AFTER THE DUST HAS SETTLED
Early last year, marketing executive Jennifer Root got tired of hearing her co-workers crow about the double-digit returns they were earning in their workplace retirement plan. So Root, 35, began funneling all of her contributions to the plan’s large-company stock funds, which had been posting yearly returns of 20% or more.
Root made the change in January 2000--just in time to watch the funds plunge in value as the stock market began to unravel.
As her losses mount, Root now feels she needs to take less risk with her retirement savings. But she’s also fearful of making any changes to her portfolio.
“I don’t want to make another move and mess things up again,” she said.
Amid the worst stock market decline in more than a decade, Root’s dilemma is shared by millions of American workers with defined-contribution retirement plans such as 401(k)s and 403(b)s.
It’s the first time many Americans have confronted month after month of losses in their retirement plans, and they’re wondering what to do now, financial experts say.
“People are asking, ‘Where’s the market going?’ and ‘Should I be making any changes?’ and ‘What are other people doing?’ ” said Peter Smail, president of Fidelity Investments’ Fidelity Employer Services Co., which handles 19% of all 401(k) assets in the United States.
The answer, financial planners say, may be to do nothing, or it may be to do a lot. It all depends on your goals, how long you have until retirement and how far you let your investment portfolio get off track.
Although losses are painful, they’re an inevitable part of investing in stocks. Because stocks have provided the best returns over time--after all, investing in stocks is simply investing in the economy, which usually is growing--most investors should keep a large chunk of their retirement savings in the market, experts say.
It’s true that the stock market has always rebounded, even though it has sometimes taken a decade or more to recover lost ground.
“If you’re young and your 401(k) is aggressively invested, that’s how it should be,” said Irvine financial planner Victoria Collins, noting that investors in their 20s and 30s have plenty of time to ride out market swings.
Standing pat can be a problem, however, when a portfolio has drifted from your intended asset allocation--that is, the mix of investments that best fits your goals, risk tolerance and time horizon.
Long-term goals generally call for riskier, usually higher-return investments such as stocks, whereas short-term goals demand a more conservative approach.
During the go-go ‘90s, some investors allowed their 401(k) portfolios to get dangerously out of balance as they poured money into tech-stock-heavy funds and other risky offerings while ignoring more conservative investments, such as bonds. These investors may find they need to move big chunks of their money around--as painful and as scary as that may seem.
“They’ve got to try to take their emotions out of it as much as possible,” said Robert Wacker, a San Luis Obispo financial planner. “What’s past is past. What you have to do now is structure your portfolio in a way that makes sense” for the future.
If you aren’t sure how best to divide your portfolio, look first to your retirement plan investment provider. Many firms offer generic asset-allocation recommendations.
There also are resources on the Internet that can help, including Intuit’s free 401(k) advisory service at https://www.quicken.com.
Asset allocation might be less daunting if you remember that there are just three basic portfolio building blocks--stocks, bonds and cash (short-term money market securities). Within the stock category, you’ll have to choose among large-company stocks, smaller stocks and foreign stocks.
It’s then a question of getting the right mix.
As many investors have learned over the last year, bonds and cash pay interest and provide a cushion in a portfolio. They grow more slowly than stocks, but they also don’t suffer the kinds of declines that stocks can.
A typical investor in her 20s or 30s, then, might want to have 20% of her 401(k) money in bonds and the rest in stocks, whereas someone in his 40s or 50s might want 40% in a mix of bonds and cash, according to mutual fund company T. Rowe Price.
Aggressive investors in those same age brackets might choose to have less in bonds and cash, whereas conservative investors might choose to have more.
How can you tell whether you’re conservative, moderate or aggressive as an investor? There are plenty of quizzes available on the Internet and in companies’ human resources departments. But financial advisors say most people can determine their risk tolerance simply by monitoring how they feel about their recent losses.
The more despairing you might feel, the more conservative you probably are--and so, perhaps, should be in your investment choices.
But remember that you have to accept lower returns over time when you take less risk. If you’re too conservative, you probably will have to save more or wait longer to retire than if you had invested more aggressively.
Once you’ve determined an asset allocation that makes sense for you, your next step is to compare it with what’s now in your retirement plan. And that’s not always easy.
Some plans don’t specify what their funds invest in. Root, for example, thought she was diversifying her portfolio by dividing her contributions among three stock funds--but all three turned out to be invested in a similar mix of large-company growth stocks. Usually, though, a call to the plan itself can help clear up such mysteries.
The final step is to bring your portfolio into line with your asset-allocation ideal. But that prospect is what brings many investors to a halt--for example, the idea of shifting a large amount now in stocks to bonds.
“People are fearful of making a mistake and more hesitant about going forward,” said planner Collins.
Some people are fixated on the idea that they have to wait for their investments to “come back” before they can shift money from one asset to another. Yet by failing to act, they risk further losses, Collins said.
Others understandably worry that the investments they sell might do better than the ones they buy. But smart investors learn to let go of the idea that they can predict or “time” the market--or that an investment that has gone down in price will necessarily rebound, Wacker said.
In the long run, it’s better to stick to an asset allocation and re-balance your retirement portfolio accordingly once or twice a year, regardless of what the market is doing, experts say.
Some planners say fearful investors can ease their anxiety by re-balancing their portfolios in stages rather than all at once.
Los Angeles planner Louis Barajas, for example, is having some of his clients transfer a portion of their 401(k) money from high-risk growth and technology stocks to lower-risk stocks and bonds each week for several weeks until the portfolio is re-balanced.
Another idea: leaving most of your money where it is, but changing how your new contributions are invested. This approach might seem like a lower-risk way to fix a portfolio, but it’s probably not a good idea for many investors, experts say.
Why? Those with large 401(k) holdings who really need to re-balance will find their new contributions won’t significantly change their asset allocations for months or even years, Wacker said. That leaves them exposed if, for example, the stock market continues to tumble.
The flip side is that long-term investors who direct all of their future contributions to cash or bonds in an attempt to lower their risk will miss an opportunity to use dollar-cost averaging to buy stocks more cheaply.
Dollar-cost averaging--investing the same amount of money at regular intervals--enables you to purchase more shares when prices are low (and, of course, fewer shares when prices are high).
When the stock market is down, it’s on sale for investors who have time to wait for a rebound, experts note.
“Nobody knows what’s going to happen next,” which is why a diversified portfolio is important, Wacker said. Investors “need to react with their heads, not with their fears.”
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Asset Allocation Ideas
How much a 401(k) investor should put in stocks, bonds and cash depends in large part on age and tolerance for risk. Mutual fund firm T. Rowe Price offers the following suggested asset allocations.
Source: T. Rowe Price
