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.

I read a report today from the Employee Benefit Research Institute (”EBRI”) that stated Americans have become more worried about the state of their retirement savings than they have been in the past. In fact, the number of people who are very confident that they will have a comfortable retirement dropped by about a quarter since last year to 27% (the largest drop in the surveys 18 year history). A lot of this is probably related to the current state of the economy and people’s uneasiness with the market. However, a number of things jumped out at me in the article that reinforced the need to build a nest egg now rather than in the future.

According to EBRI, 49% of surveyed individuals have less than $50,000 saved for retirement, and 28% have no retirement savings at all (if you exclude the value of their primary residence and defined benefit plans). This in and of itself is alarming, but what I found more alarming is what people believe to be an adequate amount of savings. According to the survey, 25% of individuals think they need less than $250,000, and an additional 16% of individuals believe they need $250,000-$499,000 in retirement savings. Now, I can’t say for sure whether they are right or not, but it seems awfully low when you consider things like increased life expectancy and rapidly rising healthcare costs. In addition, less than half of those surveyed had actually gone through the steps of estimating how much they’ll need in retirement (with a calculator or a financial advisor). Of those that did take the time to calculate their need, almost 50% made changes to their retirement planning (the most frequently cited change was to either start saving or to invest more).

It probably doesn’t surprise you that retirement savings is at the top of my mind, but what might surprise you more is that for most people it isn’t even in the top six of most pressing financial issues. It ranks behind things such as cost of living, insurance costs and paying down debt which are all important things. So you might be wondering what you can do to start building your nest egg without impairing your ability to live and pay the bills.

First, I would suggest calculating how much you might need to live how you want in retirement. This will show you how close or far you are from your retirement goal. If you want to experiment with the calculation you can try one of our calculators at http://www.smart401k.com/Calculate.aspx (I’d suggest using the calculator titled - Are My Current Retirement Savings Sufficient?). Its generally believed that you need to replace 70-80% of your pre-retirement annual income to maintain your current lifestyle. If you’re like me and want to travel the world, you might need as much or more than your current level of income. I also found it interesting to play around with rates of return on your pre and post retirement savings and number of years you’ll spend in retirement.

Next, I’d look at what you can do to make your retirement more secure. The easiest and probably most painless way to increase your savings is to increase your contributions to your 401(k). I wrote a previous post about what increasing your contribution by 1% can mean to you at retirement (”How much is a Latte Worth?“) … so give up that latte already! Then I would check to see if your plan has an auto-escalation feature, and if so, I would set it up so that your contribution increases by 1% a year. This will enable you to increase the amount you are saving without impacting your lifestyle (as long as you get a raise of more than 1% a year you won’t even notice the change). If you can do more than 1%, then do it, it’ll pay off in the future when you’re enjoying your retirement.

Scott H

Source: Employee Benefit Research Institute: The 2008 Retirement Confidence Survey

As I was waiting for my latte this morning, I began to wonder what it was worth to my retirement…..

• If you‘re 30 years old or younger it could be worth more than $60,000….
• For someone with at least 25 years until they will need the funds, it could be worth more than $25,000….
• And for someone with at least 15 years until they will need the funds, it could be worth almost $10,000….

You might be saying, “Wow, that’s a lot of money, but I just can’t alter my current budget?”

Well, you could start by drinking one less latte a week.  Increasing the amount you save in your 401(k) by $25 per month or less than $4.50 per week in take home pay (using a 30% combined tax rate) could help you build an additional nestegg for your retirement.

• For example, if you make $30,000 a year it would mean investing just 1% of you salary into your 401(k) plan. At $50,000 a year you would only need to defer slightly more than 0.5% of your annual salary.

What’s our point?  One of the most common statements people make is that they can’t save any more money or that increasing their deferral amount won’t be worthwhile.  Well, if you can skip one latte a week, you will be in a better place for your retirement.

Scott H

Methodology:  This example is for illustrative purposes only.  We used an investment schedule of $25/month, a tax-deferred account and an 8.5% annual return (this return does not represent the return of a particular investment option) to project the account balance

Questions about company stock are some of the most frequently asked by our clients, and in light of the recent events involving Bear Stearns (NYSE: BSC) and JP Morgan (NYSE: JPM) we thought we would remind you about the importance of diversification and the risk of holding a large percentage of your retirement assets in your employer’s stock.  I, like many of you, have been reading about the troubles at Bear Stearns and its recent acquisition by JP Morgan. What caught my eye was that almost one-third of the company’s stock was held by employees of the firm. After digging a bit more, I found the following statistics that surprised me (Source: Hewitt Associates & Employee Benefits Research Institute and the Investment Company Institute): Â

• 40% of employees have at least 20% of their 401(k) in their employer’s stock.
• 16% of employees have more than 50% of their account in their employer’s stock.
• 9% of employees have 80% or more of the 401(k) assets in their employer’s stock.

There are several reasons often cited for holding significant amounts of company stock, including the following:

• Many employees feel their company’s stock is safer than a mutual fund.
• Employer matching contributions often come in the form of company stock.
• Employees want to invest in what they know.

However, our belief, and the message we communicate to our clients, is that if you do decide to invest in your employer’s stock, you should limit your holding to no more than 10% of your overall account balance. This will provide you with exposure to your company’s stock, but also give you the opportunity to properly diversify your account.  If you hold more than 10%, you may want to consider rebalancing your account to increase your account’s diversification.

As a reminder to our clients, we advise you to revisit our risk tolerance questionnaire at least once a year to determine whether your recommended allocation properly reflects your current situation and risk tolerance.  If you have any questions or comments, please feel free to contact us at 877-627-8401.

Buck Wendel, Investment Advisor

As the economy has slowed recently, more and more people are taking loans from their 401(k)s.  While we generally believe that you should avoid taking a loan from your 401(k) we understand that there are times when it makes financial sense.  The main points of the article are summarized below and we have also included a link to the article on MSNBC.

Key Points

• You pay the loan back with Post-Tax dollars while the original contributions were Pre-Tax dollars.
• The maximum amount you can withdraw is $50,000 or 50% of your account value, whichever is less.
• If you leave your employer the loan immediately becomes due.
• If you fail to make the required payments or do not repay the loan in full when you leave your employer your loan will be considered to be in default.  If this occurs you will have to pay a 10% early withdrawal penalty and income taxes on the defaulted amount.

http://www.msnbc.msn.com/id/23241606/

Please let us know if there are issues that you would like more information on or if you have a question about your account that you would like us to answer on the blog.