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Rethink cash in your 401(k)

By Jennie L. Phipps ·
Thursday, December 19, 2013
Posted: 3 pm ET

Do you have cash equivalents sitting in either your 401(k) or other retirement accounts? If you do, you're missing out, not only on safe opportunities to make money, but also on the chance to keep even with inflation.

Clarence Kehoe, an executive partner at accounting firm Anchin, Block & Anchin, which specializes in auditing 401(k) plans, says one of the things that disturbed him during this year's round of audits was the number of participants who have funds in cash accounts such as money market funds. He understands this kind of thinking. "There is enormous fear of a market drop. Stocks are high and continue to rise. Bonds are problematic. When people look at Detroit and other cities, they see potential liabilities. By default, they say, 'I'm going to put this in cash.'"

While stashing funds in cash might arguably be an acceptable retirement planning strategy for a saver older than 80, for those who are growing their retirement accounts in hopes of retiring comfortably or those with a long way to go until retirement, it is a lousy idea. Kehoe points out that the rules and regulations prevent 401(k) administrators from telling participants with a large allocation to cash that they are making a big mistake, but as an independent CPA, he can safely say, "Putting money in a cash account isn't a sound financial strategy."

Kehoe thinks the best idea is a well-diversified portfolio, with money in stocks, bonds and a strategic amount in cash. But if you insist on a large allocation to cash, he says stable value funds are your best bet at this point because, "People are getting some returns from stable value -- 1 percent to 2 percent -- compared to no returns from money market funds."

Stable value funds are short- or medium-term bonds paired with insurance contracts to achieve a specific minimum return. As long as interest rates stay low, they'll be the better choice, Kehoe says. But inevitably interest rates are going to climb -- maybe next year or maybe in 2015. When that happens, moving to a money market fund could be a good idea because money market funds are much more sensitive to increases in interest rates.

Stable value funds usually have "equity wash rules" that limit transfers to money market or short-term bond funds. Participants may have to first move their money to an equity fund for at least 90 days. Having both a money market and a stable value fund might give you more flexibility. In any case, if you have a large allocation to cash, keeping an eye on interest rates is important. Don't pay more than you have to for a sense of safety.

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June 20, 2014 at 3:34 pm

Brokers tell you to do what is going to make them the most money.
Doesn't take a genius to figure out the market is atificially high.
Since the inception of 401Ks, brokers have a wad of cash to "invest" in something every week. Not like the old days where it was more sporadicly done by folks who sort of had an idea what they were doing, knew which stocks the money was going to (versus generalizations such as "a mix of equities and bonds"
Do you think they just hold this money until they find a stock that is fundamentally a solid investment? Gotta buy something!!! Up goes the price. To hell with that insanity.

January 24, 2014 at 1:36 am

I have about 75% of my money in cash and bonds within my 401k and even though the stock market has been trending upward in the last few years, I'm just too scared to invest in equities right now. I feel that there might be a bubble about to burst and I'm just too afraid to jump in again and experience the losses I had in 2008 and 2009. I would love to overcome this fear because I'm young, but just don't know how.

December 20, 2013 at 9:57 am

I currently have 10% cash in both my 401(k) and Roth IRA. I see it both as a hedge against volatility and a resource to be used when there is a sharp market drop. I am thinking a 5% drop in the S&P 500 would trigger me to use 20% of my cash, another 5% drop, another 20% of my original 10% allocation. Rinse and repeat until the market bottoms out, then built back again or rebalance when the market recovers.