A lot of investors are now opening their June statements and panicking.
In 1999, the average balance in 401(k) plans was $46,740. As of June 30, 2002, if your 401(k) was comprised of stocks in the Nasdaq composite, the average valued dropped to $16,826. Why? The Nasdaq composite is off 64 percent from 1999. In addition, assuming an 8 percent return, it would take more than 13 years for you to recoup those gains.
Similarly, if you had a 401(k) comprised of S&P 500 stocks, your portfolio as of June 30, 2002 would have dropped to $31,783 as the S&P 500 index fell 32 percent. Assuming an 8 percent return, it would take more than five years to make up for those losses.
Here are my tips for a healthy 401(k).
1. Re-balance Your 401K
Remember to maintain your long-term perspective. Even though everyone is scared to death of equities, there is good reason to believe stocks will be trading at higher prices than they are trading today. Historically, bull markets always follow bear markets. The S&P is down again this year and is threatening a third down year in a row. The last time this happened was in 1939 at the start of World War II. It logically follows that the odds of a fourth losing year are slim.
Here are the 401 k) allocations that I suggest, based on age:
30s and younger: 100 percent stocks 40s: 80 percent stocks and 20 percent bonds 50s: 75 percent stocks and 25 percent bonds 60s: 70 percent stocks and 30 percent bonds 70s and older: 50 percent stocks and 50 percent bonds
This is the identical asset allocation I suggested last March on Good Morning America. I do not believe the allocation should shift because of recent market volatility. While I am biased towards stock investments, I have always counseled diversification across different types of stocks, which mitigates risk. To that end, make sure you are not over weighted in company stock and that your equity diversification is comprised of a variety of mutual funds instead of individual securities.
2. Use Alternative Sources of Income
Draw on assets outside of your 401(k) plan and take Social Security first to allow your 401(k) plan more time to heal tax-deferred.
Another option is to trade down to a smaller home. If you are 62 or older, consider taking out a reverse mortgage. A reverse mortgage lets you tap into home equity and repay the loan with proceeds from the eventual sale of the property — often at death.
3. Don't Be Too Conservative
Ignore the doom and gloom and don't hit the brakes on your retirement plan. Though it may seem tempting, this is not the time to move your 401(k) money to a money market/cash fund. There is never a good time for that.
The typical money market fund barely outpaces inflation. More specifically, the typical money market fund has returned 5.0 percent per year versus approximately 3.1 percent for inflation. If you put $5,000 in a money market fund each year, you would have $66,034 in 10 years, less $10,500 which would have been eaten away by inflation, leaving you with a total of $55,534.
But if you put that $5,000 a year into a stock mutual fund (returning 10 percent a year) you would be looking at an overall value of $87,656 which is $73,501 after inflation. When investing in the stock market, a certain degree of risk is rewarded.
4. Market Timing Does Not Work