The other day, I was speaking with a good friend about his investments. These days, this sort of talk is always done with a little hesitation. Unlike the trend where some folks have admitted to budgetary problems, the new “I’m okay with not having any money to spend” attitude suggesting we are all in the same financial boat, talking aout 401(k) investments still offers some apprehensive moments.
A great number of investors reacted in a very predictable fashion as the Great Recession took hold. They sold their holdings on the way down, in large part because no one could predict how far down would actually be and stopped contributing to their 401(k) plans. Employers, as we have discussed here, suspended their matching contributions for several reasons (no need to spend money where it didn’t need to be spent and there was no longer any reason to offer this as an incentive to keep or hire new employees).
Adding to the mad dash to protect dwindling balances, target date funds and bond funds swelled with new contributions. This was, in many instances, akin to stuffing money under the mattress. Not that some these funds did poorly or had mediocre performance, although many did, investors felt protected or at least safe from the chaos and volatility of the open markets. It was a flight to risk-free, or at least, invest-and-forget investments.
Once-Bitten
Historically, the bad news of a falling stock market lasts about six months. This quick, fall-off-a-cliff drop to the bottom is often followed by a market where investors find innumerable bargains. Over the last decade, unlike all of the previous data on the equities market, recent recoveries, this one included have come at record speed. Five years in-between market drops and recoveries is not the norm. But possibly, could be.
This may have something to do with a much larger segment of the investment market coming from 401(k) investments. Although these plans have been around for thirty years, they have not really caught on until recently and even that trend is not fully employed by those who have access to these types of plans. Pensions may have gone away but 401(k) plans have not fully replaced them with the working public.
That fact leaves many investors vulnerable to their emotions and to the forces that promote the marketplace. A recent study done by Hewitt Associates found that the vast majority, or what they termed typical, investor under the age of forty had moved some or all of their retirement funds into target date funds. Those over the age of forty found the move to bond funds more appealing. Both of these investments, albeit conservative in nature, were forgivable. They were doing what any “once bitten” investor would do.
But now the market is recovering. You might be warned against investing in this upswing because it is being done without real job creation, without increasing inventories significantly and in the face of weaker demand than economists would like. The current stock market is running on enthusiasm and hope, with a little expectation thrown in for good measure.
If you are suddenly awakening to the fact that if you had done nothing, left your 401(k) exactly where it was and continued to contribute to the plan even as matches were reduced or eliminated, your retirement investment balance would be very close to were it was at the end of 2007. If you think that that now is the time to switch back because many of the funds you left are now showing some significant gains, you will fall victim to yet another human foible: trying to time the market.
The concept of a 401(k) plan
The whole concept of a 401(k) plan is consistent investing over long periods of time. Any interruptions in the process (you leave a job and do not enroll in a 401(k), roll your old plan into an IRA or simply took the cash and paid the penalties for dong so), you are essentially beginning at square one.
Those who moved into safer (at least seemingly) investments such as target date funds will find that they missed most of the recent market growth and are now in funds that may have too much exposure to bonds and fixed income investments. Those who moved into bonds or fixed income type investments will experience the next bubble market as interest rates begin to rise. Both investors will be caught once agin on a downward path.
And even if they exit these funds in time, they will be catching yet another market at or near the near-term top. Is it any wonder why these types of plans are underfunded or have a poor participation track record?
Investing in a 401(k) is supposed to be risky.
That is why it is referred to as investing. Numerous other writers on the subject still call it savings – which it is not – and this misnomer is creating bubble after bubble. Granted, Wall Street has its hand in this process as they continue to invent products that have little use to the average retirement investor but often impact the overall effort in ways that are only realized after-the-fact. The simple fact remains: investing is not savings.
With the assault coming from so many different angles, what are you supposed to do to offset the trouble? Three things come to mind.
Diversity: Keep at least four funds in your portfolio across a wide swath of the market. If you only have access to index funds (and many fear that the effort to lower overall costs in the plan will only increase these low cost alternatives), invest over large-cap, mid-cap, small-cap and International funds. (Add a fifth is you have access to an emerging market fund.) If you have actively managed mutual funds, look for those that do the same thing. And lastly, avoid the temptation to buy your own company stock or any other individual stock purchases. Stick with mutual funds.
Invest more: We do not put enough money away in these plans to have any real time effect on future returns. That “typical” investor in the survey mentioned above has little more than $6200 invested – at age forty! Unless you find a way to get more money into the plan, your future is in jeopardy. This might mean looking at your lifestyle and making adjustments for current expenditures. If you spend less, you can invest more.
Invest consistently: Only those that didn’t do this suffered the most grievous of setbacks. With a plan that can take money from your paycheck in a pre-tax manner, this should be a no-brainer. But folks don’t know how much is enough. Look at it this way: if you have to ask, you are not putting enough away. Start with 5% and increase it every year by one percentage point until you max-out your contributions (15%). This will eat any pay increase, or at least a significant portion of it, but the end result of such a sacrifice will be worth it. It will also avoid any effort on your part to try and time the market.
In Your Hands; Not Your Head
You hold the future of your retirement in your hands not your head. Not to suggest that investing is gambling (it is in a sense), but a lesson can be learned for those that do gamble professionally. The amateur gambler bets on possibilities while the pro takes those possibilities and filters them through probabilities. It makes gambling less fun, more technical and highly profitable. Removing the emotional side of the equation makes money.
Everyone may be suggesting that more thoughtful investing is the key to success. In truth, the less thought you put into it may prove to be the most profitable of all.
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