Your 401(k) plan is your primary source of retirement savings. In the past year, particularly the past few months, it has dropped in value almost 50%. Everything you read or hear tells you to “sit tight.” Almost every source of financial advice recommends not cashing out, and not replacing your equity assets with fixed income assets. Only those that must have the money now should cash out. You’re told again and again that you always want to buy low and sell high – never sell low. You understand that if you switch to fixed returns, you cannot experience any market recovery. But, how can you just stand by and watch your savings shrink?
What can you do with your 401(k) plan? A prior article has already discussed the advantages of continuing your contributions and taking advantage of the concept of “dollar cost averaging.” (“What Should I Do with My 401K?” October 11, 2008.) This article will consider the investments already in your plan. How can you be proactive with your 401(k) plan and still follow the current recommendations:
• Always have a strategy that results in buying low and selling high
• As long as time permits, sit tight on your plan so that you can experience the market recovery
First and foremost, continue making contributions. The tax advantages and any employer match allow you to acquire more low cost shares that can accelerate your plan’s recovery. The next step requires work on your part; after all, you wanted to be proactive. This proactive adjustment to your plan requires five steps.
1. Look at each asset class of investments allowed in your plan, and determine the dollar value you have in each class.
Hopefully, you have some diversification in your plan, perhaps having followed an asset allocation model based on your risk tolerances. Even if you have all your eggs in one basket and only have one investment, these steps may still be applied. Asset classes are nothing more than a grouping of investments with similar risks and expected returns. Some examples are fixed income, large company equities, small-cap or mid-cap equities, balanced funds, and international equities.
2. For each asset class in which you have some money, research all available investment choices in that class.
- Use all information provided by your plan
- Use on-line information available from mutual funds, Morningstar or other fund evaluation sources
- Compare the performances for the past 1 month, 3 months, 1 year, and 3 years as well as internal fees and expenses
3. Of the available choices in each asset class, decide which fund you would rank number 1 and number 2. Also, determine which fund you determine to be the most volatile – biggest swings over the same periods.
4. Using just the dollars already in an asset class, reallocate half of that amount to the fund you ranked number 1 in that class.
- If you are within 10 years of retirement, put the other half in the fund you ranked number 2 in that asset class.
- If you are 10 or more years from retirement, then put the other half in the fund you determined to be the most volatile in that asset class.
(Note: even though we may be changing investments, we are just shifting to a similar investment that probably has a better chance of recovering faster. We are not being stupid by selling low and buying high – we’re selling low and buying low.)
5. Determine the percentage of your investment in each fund, and reallocate to this percentage at least every three months.
- Be sure to check your plan’s rules for reallocating as sometimes fees may be charged. You want to be sure that the fees do not offset the gains in reallocating.
- Reallocating is nothing more than taking gains from the better performing funds whose prices are up, and shifting it to lesser performing funds whose prices are low. (A fancy process for continually buying low and selling high.)
What do these five steps accomplish? You have stayed within our rules: your strategy assures that you buy low and sell high, and that you give your investment the best chance possible of recovering. Although this may seem like a lot of work for just a little change, it is a strategy that combines almost all of the current financial advice in a proactive manner. You have the satisfaction of doing something about your retirement plan, and the confidence that you are not doing something stupid.
PlanLab News provides no investment advice nor does it offer any opinion with respect to the suitability of any transaction. Clients should consult their legal, tax, and/or financial advisor before taking actions based on this information.