What Should You Do With Your 401(k)?

By Gary S. Williams



On the dark road of a recession, you may be wondering if it's time to put the brakes on your 401(k) contributions. If your dwindling account balance has you down, you're not alone. In a year when major U.S. equity indexes were sharply negative and the Standard and Poor's (S&P) 500 Index lost 37%, there's plenty of pain to go around.

In fact, according to a recent study by the Employee Benefit Research Institute (EBRI), 401(k) investors with more than $200,000 in account balances had an average loss of more than 25% from Jan. 1, 2008, to Jan. 20, 2009. EBRI's February 2009 Issue Brief, "The Impact of the Recent Financial Crisis on 401(k) Account Balances," was based on the EBRI/ICI 401(k) database of more than 21 million retirement plan participants.

While how individual 401(k) participants have been affected by the crisis varies according to account balances, asset allocation and job tenure, all participants share a common concern: How long will it take for end-of-year 2008 401(k) balances to recover to their beginning-of-year 2008 levels?

According to EBRI, at a 5% equity rate-of-return assumption, the recovery time for the median individual with the longest tenure with his current employer would be nearly two years; at the other end of the spectrum, in the 90th percentile where participants suffered losses greater than 25%, the recovery period would approximately five years.

Of course, if the equity rate-of-return drops to zero for the next few years, EBRI projects the recovery time to increase to approximately 2.5 years at the median and nine to 10 years for those in the 90th percentile.

What you should do in the meantime depends largely on your age and retirement goals. For plan participants in the 20- to 30-year-old range, the down market is a buying opportunity since they have plenty of decades until retirement. Conversely, for employees with 20 to 30 years on the job who are closing in on retirement, steep 401(k) losses may mean delaying retirement by a year or two. In fact, a decade ago, those between 62 and 65 years might have been in an accepted retirement age range. The recession, combined with increasing longevity, has today's retirement age range between age 66 and 70. All 401(k) investors should, however, think about the following.



Consider Rebalancing

Over time, all portfolios become unbalanced as the riskier asset classes tend to outperform the more conservative bond and cash components. However, serious market declines can result in more dramatic portfolio swings.

Accordingly, while it is generally recommended that you evaluate your portfolio with an eye toward rebalancing annually, the market's recent swoon demands more immediate attention. In fact, looking for rebalancing opportunities during volatile markets can help you capture buy low/sell high opportunities as asset class performances drift apart over the short term.

As you look at your portfolio, it's also important in this volatile market to assess whether your current risk level is still necessary to achieve your goals. Of course, the beauty in making portfolio changes in a 401(k) plan is that they are free of tax consequences.



Check Your Diversification

Spreading your portfolio across multiple asset classes may help reduce volatility and potentially can increase returns over time. Interestingly, EBRI's issue brief found many participants near retirement had exceptionally high exposure to equities. In fact, nearly one in four participants between ages 56-65 had more than 90% of their account balances in equities at year-end 2007, and more than two in five had more than 70% in equities.



Get the Match

The 401(k) plan gives workers saving for retirement a tax break at contribution time and potential for tax-deferred growth. If your company still offers matching funds, make sure you contribute enough to claim your share. If you don't, you're leaving free money on the table.



Keep Investing

By investing a set amount each pay period in your 401(k) retirement account, you practice a successful investment strategy called dollar-cost averaging. Your contribution buys fewer shares when the market is up and more shares when the markets are down, resulting in a lower average cost per share over time. Right now, the market is down, creating the opportunity to buy when prices are low possibly from upside potential. While it's natural to worry about just when the recovery will occur, history provides some comforting statistics. In Advice to Investors: Sit Tight and Batten Down the Hatches, Wharton Finance Professor Richard Marston notes gains from the market bottom of the recessions of 1982, 1991 and 2001were 59%, 34% and 39%, respectively.

In fact, according to Investment Company Institute President Paul Schott, in spite the market's steep declines, only 3% had stopped contributing to their accounts and only 3.7% had taken withdrawals.



Adjust Your Timeline

Your 401(k) account may have taken a serious hit, but remember that you are planning and saving for a lifetime, not just a retirement date. That is, although you may retire at age 65, that's not the end date for portfolio growth.

In fact, recommended strategy to create a reliable retirement income stream can involve planning out to age 100. With that longer investment horizon, today's downturn can seem easier to overcome. Certainly, it's difficult not to focus on the market's 2008 nosedive, but investing for retirement security is a long-term endeavor.



Gary S. Williams, CFP, CRPC, is president of Williams Asset Management in Columbia and is an investment adviser representative of and offers securities and advisory services through Commonwealth Financial Network. He can be contacted at 410-740-0220 and Gary@WilliamsAssetManagement.com.