Lessons Learned for 401(k) Investors – Third Quarter, 2007
By Scott Revare CEO, Smart401k.com
 What a ride we had this past quarter. Here are a few notable highlights:
- The US Stock Market (as measured by the S&P 500) hit a record historic high on July 19th.
- From July 19th to August 15th 19 market days - the market dropped 9.4% - almost an official market correction.
- 36 market days later, on October 5th the market recovers the 9.4% drop and hits a new historic high.
- USA Today noted that since 1950, the Standard & Poor’s 500-stock index has posted a daily loss of more than 2% on an average of four days a year. Yet in just the past nine months, the S&P 500 has posted daily losses of more than 2% six times.
- USA Today also noted that the Dow Jones industrial average gained or lost more than 1% on 24 days in the third quarter the same number of times it did for all of 2006.
In a few short weeks the market showed us both its resilience and its newfound increased volatility. So as retirement plan investors with a long-term viewpoint - what lessons can we learn from this wild ride of a third quarter?
1. Hanging on for the ride can pay off.
It really came back, didn’t it? It seems like human nature leads us to want to do something to defend ourselves when confronted with bad events. We also seem to think that when the market drops, it will just keep going down. Whenever the markets drop significantly in one day, or over a few days, our customer call and email volume increases over 30% at Smart401k. People inevitably ask our advisors what they should do they seem to expect us to tell them to quickly sell - bail out before it’s too late! But the best prescription for long term investors is to do nothing - just hang on for the ride. Historically, the markets have always gone up over time. As long as you are properly invested (i.e. diversified) and have the luxury of 5 or more years to wait, history says time is on your side.
2. Prepare yourself for market volatility.
There are two important things to keep in mind during times of market volatility. First, be mentally prepared. The worst thing you can do is let emotions take over and start making decisions that are not consistent with your long term investment approach. Take a deep breath and make sure you are approaching any investing decisions with a long-term perspective. Second, if market volatility keeps you from sleeping at night, consider changing your long-term investing strategy. By increasing your fixed income (e.g. bond) holdings, and decreasing your equity holdings (stock mutual funds), your overall investments will experience less ups and downs. This most likely means your investment returns will be less over time, but your health and well being is more important.
3. Keep investing.
The funny thing about market drops is that they usually are accompanied by large-scale pullbacks from investors. Many investors sell what they have, and even more stop their contributions to their retirement accounts. Investors withdrew $12.3 Billion dollars from stock funds in August. Yes, that’s the month that the S&P hit its quarterly low. In the months since, the market hit a new high. When you know you are going to be investing in the market over many years, isn’t it better to be investing when the market is lower?
4. Stay properly diversified.
It’s easy for market movements to put your investment allocations out of whack. Different types of investments grow at different rates over time. For example, international funds have grown faster than most US based funds this year. By getting your investments back to your target allocation percentages, you are in effect selling investments that are relatively higher priced, and putting your money in investments that are relatively lower priced, since they haven’t grown as fast. This seems counter-intuitive, as you would naturally think you should keep investing in something that has been going up. But this approach ensures that you are moving money out of investments that have already experienced higher than market-average growth before those investments inevitably experience a drop back to market averages. You are in effect œselling high and buying low.
If you stick to your long-term investing strategy and ride out any market gyrations, you put time on your side working to your advantage. Historically speaking, that’s a good thing.
