Columbia, SC (WLTX)-- Financial markets declined due to the announcement from the Federal Reserve regarding a strategy called Operation Twist. While this was already expected, there was anticipation that the Federal Reserve would announce some additional measures to prop up the economy. Instead they warned of "significant risks to the economy" and did not provide any further anecdotes for the sluggish recovery. Fee only Certified Financial Planner Laura Sharr-Bykowsky offers the following answers to current questions about turmoil.
What is Operation Twist?
It is a mechanism by which the Federal Reserve will attempt to lower longer term interest rates, particularly mortgage rates, in order to stimulate lending and invigorate the economy. They will buy $400B of US treasuries with 6-30 year maturities through next June and will also sell and equal amount of short term Treasuries. This will "flatten" the yield curve. Unfortunately, this move will help debtors but hurt savers.
Will this help the economy?
If you look at how financial markets responded, they are telling us that there is not a lot of confidence in this strategy. Prospective buyers are not buying homes because rates aren't low enough, they aren't buying homes because housing prices are still declining, credit is tough to obtain unless they have excellent credit scores, and banks are requiring decent down payments.
Plus, this reduction in long term interest rates will have other negative consequences. It will hurt banks, which rely on the spread of short term and long term rates for profits, as well as insurance companies and pension funds who use longer term Treasuries to meet their obligations.
Unfortunately, the effect of monetary policy on the economy at this point is limited as we are already have historically low interest rates and high money supply. This leaves us with the alternative of fiscal policy which will be tough given the divisions in Congress.
This is a crisis of confidence; and, Americans need more certainty with respect to their future. Solutions are required to address the oversupply of housing and indebtedness of homeowners, the stubborn unemployment rate, and lack of clarity on long term taxes and regulations.
What is an investor to do? Here are some financial mistakes you want to avoid in the midst of this volatile market.
What Not To Do:
- Stop contributing to your 401K.
Don't get too scared of the market and stop contributing to your 401K or move to cash. You need these contributions and growth over the long term to reach your goals so focus on the fact that most often markets will recover losses over 3-5 years periods so as long as you don't need the money now you should not be cashing out as you lock in the losses.
- Jump on the "bubble" bandwagon.
Investors should not rely on one asset class that seems to be on a tear (like gold) to bail them out of these meltdowns. Holding a diversified mix of assets is the best protection against this volatility. Exposing yourself to only one asset class just increases your risk. Remember what happened to real estate, which was a "sure thing" only a few years ago.
Paralysis and procrastination are also not ideal. Have a methodical plan and stick to it. Re-balancing is something you can do that is constructive, as you buy low and sell high. This may be a great time to see a financial planner so that he or she can put together a comprehensive financial plan for you.
- Take an early retirement.
People who retire in the midst of a market downturn (or at periods of high valuations) are at greater risk of outliving their funds. Make sure to rerun your projections and or adjust spending to improve your chance of success. If you can work longer; even a year or two can make a huge difference.
- Focus on spending the money on short term expenses.
When people experience sharp market downturns like we have had recently, they are more likely to "spend for the day" because they are concerned what the put aside will only lose value quickly. Make sure that you are not jeopardizing your long term goals.