How can I recover from losses in my IRA?
I am trying to invest today to help my son in the future. I put $2,000 into an IRA, but between the fees and bad investment decisions, it has been losing money and its' value is currently below the initial deposit. Is there anything I can do to minimize or regain my losses? Can I move it to another investment vehicle to save what is left? What strategies are out there for how to recover from this and how should I reevaluate my savings strategy?
A great strategy is to ensure you have the following elements:
- Broad diversification (e.g. ETF portfolio with stock and bond allocations)
- Low fees and expense ratios
- Tax advantaged account (e.g. Roth IRA)
Historically, a properly balanced and managed portfolio can increase in value with the market while cushioning downside risk. Your funds can be managed for you in a low-cost ETF portfolio at Betterment.
There are a few things to consider as your son approaches making changes to his IRA in order to maximize it's efficiency and effectiveness. Here are my suggestions:
Investments in the stock and bond markets are naturally volatile, so it isn't uncommon for new accounts to dip below their initial value in their early days. Because an IRA is generally considered a long-term investment, and I assume your son has many years (or even decades) before retirement, this kind of short-term decline will, in hindsight, be considered an insignificant blip in the accounts long-term growth. With that in mind, I would caution him from lowering the account's risk exposure because of jitters felt from a momentary slump. Risk is inextricably linked to return, and if his objective is growth, he'll need to find a way to stick it out for the long haul.
A strategy I suggest for maintaining long-term investments with less day-to-day worry, is to build a healthy emergency cash reserve of 3 to 6 months of living expenses. This would give your son a buffer around his IRA by accommodate unanticipated cash short-falls, while allowing him to weather through periodic market declines with his IRA intact and posed for continued growth when the tides eventually turn.
That said, there's no harm in reviewing your son's asset allocation to make sure it's highly-diversified (an important tool for eliminating unsystematic risk) and properly matches his risk tolerance. Making sure his investments are in alignment on these two fronts will go a long way in allowing him to feel confident sustaining, and regularly adding to his IRA between now and retirement, no matter what the markets are doing.
And your instincts are correct in wanting to examine the fees he's paying. Ruthlessly minimizing fees will allow your son to leaving more in his account to compound and grow over time. Annual fees of even 1% can cause considerable drag on investment returns, so it's worth taking a hard look at the individual assets to determine his ongoing expenses, and add that to any management costs. Now compare what you calculated to the cost of a few index mutual funds whose annual expense ratios are only a fraction of a percent. Would he benefit from a change? Cutting his annual expenses will be one of his best strategies for boosting long-term results.
The good news is that in an IRA your son won't face any tax implications from reallocating the investments within his account, or even from rolling the account to a different custodian with access to lower fee investment options. Companies like Vanguard and Fidelity offer low-cost, passively-managed funds that would allow him to keep his expenses down and maximize what remains in order to build back to his initial account value and beyond.
Yes, you can move it to another investment vehicle and maybe you might want to change custodians. For a small amount of money pick a bond fund and a large capital stock fund with low fees and good ratings and then committ to investing a regular amount each month, or quarter, or year and sit back and give it time. If you are very aggressive you want just the stock fund and if you are ultra conservative you want just the bond fund and if you are right in the middle moderate do 50/50 of each. Go 60/40, 70/30,... whatever you feel comfortable with. Low fees and good rated funds will pay off in the long run. The only way to get back an investment loss is to pick stable investments and wait. Time heals everything.
Congrats on putting away money for your son. It may seem like a silly thing to say, but it often goes with a wish that never gets implemented.
Over last number of years I’ve noticed a few things from investors. Investors who ask similar questions about losses and recovery tend to have either increased value significantly and then watched it disappear quickly or they watch their value disappear with fees and investments that always seem wrong. So if this is you, understand you a not alone.
The only way I know to effectively increase your odds of minimizing or regaining your losses is to develop a strategy that gives you the probability of achieving that goal. This means you need to understand systematically how, when, why and where you enter the investment/trade and at what point the trade is wrong and how, when, why and where you leave the investment/trade. You’ll want to read a good bit of books on this as it is simple but difficult. This concept holds true for both passive or active investing (you’ll hear this arguments in financial advisor circles a lot). Passive is just a lot easier to understand in my opinion. But just make sure you make it your own. If you’re looking for easy tips to make up your difference than I would say “good luck”. Every strategy has its losing periods and winning periods so its important that you fully understand your own. I could probably give you a number of successful strategies but it would not work for you unless you made them your own in some way. I would recommend that you at least spend 20 hours per week devoting yourself to understanding these concepts and many more. Or I would look to do what you do best to make the money, put the savings into your son’s account and implement a passive strategy with or without and advisor. I keep telling people that if you want to invest/trade yourself then you’re not a long-term client of an advisor. As an advisor, we are here to do what you do not want to do or don’t have the time to do. Or like some of my past clients, hire an advisor till you invest well enough to do it yourself. Best of luck on your journey!
This is going to be contrary to most advisors who tell you to buy-and-hold in a certain allocation based upon your income, age, etc.. but in my opinion, you need a sell discipline so to minimize losses and not let them get away from you. The fees shouldn't be much of an issue UNLESS you are doing commission based investing, not fee based. If you have an advisor working on commission or you are buying loaded funds, STOP! STOP NOW! You should be using low cost exchange traded funds (ETFs) and/or low cost, no load mutual funds.
Getting back to the losses, when the best managers in the world in all of the various categories - stocks, bonds, commodities, currencies - were asked what their secret was, all of them said "I kept my losses small." So it is not that you will be wrong sometimes, you absolutely will. The question is how will you handle the losses? Compounding works both ways, and when you let losses turn into big, double digit losses, it can significantly hurt your asset base and recovering is much more difficult.
The worst thing you can do is to say "I will wait until it gets back even and then sell." WHAT?! This has no mathematical reasoning behind it but is simply so you don't have to admit that you were wrong. This is called behavioral finance. The correct question you need to ask is whether the investment is still valid because it is not behaving as planned and more importantly is there a better investment that will do better going forward.
What you need is sound strategy, not products. And the way to regain your losses is to grow the portfolio back to its original value & then continue growing it.
Hope this helps and best of luck, Dan Stewart CFA®