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Tuesday, September 16, 2008

Don't Mess Up Your 401(k) in a Down Market

Okay, this is not investment advice. If it were, why would you take it from an HR guy when you have so many registered financial advisers at your disposal? This is just a set of observations about mistakes I've seen people make in knee-jerking to a falling market. Take this for what its worth, research your own 401(k) investments, get competent advice, etc...before making investment decisions. Meanwhile, consider this premise; that the market has been here before and come back, that Phil Graham is right in his assessment that as a nation we could be a little more resilient, and that television news coverage is sensationalism detached from the reality of the market. In other words, this isn't a market for the faint of heart but neither is it a meltdown, a historic depression, or any of the other hyperbole you've heard on television.

1. We've Been Here Before- Check out the historical chart of the Dow Jones averages starting in 1900 and continuing up to the present day. Two things to note; look at all the big drops along the way, and take a look at the difference between where it started and where it is today. The market always rebounds; always rebounds. In my working lifetime we've had three major corrections; the junk bond correction or "Black Monday" in 1987, the "Dot Bomb" correction of 1999/2000, and the "junk mortgage" correction of this week. This happens every few years when greed and speculation come before the underlying value proposition of an investment. When the bubble bursts there's a sell-off, market values correct, and then the market value recovers. On Black Monday Sam Walton lost $1m; when asked how he felt about it he said, "So what, it's all on paper". He died a billionaire, by the way.

2. Its Just On Paper Until You Act - When you trade mutual funds after a loss you make those losses real. Up until that time you hold the same number of shares or fractional shares as you did before the price dropped, they're just worth less. Once you move from that fund to another within the plan you've sold those shares for the lower value and bought others at their low value. If that's what you intend to do because you think the other fund will fall slower or rise faster, that's up to you. Just know what you're doing before you react to the falling price of that fund.

3. You're Probably Not Retiring Today - Unless you are, you don't need your 401(k) money. No action is required on your part in reaction to a falling market. Think about the number of years between now and when you retire, go back that many years on the historical chart above, and see how much the market has risen in that time. This is the appreciation in value that you'll miss if you panic. AOL's Finance page had a great article on this topic earlier today that's worth the read.

4. Consider Increasing Your Payroll Deduction - Remember, your 401(k) is not a bank account where you track the dollars. Its a collection of mutual fund shares that you purchase over decades and watch them appreciate. If the price of cars drop and you need one, that would be the time to buy, right? Same with houses or any other "thing" that you need. Well, you need mutual fund shares to sell when it comes time to retire. If they're selling at a discount, you might consider buying more while the price is right. The only way to do that is to increase your payroll deduction going into your 401(k). That sounds counter intuitive when food and gas prices are rising and CNN's financial guru's are shrieking like little girls, but its not always a bad idea.

In my experience, the people who've made a bad market into a bad retirement move are those who react by selling their shares, going to cash or stable value funds, and/or stopping their deductions into the plan. Personally, when the news is this bad I just stop checking my fund balance for awhile and remember that I have 23 1/2 years before I'm social security eligible, that activity is not progress, and that motion is not necessarily forward movement. Often the smart move is no move at all, or a move in the opposite direction of the herd.

Again, seek competent advice before making investment decisions.





3 comments:

Kenneth Purdom said...

Your right

Kenneth Purdom, Senior Workplace Training Advisor
Dave Ramsey’s ‘Financial Peace Workplace Edition’
1749 Mallory Lane, Suite 100 / Brentwood, TN 37027
800-754-4220x148 /615-371-8881x148 /615-371-5007 fax
kennethp@daveramsey.com

Anonymous said...

Generally speaking you may be right for those who have 23 ½ years to recover, but that’s not the case for many of us who are seeing our 401k loosing 8% to 10% or more per quarter. I will be eligible to retire in 4 years and this is my goal. If I look back 4 years in the Stock Market I see more losses. At the current rate of market decline, assuming the downward trend continues, my 401k will be worth 0. So you think I should continue the course?

Jim Thomason said...

To Anonymous:

I wrote this post on September 4th and we're in a different world now. However, your time horizon to retirement may be 4 years, but your need for continued earnings is more like 25 years. You'll need additional lower-risk earnings throughout your retirement. You won't just retire, cash out, and put your (k) money in a mattress.

I am personally planning to increase my investments in savings instruments in about 90 - 150 days when its expected that we'll hit the bottom of this recession. Most job loss will have occured by then and those jobs still around April 15th will most likely survive this business cycle.

At your age group you can not only maximize your contributions but also make federally-allowed makeup contributions. You should consult a competent investment advisor as to where to put your money, and consider increasing your contributions around mid-April.