Here’s what an economist had to say about investing on ABC 7 Eyewitness News tonight:

• Third quarter 401(k) statements are reaching homes now. Don’t look at your statement.
• If you put more money in your 401(k), put it into Treasuries.
• If you are thinking about stocks, think again. They look cheap now, but they’ll be cheaper later.

I suppose if you would go insane after seeing your 401(k) balance, it would be a wise decision for your mental health to hide your head in the sand. Times like these test the investor. Putting your money into stocks is risky; if you want the returns touted by finance professionals, you have to accept that risk. It’s easier to accept that risk when the market is moving upwards.

I’m not quite sure the same tips apply to the 25-year-old with 40 years before retirement and the 60-year-old approaching retirement.

This is interesting advice from an economist. What do you think?

The Dow Jones Industrial Average, a measurement of the stock market at large, ended below 10,000 yesterday. That’s the lowest closing since 2004 and it’s quite a drastic change from a year ago, when the market closed above 14,000, the highest watermark for the Dow.

It’s tempting to just stick my head in the sand. I have been looking at my investment balances, though. While it’s hard to separate my emotions as my 401(k) balance quickly moved from about $50,000 to about $40,000 despite contributions, I try to keep in mind that my time horizon is decades in the future.

When the market is in turmoil, it should put asset allocation into the front of any investor’s mind. For people who have a long time before retirement like me, it’s not a good idea to run for cover. It might be a good time to ask yourself if you’ve accurately thought about your risk tolerance. It’s much easier to say you’re willing to accept more risk in return for a higher return over the long term while the market seems to be increasing without bounds. But if you freak out when you lose 20% on paper and consider evacuating your money, either you underestimated your ability to accept risk or you just need to work a little harder to separate your emotions from your financial decisions.

I’m sticking with my “aggressive” retirement portfolio of 100% stocks. My contributions are split evenly between large cap growth, large cap value, international, and commercial REIT, while my current balance has more of a mix including mid cap growth, mid cap value, and small cap stocks. Half of my employer matching contribution is in company stock, and I exchange out of that stock when I’m in a good position to do so.

And my performance this year through September 30 is a loss of 20.85%.

On the positive side, I’m purchasing my investments at a much lower price now than I was last year at this time.

While some pundits are calling for a Dow as low as 8,000 before we hit bottom, it doesn’t make sense to make reactionary decisions, particularly when the money is invested for the long-term. It does help to review your risk tolerance to determine if you can face downturns and to find a way to strive to separate your emotions from financial decisions. Emotions are there to guide us, to let us know what may be right for us, but when emotions form the basis of financial decisions, investments suffer.

It’s very tempting to quickly peek at your investments to see if they’ve gone up or down in the past twenty-four hours. The same technology that makes our lives so much easier, computer software, can drive us insane. It takes almost no effort to log into my company’s 401(k) website. When I’m at home, Quicken is only one Quick Launch icon away. At any given time, morning or night, it can take me less than 30 seconds to determine whether my tune for the day is The Gold Diggers’ Song (We’re In the Money) or Stormy Weather.

This is not necessarily a good thing. While I can usually control myself, I’ve occasionally pulled the trigger and rebalanced my 401(k) asset allocation when I shouldn’t have. These days I pay less attention to detail but I haven’t solidified my asset allocation strategy.

Susan Byrne recently shared with Money Magazine the best investment advice she ever received. Susan, the founder, chairman and chief investment officer of Westwood Management, learned while she was managing other people’s money but doing a poor job with her own assets, to keep her hands off her 401(k) except for once a year.

It’s often best to keep your eyes and hands off. Stick to your asset allocation strategy and rebalance the portfolio annually, automatically if possible.

Perhaps this is true for more than just investments, but I’m often tempted to touch things I can see. I’ve stopped looking at my investments daily, but the next step is to determine an asset allocation and stick with it. Are you tempted to change your strategy, particularly when you see your balance declining from day to day?

The smartest advice I ever got, Money Magazine

Fidelity and Vanguard, monsters in the world of mutual funds, are busy creating new products catering to the vast number of baby-boomers approaching retirement. These products are designed to compete with annuities, insurance products with guaranteed income, but are investments products so they offer no guarantees. Like target retirement funds, the asset allocation of these funds of funds changes over time, but they are managed more actively.

Fidelity’s strategy is to create “Income Replacement Funds.” While target retirement funds are organized by the projected retirement date, the Income Replacement Funds are designed to liquidate in a particular year. There will be a fund for every other year between 2016 and 2042. Between the times of investment and liquidation, the fund will provide a monthly cash payment based on investment gains and possibly a portion of the principal.

On the other hand, Vanguard will be offering three different portfolios: Growth Focus, Distribution, and Growth and Distribution (a combination). The purpose of the Growth Focus portfolio is to maintain your principal while investing aggressively. The Distribution portfolio is designed to maximize your monthly payments while preserving the principal as much as possible. The Growth and Distribution portfolio falls somewhere in the middle of the other two.

In this way, with no end date, the Vanguard funds will operate more like a university endowment.

...[U]nlike annuities, these funds let you keep your money. After the $25,000 initial investment, you can buy additional shares or sell them without penalty, a big advantage if you need to pay for an unexpected expense.

The $25,000 investment sounds steep, but these funds are for retirees who may be changing their perspective at retirement. They will have the funds from their 401(k) and IRAs which will be tapped to help pay for expenses once retirement is in full swing.

I have not yet seen any information about projected fees to cover the operation and management of these funds.

Turning savings into income, Eugenia Levenson, Fortune Magazine, June 18, 2008.

Here is a case study in why you shouldn’t fret over the details in an account that’s designed to keep funds invested for the long term. I would probably stay saner if I wait three decades before looking at my 401(k) account again.

I received my retirement account statement in the mail today. This is one of the last of my accounts for which there’s no electronic-only option for statement delivery.

Despite investing about $3,500 throughout the first quarter, the account’s balance is down almost $1,000 since December 31. That’s a loss of $4,400 if realized.

All in all, my performance for the first quarter was a sad -9.2%. That reflects my allocation of 33% large cap stock, 17% mid cap stock, 2% small cap stock (likely the most expensive of the fund offerings), 26% international stock, 10% commercial real estate (REIT fund), and 12% company stock. Company stock performed the worst over the quarter, with a drop of 15.5% (annualized).

I divested significantly out of company stock when it was very close to its high last year, so the decline didn’t hurt me as much as it would have otherwise. I still have probably too much invested in the company, since I also have stock purchase plan from the last two quarters. Of course, my income relies on my company as well.

How was your first quarter performance? Better than mine, I hope. I’d be better off if I file or even shred these statements, never to be seen again.

Today I increased my 401(k) contribution, a move which will bring me significantly closer to my goal for investing up to the limit allowed by the government in 2008 ($15,500). My 401(k) account is split into three portions: my before-tax contributions, my Roth contributions which are after tax, and my company’s employer matching contributions, which are considered before-tax contributions as well but don’t contribute towards the $15,500 limit.

I increased my before-tax contribution rate from 12% to 20% of my salary while leaving my Roth contribution rate at 13%. I decided to take this approach rather than leave the before-tax and after-tax contributions equal to each other to take more advantage of the tax benefit this year.

In an world of overly simplified platitudes and one-size-fits-all “advice,” there is little repeated more in personal finance than the importance of the emergency fund. Typical popular financial advice prescribes a high-yield savings account in which one can store three to six months’ worth of expenses. Suze Orman suggests aiming for eight months’ expenses in a savings account. David Bach believes four months is a good starting point for an emergency fund.

Advice for a fat emergency fund sounds good when high-yield savings accounts are actually providing high yields. When interest rates are low, it can be financially detrimental to leave so much cash uninvested. It may be worthwhile to diversify. Rather than having just an “Emergency Fund,” like a “subaccount” at ING Direct with its own name, this can be only one component of a larger scheme. To encompass all that could be included, perhaps “Emergency Plan” is a better term than “Emergency Fund.”

I am not talking about a box that you keep in the trunk of your car that contains a gas mask, a gallon of water, a hand-crank radio, and a can opener, like one of my coworkers. While that might be helpful for the Y2K bug when airplanes fall out of the sky in midflight, this “Emergency Plan” refers to finances only. There are five components.

1. Mattress cash stash. Obviously not hidden beneath your mattress, having some cash in the house—hidden in a weird place that a burglar would not think to look—gives you access to fast cash if you need to leave right away without any time to stop at a cash machine. Also, if the ATM network is down for some reason, you won’t have any trouble trying to access some money. It would be impossible to predict how much you would need before you could access the banking system in a catastrophic event, so I think the guideline here is just to be reasonable. Maybe keep a couple hundred dollars in cash around the house.

Of course, in the worst situation imaginable, money itself would lose all value and society would be reduced to a system of bartering for what you need. Even gold, which some people claim has intrinsic value that paper money does not (it doesn’t), could be worthless. Don’t bother keeping bars of gold around. The idea is to prepare within reason. Keep this amount as low as possible; money sitting around loses value relative to the things you would need to trade it for thanks to inflation of the money supply.

2. Liquid account. Unless the banking system fails, you should be able to access your next level of emergency fund within 24 hours. With interest rates decreasing every week, it might make sense to seek out better paying liquid investments like money market funds. All of the cash I have earmarked for emergencies, about $10,000 right now, is held at ING Direct, currently one of the lowest of the “high-yield” savings accounts.

It wouldn’t hurt to add layers to this level. This year, I will change my Emergency Plan to leave cash in the amount of expenses for one month or less at ING Direct while increasing my savings at a money market fund that beats inflation like the Vanguard Prime Money Market Fund, currently earning a 4.55% yield. Between my mattress stash and liquid accounts, I want to be able to cover three months’ worth of my current expenses. That’s a little lower than what’s recommended by the gurus, but I chose this amount because the chance of losing both of my sources of income at the same time is low and I believe I could find a new job quickly if necessary.

Bankrate discusses using certificates of deposit or bond funds for this portion of liquid savings, but they are not liquid enough. The interest premium offered over high-yield savings accounts and money market funds, usually small, won’t outweigh the chance of paying an interest penalty for early withdrawal before maturity.

3. Investments. With investments, we’re starting to get into the territory of the money you’d be better of not touching, even in an emergency. The Roth IRA is the first stop if you need to tap your investments in an emergency. You can withdraw your contributions (not your earnings) without penalty, taxes, or fees (depending on your broker). Once the emergency condition has subsided, you can still contribute the money you withdrew back into your Roth IRA.

If you don’t have a Roth IRA, you may have to turn to taxable investments. This isn’t a great option, but still better than the next. If you have to sell when you’re investments are down, you’re not doing yourself a favor down the road. You may get some tax benefits in this case, but you’ll have to determine whether it’s worthwhile. If you sell your investments while they’re higher than they were when purchased, you will owe taxes, which could be just as troubling in the short term if you’re still in an emergency condition. Either way, you’ll also contend with transaction fees.

Stay away from granting yourself a loan from your 401(k). If you lose your job during this emergency, your 401(k) loan will become due immediately. That’s an unaccessible level of risk, at least for me.

4. Credit. This is a slippery slope. Some recommend using a home equity line of credit as an emergency fund but having a HELOC in the first place means having an interest expense every month. The purpose of a HELOC goes beyond emergency funds, and therefore shouldn’t be the only part of an Emergency Plan.

Credit cards should be avoided in most cases. They could be used most effectively when you know that the emergency condition will subside before your credit bill comes due. Interest charged for credit card accounts is usually way too high for effective emergency use. If you have a special promotion with your credit card, like 0% APR on purchases or cash advances, then taking advantage of these deals could pay off. It requires extra special attention to make sure you don’t fall into any of the credit card traps. If you end up owing back interest due to a late payment, even in an emergency situation, you could be paying for this emergency longer than you would otherwise.

5. Friends and family. While I originally thought this fifth component is outside of one’s control, if you’ve done a good job of taking care of the universe around you, the universe will return the favor when you’re in need. If you’ve made a habit of helping those in need when you were able, when you’re in need, perhaps someone will be there to look out for you. Perhaps this will be in the form of your roommate or friend lending money to you at a very low rate or a gift from your parents. Either way, it’s best not to rely on help from the universe, as there are no guarantees. When you save cash in a money market fund, it’s guaranteed to be there when you need it. Friends and family can provide powerful assistance, but if you don’t need it, don’t take it.

Here’s a secret. There are actually six components.

6. Reduce your expenses. One thing you can do to make your Emergency Fund last longer, or save more for next time, is reduce your expenses temporarily. Make some sacrifices, like the Expensive Coffee-Relate Drink, cable television, or weekly dining engagements. Desperate times call for desperate measures. Feel free to indulge again once you find a new job or otherwise increase your cash flow to normal conditions.

What is your Emergency Plan? Do you consider yourself covered with cash in a savings account, or do you take a more complete approach?

Image credits: tanakawho, ChicagoEye

This is the last installment of the series in which I offer a few suggestions for picking up the pace of your savings. For those not familiar with the concept of “hyperdrive,” the word refers to traveling faster than the speed of light, common in science fiction. This is the speed I would like my savings to accumulate, so I’ve compiled a few tips to help reach that pace.

In my company, there is a scheduled time that all employees receive information on their bonuses and annual pay increases—even if the answer is $0 to both. That time, coinciding with annual reviews, is coming shortly. This yearly event offers a great chance to accelerate savings. It comes down to how you handle the raise and bonus.

6. Make Your Raise Invisible. Your boss has just informed you that you will be receiving a raise of 3% and a bonus of $5,000, both taking effect in the next pay cycle. What is your first inclination? From talking with my coworkers, it seems to be common for the bonus and raise to be spent already. Anticipation of a pay increase seems to inspire spending ahead of time. Thus, it may make sense for many people to use the bonus and raise to pay off debt.

Since this is a series about saving, I am taking the position that no significant debt needs to be paid off. Your raise and bonus would go far to pay down high-interest credit card debt or a home equity loan. But if your goal is to maximize your savings, the raise and bonus can come in handy.

A general guideline is to increase your savings percentage by the percentage increase of your raise. That is, if you receive a 5% raise and you’ve been saving 10% of your income, increase your saving to 15% of your income. This means that your increase will be invisible to you and your budget.

Before-raise salary: $50,000
Before-raise 10% saving: $5,000
Left over: $45,000

After-raise salary: $52,500
After-raise 15% saving: $7,875
Left over: $44,625

This is an interesting number game. With this raise, you are earning $2,500 more than you were previously, but you are savings $2,875 more in the new year. By applying your raise increase percentage to your savings percentage, you’re actually saving a larger portion of your income. You are also reducing your left-over income after savings, but not by much (less than 1% of your new salary).

I’ve taken another approach in the past, focusing on retirement investments rather than straight rainy-day savings. I am not currently maximizing my 401(k) contributions, nor was I when I received my pay increase in prior years. When I received my raise each year, I increased my 401(k) contributions by the same percentage.

Whether you’re putting a larger percentage of your income in a high-yield savings account or a tax-advantaged high-yield fund, you’re making a good decision, but a larger deposit in your savings account will allow you to see your interest grow exponentially with each paycheck.

When it comes to the bonus, this is a no-brainer. As long as you don’t have debt, a lump sum deposit into your savings account can provide a boost towards your savings goal.

It’s quite possible, in an economic downturn or as a result of poor performance, that the raise offered by your employer is invisible itself. That’s a discouraging sign regardless of the reason. I’d suggest increasing savings, anyway, if possible. You’ll also be faces with increased prices. Your raise doesn’t need to match inflation, particularly if your expenses are lower than your income, but the government’s official inflation number is generally used as a benchmark for an “adequate” cost of living increase.

Most employees will receive some sort of increase this year. If you are one, you have the opportunity to get one step closer to hyperdrive by making that raise invisible.