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401(k) investors’ best friend

By Barbara Whelehan · Bankrate.com
Friday, August 5, 2011
Posted: 3 pm ET

When it comes to retirement planning, 401(k) investors are notorious for succumbing to inertia. After setting up their contribution levels and selecting funds, they turn their attention to other things -- often for years at a time. Participants who are automatically enrolled in their plans take the ultimate hands-off approach.

So it came as a surprise to learn that 401(k) trading volume had increased significantly between July 25 and Aug. 1, according to Aon Hewitt, which keeps tabs on 100 401(k) plans representing nearly 5 million workers. Plansponsor.com reported this week that fund transfers normally range between $300 million and $400 million trades per day, but during that period, trading volume exceeded the normal level by a factor of two or three, peaking at $900 million-plus on Thursday, July 28.

What was going on then? Well, that was when bickering in the Capitol reached a crescendo. Members of Congress pushed their own agendas, putting the nation's solvency on the line while Americans watched in horror. (Were you happy with the outcome of the debt deal? My take is that it's too little, too late.)

Knee-jerk reaction

I contacted Aon Hewitt to see what 401(k) plan participants did, if anything, when the Dow dropped 513 points on Thursday. "Trading volume reached $857 million, more than twice the volume Aon Hewitt sees in a typical day," says MacKenzie Lucas, a spokesperson for the global consulting firm. "All the assets moved into fixed-income investments, primarily into stable-value funds (70 percent) and bonds (23 percent)."

Bankrate's senior financial analyst Greg McBride, CFA, has strong opinions about what 401(k) plan participants should do in tumultuous times. I asked him: Should they change their investment strategy when the market starts acting ugly?

"Investment strategy should change as life circumstances change, not as a result of the inevitable ups and downs of the economy and financial markets," he says.

"For 401(k) investors, the time horizon is decades -- both before and after retirement. Over the course of decades, we're bound to see a lot of volatility. Resist the urge for knee-jerk reactions based on volatility and instead base your investment strategy on life circumstances, such as time horizons and retirement goals."

In fact, market volatility can be an investor's best friend. This is especially true for 401(k) plan participants who regularly invest a set amount every payday, a phenomenon known as dollar-cost averaging. When the market heads south, 401(k) investors are effectively buying more fund shares on the dip. That's what all investors want to do because it results in big gains when the market does recover.

Investors who seek shelter from the storm could miss out on beautiful sunny days for the markets. The last 10 years or so, considered a lost decade due to two grizzly bear markets, didn't seem to offer investors much hope. Yet if you'd invested $10,000 in a Standard & Poor's 500 index fund on Aug. 1, 2001, you would have made some money over the following 10 years.

The chart below shows what would have happened to your $10,000 investment if you happened to pull your money out on the market's best days due to really bad stock market karma. In this example, inertia proves to be a superior investment strategy.

The folly of market timing

How much would you have gained or lost as of July 31, 2011, if you had invested $10,000 on
Aug. 1, 2001, and:

The folly of market timing
The above example shows the hypothetical growth of a $10,000 investment in the Standard & Poor's 500 index during the 10-year period from Aug. 1, 2001, to July 31, 2011. Source: Morningstar.

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1 Comment
VGalliart
August 06, 2011 at 2:17 pm

My retirement is going to be the day I drop dead. I have worked for 40 years and have unfortunately only accrued 18K total! Every company I worked for either did not offer any retirement plan or had me work for 6 months and then lay me off just in time for benefits to kick in. Now you ask yourself, what kind of company would do that to their employees....Hospitals! I have been an RN for the last 20 years. They would much rather hire inexperienced new grads rather than pay an experienced nurse. I was paid far better in my first 2 years of nursing and then earned progressively less each year thereafter. And you wonder why we are going to experience a nursing shortage? Who in their right mind would want a job that pays LESS each year for your experience! Life isn't always fair, but it angers me to see what CEO's get for compensation while the working stiffs get little to nothing.