-- Many investors are peeking at their 401(k) balances and discovering that, in one short year, they've lost the equivalent of a new car. It would have been a lot more fun losing that money by driving a Cadillac into a hotel swimming pool.
So as you peruse your options for where to put next year's 401(k) money, you're probably leaning toward the safe options. In fact, if your 401(k) plan allowed you to bury your cash in a coffee can, you'd probably opt for that.
Logically, however, you'd think that the best place to put next year's savings would be in this year's worst performer. After all, you're supposed to buy low and sell high.
But that strategy hasn't done much for performance. Neither has putting your new money into last year's hottest performer. What matters most is how you allocate your overall savings — and how much you save.
Managing a 401(k) involves two decisions: Where to invest your current balances, and where to put your future contributions. Today we're going to deal primarily with the latter. You're continually shoveling money into a 401(k), and it would make sense that how you direct that money could affect performance.
We conducted a small experiment to see whether there's any reasonably simple strategy for making the most of your new contributions. Let's assume that, 20 years ago, you had $10,000 in a 401(k). You put $2,000 apiece in a large-company stock fund, a midcap stock fund, a small-cap stock fund, a government bond fund, and a corporate bond fund.
Each year, you contributed $2,000. Had you simply split your money evenly between the five options, you would have had $149,201 by Sept. 30, according to Lipper. (In case you're wondering, we used Lipper's indexes for each type of fund. The indexes measure the performance of the largest funds in each category.)
But what if you had funneled your money into the previous year's laggards? In 1988, for example, you would have invested $2,000 into small-company stock funds, which tumbled 5.5% in 1987. You would have picked a winner, too: Small-cap funds soared 20.3% in 1988.
Overall, however, the strategy actually detracted from performance. Your account would have ended September at $146,800, a bit less than if you had simply split your new contributions evenly among the five funds. There are several possible explanations for this.
First, and most plausibly, is that stocks tend to outperform bonds. By putting your money into the worst-performing option, you would have tended to add to your bond funds fairly frequently. In fact, your $2,000 would have gone to government bond funds 11 years out of 20.
Secondly, one bad year in the stock market is sometimes followed by another. The strategy would have put you in midcap stock funds in 2002, which fell 18.5% in 2001. The funds plunged another 25% in 2002.
Interestingly, if you had put your new money into the previous year's winners, you would have fared slightly better, ending September with $151,000 in your account. This, too, makes a bit of sense: Overall, stocks had more winning years than losing ones the past 20 years.
Over the long term, however, where you put your new money isn't as important as your overall mix of stocks and bonds. Although stocks have been a form of fiscal torture in the past decade, they have fared well over the past 20 years.
As you can see from the chart, your returns over the past two decades depended mainly on how heavily weighted your portfolio was towards stocks.
Currently, the stock market has all the charms of a shoebox of scorpions. If the market scares you, there's another, low-risk, surefire way of increasing your retirement savings: Save more.
You probably won't notice too much if you contribute another 1% a year to your 401(k) plan — but over the course of 20 years or more, it will probably have a bigger impact on your retirement account than fiddling with your 401(k) options.
John Waggoner is a personal finance columnist for USA TODAY. His Investing column appears Fridays. new book, Bailout: What the Rescue of Bear Stearns and the Credit Crisis Mean for Your Investments, is available through John Wiley & Sons. Click here for an index of Investing columns. His e-mail is firstname.lastname@example.org.