What To Do With Your 401K
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Dead cat bounce: A temporary recovery from a prolonged decline or bear market, after which the market continues to fall.
These days, the tools people have to feather their nest are dwindling. Companies are freezing pension plans, eliminating the match for 401k plans, and all retirement plans have been hit by huge losses in the stock market.
Now is not the time to hide. Open your statement, inform yourself, then act if it's appropriate.
"You don't want to panic," "The last thing that you want to do is make a decision based on emotion. You don't want to sell, completely everything, because when you sell, that's when you've truly lost money. You're locking in those losses."
Look at what you have, sell what doesn't make sense to keep, but don't stop contributing to those retirement plans all together.
"When you're investing now, you're buying investments at low prices," "You want to make sure that you're investing in something that's a good allocation. A good investment that makes sense for you. But now is a great time to buy because you're buying things at lower prices."
Other things to consider-- now might be a great time to turn a conventional IRA into a Roth IRA.
"Let's say you had $40,000 and now you have $25,000. You take that traditional IRA of $25,000 and you put it into a Roth IRA. You will have an income tax bill to pay on the $25,000, not $40,000 of what you had, but $25,000,"
The pay off is that Roth IRA now grows tax-free. A traditional IRA gives you a tax break now, but you pay taxes on all the gains.
Not everyone qualifies to convert a traditional IRA to a Roth IRA right now. That will change in 2010, when the IRS rules change to allow anyone to make a conversion.
For current rules, click here.
In these tight times, people may be tempted to take money out of their retirement plans. Make that a last resorts,
If you're under age 59 1/2, you will pay a ten percent penalty, plus taxes on what you take out. Plus, you're nest egg will be even farther behind.
Money Builder
The $5,000 Portfolio
David K. Randall, 04.14.09, 6:00 PM ET
One of the biggest misconceptions about investing is that it takes a lot of money to get started. Thanks to mutual funds and exchange-traded funds, you can start building a solid portfolio for as little as $5,000.
Before you get ahead of yourself, remember: Every investment holds some element of risk. For money you're going to need in the next year or two, stick to bank accounts. After all, the last thing you want is for your ability to pay your rent to drop along with the stock market. But if you've saved up $5,000 or so you won't need in the near future, investing in stocks, bonds and funds is a proven way to build your personal wealth over the long term.
There's no right single answer to what your investment portfolio should look like, but it should give you the opportunity to grow your money without taking on too much risk. The way to do that is to diversify what you own. That means owning a mix of investments: some that pay off over the long term and some that provide more steady returns.
Say you're 30 years old and about to start building a securities portfolio for the first time. Most financial advisers will recommend putting the bulk of your assets in stocks. True, nobody can predict whether the stock market will rise and fall over the next few months or years, but over the long haul, every $1 invested in stocks at the beginning of a year has, on average, turned into $1.06 by year's end.
The down side: It's a rough ride. Some years, your money will grow a lot more than 6%; other years, you'll suffer big losses. The important thing is to keep the faith and commit yourself to holding on to whatever you purchase for at least three to five years, but preferably a lot longer.
What should you buy? A good first step is to put $3,000 of your $5,000 in an index fund like the Vanguard Total Stock Market Fund (you'll find it by searching for VTSMX on Forbes.com). The fund, which charges a management fee of just 0.15%, known as an expense ratio, is a good choice compared with funds that charge fees as much as 5% of the money you invest. The Vanguard fund has a minimum investment of $3,000 and encompasses 3,386 stocks, making it a great way to diversify.
By purchasing this fund, you'll own shares in practically every publicly held company in the U.S. Sure, some of them might fail. But you'll also be buying the up-and-comers that nobody knows about yet--probably even the next Google. Owning such a broad index will protect you from the ups and downs of individual companies and increase the odds that your investment will grow over the long run.
Does individual stock-picking sound more exciting? Probably, but consider the drawbacks: First, you can make a bad bet and spend $20 per share on a company that may soon be worth $1. Second, the act of buying and selling repeatedly makes you a cash cow for brokerage companies, which charge fees ranging from $8 to $20 for each trade you make. You'll need to pick a steady stream of winners just to break even--and even professional money mangers have a hard time doing that.
When you buy the Vanguard fund, or an equivalent from another low-cost vendor like Fidelity Investments or T. Rowe Price, you'll be offered the option to reinvest your dividends. Do it. Currently, your $3,000 will buy you about 148 shares in the fund for $20.27 each. The next time it pays dividends, you'll receive about 15 cents for each share you own. If the price doesn't change much between now and then, your 15 cents per share will net you $24 each quarter, or 1.2 new shares. Reinvesting simply means your dividends will automatically be used to purchase new shares.
With $2,000 left to spend in your $5,000 portfolio, look for a safe, steady investment. Set aside $1,500 for bonds that will pay out reliable returns. Sure, bonds don't have the high reward potential stocks do, but they will give your portfolio a firm foundation with less risk.
Unfortunately, many bond index funds require a $3,000 minimum investment, so you won't have enough money right now to purchase one. One alternative is an exchange-traded fund (ETF) that holds bonds. Two good choices are the iShares Barclays Aggregate Bond Index (AGG), which charges 0.20% a year in expenses, and Vanguard's Total Bond Market (BND), which charges a fee of 0.09% per year.
Buying shares in an ETF will cost you about $15 per transaction in fees, depending on your broker. In return, you'll get monthly payments for each share you own. Consider holding bonds and bond funds inside tax-sheltered accounts like a 401(k) or IRA, as the dividends your bonds pay will trigger tax liability if held outside these types of accounts.
There are some bond mutual funds that have a lower minimum investment, but have slightly higher expense ratios than ETFs. Compared with paying commission fees to buy an ETF, you may come out ahead by choosing funds like JPMorgan's Core Bond Fund (PGBOX), Pimco's Total Return Bond Fund (PTTDX), or the Schwab Total Bond Market Fund (SWLBX). Each has a minimum investment of $1,000 or less and reasonable expense fees.
You now have about $485 left. Resist the urge to blow it on a speculative stock. Instead, put it into a few dozen shares of an international stock ETF like the Vanguard Total World Stock (VT), the iShares MSCI AWI Index Fund (ACWI), or the SPDR MSCI ACWI ex US (CWI). Each of these funds buys stocks in companies around the world. The advantage here is that you spread out your risk even further, without needing expert knowledge of a particular sector or country.
With the basics covered, you're on your way to a prosperous future.
What should you do with your 401(k)?
On the dark road of a recession and with the uncertain future of the stock market, you may be wondering if it's time to put the brakes on your 401(k) contributions. If your dwindling account balance has you down, you're not alone. In a year when major U.S. equity indexes were sharply negative and many investments lost over 40 percent, there's plenty of pain to go around. Here are some actions you might want to consider taking to give the most aid possible to your 401k:
• Consider rebalancing.
Over time, all portfolios become unbalanced as the riskier asset classes tend to outperform the more conservative bond and cash components. However, serious market declines can result in more dramatic portfolio swings. Accordingly, while I generally recommend evaluating your portfolio with an eye toward rebalancing annually, the market's recent swoon demands more immediate attention. In fact, looking for rebalancing opportunities during volatile markets can help you capture buy low/sell high opportunities as asset class performances drift apart over the short term. As you look at your portfolio, it's also important in this volatile market to assess whether your current risk level is still necessary to achieve your goals. Of course, the beauty in making portfolio changes in a 401(k) plan is that they are free of tax consequences.
• Check your diversification.
Spreading your portfolio across multiple asset classes may help reduce volatility and potentially can increase returns over time. However, diversification does not ensure against market risk, as we have seen over the last number of months. Interestingly, EBRI's issue brief found many participants near retirement had exceptionally high exposure to equities. In fact, nearly one in four participants between ages 56 to 65 had more than 90 percent of their account balances in equities at year-end 2007, and more than two in five had more than 70 percent in equities. To guide employees to more appropriate risk levels, many 401(k) plan sponsors are now offering investments which automatically rebalance asset investments into more "age appropriate" allocations.
• Seek the help of a professional.
When the day comes for you to retire, you may want to move from your 401(k) to an IRA that offers more investment alternative. Why not "test drive" a professional financial adviser until then? Find an adviser that will give you some advice on your 401(k) now and see if there is good chemistry between the two of you. By retirement, you may have a better idea if they are the right adviser for you.
• Get the match.
The 401(k) plan gives workers saving for retirement a tax break at contribution time and potential for tax-deferred growth. If your company still offers matching funds, make sure you contribute enough to claim your share. If you don't, you're leaving free money on the table.
• Keep investing.
By investing a set amount each pay period in your 401(k) retirement account, you practice an investment strategy called dollar-cost averaging. Your contribution buys fewer shares when the market is up and more shares when the markets are down, resulting in a lower average cost per share over time. Right now, the markets are down, creating the opportunity to buy when prices are low. This buying low will likely pay off once markets improve. Investors should consider their ability to continue purchasing through periods of low price levels.
• Adjust your timeline.
Your 401(k) account may have taken a serious hit, but remember that you are planning and saving for a lifetime, not just a retirement date. That is, although you may retire at age 65, that's not the end date for portfolio growth. In fact, in recommending strategies to help create a reliable retirement income stream, I often plan out to age 100. With that longer investment horizon, today's downturn can seem easier to overcome. Certainly, it's difficult not to focus on the market's 2008 nosedive, but investing for retirement security is a long-term endeavor.
• Move it to an IRA.
If you find yourself unemployed, do all you can to not withdraw the money from your retirement account. Taxes and penalties will take a huge toll on what the market has already pillaged. I recommend a direct rollover into an IRA. This will avoid the taxes and penalties, and an IRA account can potentially offer you a wider variety of investment options - which may better help you work toward your asset allocation objectives and financial goals.