|
Forums |
Finance |
For What It's Worth |
Re: Don't Bailout on Your Nest Egg
|
|
|
|
|
|
|
|
blog article
articles
article
body
If you're like most people, you weren't exactly looking forward to the arrival of your quarterly 401(k) statement. Due to our fears over what might lurk inside that envelope, countless thousands of these statements sit unopened. Still more went straight into the "circular file" no doubt.
And if you did muster the courage to take a peek, you weren't exactly thrilled with what you found. I won't sugar-coat it with a pep talk about how it could have been worse. Let's face it—the 401(k) losses we've all piled up this year, especially in the most recent quarter, have been tremendous.
But I am here to tell you why this is not the time to halt your 401(k) contributions or flee to the relative safety of cash. In fact, the worst thing you can do right now for your retirement is take your ball and go home.
Here are three reasons why your 401(k) remains a better place than your mattress to stash your extra cash:
1. Running with the Bulls
History has shown when the stock market hits rock bottom, the resulting bounce back to positive territory tends to be swift. By dumping the stocks in your 401(k) now and sticking that money in your underwear drawer, you'd essentially be locking in your losses—and giving up any chance of getting in on the action as things improve.
As MarketWatch's Jonathan Burton reports, exiting the market at the wrong time can severely hurt your long-term returns. For the 10-year period from 1998 through 2007, the S&P 500 returned an annualized gain of nearly 6 percent.
But had you missed the 10 best trading days during that stretch, the return would have been a meager 1 percent. Missing just the top 20 days of the 2,000+ trading sessions during that stretch would have found you with an annualized LOSS of almost 3 percent.
So vacate your stock position at your own risk.
2. Bargain Shopping
We've agreed that pouring money into your 401(k) is a wise move. This means you'll be able to take advantage of dollar-cost averaging, which Forbes.com's Investopedia defines as:
"The technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. More shares are purchased when prices are low, and fewer shares are bought when prices are high."
Huh? In its simplest terms, dollar-cost averaging means that rather than buying shares via a lump sum upfront, you buy them via an installment plan. If you're contributing money to your 401(k) with each paycheck, as many of us are, you're participating in dollar-cost averaging. If a $100 biweekly contribution produced 10 shares (at $10 apiece) of a particular mutual fund earlier this year, that same $100 might get you around 14 shares (at $7 apiece) today.
So what does this all mean for you? For starters, due to the beauty of dollar-cost averaging, individual investors don't need to worry about "timing the market" and finding the best time to jump in…or out. (Look no further than point No. 1 above for why this is risky.)
As soon as you start playing the market-timing game by halting or cutting back on your 401(k) contributions, you've lost the benefits of dollar-cost averaging and assumed the risks of market timing.
Continuing to make regular, steady contributions minimizes your risk, lowers your cost basis, and puts you in a better position to capitalize on coming market gains. But don't take my word for it. Read what The Wall Street Journal's Jeff D. Opdyke has to say about why those of us who continue to make steady 401(k) contributions are doing just the right thing.
3. Free Money!
Alright, I saved the best for last.
In my opinion, the most attractive feature of 401(k) plans isn't the tax savings many experts tout. Sure, it's great that you can contribute a significant share of your earnings pre-tax, and of course, putting off the tax hit until you begin making withdrawals during retirement is nice.
The real benefit of 401(k) plans comes from the matching contributions offered by most employers. It's the closest thing to a free lunch that you'll find today. And who doesn't like a free lunch?
Say you earn $50,000/year and your employer matches, dollar-for-dollar, your 401(k) contributions up to 6 percent of your earnings. So over the course of the year you contribute $3,000 and your employer matches that—DOLLAR-FOR-DOLLAR. That's $6,000 total into your 401(k).
I know what you're thinking. These days, not only will the $6,000 not grow… you're also fearful it will actually shrink if the market swoon continues. Believe it or not, it still makes sense to contribute up to the level of your employer's match.
Let's assume you started at zero, made the $3,000 contribution referenced above—and your employer deposited its match—over the course of the full 12 months of 2007. So your 401(k) had a hypothetical balance of $6,000 on January 1.
Even if that balance had been invested 100 percent in equities (not a wise move, but that's for another time, so for the sake of establishing a worst-case scenario let's go with it here) in an index fund mirroring the blue-chip Dow Jones Industrial Average, the mini-crash of 2008—including the historic bleakness of September and October—would have left you with losses in the neighborhood of 30 percent. That would make your balance as of November 1 somewhere in the neighborhood of $4,200.
Although some would look at this as a "loss" of $1,800, on the most basic level you put out $3,000 and got back $4,200—a 40 percent return. And that's during an absolutely treacherous 10-month period. Stuffing money in your mattress won't return 40 percent annually, nor will savings accounts or certificates of deposit.
Continuing to contribute at least up to the point of your employer's match is one of the smartest things you can do in this turbulent financial environment.
So don't run for the hills just yet. Stay the course and keep building your nest egg slowly.
Message Edited by Anthony_Catalano on 11-18-2008 04:28 PM
|
|
|
|
|
|
