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Don't Stop Thinking About Tomorrow - 401(k) Contributions in a Down Market
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By Clifton Linton
Senior Writer, mPower |
Moms always know how to make everything right.
Kevin Zook, 26, was fretting about his declining 401(k)
balance in August. He had invested all his money in his plan's most aggressive funds
because he figured his "threshold for pain was pretty high," given his long
investing time horizon.
But what he hadn't foreseen was his worried reaction to
negative returns. He told his mother — the person who taught him good savings habits,
and his investing partner in mutual funds outside his 401(k) — about his concerns.
She's been saving and investing for years. "She told me not to worry about it,"
he said.
On advice from her and others, Zook diversified his
portfolio by moving 10 percent of his money into a bond fund. That relieved some of his
worries.
There are many other individuals, however, who haven't
managed to put their minds at ease. As quarterly statements arrived in October, many
401(k) savers numbed by a 1ý-year market decline were shocked by another sharp drop in
their balances. With the economy slowing and fears of additional terrorist attacks
prevalent, some retirement savers are questioning whether to remain invested in stocks,
whether to temporarily stop contributing in order to pay off bills, or whether to
completely pull out of their 401(k) plans.
Many Participants Worried
Indeed, 47 percent of consumers surveyed in the last two
weeks of September by CIGNA Retirement and Investment Services said they will make changes
to their retirement accounts if their balance is lower at the end of 2001 than it was in
January. Of that 47 percent, 17 percent said they plan to invest in more conservative
investments, while another five percent said they will stop contributing altogether. But,
that's the wrong thing for a retirement saver with a long-term outlook to do, financial
planners and retirement industry experts say.
Deviating dramatically from your savings and investment
plans could hinder your attempts to reach your retirement goals, said Malcolm Greenhill,
certified financial planner (CFP) with Sterling-Wood Financial in San Francisco.
"The only reason people save is to achieve their
goals. If you have a plan and stick with it through bull and bear markets, you are likely
to achieve that plan," he said.
"You can come out of the market, but you won't be able
to achieve these goals."
Think about Tomorrow
Savers thinking about halting contributions need to
consider the downside to such an interruption. This decision often seems simple.
"I'll stop for a few months, and then start up again." What many people fail to
realize is how difficult restarting can be. Just like going to the gym or staying on a
diet, developing good habits takes time and discipline.
"Saving is a habitual thing," said Ian Glew,
senior vice president with CIGNA Retirement and Investment Services.
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| "I would not suggest that a client
pull out of a 401(k) and take the penalty and tax hit. Just because someone is
dissatisfied with the market is not a reason to pull the money out." |
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| — Brian Orol, CFP and president of
Strategic Financial Planning Group |
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Because of folks' inherent inertia, it's not uncommon for a
pause intended to last several months to stretch to a year or more.
"It is our experience that people restart saving later
than they expect," Glew said.
Additionally, the disposable income you get when you stop
saving may actually be less than you expected. A $1,000 contribution to a 401(k) is only
really worth $720 in your pocket after taxes, if you are in the 28 percent tax bracket.
What's more, if your employer offers a matching
contribution, you'll miss out on it when you're not participating.
And if you've left your job and are thinking about cashing
out, you will be doing so with some of the most expensive money you can find, if you are
younger than 55. Taxes and penalties can eat up 40 percent or more of your balance, and
given the market's levels right now you would be cashing out of your investments when
they're far from their highs.
"I would not suggest that a client pull out of a
401(k) and take the penalty and tax hit," said Brian Orol, CFP and president of
Strategic Financial Planning Group in Raleigh, N.C. "Just because someone is
dissatisfied with the market is not a reason to pull the money out."
Finally, by cashing out you will reduce your retirement
savings as well as your chances of succeeding with your retirement plan.
Fears and Ignorance
The market's declines have highlighted an unfortunate
reality — many 401(k) participants, used to the constant gains the markets provided
in the late 1990s, didn't understand how the markets worked or how their portfolios would
behave when they chose their investments.
Ronda Rossley, 42, is one of them. She invested
aggressively, figuring she could take a hit. She didn't expect to be clobbered by a
freight train. With her 401(k) account currently down 40 percent from its 1999 highs, she
fears she may completely lose the $20,000 she saved in her plan over the last five years.
"I'm getting my 401(k) statements and it's depressing.
... My fear is if (the market) continues to go down, three more statements and I won't
have a penny," she said.
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| "I'm getting my 401(k) statements
and it's depressing. ... My fear is if (the market) continues to go down, three more
statements and I won't have a penny." |
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| — Ronda Rossley, 42-year-old
401(k) investor. |
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Rossley created an equity-dominated portfolio, but admits,
"I am completely clueless about how the markets work. I just assumed it would sit
there and go up."
Her fears of losing her entire portfolio are probably
unrealistic, and might be tempered if she had the opportunity to learn the basics of
investing, risk and diversification.
The market's current behavior, while distressing, is
"perfectly normal," said Joel Ticknor, certified financial planner and president
of Ticknor Financial Inc. in Reston, Va.
Quoting figures from Ibbotson Associates from 1926 to 2000,
he said that, on average, stocks returned 11 percent a year, bonds returned 5.3 percent
and money market securities returned 3.8 percent. But, stocks' great gains come with a big
caveat. One out of every three years, stocks lost money; one out of every seven, stocks
declined 10 percent; and once in a generation, stocks fell 20 percent or more.
Ticknor runs through this example with all of his clients.
"I don't have anyone sign up for stocks without going through this drill," he
said.
As a whole, stocks are the only investment that over time
has consistently provided returns that outpace inflation. This is important because
inflation is a risk that is even more threatening to retirement savers than a market
downturn. But you can't invest in just any stocks and get a good return. You need to
develop a well-thought-out asset allocation strategy in order to minimize your portfolio's
swings and maximize your potential return at your chosen risk level.
When told how stocks typically perform, Kevin Zook
admitted, "I guess I didn't really understand all of that. I got used to that really
good performance."
Zook said it was comforting to realize that the market was
behaving normally. "I was looking for reassurance that the best thing to do is
nothing," he said.
That's what many financial planners urge, providing you
have a good investment strategy in place. CIGNA's Glew said retirement savers need to put
on blinders. "You really need to take the long-term view," he said.
"I think we focus on (current market values) because
the media and investment industry focus attention on that. There is a lot of hype around
market values, but that's not important for retirement investors," Glew said.
Retirement savers need to keep in mind that the current
value of their portfolio isn't as important as the value of their portfolio at retirement,
which may still be another 10 years or more away.
Bargain Hunting
Amid all the gloom, financial planners do have some good
news for long-term savers — the stock market is on sale.
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| "I think we focus on (current
market values) because the media and investment industry focus attention on that. There is
a lot of hype around market values, but that's not important for retirement
investors." |
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| — Ian Glew, senior vice president
with CIGNA Retirement and Investment Services. |
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"It's an ideal time to be investing," said
Melanie Woloz, CFP with Woloz and Associates in Los Angeles. "Ideally when you go to
the store and buy, you want to go ... when everything is on sale."
Most retirement savers have a long enough time horizon that
even if prices fall a little more after they buy, they will likely hold on to their
investment long enough for it to make a profit.
"You have to close your eyes and ignore it,"
Woloz said.
If you continue contributing to your 401(k) while the
market is down, you are using a strategy called dollar-cost averaging that actually lowers
the average cost of your investments.
You are buying equities when the price is low. "This
will lower the average price of equity investment and (further) compound your return over
time," said David Wray, president of the Profit Sharing/401(k) Council of America.
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The information provided here is intended to help you understand the general issue and
does not constitute any tax, investment or legal advice. Consult your financial, tax or
legal advisor regarding your own unique situation and your company's benefits
representative for rules specific to your plan.
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