An important issue facing investors as the economy emerges from the current financial crisis is what they should do with their retirement accounts. Going forward, investors should not drastically reduce the fractions of stock holdings (direct holdings plus holdings of U.S. equity mutual funds) in their retirement accounts. Typically, during periods of poor economic growth and after large stock market declines, future stock returns on average are higher than at other times in the business cycle. They certainly are not lower than at other times. Since expected future equity returns right now are the same or higher than at other times, investors are better off if they invest larger fractions of their retirement portfolios in equity than at other times in the business cycle. The one caveat to this advice is that the current crisis may signal a period of high volatility for equity returns which would provide investors with a motive for reducing the fractions of their retirement accounts invested in equity. However, it is unlikely that this channel outweighs investors’ desires to hold higher fractions of their portfolios in stock because expected future stock returns are higher than average.
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