Andrew* was so excited to finally announce his retirement to all his family and friends. His 401(k) account had grown to levels that made him feel secure about his retirement future. His time had come! The problem for Andrew was that it was the summer of 2008. In the next few months, the U.S. stock markets would take a fall of epic proportions, there would be a crisis in the banking system, and venerable financial institutions would collapse. The last few months of 2008 through the early part of 2009 were scary times indeed.
Andrew fell into a desperate panic, sold everything in his 401(k) account, converting it all to cash. He just couldn’t stand the pain of watching his account lose half its value and was convinced that his retirement plans had been sabotaged by a cruel twist of fate. He withdrew from his planned retirement and began to hunker down and wait until he could get back in the market someday and hopefully recover his lost account value. Patiently he waited on the sidelines, holding cash, and hoping to find just the right moment to re-enter the stock market. Then in April 2009, the U.S. stock market began to take off and moved quickly to levels unexpected just a few months before. Not quite sure what to do and when to do it, Andrew missed his opportunity to get back in the market. Eventually, he did begin to reinvest, but much of his hope for recovery was lost due to his poor timing. Today, nine years later, Andrew is still reeling from those dark months in the fall of 2008.
Take a look at your own 401(k) account right now. Are you holding stocks that have grown in value over time? You probably are. Investors have enjoyed a bull market for stocks in recent years that is one of the longest running in history. And yet, it is the nature of the stock market behavior that what goes up eventually comes down and the cycle continues, up and down, over and over again. Is your 401(k) account built to last when the next stock market downturn comes? Right now, when times are good, might be the right time to find out.
Maybe it is time for you to consider reviewing your accounts, making any adjustments that are needed, and then formulating a plan on how you will handle a downturn, if and when it may come. First, check your emotional readiness. Imagine you are looking at your account statement and you see a 20% drop in value from the last statement. How would you react? If you are not accustomed to thinking in percentages, calculate what a 20% drop in value would mean for your account and express it in dollar terms. Thinking about such a possibility, are you feeling queasy in your stomach or are you calm in the knowledge that stock markets cycle up and down and have been doing so for as long as there have been records kept on stock market activities? Either way, you may need to develop a plan. In the absence of a plan, you may fall prey to panic behaviors that are not in your best interest long term.
Next, look at the allocation of your investments. If you have had a target allocation of 60% stocks and 40% bonds, your actual account may be looking more like 70% stocks and 30% bonds because of the rising values in the stock market over time. To get things back on track, maybe you should sell off enough stocks and invest the proceeds in bonds to get back to your original planned asset allocation. This kind of activity is called portfolio rebalancing and should be done periodically to keep asset allocations in line with your overall financial plan. I generally recommend rebalancing at least once a year. Some 401(k) plans offer automatic rebalancing. If this feature is offered, it is a good idea to take advantage of it.
Now, review your plans for retirement. If you are older and your planned retirement is in the near term, you may want to consider trimming your stock allocation as you approach your retirement date. In this way, you may be able to avoid the sense of panic that Andrew felt as he watched his retirement plans evaporate in a crisis moment. However, don’t just trim back your stock allocation and forget it. Reconsider what allocation will be appropriate for you to carry you through your retirement. If you are in your middle sixties, you may have another twenty or thirty years of life expectancy and this should be part of your evaluation of appropriate asset allocations as you manage through your retirement.
On the other hand, if you are in your twenties or thirties, you may want to consider a higher allocation to stocks because you have the benefit of time on your side. You will likely have plenty of time to recoup short-term losses and any stock market downturns allow you to purchase more shares at lower prices. Remember, in a 401(k) plan, you are probably contributing to your plan every pay period and downturns in the stock market may work in your favor with the opportunity to get more for your money.
Check your contribution levels. Are you fully maxing out what you are allowed to contribute? If not, could you make a plan to increase your contributions? Increasing contributions in very small increments, maybe 1% or 2% at a time, may hardly even be noticed in your take-home pay but could make a big difference in your retirement nest egg. If you are over age 50, have you taken advantage of the “catch up” contribution provision available in most 401(k) plans? This provision can add another booster to building your retirement fund. In 2018, individuals can contribute $18,500 per year to a 401(k) plan. Another $6,000 per year can be added if you are over age 50 under the “catch up” contribution provision for a total of $24,500 per year. These contribution amounts are indexed to inflation and may change over time.
You should also look at your diversification. Do you have your “eggs” spread over many baskets or are you concentrated in just a few? Consider broad diversification of both domestic and international stocks, large well-established companies, mid-size companies, and smaller emerging companies, developed and emerging markets, short, intermediate, and long-term bonds. Other asset classes may be offered in your plans such as real estate or commodities. If so, you may want to consider these as well. Consider also seeking professional help for guidance on developing a diversified asset allocation that is right for your individual situation.
With careful attention and regular monitoring, managing your 401(k) plan account can help you build a solid foundation for your retirement future. If you have a well thought out plan in place and stick to your plan even when there may be turbulence swirling around you, you can weather stormy downturns in the stock markets and stay on track for your planned retirement. If Andrew had been more patient and not panicked when markets swooned in a downward spiral that seemed to have no end, he could potentially have seen his accounts recover their value much more quickly than he could ever hope for sitting in cash on the sidelines, waiting to get back in.
Looking at stock market history, downturns, even very severe ones, eventually do recover and things eventually move on to new highs. While there are no guarantees of what will happen in the future, the up and down pattern of stock market behavior has been characteristic of stock markets for all of recorded history. If you have a plan in place and know in advance how you will handle the inevitable ups and downs of financial markets, you may be in a better position to make it through successfully.
If you want to take a reading of how you are doing on your path toward preparing for retirement, consider taking my free retirement readiness self-assessment. You can access it by clicking here. Visit my website to access many helpful blog posts, videos, and other resources to assist you in managing your financial life. If you would like a free, no obligation private consultation with me to evaluate your situation, you can contact me directly at 501-823-2171. I love helping people plan for their financial future and it would be my pleasure to help you. I look forward to hearing from you.
*Andrew is not a real person. Andrew’s story is based on actual experiences of many individuals presented in composite for illustration purposes only.
Investing involves risk and clients should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. The information contained herein is intended for information only, is not a recommendation to buy or sell any securities, and should not be considered investment advice. The information and opinions expressed herein are obtained from sources believed to be reliable, however, their accuracy and completeness cannot be guaranteed. Past performance does not guarantee future results. Please contact your financial adviser with questions about your specific needs and circumstances.
Investing strategies, such as asset allocation, diversification, or rebalancing, do not assure or guarantee better performance and cannot eliminate the risk of investment losses. There are no guarantees that a portfolio employing these or any other strategy will outperform a portfolio that does not engage in such strategies.
International investing entails special risk considerations, including currency fluctuations, lower liquidity, economic and political risks, and different accounting methodologies.
Investments in commodities may be affected by the overall market movements, changes in interest rates and other factors such as weather, disease, embargoes and international economic and political developments. Commodities are volatile investments and should form only a small part of a diversified portfolio. An investment in commodities may not be suitable for all investors.
In general, the bond market is volatile, and fixed income securities carry interest rate, market, inflation, credit and default risk. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
Investments in real estate may be subject to greater volatility than investments in traditional securities and pose special risks. The value of real estate and portfolios that invest in real estate may fluctuate due to losses from causality or condemnation, changes in local and general economic conditions, supply and demand, interest rates, property taxes, and regulatory limitations on rents, zoning laws, and operating expenses.