The answers must consider individual situations, but a few basic concepts should always be considered before making decisions to each question.

Should I take my money out of my 401K Plan?

If you take your money out of your plan, it is subject to income taxes. Paying taxes on the decreased values will increase your losses. If you are under 59 ½ you may pay an additional 10% penalty tax. You can avoid the taxation by rolling over to an IRA, but that generally provides no advantage to leaving it in the 401K. Unless the money is immediately needed for another reason, you should not take it out of the plan.

Should I change investments in my 401K?

If you are close to retirement, say within five years, you definitely want to reexamine your asset allocation to be sure you are not too heavily invested in stocks. If you are already retired, you want to be sure that the portion, from which you are taking your retirement income, is in very conservative investments. In most cases, if your investments are diversified, you should consider leaving them as they are. If you move them to a low risk investment now, they will not be able to recover. The more time you have between now and retirement, the longer you can wait for the values to recover.

Should I continue to make contributions to my 401K?

Yes. First, you always want to take advantage of any employer match—it is free money. For example, if the employer matches $.50 for each dollar you contribute, that’s like earning 50% after taxes for each matched dollar. Regardless of economic conditions, you should always contribute up to the amount that the employer will match.

The other reason that you want to contribute is called dollar-cost-averaging. This principle always works to your advantage, but it is especially advantageous when the market is down— like it is now! Here’s how dollar-cost-averaging works. My making monthly contributions, you purchase shares based on their value each month. If the price per share goes up, you get a few less shares that month. If the price goes down, you get a few more shares. Proportionately, you get more additional shares when the price goes down than you give up when the price goes up. Consider the example in the chart below.

$100 is contributed each month. The first month the price per share is $5, so 20 shares are purchased. The price goes up the next month to $6 per share. The $100 buys 16.667 shares. The third month, the price is back to $5 and 20 shares are purchased. The next month the price drops to $4 per share, so you receive 25 shares. If the price returns to $5 the next month, 20 more shares are purchased. You now have a total of 101.667 shares worth $5 per share for a total of $508.33. It is easy to see that the average price paid per share was $5. Had all $500 invested been invested at the average price, you would only have had 100 shares worth $500. Systematic purchasing with varying prices allows you to do better than the average.

Let’s continue the prior example, but this time let the prices go really low. This time, the price continues to decline to $1 per share. It would be easy to get discouraged when the price has fallen so low and values so low, but continuing to contribute each month until the market has reversed, provides substantial gains. In this example, dollar-cost-averaging has produced 30% more value than would have been earned buying the stock each month at the average price.

If we had lost our nerve when the price reached $1 and quit making monthly purchases, we would have only had $1,325 when the market had recovered.

For someone who is a number of years from retirement and has time to let the market recover, dollar-cost-averaging can make this economic crisis a “blessing in disguise.”

Photo credit: m kasahara

Companies and advisors, who used Retirement Road Map from Impact’s PlanLab®, last year, can reassure their clients that their retirement plans are fine. Retirement Road Map recommends time horizon investments by retirement phases. The two images are pages from Retirement Road Map that explain investing by phases and time horizons (click to see full size).

Investing by Phases

Investment Time Horizons

Consider the case of Sam and Sara. They retired October 2007 when they were both age 65. They wanted to know how much should be invested, and how it should be invested to provide their desired retirement income.

Retirement Road Map Assumptions:

On the first anniversary of their retirement in October 2008, the country was in for a big shock. Sam and Sara found that there very conservative investments, from which they were withdrawing their retirement income was just about what was expected. But, the conservative investments had lost 10% of their value, their moderate investments had lost 20% of their values, and the aggressive investments had lost 30% of their values.

You can tell Sam and Sara that they should continue to make their regularly scheduled withdrawals. A plan that invests by phases and time horizons is design to allow market recovery over an entire phase. Even after what were larger first years loses than ever anticipated, they don’t have to make any immediate changes. With a few simple calculations, you determine that if the very conservative investments continue to earn 2%, and each of the other classes of investments average earning an extra 1 ¼ %, then their plan will continue to support their planned income through age 100. Their retirement plan allows for slow recovery, so there is no need for drastic adjustments.

Retirement Road Map uses conservative assumptions that are about half of the twenty year averages. Assuming slight increases in the assumptions are reasonable. Combining conservative assumptions with investing by phases and time horizons makes retirement plans secured. Plans don’t require major adjustments while in retirement – even when the completely unexpected happens.

Don’t your retirement clients deserve to have a retirement plan that takes advantage of the market and higher returns, but in a way that minimizes frequent adjustments and retirement income worries? They deserve a retirement plan made with Retirement Road Map.