JOB GAINS SHOCK THE MARKETS : Wall Street Reels : WHAT SHOULD YOU DO? / Q & A : Wait for Things to Settle Down Before Making Any Decisions
In light of Friday’s stock market tumble and interest rate rise, what should you do now with your stocks, bonds, mutual funds, savings, mortgage and other borrowings? Some answers to key questions:
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Q. The stock market tumbled and bond yields rocketed because the economy added far more jobs than people expected. Why is that bad news for stocks and bonds?
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A. Everybody had been expecting a weak unemployment report, which would help spur the Federal Reserve Board to cut interest rates. Prospects for lower rates are great for bonds. And lower rates could lead to modest economic growth and strong corporate earnings--the best of all possible worlds for stocks.
However, when the jobs report came out as strong as it did, Wall Street began to worry that the economy would grow faster, which could lead to higher interest rates and inflation--terrible news for stocks and bonds. With the stock market at all-time highs, many investors sold.
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Q. Is this going to be like 1987, when a big drop in stock market prices on a Friday led to a huge crash the following Monday?
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A. Stocks may decline more, but a full-blown crash is seen as unlikely, experts say.
Many of the conditions that characterized the crash of 1987 and other big sell-offs are not present. Interest rates are much lower than they were in the late 1980s, and inflation appears to be well under control. Alternative investments, such as bonds, real estate, gold and certificates of deposit, don’t look very attractive.
However, many pundits say the market will remain skittish next week, waiting for further economic news. If more reports indicate that the economy indeed is growing much faster, bond yields could rise further, in turn hurting stocks. But a stronger economy could help many stocks, in signaling that higher corporate profits could be on the way.
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Q. My retirement plan--a 401(k)--is primarily invested in stocks. Should I switch out of stocks to play it safe?
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A. No. “Never get caught up in these emotional swings in the market,” said Hugh Johnson, chief investment strategist for First Albany Corp. in New York. “When you do, you end up making an emotional decision, and emotional decisions are almost sure to be wrong.”
If you have a reasonable asset allocation strategy, stick with it, experts advise. Chances are you put the bulk of your retirement investments in stocks because you have a long time horizon and stocks remain an attractive long-term investment, although the short-term “correction” of market prices may continue, said Michael Metz, market strategist at Oppenheimer & Co.
“Individual investors should ignore the lunacy of Wall Street,” Metz said. “When the market is up, they should sell. When it’s down, they should buy. Obviously, be careful about what you buy, but if you are a long-term investor, you should be looking for entry points.”
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Q. When I saw the market was down 200 points earlier in the day, I panicked and cashed out of my mutual fund and sold some stocks. Now I’m wondering whether I made a mistake. Should I put the money back?
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A. The damage has already been done. If you can’t afford to lose any part of your investment, or need the money right away for a house down payment or other expense, you probably shouldn’t have that money in stocks anyway.
If you simply are skittish about stocks, consider waiting until the market settles down. The next few weeks could continue to be volatile. Sit on the sidelines until you feel less skittish.
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Q. If I have some cash and don’t want to invest in the stock market until things settle down, where should I put it? Rates on bank certificates of deposit don’t seem so attractive.
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A. You’re probably best served to put your cash into a high-yielding, bank-insured money market account for a few weeks, said Martin Bradshaw, president of Bradshaw Financial Network. Admittedly, these accounts pay precious little interest--about the best you can do on a small deposit is 5.25% today, he added. But it leaves your money easily accessible, which is handy when you don’t know which way the markets are going.
If it turns out that stocks and bonds go through a long, tough stretch, you can move into higher-yielding certificates of deposit later. However, once you invest in a CD, you’re locked in. To take your money out early, you could face a hefty early-withdrawal penalty. So don’t lock your money away until you’ve had a chance to consider your other options and feel comfortable that you know which way the wind is blowing.
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Q. I’ve been investing in bonds for years, thinking they were less volatile than stocks. But my bond funds are getting hit by double-digit declines--just like they were a few years ago. What am I doing wrong?
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A. You’re probably concentrating on the long end of the market--funds that buy 20- and 30-year bonds, said Christopher Orndoff, vice president of fixed investments at Payden & Rygel, a Los Angeles-based money management firm. These funds gain value when rates fall but lose value when rates rise. If you want reduced volatility, you should be investing in short- or intermediate-term funds, he said.
Alternatively, you can get out of mutual funds altogether and buy individual bonds. As long as you buy quality bonds that bear little default risk--and you are willing to hold until maturity--you can insulate yourself from day-to-day swings in market prices. Clip your coupons and expect to get back your principal at maturity.
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Q. I usually like bond funds because they give me the option of getting higher yields when market rates rise. Wouldn’t I be shooting myself in the foot if I bought individual bonds instead?
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A. If you have enough invested to “ladder” maturities--having some bonds mature in one year, some in three, some in five and so on--you eliminate the risk of getting low yields on all your investments when interest rates rise. That’s simply because you are regularly getting back a portion of your principal that can subsequently be reinvested at the going market rate.
However, if laddering maturities requires more money than you’re comfortable investing in bonds, or if you like the convenience or access of mutual funds, short- and intermediate-term bond funds may be your best bet.
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Q. How does this affect my mortgage and other loans?
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A. Higher yields on Treasury bonds lead to higher rates on long-term loans, such as home mortgages. They also indirectly affect savings deposit rates. If the rise in bond rates proves lasting, it could make it easier to find a higher-yielding certificate of deposit.
Meanwhile, the rise also tends to make homes less affordable because monthly payments rise with interest rates. If you were planning to refinance your mortgage, the deal is now less attractive if you failed to get a rate locked in when you applied for the loan.
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Q. I am in the middle of refinancing my home and I know mortgage rates are somehow tied to the rate on long-term Treasury bonds. Is this going to affect my loan rate?
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A. It depends. If you got a “rate lock” that guaranteed your interest rate for a set period, you are unaffected. Assuming the rate lock will last until your loan is funded--and usually they do--your loan will be made at the contracted rate.
But if you opted not to lock your rate because you thought loan rates might be headed lower, you are definitely affected. The rate on 30-year conventional mortgages popped up by about 0.3 percentage point Friday, said Sam Lyons, senior vice president of mortgage banking at Great Western Bank in Northridge. Unless the bond market turns around on Monday, you’ll pay more for your loan.
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Q. How much more will it cost me?
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A. Assuming you had secured Thursday’s 30-year conforming loan rate at Great Western, which was 7.70% on a $100,000 loan, and the loan is funded at Friday’s rate, which was 7.95%, your payments will rise by $17.32 per month to $730.28. At the lower rate, your monthly payment would have been $712.96.
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Q. My current loan rate isn’t that much higher than Friday’s market rates. Should I just cancel my refinance?
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A. Not necessarily, according to Lyons. Some people think the bond market overreacted to faulty employment data. If that’s true, interest rates could slip back downward over the coming weeks. And if you cancel your refinance, you are likely to lose any upfront fees you’ve already paid.
A better idea is to ask your bank to temporarily stop processing your application, Lyons suggested. The bank will probably be willing to hang on for a week or two. In the meantime, rates might ease back.
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Q. What if they don’t?
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A. Then you might want to cancel your refinance. The key question to ask is: How long will it take you to pay off your refinancing fees--the points, title insurance and other fees that usually amount to 2% of your loan amount--through the savings on your monthly payment? If Friday’s interest rate hikes mean that payoff date is so far in the future that you’re not sure you’ll still be in the home, you ought to back out of the deal.
Markets Coverage:
* EXPANDED TABLES: The stock and mutual fund lists are enlarged today for a more complete look at Friday’s wild activity. D5
* Stocks, bonds in huge sell-off. A1
* Jobs surged unexpectedly. A1
* For Main Street, news is good. A1
* Small investors bracing. D3
* Not many similarities to 1987. D3
* Key market curbs kicked in. D3
* Milestones for the Dow. D3
* How traders see bad in good. D3
* Economists caught by surprise. D4
