Retirement – What To Do With Your 401(k) Plan Now?
Is it time to throw in the towel on your 401(k) plan? Over the last year, more than $1 trillion dollars has simply evaporated. Many investors saved diligently for years. They’re now looking at account balances down by 40% or more. With no end in sight to this grizzly of a bear market, millions of Americans are feeling the overwhelming urge to pull the plug on their 401(k)s.
Take the case of one of my good friends.
John is a prime example of the perfect saver. A 40 year old software engineer, he started contributing to his company’s 401(k) plan at the age of 22. He steadily increased his contributions over the years as his income grew. His investments are diversified. And, he stuck to his plan through good times and bad (even the bursting of the dot com bubble in 2000).
John called me in a panic.
His 401(k) has lost almost $180,000 in the past year. To make matters worse, his employer recently announced a round of layoffs. He’s gone from being on pace for an early retirement to possibly not retiring at all. The abject fear in his voice sent shivers down my spine.
He fired off several questions in rapid succession.
Should he keep making contributions? Should he move everything into cash? Should he take a loan from the account to pay down his debts?
This is what I told him.
401(k) Tip #1: Make a plan.
Everyone should have a sound plan for achieving their retirement goals. If you don’t know how much money you need for retirement, you can’t possibly know how much to save or how to invest it. And, when times are tough, your plan will help you evaluate the damage to your portfolio.
401(k) Tip #2: Keep making regular contributions and increase them if you can.
The worst time to stop contributing to your 401(k) is when the market is down. Think about it. When the price of gas falls, do you stop filling up your car? No. If anything, you fill up more often before prices go back up.
The same principle applies to your 401(k). You want to keep adding to your investments (and buy more if you can) while they’re selling at a discount. Lower prices mean you can buy more shares with the same contribution. This lowers your average cost basis and sets you up for bigger returns when the market recovers (and trust me, it will recover).
401(k) Tip #3: Review your asset allocation.
The foundation of your retirement plan is your asset allocation strategy. This is the optimal mix of stocks, bonds, and cash for your portfolio. The right mix for you depends on your specific goals, time horizon, and tolerance for risk. Research shows more than 90% of your long-term investment returns are determined by your asset allocation.
Right now is a critical time to review your asset allocation. While your gut’s saying sell out of stocks entirely, your asset allocation might say to buy more. Following a sound asset allocation strategy will bring discipline to your decision-making and better long-term returns.
401(k) Tip #4: Diversify your investments and keep costs down.
As the old saying goes, “don’t put all your eggs in one basket.” Spread your investments across several different mutual funds. Diversify by size of company through large-cap, mid-cap, and small-cap stock funds. Get exposure to both growth and value investment styles. And, don’t forget to include an international fund.
Keep your costs down by selecting funds with lower expense ratios. The expense ratio pays for management fees and marketing costs. Don’t give away more of your money than you have to.
Index funds will have the lowest expenses because they’re not actively managed. Expense ratios for small-cap and international funds are higher on average than those for large-cap domestic stock funds. As a general rule, you shouldn’t pay more than 1.5% for a stock fund.
401(k) Tip #5: Don’t move all of your assets into cash just because the market is down.
I know it’s scary to see huge losses on your account, but selling out when the market’s down is a catastrophic mistake. Right now those losses are on paper. If you sell out, you lock those losses in forever. If retirement is still years or decades away, you have plenty of time for your portfolio to recover.
401(k) Tip #6: Borrow from your 401(k) only as a last resort.
In these tough economic times, the temptation to borrow from your 401(k) can be overwhelming. My advice is to first exhaust all other options. And, make sure the purpose of the money is important enough to justify raiding your retirement plan.
Consider the consequences of taking the loan. Every dollar you take out of your plan is one less dollar providing tax-deferred growth. If you fail to repay the loan or make the scheduled interest payments, the loan could be treated as taxable income. And, some plans require borrowers to suspend making contributions to their plan for a period of time.
After I passed on my 401(k) tips, John felt a lot better about his situation. He’s going to review his plan, assess the damage to his portfolio, and make reasonable adjustments. He’s also going to explore other options for paying down his debts before taking a loan from his 401(k).
Right now is a critical time for your retirement plan.
Don’t let fear of the bear push you into making a catastrophic mistake. Follow my 401(k) tips and take back control of your future.
Category: Stocks
