Despite the market's precipitous drop this year, most workers with 401(k) plans have apparently kept their cool.
That's the good news from a new study by the Investment Company Institute (ICI), a mutual fund industry trade association. Too often, when the market plunges, people freak out and sell, withdrawing their remaining money and parking it somewhere "safe" -- like in a CD. That's not usually the best move, because:
- Their nest egg has already shrunk quite a bit, and this move won't undo that.
- CDs and other "safe" options have historically grown much more slowly than the stock market.
- The stock market is likely to recover and go on to new heights.
The nitty-gritty
Here are some numbers from the ICI's look at 22.5 million 401(k) accounts. In the first 10 months of 2008:
- Just 3% of participants stopped adding money.
- Just 3.7% withdrew money from their accounts.
- 15% had outstanding loans from their accounts.
The first two are good signs, but that last number is a little troubling. We should really think twice before borrowing from our accounts, since our future earnings need all the time and help they can get to grow. If you take out a chunk of your nest egg, you'll have to pay it back; until you do, it will be missing out on any gains in the market. Look at what kinds of moves can happen in short periods of time. Here are some numbers from the week of Aug. 7 to Aug. 14, 2006:
|
Company |
Gain |
|---|---|
|
Yahoo! |
8% |
|
Adobe |
7% |
|
Abercrombie & Fitch |
15% |
|
Advanced Micro Devices |
21% |
Studies have shown that much of the market's gains happen on relatively few days, making it nearly impossible to time the market well.
The reasons
I'd like to chalk up Americans' sensible inactivity in their 401(k) accounts to their burgeoning financial savviness. I'm sure that theory's true, to some degree. Financial illiteracy is slowly shrinking, and we here at the Fool doing our part to wipe it out. (Please learn more about our Foolanthropy campaign, and consider joining us in this important battle.)
But I suspect that much of the credit goes to procrastination and laziness. Even in our regular brokerage accounts, where we can easily buy and sell stocks with a few clicks of the mouse, we often put things off. Procrastination can be a good thing if it keeps us from trading frequently, impatiently jumping into and out of stocks and racking up heavy commission fees. But delays can be bad if they prevent us from regularly adding money to our nest eggs, or taking advantage of great opportunities when they appear.
It's also bad if we invest that money suboptimally. For example, 401(k) accounts typically give you lots of possible investments, from money market-like funds to aggressive stock funds. If you're a long way from retirement, you'd do well to focus mostly on stocks, since they're proven to pack the biggest long-term punch. But even among stock funds, there are bad ones, so-so ones, and great ones. Seek out the best investments you can find by examining the following factors:
- The fees.
- The managers' philosophy and tenure.
- The fund's long-term track record.
- How often the fund buys and sells holdings (turnover).
- Whether the fund charges a load.
If you haven't got the time or energy to do much research, seek out a top-notch mutual fund. As just one example, the Fairholme (FAIRX) fund has turned in a market-whomping five-year average annual return of 5%. Its recent top holdings included Pfizer
So be smart about your 401(k), and let it grow for you!
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