanwhile, the government initiated its largest ever intervention in the economy. At the March low, the S&P 500® Index (.SPX) had lost 57% from its peak, and the more than 11 million workplace savings plan participants serviced by Fidelity had an average balance just over $46,000—a far cry from the average balance of $65,000 in March of 2008.

Some investors, spooked by deep declines, retreated from the stock market in hopes of stemming the losses in their workplace plans. One strategy: Weather the storm in cash before putting their hard-earned savings back into the equity market. “There were definitely investors who just weren’t comfortable with the direction of the markets, and who wanted to try to avoid the volatility by moving out stocks,” says Beth McHugh, vice president of market insights at Fidelity.

The snapback power of equities

For many, the move out of stocks backfired. The stock market started a powerful rally on March 10, 2009—and investors without exposure to equities missed out. The investors who reduced their stock allocations to 0% during the fourth quarter of 2008 or the first quarter of 2009 saw their average account balance decline nearly 7% during the 18 months through March 2010. By contrast, the investors who maintained an exposure to stocks saw their account balances jump an average of nearly 22% over that same time period. (See the table below.)

The stock market’s surge was a determining factor. Investors who stuck with their equity allocations enjoyed the benefits of the rebound. Meanwhile, many investors who tried to time the market locked in their equity losses and missed the market’s partial recovery during this period. “One of the fundamental principles of investing is not to try to time the market,” says McHugh. “The good news is that only a very small percentage of people actually reduced their equity exposure to 0%. Most people stayed the course and saw their account balances grow.”



The value of regular savings

Some investors in workplace savings plans dealt with the market downturn by just stopping their regular contributions. For some, eliminating regular plan contributions provided a way to free up extra cash to cope with financial pressures from the recession—say, if a spouse lost his or her job. Others figured they’d stop throwing good money after bad, and would resume contributing again after the market picked up.

Again, this strategy prevented many investors from taking full advantage of the stock market’s rebound. Investors who continued to contribute to workplace savings plans on a regular basis enjoyed a 29.3% leap in their average account balances for the 18 months through March 2010 thanks to market gains, contributions and other plan activity. Meanwhile, plan participants who stopped contributing in late 2008 or early 2009 experienced an average gain of just 15.3% on average.

One reason for the difference: Investors who maintained regular contributions took advantage of relatively low prices during the stock market’s slide. Making contributions on a regular basis—a strategy known as dollar cost averaging—reduces the number of fund shares purchased at market peaks and increases the number of shares purchased after the market falls. “You need to take the long view when saving in a workplace retirement plan,” says McHugh. “Investors who kept contributing during the downturn continued to invest using dollar cost averaging in their portfolios.”

Ready, aim, invest

What the recent downturn shows is the importance of taking a longer-term view. We believe that investors should have a plan that includes a target asset mix. The recent ups and downs in the market—and investors’ reactions to those shifts—have strengthened the case for having a good plan and sticking with it.

For folks who have a hard time sticking with a plan, the recent downturn also illustrates some potential advantages of target-date, or lifecycle, funds in workplace savings plans. Such funds can help take the guesswork and emotion out of building and maintaining a portfolio suitable for an investor, and adjust the asset mix over time. This can help an investor ride out difficult periods in the market. Consider: During the one-year period through March 31, 2010, more than 62% of plan participants who didn’t hold all their assets in a target-date fund or managed account underperformed the Fidelity Freedom Fund targeted to a retirement date based on their age (assumes retirement age is 65).

The recent bear market was the worst many investors had ever lived through. As such, it may provide some valuable learning opportunities. According to our research, certain lessons are clear: Maintaining a disciplined investment strategy—including an asset allocation consistent with time horizon, financial situation, and risk tolerance, and regular contributions—is important to maximizing a workplace retirement plan’s benefits through both up markets and down markets. “Some of the best periods to invest have historically come on the heels of the most unnerving times,” says McHugh. “To have the opportunity to reach your goals, we believe investors should set their plans for the long term—and not let themselves be interrupted by short-term events.”

Quoted:
Buy low, sell high.

Quoted:
I'm convinced the stock market is a rigged game.
No more for me.

Quoted:

I'm convinced the stock market is a rigged game.



No more for me.

Quoted:
Don't EVER let emotions rule your investment decisions.