Political turmoil ahead? Keep Calm and Invest On
While the results from this week's divisive midterm elections might set the stage for political showdowns and stock market turmoil, IRA investors could take a lesson in how to manage any potential upheaval from how they've navigated such turmoil in the past: Keep calm and invest on.
According to Bloomberg, US political disputes are one of the most common causes of significant drops in the stock market. The stock market dropped 19% in the summer of 2011, after warring politicians took the US to the brink of default and Standard & Poor's stripped the US of its AAA credit rating.
But one thing that IRA investors have demonstrated, according to an analysis by the Investment Company Institute (ICI), is that they can remain steady under pressure and be rewarded for it in the long run.
To conduct its analysis, the ICI analyzed the contribution, rollover, withdrawal and asset allocation activities of 5.5 million traditional IRA investors from 2007 to 2012 -- one of the most tumultuous investment periods in recent memory. That five-year period captured the bursting of the housing bubble, the worst annual stock market contraction since 1931, a climb in the unemployment rate to 10% and the Great Recession.
What did the organization find?
Despite witnessing the worst financial crisis since the Great Depression, traditional IRA investors showed little reaction to the crisis and many were able to emerge from it with higher retirement savings balances.
Here are three of the report's highlights:
While you might expect a significant reduction in the number of investors contributing to their IRAs amid a financial crisis, the ICI found that contributions declined only slightly. For example, 10.5% of investors aged 25 to 59 contributed to their IRA in tax year 2008. That number slid to 9.6% in 2009, 9.5% in 2010, and 9% in tax year 2012 -- 1.5 percentage points below that of 2008.
- Asset allocation:
Despite a sharp plunge in equity markets, there was not a mass exodus out of stocks. Investors aged 25-59 had 75.6% of their traditional IRA assets invested in equity holdings at the end of 2007. That fell to 64.5% by the end of 2008 as the stock market plunged. But, as stocks recovered, it rose to 70.7% by the end of 2010.
A wide swath of investors -- those aged 25 to 69 -- were able to emerge from the financial crisis with higher balances in their traditional IRAs, buoyed by the current bull market. Balances, on average, grew from $52,010 in 2007 to $64,810 in 2012 for those between the age of 25 and 59, while they increased from $133,190 to $156,020 for those aged 60-69.
The one age group to suffer a drop in their balances were investors aged 70 or older. Their average balance declined from $190,960 to $181,070. The ICI attributed much of that decrease to rules surrounding traditional IRAs, including required minimum distributions and the inability to make regular contributions to traditional IRAs in the year you reach 70 1/2 and older.
In retirement planning it is often said that slow and steady wins the race. IRAs can be a great retirement savings vehicle, and an important tool in your overall portfolio. As this ICI study illustrates, traditional IRA investors who remained invested in their accounts and avoided knee-jerk reactions to the day's headlines were able to grow their nest eggs over time. It's a lesson that might come in handy if a divided Washington once again brings turmoil to the markets.
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