Will the Dow's Plunge Crush Your Retirement?

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The bull market in stocks over the past four years has been the greatest gift that many retirement investors could ever have asked for. Pulled back from the edge of a financial precipice they might never have recovered from otherwise, disciplined investors have seen their retirement accounts recover most or all of their losses during 2008's market meltdown, as gains of around 100% for the Dow Jones Industrials (INDEX: ^DJI  ) and the S&P 500 (INDEX: ^GSPC  ) have boosted the fortunes of those who stayed invested in equities.

But a massive sell-off for the Dow following the election has raised the specter of an end to the bull run. The last thing investors want to do is ride their hard-earned gains all the way back down again. Will buy-and-hold followers end up all right, or will the market punish them for their adherence to a long-term investing view?

Record retirement balances
Before the recent market turbulence, the financial health of American workers appeared to be better than ever. According to a recent report from Fidelity Investments, which administers roughly 12 million accounts for more than 20,000 company retirement plans, the average 401(k) balance hit $75,900 in the third quarter, the highest level since Fidelity started tracking its 401(k) balances 12 years ago. That average represents a better than 4% increase since the second quarter and an 18% boost from a year ago.

Similar figures from Vanguard confirm Fidelity's findings. Vanguard's average 401(k) balance rose to $85,330, also a record high since Vanguard started looking at its figures 14 years ago.

What's behind the gains?
Certainly, a favorable market has helped push 401(k) balances higher. With the S&P up 27% over the past year and bonds also seeing solid gains, investors who had their 401(k) money in just about any type of investment other than cash definitely had the winds at their backs.

But if the recent swoon in the Dow turns out to be the beginning of a bigger downward move, will those gains go up in smoke? The answer is probably no, because the market can't take all the credit for rising 401(k) balances.

Contributions to 401(k)s are also responsible for much of their recent growth. Encouragingly, Fidelity found that both workers and employers alike are doing their fair share in boosting 401(k) balances by increasing their respective contributions to their retirement plans. Employees now contribute an average of 7% more to their 401(k) accounts than they did five years ago. Moreover, employers are pitching in, with a 19% jump in the amount they're setting aside on behalf of their workers in the form of profit-sharing contributions and employer matching.

At least on the worker side of the equation, automatic enrollment and escalation programs are behind some of the increased savings rates. But interestingly, Fidelity found that workers tend to save more when they aren't automatically enrolled in a plan, setting aside more than twice the percentage of their salary as plans featuring auto-enrollment. The report blames the disparity on plans setting default investment rates too low, with 3% being a typical level.

The real threat to your retirement
Clearly, falling markets reduce 401(k) balances. But over the long run, ups and downs in the market tend to even out. If you keep contributing to your retirement account, the odds are a lot better that your balance will recover more quickly from occasional market dips.

The bigger reason for concern, though, is that market weakness may indicate falling corporate earnings down the road. During the last recession, Ford (NYSE: F  ) , United Parcel Service (NYSE: UPS  ) , and FedEx (NYSE: FDX  ) were among dozens of companies that temporarily suspended 401(k) matching contributions until times got better. Given how essential employer matching and profit sharing have been in restoring retirement plan levels, any danger of seeing them disappear again is cause for worry.

So if you're using your 401(k) to save for retirement, don't fear the Dow's recent drop. But keep your eye on earnings at your employer, because losing benefits like employer matching and profit sharing could have a bigger long-term impact on your retirement prospects.

Even with a 401(k), it's also important to invest elsewhere to get access to the best individual stocks. For instance, Ford has been performing incredibly well as a company over the past few years -- it's making good vehicles, is consistently profitable, recently reinstated its dividend, and has done a remarkable job paying down its debt. Is now a good time to buy, or are there hidden risks with the stock that investors need to know about? To answer that, one of our top equity analysts has compiled a premium research report with in-depth analysis on whether Ford is a buy right now, and why. Simply click here to get instant access to this premium report.

Read/Post Comments (4) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 09, 2012, at 1:28 PM, tychicum wrote:

    It is Obama's plan to redistribute wealth. Everyone will be on food stamps ...

  • Report this Comment On November 10, 2012, at 1:50 PM, TMFDarwood11 wrote:

    Interesting and spot on. I'm very happy to see that people are not only reducing debt, but they are diverting some of those funds to retirement savings.

    Overall, I think that's better for the health of the economy than spending on bling.

    Current retirees are struggling with extraordinarily low returns on cash, and everyone else who has a 12 month cash "emergency fund" is also losing a bit to inflation. With the flight to bond funds, I'd say future inflation poses serious risks for some portfolios. Low interest rates may also mean some retirees are selling funds beyond so called "safe" 4% withdrawal to meet annual needs.

    Perhaps in the near future there will be a need for an article entitled "Will Inflation Crush Your Retirement?"

    Yes, the DOW is down 6.2% from its recent highs. It will possibly continue to drop. However, it's useful to monitor one's total retirement accounts. For example, my retirement funds have dropped 1.35% over the last quarter.

    What does that really mean? If I were retired that 1.35% might require a $135 reduction in my income next year for each $10,000 withdrawn from retirement funds. I say "might" because such withdrawals would be after any interest, dividends and bond yields. Of course, I'll have a "cash bucket" and so I won't be selling any stocks for a few years. So the portfolio has a few years to recover from any short term losses. Technically, I'm retired, but I am working part time and ditto for the spouse in 2013.

    I won't be losing any sleep tonight, and my spouse and I will keep working, saving some and investing via 401K and Roth-IRAs.

  • Report this Comment On November 11, 2012, at 10:16 AM, gskinner75006 wrote:

    One of the nice things about these day trader pull backs is dividend reinvestment future returns are greater as the reinvestment has more purchasing power. I see the same thing with the traders playing the date of record game.

  • Report this Comment On November 13, 2012, at 6:10 PM, scottlogic wrote:

    If you understand withdrawal rates during retirement, it's essential to have cash or safe $$ to draw from during market downturns -or- a system to help avoid/reduce those corrections when they occur without having all of your money out of the market. If you invest your money too conservatively you can run the risk of outliving your money or not keeping up with inflation. 401k's are great "accumulation" vehicles, but horrible "distribution" vehicles. When planning your retirement income, make certain you understand BOTH "accumulation" rates and "distribution" rates.

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