Sept. 30, 2008 -- With the nation's financial markets in turmoil, many are wondering what it means for their retirement funds.
In a piece of good news, the Treasury Department announced Monday that it will guarantee the money invested in money market funds before Sept. 19.
"Good Morning America" contributor Mellody Hobson tells you the five things you need to know about your 401(k) during these difficult financial times.
Your Money Is Safe
As you know, I am a big believer in the 401(k) plan. For most of us, it's the first and best place to invest, no matter how the current stock market is performing. Typically, your employer takes an equal percentage from each paycheck and invests it directly into your 401(k) plan. And with the market down, one of my favorite market factors comes into play — that of dollar cost averaging.
Dollar cost averaging is the approach to investing a set dollar amount over a specific period of time, which allows you to buy more stock when prices are low and less when prices are high. At the end of the day, the price balances out and you are able to take advantage of both the upside and downside of the market -- a terrific opportunity in a market like we are seeing lately.
I want to reassure people, yes, your 401(k) is safe. The one thing I would recommend people do is pull out their most recent 401(k) statement or ask someone in your human resources department for an update, to make sure your savings are diversified—spread across more than one investment type.
Time and time again, the lesson we can take from the demise of a company like Lehman Brothers is that it is never a good idea to have all of your eggs in one basket.
You Should Keep Contributing
It is never a good idea to sit on the sidelines when it comes to saving for retirement. As I have said time and time again, it is absolutely impossible to time the market. There have been a number of studies that have shown that the negatives of missing just a handful of the best days of the market far outweigh the benefits of missing the worst days, and we all know there is no way to predict with 100 percent certainty the good and bad days of the market.
Again, one of my favorite sayings is that bull markets always follow bears. After the last bear market, stocks zoomed up almost 33 percent just one year later. You do not want to miss out on this rebound!
You Should Not Cash Out of Your 401k
The average American has had 11 jobs by age 42 — long gone are the days when an employee would work at one company for an entire career. You have three choices when you leave your employer:
1. Keep your money invested in your former employer's plan.
2. Roll your money over to your new company's plan or to an IRA.
3. Cash it out.
The first two are good options. The third, to cash out, is not a good idea --especially if you are under the age of 59 ½, unless you have an emergency that requires you to tap into the money.
Unfortunately, a great number of people cash out. Hewitt Associates has done a lot of detailed analysis on 401(k) ownership, and has found that 45 percent of employees, upon leaving an employer, opt for a lump sum and do not roll the money over. Assume you have $5,000 invested in a 401(k) and cashed out the money, after paying a 10 percent early withdrawal fee AND federal and state income taxes, you would be left with about $2,900.
You Should Roll Over Or Keep Your Money With Your Former Employer
Instead of cashing out, roll your money over or keep it with your former employer. If you left the same $5,000 in your employer's 401(k) or rolled it over to an IRA, you would have more than $34,000 for retirement, assuming an 8 percent annual return for the next 25 years.
If your account balance is less than $1,000 most employers just cash the employee out. And for those with a balance below $5,000 their money will automatically be rolled to an IRA, unless the employee chooses to cash out. For those with more than $5,000, I recommend moving your money to your new employer if your new plan has a diverse choice of investment options and if the employer provides some form of free investment advice for participants, such as online Web tools or seminars. As many people may have multiple employers and 401(k) plans, I recommend you role all assets into a single plan or IRA. It is much easier to keep track of one plan and to stay on top of your investment choices to make sure you are making the most of your plan.
You Should Only Take a Loan Against Your 401k If It Is Your Last Option
The percentage of employees taking a loan against their 401(k) plans has more than doubled in the last two years. In fact, according to a study by Boston College, more than 18 percent of employees took out a loan last year against their 401(k). Taking out a hardship loan from a retirement plan should only be a last resort — it's not an ATM machine.
Before you take this step, which penalizes you in retirement — cut back on eating out, discretionary purchases like clothing and vacations, fuel costs, and so forth. The math works out that for every $10 you take out from your account, you really have $6 or $7 to spend thanks to the fees and to the time value of money — less money to reap the benefits of compounding.
Mellody Hobson, president of Ariel Investments in Chicago, is "Good Morning America's" personal finance expert. Click here to visit her Web site, www.arielinvestments.com. Matthew Yale contributed to this report.