IRA contributions in a bear (bad) market: Should I build up cash savings instead?

Question

I have a retirement account (not a 401k with a match, just an individual retirement account) and over the last few years have gotten statement after statement of losses on the value of my retirement savings. I understand that to pull out of the fund I would lock in those losses but any thoughts on a strategy of reducing the contribution temporarily and just focusing on building cash savings (e.g. Certificate of Deposit)?

Answer 1

You have heard the old adage "Buy low, sell high", right? That sounds so obvious that you'd have to wonder why they would ever bother coining such an expression. It should rank up there with "Don't walk in front of a moving car" on the Duh scale of advice.

Well, your question demonstrates exactly why it isn't quite so obvious in the real world and that people need to be reminded of it.

So, in your example, the stock prices are currently low (relative to what they have been). So per that adage, do you sell or buy when prices are low?
Hint: It isn't sell.

Yes. Your gut is going to tell you the exact opposite thanks to the fact that our brains are unfortunately wired to make us susceptible to the loss aversion fallacy. When the market has undergone a big drop is the WORST time to stop contributing (buying stocks).

This example might help get your brain and gut to agree a little more easily: If you were talking about any other non-investment commodity, cars for instance.

Your question equates to..

I really need a car, but the prices have been dropping like crazy lately. Maybe I should wait until the car dealers start raising their prices again before I buy one.

Dollar Cost Averaging
As littleadv suggested, if you have an automatic payroll deduction for your retirement account, you are getting the benefit of Dollar Cost Averaging. Because you are investing the same amount on a scheduled interval, you are buying more shares when they are cheap and fewer when they are expensive. It is like an automatic buy low strategy is built into the account.

The alternative, which you are implying, is a market timing strategy. Under this strategy, instead of investing regularly you try to get in and out of investments right before they go up/drop. There are two MAJOR flaws with this approach:

1) Your brain will work against you (see above) and encourage you to do the exact opposite of what you should be doing.

2) Unless you are clairvoyant, this strategy isn't much better than gambling. If you are lucky it can work, but because of #1, the odds are stacked against you.

Answer 2

You should consider dollar cost averaging your investments. Retirement account is perfect for that - it's long term with periodic deposits.

Overall, by investing in stocks now for a long term, you'll benefit more because the stocks are at their low(er) point.

Answer 3

The first two answers to this are very good, but I feel like there are a couple of points they left out that were a little too long for comments. First off take a look at the expense percentage,the load fees, and the average turnover ratio for the funds in your retirement account (assuming they are mutual funds). Having low expense fees <1% preferably and turnover ratios will help tremendously because those eat into returns whether the value of the fund goes up or down.

The load fees (either incoming or outgoing) will lower the amount of money you actually put in and get out of the fund. There are thousands of no-load funds and most that have a backend load for taking the money out have clauses that lower that percentage to zero over several years. It is mostly there to keep people from trying to swing trade with mutual funds and pull their money out too quickly.

The last thing I would suggest is to look at diversifying the holdings in your account. Bond funds have been up this year even though the stock market has done poorly. And they provide interest income that can increase the amount of shares you own even when the value of the bonds might have gone down.