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Boost Reserves or Buy Stocks?

By JLP | December 26, 2008

Many people who save regularly are facing a similar dilemma in the wake of the 2008 market chaos as they look ahead to setting 2009 goals. Should I boost my cash reserves or should I buy stocks?

Cash is probably the right choice if you:

Of course, there is never a BAD time to be boosting reserves; it’s hard to argue against such conservativism even in the best financial times. We all need to have money set aside in case we are temporarily disabled, lose our jobs, have a medical emergency, etc etc. Then there is that new car/TV/appliance/engagement ring we plan to buy in the next 5 years for which it is best to have cash to pay.

But it is also tempting to buy stocks in what appears to be a fantastic opportunity of a generation, especially if you:

  • Don’t need the money for 10+ years,
  • Have an income that is stable and/or easily replaceable,
  • Don’t have many obligations such as dependents or large fixed costs, and
  • Have an emergency fund that will get you through a few months in a pinch.
  • I for one am torn.

    The markets are down around 40% for the year. Buy Buy Buy! screams the greedy voice in my head. I realize that I’ve been known to try to “catch a falling knife” before by making a bad stock pick and buying more and more shares as it tanked to near-worthless territory. But this is different; this is the whole diversified market. What could be more advisable than boosting my 401k contribution and taking advantage of a market dip early in my formative saving years?

    So I did that; I suspended all other savings and boosted my 401k contribution to 20%. It has been exciting to see my contributions and balance rise a bit over the last couple of months. But at the same it has been disheartening to notice that my emergency fund has frozen. It just sits there, not getting any bigger like it used to every month – and it’s not that big to begin with. It would really only get me through 1.5 months of expenses if I got laid off.

    On the other hand I have credit and taxable investments and wealthy relatives who could help in a real emergency. And in a temporary pinch (like a tenant vacancy), I can always suspend my 401k contributions…

    But will I ever really know or notice the difference if I cut my 401k contributions back down to something reasonable and stock up on reserves this year instead? So I’ll end up with $568K instead of $600K in retirement funds one day down the line because of this choice. Does it really matter? Isn’t it more important to protect myself in the short term and make sure I have a comfortable cushion in case I can’t – or don’t want to – work in the foreseeable future (as opposed to my wholly unforeseeable retirement)? I mean it’s not like I’m not saving for retirement; I just really don’t have to go all in.

    I am one of those odd people who is half crazy conservative (i.e. I want to buy physical gold to barter with in case of financial Armageddon and I want to own raw land outright which I can farm in case of the Great Depression II, and I want all my other investments in inflation protected government insured securities) and half crazy aggressive (i.e. I want to load up on 100% stocks – especially international ones which have really tanked, and I want some commoddities exposure and to bet on oil, and I want to leverage up my balance sheet to buy lots of real estate that will boost my income down the road, and who really has a year’s worth of expenses sitting in cash??).

    I know that the reasonable thing to do is limit my 401k contributions to 10% and put the other 10% in cash. That’s probably the reasonable thing to do. But I think I am going to see how far the 20% in my 401k can take me before I start to feel any sort of crunch. How are you prioritizing your financial goals in the coming year?

    More from Meg at The World of Wealth

    Topics: Miscellaneous | 12 Comments »


    12 Responses to “Boost Reserves or Buy Stocks?”

    1. John Says:
      December 26th, 2008 at 4:55 pm

      This was a great blog engry. So many folks are wondering which way to go with money. There is a cool post over at http://www.fitandwealthyblog.com about the economy in 2009. That might help in terms of deciding what to do. Thanks for sharing.

    2. Rich Says:
      December 27th, 2008 at 1:14 am

      We faced a similar decision. My wife lost her job a few months ago, and recently found a new one. But her new job doesn’t seem so stable, so we’ve been trying to boost our savings over paying down debt in the short term.
      Don’t forget though, if you get laid off you will receive unemployment income. We became tight enough with our money that unemployment + my income was enough to sustain us without resorting to dipping in the emergency fund. And now we are saving even more now that her income has gone up.
      I think in the long run you will be fine putting more money in your retirement account, as long as you can get used to comfortably living on a reduced salary.

    3. Jason Bontrager Says:
      December 27th, 2008 at 7:07 am

      I’ve upped my monthly stock purchase by $50, but otherwise haven’t changed much. I’ve cut one monthly expense for a purchase that I’d been losing interest in (comic books), and I’m planning on taking fewer road-trips to Austin in the coming year. My cat probably won’t last another year either, and I won’t be replacing her when she goes (amazingly expensive things, diabetic cats).

      As for my “emergency fund”, I don’t have one as such, just a money market account that I use as my primary checking account. I just try to see to it that less leaves than enters (difficult during the holidays, but those are past now). I do have another checking account that I keep active just in case I need to write a check for less than $100. I only keep about two grand in that one though, and I should probably transfer half of that over into my money market account, which provides better interest.

      So that’s it. Keep investing and keep saving. My 403b is maxed out and has been since I started my current job, so no need to worry about changing that.

      I have two big expenses on the horizon, a bathroom renovation and, eventually, a newer car. Those are going to hurt, but I’ve got funds to cover the first, and my current car still runs, so I’m putting off the second as long as possible.

    4. Stacey Says:
      December 27th, 2008 at 12:18 pm

      It’s the old “good enough” yardstick. I’m not fretting over it–I’m splitting some to ING savings, doubled DRIP to P&G, continuing to max DH’s 401K and continuing my $150/mo to my T Rowe mutual fund and $500/mo to the boys’ 529s (which is less than 1/2 of what we used to fund.) We have a healthy emergency fund balance in an ING Savings Acct; however, since IMHO things are going to get worse before they get better I’ve also laddered CDs to sleep better at night. Since our portfolios are down 40-50%, including what used to be healthy 529 balances, my goal is to stay flexible and keep balances in instruments I can get to, penalty-free in case the worst (illness/job loss) comes home to roost w/us. I’d be less conservative if we weren’t carrying 2 residences, but that’s not “the hand” we’re currently holding :(

    5. Mark Says:
      December 27th, 2008 at 3:23 pm

      I have actually been increasing my savings the last 2 months. I am going to switch and increase my investments this coming year.

    6. Jason Bontrager Says:
      December 28th, 2008 at 9:42 am

      So here’s a question: who thinks selling short now, with a contract to buy back on January 21st, 2009, might be a good risk (assuming such an arrangement is possible…I’ve never sold short)?

    7. Single Guy Money Says:
      December 28th, 2008 at 11:30 am

      I’ve decided to increase my cash savings instead of throwing more money in the market. I have increased my 401k contribution but other than that, I am more focused on saving cash.

    8. Doug Says:
      December 29th, 2008 at 6:37 am

      Money—Supply, Velocity, and Loss of
      We all know that the money supply has been increasing, and many have been surprised at the decline in prices that has accompanied the recent “growth” of the money supply. We all know that inflation is a monetary phenomenon, Right? Yes that is right, but lets take a closer look at what is happening with the money supply and the velocity of money. If inflation is a monetary phenomenon and money supply is increasing, why aren’t we already seeing inflation? During the time that the money supply has been growing the velocity of money has been declining—at an alarming rate. Why has the velocity declined. Financial innovations—such as those nasty Collateralized Debt Obligations (CDO’s) increased the velocity of money. These innovations were “productively” increasing the velocity of money when they were created and when all was well with their value. As the credit crisis evolved–we had to unwind all of the “productivity” that was gained through the use of these “darling turned ugly duckling instruments”. This unwind took its toll on the velocity of money and the real damage will be the unseen damage that is yet to come. What unseen damage? The damage that will be done as the velocity of money declines as these instruments are “cleaned up”. The decline in velocity caused by the unwind of these instruments has contributed to the false sense of “deflation” that has gotten so much attention from many “talking heads” lately. We know, through both common sense and historical numbers that the velocity of money declines during recessions—sometimes sharply. During a NORMAL economic cycle, the decrease in velocity would be normal as central banks would increase the money supply, get the economy going again and then the velocity would again rise.
      Read the remainder of the article at http://www.stockshotz.blogspot.com

    9. Daniel Says:
      December 29th, 2008 at 11:11 am

      This is a good post and I find myself torn between saving and investing and paying off debt often. For the upcoming year we decided to try to pay off all our non mortgage debt by June. We decided to do this because we currently have enough in our emergency fund to sustain us for 6 months if we both lost our jobs. At that point we plan to boost up contributions to a non retirement investment account where the money will be available to us if we absolutely had to use it.

    10. Bill M Says:
      December 29th, 2008 at 12:44 pm

      I have decided to pay off all debt except the house and invest a little every week at the same time. I try to keep around 10k on my checking account at all times for the unexpected.

    11. Craig Says:
      December 29th, 2008 at 2:44 pm

      I am young and in a position that I can put money away for 10 years without really needing cash now. Have no financial responsibilities other than myself. Of course I don’t know if the stocks will go down more or can predict what the next few yrs could bring in my personal life. If I am laid off I could be alright for 2 months but would struggle after and am not sure if I should take the risk and load up my IRA and future savings or keep the cash now.

    12. Stacey Says:
      December 29th, 2008 at 3:09 pm

      @#10 Bill, are you earning any interest on that $10K in checking? If not, you should shop around.

      @#11 Craig, re: your last sentence, savings can be “cash-like” you know…cds, savings accts, even savings bonds (E-series or I-series). Go to http://www.treasurydirect.gov if you want to learn more about savings bonds. You can purchase direct from that site if you don’t want to go thru a bank. Then your “inventory” is on-line–no bonds to lose or get stolen! Also, they have a nifty Savings Bond Wizard for tracking (by serial number) your bonds’ value, next interest date, etc. so you could track all your bonds, no matter where purchased (on-line or at a bank.)

      For us, our savings bonds have been a welcome port-in-the-storm. Some are even yielding 6% (I-series bought in 2000) Wish I had invested in more at that time :)

    Comments