Help a Reader – Should You Continue to Fund Your 401k With the Recent Market Downturn?

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help reader 401k investing retirement recent 2011 market downturn crash

Happy Friday everyone!

Yesterday, I received the following great question/message from a reader about the recent market downturn we have experienced:

Considering the current plight of the stock market, do you still recommend for 20-somethings to max-out contributions to their 401k retirement accounts? Or, should they invest in a high-interest cash savings account instead? 

I am a 29-year-old with a lifecycle mutual fund with Fidelity and just lost $2,000 in the past two days and am wondering what to do. Thanks for your help!

Reader Financial Details:

  • Already has adequate medical, dental, and vision insurance.
  • Has 6-9 months worth of living expenses in a cash savings emergency fund. 
  • Employer does not match 401k contributions.
  • Currently maxes out 401k with 100% of contributions going to the Fidelity 2050 Freedom Lifecycle Fund.
  • Does not have an IRA.
  • Is currently satisfied with the asset allocation offered by Fidelity through the 2050 Freedom Fund. Also prefers the “hands off” approach offered by lifecycle funds.


How would you advise this reader to proceed? Please share your insight by commenting below!

Below is my take on how the reader should proceed.

“Target retirement funds are a good thing to have if you want a “hands off” approach to investing, which is probably best for a lot of people! So, good job on that part.

Now that the market’s already gone down, now is not the time to sell stock holdings and contribute to a cash account. Let’s just nail that down right off the bat.

However, the answer to your question goes a little deeper than what to do ONLY at this instance as a result of the past two weeks. It centers on your overall investing approach. If you’ve followed the steps below, you should not have to worry about changing your contributions to your 401k based on ups and downs in the market since your asset allocation will take care of this naturally.

Step 1: Follow the My Personal Finance Journey account hierarchy order to make sure you have health insurance and a proper emergency fund BEFORE contributing large amounts to your 401k, which you’ve already done. Nice work!
Step 2: Follow my 6 step program to creating your personal investment strategy. A very important part of this is forecasting your cash needs and ability to sleep at night with fluctuations in the stock market in the future in order to determine your appropriate fixed income asset allocation level.

Once you determine this, you can then implement this fixed income (stable investment) in your 401k investing. Personally, a fixed income % of 25% works well for me.

I just checked in to the Fidelity Freedom 2050 fund, and it carries about 22% fixed income securities.

You have to figure out FOR YOUR SPECIFIC SITUATION (using the posting series above) if 22% is sufficiently stable for you to be able to sleep at night. However, off the top of my head, if you are in your late 20’s, you are most likely on the right track with that Fidelity Freedom Fund – just make sure in the future that you can sleep at night with that allocation.


However, since your employer does not offer matching funds for 401k contributions, it is a better idea to first fully fund an IRA (and most likely a Roth IRA since the reader is only 29 years old) before maxing out your 401k each year. This is due to the fact that IRA’s (especially ones from Vanguard) offer more mutual funds options and also often lower fees on mutual fund expense ratios.”


To summarize, below is how I think the reader should proceed:


1) Do not start contributing to a high yield cash savings account.
2) Open up a Roth IRA with Vanguard. Fully fund it before beginning to contribute to your 401k and invest in low cost index mutual funds or Vanguard Lifecycle Funds (similar to the ones offered by Fidelity). Or, you can fund the two accounts concurrently if you are confident you can fully fund the Roth IRA before the end of the year. Opening an IRA is better than an individual taxable account because you can invest in the same mutual funds offered by Vanguard, except that IRA are tax-privileged, saving you money in the long run.
3) Each year as you age, re-evaluate your asset allocation and ensure that you can “sleep at night” with the level of risk you (equity investments) you decide to go with.

Important Legal Disclosure: I am not a financial professional, and this does not constitute professional financial advice. Before acting on any ideas proposed here, you should consult your financial professional.

    ***Photo courtesy of http://www.flickr.com/photos/dimi3/3096166092/sizes/l/in/photostream/

    Comments

    1. I would absolutely recommend continuing to do as you are with your retirement fund regardless of what the market does. In fact, I only check my 401k balance once a year, at tax time. I don't even look at the present value because you cannot think of it as “losing 2000 dollars”. As long as you aren't cashing out, you haven't technically lost anything.

      These are long-term investments for a reason. Right now with everything so low, it can really only go up.

      • Good call Kathryn. Do you invest in Lifecycle mutual funds or something else that automatically maintains the correct asset allocation?

        If not, in that review you do once per year, make sure to rebalance!
        My recent post Help a Reader – Should You Continue to Fund Your 401k With the Recent Market Downturn?

    2. I would actually throw in more money! The stock market is now at a discount and it's got 40 years to grow! If you were 60 years old, then I'd say to take some action and safeguard your investments, but since you're young, keep on investing!
      My recent post 10 Ways to Ruin Your Credit Rating

      • Good call Derek. I've had about $500 extra in side income from this past month that I've thrown in small cap index mutual funds this past week.
        My recent post Help a Reader – Should You Continue to Fund Your 401k With the Recent Market Downturn?

      • affordanything says:

        I completely agree!!
        My recent post One Joke, Four Quotes, and a Parable

    3. Even though there is no matching from the company, I would suggest not changing any of the reader's routines, because as we all know getting into goo financial habits is tough. Plus, I look at it as a prime way to add more value to the portfolio since the current contributions will be invested at depressed levels. Because the reader is in it for the long-term, that's what they should be considering, not so much what is happening on a day-to-day basis.

      I like the idea of contributing to the IRA simply for the sake of having additional funding in retirement. If one source is good, then two sources would be better in my view. Plus, there is a lot more freedom to choose a targeted fund if they decide to go with a discount brokerage, and they won't be limited if they even decide to change their strategy later on in life.

      Then again, I don't have them in front of m to ask them all of the pertinent questions that go into providing a complete answer.
      My recent post Let’s All Play The Money Transfer Game

      • All good advice Eric! Thanks for getting involved in the convo!

        I agree though. Having an IRA is beneficial because it often gives much better options for investing than do 401ks.
        My recent post Help a Reader – Should You Continue to Fund Your 401k With the Recent Market Downturn?

    4. You should continue contributing. Your investment timeline is long and this downturn will be just a blip in history soon. I also recommend opening a Roth IRA account, but I would fully fund the 401k first. Even with no match, the tax saving is very good.
      My recent post Are Your Insurance Policies Lagging Behind Your Finances?

      • Thanks for commenting Joe!

        Wouldn't the tax savings of the Roth IRA be more significant in the long term (as in when he retires) and warrant fully funding the Roth before the 401k?
        My recent post Help a Reader – Should You Continue to Fund Your 401k With the Recent Market Downturn?

    5. I agree with the advice given. I would fully fund the Roth first before the 401(k). When the market takes a nose dive 35 years before retirement you don't have to worry. Think of it more like the market is having a sale. You can buy those stocks today at a lower price than you got them yesterday. Hooray!!
      My recent post Do you have an emergency fund?

    6. I am of the camp that you buy when the stocks are down (buy low, sell high). Granted for retirement you won't be selling these stocks for a long time, but now is a great opportunity for you and others our age to get more shares. Remember, the number of shares that you own doesn't decrease, just their value. You still own those shares and your goal is to get as many as possible so that when the market eventually goes back up (months, years, decades) you will be in an even better position than before.
      My recent post Fighting Reward Inflation: Reward Your Childhood Self

      • Thanks for commenting Amanda! Actually, inside of a retirement account, you do in fact have the freedom to buy and sell stocks without being hit with taxes, provided that you don't withdraw the money. In fact, it's a prudent idea to periodically rebalance your portfolio to maintain a proper asset allocation. This often involves selling your holdings and buying shares of different asset classes.
        My recent post More Money and a Raise, Please!

    7. If it were me, I would be opening a Roth and contributing a set amount (about $416 on average) monthly to max it out. THEN I would max out the 401k, assuming it has good investment options and I want the tax deferment on my income. (In fact this is exactly what I do.) What the market is doing right now doesn't change my plans. Why would I want to contribute less or not at all during the times when I can get more for my money? (Unless I think there's going to be a total, system-wide market collapse that the world will never recover from in my lifetime or my child's life time. In that case, I'm investing heavily in some land and supplies somewhere where I can live self-sufficiently.)
      My recent post Get Out of Debt Fast — The Real Way

    8. affordanything says:

      Also don't forget that over time, the market grows — so dont worry about these dips if you're young and you're in it for the long haul. You'll get the benefit of both higher stock values AND reinvested dividends, which is substantial.
      My recent post One Joke, Four Quotes, and a Parable

    9. Roth IRA is definitely the way to go! They seem pretty well off; maybe they want to continue diversifying further by getting into real estate or something else. With no match, the 401k isn't all that attractive.
      My recent post You Should NOT Be Losing Sleep Over This Market Crash

      • Agreed Darwin. Thanks for sharing. Even without the match, if I was able to max out my Roth IRA and still had money left over, contributing to the 401k might not be a bad idea, given the tax advantages.
        My recent post My Personal Finance Journey Vs. The United States of America – Round 2 – What Interest Rate is Your Savings Account Earning?

    10. Question about the Life Cycle retirement plans – I hear that those types of plans typically have higher fees. Is there any truth to this? I have part of my 401(k) in a life cycle and I'm wondering if fees are eating up part of my gains. Don't want to make saving for retirement any harder on myself then I have to! Thanks!

      • Evening Sarah! I would have thought so due to the fact that you're essentially having someone else manage your asset allocation, so it's less work for you.

        However, I was pleasantly surprised when I logged on to Google Finance and saw that this really is not the case, at least with Vanguard: Here's an example –

        The Vanguard Target Retirement 2040 carries a 0.19% expense ratio, and the three main funds it invests in are the Vanguard Total Stock Mkt Idx Inv, the Vanguard Total Intl Stock Index Inv, and the Vanguard Total Bond Market II Idx Inv.

        The expense ratios of these individual mutual fund components are 0.18%, 0.26%, and 0.12%, respectively. If you do the math, it's amazing to see that the average expense ratio is 0.19%, the expense ratio of the fund.

        So, at least with Vanguard, it's not costing you any more money. However, the key is to just do the comparisons on the funds you own and make sure you're paying a fair expense ratio.

        My recent post My Personal Finance Journey Vs. The United States of America – Round 2 – What Interest Rate is Your Savings Account Earning?

    11. Jason Albright says:

      The unfortunate truth is that there is no such thing as high-yield cash savings these days – the banks are just holding on too tightly to give anyone decent interest rates.

      I love all the recommendations I’ve read in the previous comments – especially the recommendation to diversify. An IRA, Roth IRA and realestate are all great places to start (especially with the inevitable upturn that the realeastate market should be seeing over the next few years!).

      Let me throw in another savings strategy that most people don’t consider: Collectables. Now, hear me out for a second. If you are in a stable financial situation and have a well diversified savings strategy, then looking into collecting something you love can be a fun new way to save.
      For example, I know a guy who collects comic books as his “savings” and makes better yearly returns then he ever could on the stock market as the worth of his collection goes up.
      For someone in as great of a financial position as the Reader, I would recommend first setting up a Roth IRA, and then looking into the possibility of the great hobby/savings account that collectables can provide. 🙂

      • Interesting advice Jason! I've read about these sort of non-traditional investments, but have never bridged out so far beyond index mutual funds and real estate.

        Do you personally invest in collectibles?
        My recent post More Money and a Raise, Please!

    12. moneycone says:

      Let's look at the advantages: He is young and time is on his side. Has decent emergency fund and hasn't gambled with questionable or high risk stocks. The down side is, there is no employer match and he can afford to take some risk since he is relatively young, but hasn't.

      Should he stop investing now that the market is down? You get the best returns when the market bounces back not when everyone's making money. Simple truth when it comes to investing. Now would be a terrible time to stop investing, especially considering he doesn't need the money right away.

      The returns on the particular target fund he's chosen are actually lagging behind s&P and has an ER or 0.80 which in my opinion, is steep. He should consider other alternatives with lower fees but a little more involvement like a lazy portfolio with ETFs. I know Fidelity offers 25 free iShare ETFs commission-free. Something he should look into to keep costs low.
      My recent post Market Meltdown, What Should You Do?

      • Thanks for your advice Moneycone! I would agree that there are definitely ways in which he can improve his returns by lowering his investment fees, since a Lifecycle Fund isn't the best way to do this. However, one key for him is to keep things as simple as possible (he doesn't want to have to adjust or rebalance his portfolio, which he would potentially have to do with a set of index ETFs). Because of this, I think it's all right for him to stay with his Lifecyle Fund, even though it's not totally ideal.
        My recent post More Money and a Raise, Please!

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