-- The nation is experiencing what some have called the worst financial crisis since the Great Depression. And based on the sharp drop in the value of their 401(k)s, few American families would disagree. Now, more than ever, they need advice on how to deal with the crisis.
Jerry Costilow, for example, retired in 2004 because of health problems. For now he relies in part on Social Security Disability payments. Through the end of September, the value of his 401(k) was down more than 25%.
"My 401(k) is killing me," says Costilow, 63. "It's one of those things where you beat your head against a wall."
But 401(k) participants shouldn't just ignore their dwindling balances. And they need to avoid steps that could make their problems worse.
Among the biggest mistakes:
•Stop contributing. During the past 12 months, 20% of consumers 45 and older stopped putting money into their retirement plans, according to a recent survey by AARP.
"You're missing out on free money," says Pamela Hess, director of retirement research at Hewitt. "When you stop contributing, you don't get any company match and so you're losing out." Keep in mind that when the market is going down, the company match will help cushion your losses.
•Cash out. At a time when the market is crashing, some workers are withdrawing money from their retirement savings. During the past 12 months, 13% of older workers said they have prematurely withdrawn funds from their retirement plan, according to the AARP survey.
Unless you have no other way to deal with a crisis, it's a bad idea to withdraw money from your 401(k) plan before you reach retirement age.
For one thing, you take a significant tax hit, says Christopher Jones, chief investment officer for Financial Engines, which provides advice to 401(k) plan participants. There are early-withdrawal penalties, as well as the income taxes on the withdrawals. That could easily add up to 50% or more of the money you've taken out, Jones says.
•Transfer out of stocks. When the stock market plummets, many 401(k) participants want to bail out of stock funds. In the first 10 months of the year, there have been more transfers out of stocks and into fixed income funds than at any other time period since 1997, according to Hewitt Associates. Historically, individual investors have a poor track record of rebalancing their investments, Jones says. When the market is going up, they tend to invest more aggressively in stocks, he says. When it's falling, they become defensive and shift into cash or fixed income funds, he says. But when you bail out during downturns, Jones says, you risk missing out when the market recovers.
•Overly concentrated in company stock. The collapse of Enron in 2001 should have provided a cautionary tale. But too many workers ignore that lesson and are still overly concentrated in company stock in their 401(k) plans.
Patricia McFarlan, 53, of Oakley, Calif., who lost her job at AIG last year, had invested about 25% of her 401(k) plan into company stock. "I think we were in denial that this could ever go bad," she says. "But now my AIG stock is basically worthless, and I feel sick to my stomach." She isn't alone. "We've seen a huge number of individual stocks just get crushed in this market in the last year," Jones says.
So how do you cope?
Some positive steps to take:
•Check your comfort level. It's not a good time to suddenly shift all of your investments into cash, but it's also not smart to just put your statements in a drawer and not look at them.
Instead, now is the time to consider your risk tolerance. "If you are very uncomfortable with the swings in the market, then you need to revisit your allocations and make sure you have a more comfortable ride to the end goal," says Trisha Brambley, president of Resources for Retirement, a consulting firm in Newtown, Pa.
Some people never rebalance their portfolios and end up with too much in stocks. Others may have jumped onto the bandwagon when stocks were going up and now regret it. Don't just sit tight and wait for the market to rebound. If you seldom reassess your asset allocation, do it now. And if your investments are too risky for your tolerance, then you should start making some smart changes.
•Check your target-date fund. Even if you've invested in a target-date fund, it doesn't mean you should totally ignore it. These funds invest in a mix of stocks, bonds and money funds, based on when you plan to retire. They are popular because plan participants don't have to create their own portfolios or rebalance their investments.
But target-date funds are not all alike. "If your target-date fund happens to have a high allocation to stock, you have to ask if you're with that," Brambley says. You don't need to drop out of the target-date fund, but you can tweak it by adding some other investments to your plan, such as a fixed income fund, which could reduce your risk, she says.
•Consider your retirement horizon. Even if you're close to retirement, you shouldn't suddenly decide to get out of stock funds to protect your savings. People are living longer than ever. If you're 60, you'll need to make your savings last another 20 years or more. So you should first consider how much of your savings you'll need in the next few years compared with later years. And that should help you decide how to rebalance your portfolio. "When you hit 67, you should still be diversified and have some equity exposure to help make your money work for you in the next 20 years," Hess says.
•Consider all your options. If you plan to retire in a few years, your 401(k) may not have enough time to recover. So you need to consider other ways to make your money last.
Many people will decide to delay their retirement. "The good news is that just working a couple of extra years can make a pretty big difference," Jones says. Instead of drawing down your assets, you'll have time to accumulate more savings and earn a higher return on your investments.
You can also try to cut back on your spending and change your retirement expectations. Working part time is also an option.
No matter how old you are, it's hard to know what to do when your 401(k) savings goes over the cliff. Many plan participants want to hold onto their funds until the stock market recovers. But others can't stand the pain and want to bail out.
Here's a less drastic option: Instead of transferring all of your stock funds into bond funds, invest future contributions in conservative investments, Brambley says. That can help reduce your risk without locking in your losses. And that way, you won't miss the recovery.