Discipline, sensible asset allocation and periodic rebalancing remain the keys to long-term success.
Julie Wilhelm breathes easier now when her 401(k) statement arrives. As the effects of the Great Recession have subsided and the stock market has rebounded, Wilhelm is among many 401(k) investors who have seen their retirement funds bounce back.
"Yes, I'm opening the envelope now, but it wasn't that long ago that I didn't want to," Wilhelm says. "Since the first of this year, though, the balances are finally creeping up."
"A few years ago people called them their ‘201(k)s' because they had lost so much value," says Michael Eischen, president and owner of Eischen Financial Group. "Now they're back to 401(k)s. Their ongoing contributions helped them to recover, in addition to good market returns."
The biggest winners: steely investors who didn't pull out of equity investments as the stock market plummeted.
"The black cloud has let up over 401(k)s if you stayed invested and had diversified investments. Many people pulled out, though, because of panic and a flight to safety in nonequity investments," says Robert Bullock, a Columbus-based senior investment manager for Chase Investment Services.
Despite the market downturn, research by Vanguard shows retirement wealth actually grew for the typical 401(k) plan participant from 2005 through 2010. The 2010 account balances--median $26,926, average $79,077--were the highest since Vanguard began tracking this data in 1999.
Maybe you didn't have nerves of steel. Maybe you panicked and moved your 401(k) out of stocks and into a money market fund in late 2008 or early 2009, just as the equity markets were bottoming out. You have some catching up to do.
"Participants, who out of fear, sold their holdings to cash in late 2008 or 2009 and still remain in cash have missed a significant run-up in asset prices. But it is never too late to move cash into stock market holdings; it just needs to be done strategically," says Mark Palmer, CEO of the Joseph Group Capital Management.
So what's the best strategy for 401(k) investing now? On one hand, the stock market rose dramatically in 2009 and 2010, and the first half of 2011 looks strong. On the other hand, high food and gasoline prices, persistent unemployment, record federal deficits, worldwide political instability and the ever-looming specter of inflation suggest there could be trouble ahead.
Still, the consensus of experts is that the key to long-term 401(k) growth is not complicated.
It's back to basics.
The Dow Jones Industrial Average (DJIA) peaked at 14,164.53 in October 2007. Seems like a lifetime ago, doesn't it?
"When the market was running up, you could do almost anything and still make money. 401(k) investors gained confidence in their ability. When their balance dropped along with the market, they weren't as sure," Palmer says.
"People thought they were OK with the amount of the risk they had within their 401(k), but when the market dropped steadily in 2008 and 2009, they started losing sleep," says Catherine Golladay, a Cleveland-area vice president at Charles Schwab, a 401(k) service provider to approximately 1.5 million plan participants.
As the Dow plummeted toward its March 2009 trough of 6,547.05--more than 50 percent below the 2007 peak--rattled investors threw their financial plans out the window and shed equity investments. Money shifted into bond accounts and money market cash accounts in a "flight to quality" or "flight to safety."
"We saw investors jump out of equities at the bottom and into bonds at their peak price. Some probably will get burned again in the bond market, even though they thought they were doing the smart thing," says Brian Edwards, senior vice president of the Edwards Group at Morgan Stanley Smith Barney.
"Billions of dollars came out of equities," Bullock says. "When equities imploded, bonds weren't doing terribly well, either. Cash was the only thing people felt good about getting into. Once you pull the money out of equity funds, you often second-guess when to put it back in."
Do investors need a new plan, or maybe a return to the old one they discarded? "You not only need a financial plan for long-term investments like 401(k)s, but also a commitment to the plan to ride out the bad times," Eischen says.
"You must be accountable to yourself and your financial goals. For short-term goals, don't get greedy. For long-term goals, don't be fearful," says Gary Vawter, president and owner of Vawter Financial.
Vawter's client Jim Dedrick speaks often with Vawter about financial priorities. "We've worked with him almost 20 years and have made adjustments as time passed," says Dedrick, a semi-retired chemical industry employee who lives in Medina. "My wife and I were able to achieve our key milestones.
"My 401(k) and my wife's 403(b) [a retirement plan for employees of schools and nonprofit organizations] were our primary sources of wealth," Dedrick says. "We both invested early on, and I had a company match. Gary helped us maximize our plans and build on them for our retirement years."
The Dedricks are a good example of how steady contributions can build a solid retirement plan. The 2011 maximum annual 401(k) contribution is $16,500. Participants age 50 and older can contribute an additional $5,500 in "catch-up" dollars. Advisors recommend "maxing out" your annual contribution, or at least increasing it as your income rises.
"Generally, employees don't turn off their 401(k) contributions during bad economic times. The market is rebounding, so participating in your company's 401(k) makes sense today, and helps build future wealth," says Trent Baker, assistant vice president of the Edwards Group at Morgan Stanley Smith Barney.
Allocation & Rebalancing
You've committed to making regular contributions to your 401(k) over the long haul. Good start. But how often should you move your money around within the various investments your plan offers?
"Many or most people have an autopilot approach to investing in their 401(k), so they don't do a lot of shifting," Vawter says. "This actually can serve them well, as long as periodic adjustments are made to reflect their changing goals and retirement time horizon."
After the turmoil of the last few years, more investors are turning to financial professionals for advice (See "Professional Help"). "We are finding that investors are less willing to self-direct their accounts," Palmer says. "They understand the days are gone when they can just buy and hold in their accounts. They are looking for professional management."
Wilhelm and her husband, Tom, began working with Eischen in 2005. "I had so much respect for my mother and father and what they worked hard to leave me. We wanted the money I inherited to work for us," she says.
The Pataskala resident is a Columbus medical office employee; her husband is a small business owner. "Our priorities emerged and now we have a good plan. I understand Mike can't change the economy, but he put us and kept us on the right track," Wilhelm says.
Plan participants determine the percentage, or allocation, of their 401(k) that's to be invested in various asset classes. It's a critical decision. "What makes or breaks your 401(k) performance is the asset allocation," Eischen says.
Plans commonly include equity, bond, commodity and cash funds. Many also offer diversified lifestyle or target retirement date funds, in which the mix of investments grows more conservative--and less volatile--as retirement nears.
"You need to know what makes up each investment choice, because throwing darts isn't a plan," Bullock says. "You see one sector doing well and you want to put more money into it, but that's investing with your emotions. A good sector today may be a bad sector tomorrow. A mix of investments keeps you from being over-invested in any one fund. I can't emphasize enough how important it is to diversify."
"Asset allocation is the most significant factor in determining the long-term performance of an investment portfolio," Palmer says. "Over longer periods of time, the greater the exposure to the stock market, the greater the exposure to market risk, but the greater the overall return is likely to be."
While 401(k) plan administrators provide each fund's rate of return over various time frames-from one quarter to 10 years or more, depending on how long the fund's been in existence-participants can find it challenging to assess the risk of each investment choice. "You need to find out what sort of investments make up the fund and in what percentages," Bullock says.
Without professional help, that's easier said than done. "Very rarely do I see a client who can tell me how much risk they have in a particular 401(k) investment choice. I can look at the returns and underlying accounts and see if they're being rewarded for the risk," Eischen says.
A 401(k) plan allows investors to regularly buy a certain dollar amount of a particular fund. Such "dollar cost averaging" means more shares are purchased when prices are low and fewer shares are bought when prices are high. "You don't panic when the market falls with dollar cost averaging," Edwards says. "But why is this so hard to do, particularly in times like 2009? Money is an emotional topic, and what's in your best financial interest may not feel good."
Most advisors recommend rebalancing your investments annually, to bring them back in line with your chosen asset allocation percentages. "You might have had an initial allocation that got out of whack, or you're overexposed in a certain category. Rebalancing fixes that," Vawter says. "It also forces you to sell high and buy low. When you take profits and trim to the targeted allocations, it pushes money to other allocations that didn't do as well."
An easy example: Your target allocation is 60 percent stocks, 40 percent bonds. You start 2011 with $60,000 in equity funds, $40,000 in bond funds. By the end of the year the equity funds have gained 20 percent, to $72,000, while the bond funds have fallen 10 percent, to $36,000. To rebalance, you sell $7,200 of equity funds (sell high), and buy $7,200 of bond funds (buy low), returning your total account to the desired 60-40 mix.
"Rebalancing is investing discipline, because it focuses you to do what you don't want to do emotionally," Eischen says. "Without rebalancing, there's no discussion, no strategy. You're flying by the seat of your pants and it's easy for the herd mentality to take over."
The Road Ahead
"With the markets rebounding, we're seeing confidence return. Money is flowing back to equities, but it's not a stampede," Bullock says. "Just because the market is doing well, though, doesn't mean equities are where you should be investing. That's where your plan comes into play."
Typically 401(k) account allocations mirror contributions. "We don't look at it as two pots of money," Palmer says. "However, some investors right now prefer to be more aggressive with the new dollars they're putting in, while keeping the dollars already in the 401(k) at a more conservative risk level."
Depending on where your news is coming from--Wall Street or Main Street, Columbus or Islamabad--your view of the future can vary widely. "A lot of investors have seen rather remarkable results more recently, so there seems to be a disconnect between what's wrong in the world and growing 401(k) account values," Vawter says.
Inflation or sharply rising interest rates could roil the investment markets, but so far neither has happened. "Inflation is heavily tied to wages, and we're just not seeing wages rising out of control right now," Edwards says.
Whatever the future holds, many people seem to be coming to terms with a new retirement reality. "Compared to 15 years ago, we're finding that investors' retirement dreams are more realistic now," says Golladay. "Instead of sailing off in the Caribbean, they'd like to have a retirement where they're comfortable and can do the things they enjoy."
Lisa Hooker is a freelance writer.
Reprinted from the July 2011 issue of Columbus C.E.O. Copyright © Columbus C.E.O.