Smart401k Blog

A customer wrote us yesterday and told us that they didn’t need our advice right now because they had pulled all their money out of the market and put it into the money market fund in their account. While this is not the first time this has happened, it still bothers me a great deal whenever I hear about it.

There are certainly very legitimate reasons to move your retirement money into a cash-equivalent investment like a money market or stable value fund.  When you don’t have the time to ride out shorter-term ups and downs of the market, you may need to get more conservative with your money.  But the more frequent reason people pull out of the market is flat out nervousness.  Many people that get nervous about the markets are tempted to pull their money out before (they think) things could get worse.  When the market starts to go back up, the plan is to jump back into their original investments, reaping the rewards of future market gains. 

Well, I’m here to tell you two things: 

1.  Pulling out of the market whenever you fear further declines is a form of market timing

2.  Market timing is extremely risky and can easily cost you tens of thousands of dollars if your timing is off the slightest bit.  Read on to get the facts. 

Goldman Sachs Asset Management did a study that looked at market returns as represented by the S&P 500 Index from 1986 to 2006.  Here is what the data shows:

Stay invested in all 5,297 days of this study period, and the annual return is 12.12%

Miss the 10 best days and the annual return is 8.56% - a difference of 3.56% per year.

Miss the best 40 days and the annual return drops to 1.87%.

Miss the best 70 days and the annual return drops to -3.02%. 

As the data above indicates, if you are out of the market only a handfull of key times, your returns can be severely impacted.  What does this return difference mean in terms of dollars in your account at retirement?  Let’s say you just missed the 10 best days over the above 20 year period, saved $400 per month for all of those 20 years, and had a return on your investments of 8.6% (rounded for our calculator) per year.  You would have $254,500 after the 20 years.  Under the same assumptions, except if your return were instead 12% per year (rounded for our calculator), you would have $ 399,700 - a difference of over $145,000 (these are before tax numbers).  And that’s only 10 days! Imagine if you had missed the top 70 days, just over 1% of the days covered in the time period, and lost money! 

Given these numbers, is it really worth the risk of going in and out of the market?  We think not.

-Scott Revare

The returns listed are based on the S&P 500 Index, which is the Standard & Poors’ 500 composite stock price index of 500 stocks, an unmanaged index of common stock prices. The index figures do not reflect any deduction for fees, expenses or taxes.  Past performance is not indicative of future results.

This entry was posted on Wednesday, June 4th, 2008 at 11:21 am and is filed under Commentary from the CEO, Retirement Investing Education. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.