How to Stay the Course: 401(k) Edition

How to Stay the Course: 401(k) Edition

Published On: May 7, 2020

Written by: Ben Atwater and Matt Malick

In theory, 401(k) investing should be straightforward.

Young savers typically build a stock-heavy portfolio because equities have historically outperformed fixed income over the long-term.  During volatile times, we encourage young investors to focus on the long-term and simply stay the course.  Even more so because the beauty of a 401(k) is you are contributing money systematically, with every paycheck. 

Older 401(k) participants, particularly those approaching retirement, usually shift toward a lower allocation to stocks and a higher allocation to bonds for increased stability, while staying invested and avoiding panicked portfolio changes when financial markets become erratic.

But in practice, as some of you may have experienced over the past three months, investing is anything but straightforward.  Fear can take over and, as you see your account balances decline, the temptation to bail out intensifies.  It feels like simply a matter of stopping the pain. 

If you succumb to your fears and sell stocks, deciding instead to wait until things “calm down,” the market inevitably sounds the all clear long before you realize it has done so.  Before you know it, you miss a major recovery and then find yourself waiting for another pullback.  It is a vicious cycle. 

So how best to avoid panicked decisions and stay the course?  And just as importantly, how can you take advantage of market volatility and position yourself for eventual market recoveries?

First and foremost, if you have a 401(k), we encourage you to contact us for help managing it in coordination with your other accounts.  Even if we have already discussed your 401(k) and offered fund recommendations, financial market gyrations this year may mean it is time to rebalance.  Please reach out to us if you would like to discuss your 401(k) portfolio.

Every 401(k) plan offers participants a menu of investment options and nearly every fund menu is different.  But most 401(k) fund menus today include target retirement funds.  Across the 401(k) industry, these all-in-one funds have become immensely popular as a means for plan participants to “set it and forget it,” knowing that their asset allocation should generally match their investment time horizon throughout their lifetimes. 

As the name implies, target retirement funds assume that an investor will retire close to the indicated calendar year (e.g. 2025) and the fund managers adjust the fund’s underlying allocation to become more conservative as time passes. 

As an example, the chart below illustrates the “glide path” of a Vanguard target retirement fund, with heavy equity investments in the early years, gradually shifting toward bonds beginning at 25 years until retirement, and ending with a static allocation 7 years after the target date.

Target retirement funds can be an especially effective tool during periods of extreme market volatility for two important reasons.

First, they follow the glide path over time, which means you are better prepared when volatility arrives.

The most recent bull market ran from March of 2009 until early 2020, almost exactly an 11-year stretch, and saw equity markets grow by leaps and bounds.  A 401(k) investor who started in 2009 with a mix of 80% stock funds and 20% bond funds but never reduced his stock allocation as he got closer to retirement might have found himself overexposed to equities as he entered the recent bear market.  Target retirement funds, on the other hand, would have reduced stock exposure in the decade leading up to this bear market.

Second, target retirement funds are regularly rebalancing, so you do not have to.

While the target asset allocation follows the glide path by gradually getting more conservative over many years, the fund managers are making periodic adjustments to make sure the fund matches its current target allocation.  This process of rebalancing effectively shifts money into equities in weeks and months when the stock market falls and takes profits from stocks when they do well.  In other words, investors in target retirement funds can take advantage of short-term volatility over time.

Not all mutual fund companies create target retirement funds equally.  They have different glide paths, different underlying investment strategies and different fee structures.  As such, we encourage you to contact us to discuss your 401(k) and whether these all-in-one funds make sense for you in the context of your overall financial plan.

These are confusing times for all investors, and all Americans for that matter.  But financial markets have survived other pandemics and recessions, along with wars, terrorist attacks and financial crises.  A disciplined investment process, coordinated between all your financial assets and potentially including a target retirement fund, can help 401(k) investors stay the course and achieve long-term financial goals.  

During this crisis, numerous clients have asked about sharing our messages.  We truly appreciate the positive feedback and would encourage you to forward these notes to family, friends and business associates.  Given the current climate, we are open to adding additional recipients to our communications.  If you know someone who would like to receive these essays directly, please let us know.

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