Saturday, October 18, 2008

Have You Checked Your 401 (k) Lately?

Well, don’t. At least, don’t check the total. You won’t be happy. Instead, look at your asset allocation. That’s the page that shows whether all of your 401 (k) is in aggressive growth stocks or in conservative funds or even in bonds. Typically, it will show a mixture. Your job now is to be your 401 (k)’s arbiter of how much should be in which kind of investment.

No one else can tell you what mixture of risk and assurance will allow you to sleep at night. But before you rashly sell and buy, consider your own personal track record when it comes to risk. Have you tended in the past to go whole hog for iffy stocks? And has that worked for you? Or is your style to lock all your money into extremely safe, low-growth stocks or no-growth bonds? Has your capital merely crept along, barely keeping pace with inflation? Is that good enough for you? You are the only one who can decide if you are happy with the trend of your investments. But you do need to know who you are as an investor. And this is something you should know regardless of the current state of the stock market or the economy.

Has your understanding of the market, especially of ups and downs, been proved faulty? Years ago, mine was, and I took that lesson to heart. I had been given some stock in a big corporation. It made a large investment in a product line that tanked in a very visible fashion (think Classic Coke or the Edsel), and its stock took a beating. So I sold it. Big mistake. A company that large commands so much talent and market presence that it soon had another wildly successful product. The stock split, and then split again. And it has been on an upward trend ever since, although I am sure it has had periods of being down a bit, too. I haven’t been looking carefully, because it reminds me of how I lost a huge amount of profit. All because I thought a momentary down was permanent. In these extremely volatile times, you need to consider that lesson. Some businesses are going to do well in the future regardless of current craziness. Others are headed for oblivion. If you don’t have enough knowledge to forecast which is which, then your choice is to educate yourself or let a fund manager do the worrying.

I could have bought stock in that company again, and participated in the rest of its good times. But being stubborn and stupid about a mistake is a common human failing. It even has a behavioral economics name, the disposition effect. That’s when we tend to throw good money after bad, even though we know we should cut our losses. I’ve talked about it on this blog in the past, although not by name, when it comes to being stubborn about staying in a house you can’t afford. Turns out we’re all doing this all the time in all areas of our lives. That’s probably why your friend took so long to dump that loser she dated.

I tried again with the stock market, years later. I bought an index fund. But I hadn’t been paying attention to the trend of the market, which was down. It immediately lost one third of its value. So did everything else in the stock market, of course, but I felt like an idiot. Because I was. The safest thing to do if you aren’t an expert on the stock market is to hire an expert to work for you. Individual brokers haven’t usually been the answer for the modest investor; mutual funds have. With a mutual fund, you spread your risk because you buy a defined mixture of assets, and then depend on the fund manager to keep buying and selling the right assets at the right moment. Still, in a precipitously down trending market, you’ll initially lose money.

I’ve previously advocated putting money into bank savings accounts or CDs, and I still do. It still makes sense to protect your principal. The problem with utterly safe bank investments and bonds is that they don’t grow your principal. So you have to decide what you are saving for. And this is where it gets sticky. If you are saving to pay your mortgage, car payment, tuition payment , and other set obligations for the six months to a year it might take you to find a new job if you lose your current one, a bank is the best place for the money. Why? Because as I have said before, even the deflated value of money in the bank still pays the original percentage of a fixed obligation. If the mortgage is $2,000 a month, it’s still that a year later. So if you have $24,000 in the bank to pay your mortgage for a year, you’re fine. But you don’t necessarily want to have two or three years of payments sitting in the bank not keeping pace with inflation and not growing. And that’s why people turn to the stock market.

What you want to think about is how long you have to grow the bulk of your savings as investment, versus when you want to draw on that money. And that’s unfortunately where the current stock market mess is giving people anxiety attacks. Because some of us need to retire very soon, or we need to draw on education accounts to pay for college very soon. As Jim Cramer of the TV show “Mad Money” said recently, if you need the money in the next five years, pull it out. He has been credited and vilified for saying this, because the stock market went even lower after he said it. Is the advice of one man that influential? Possibly, in a time of general panic. But then why did Warren Buffett’s three billion dollar investment in GE stock not send every investor in the world to buy GE? Incidentally, Cramer put his money where his mouth was. He sold stock from his elder daughter’s college fund because she’s in college now. He’s holding the stock in his younger daughter’s college fund because she has several years to go before college. My own personal decision has been to leave all my investments in the stock market as is. But then my own 401 (k) and SEP IRAs are so small that they’re not particularly significant to my future. I still have hopes that I can grow them so they could become substantial, which is why I am leaving them in.

Most of us are familiar with the concept of dollar cost averaging. This is a great time to buy stocks cheaply. So keep shoveling all you can into your 401 (k), acquiring more assets in the proportions that make you feel comfortable. Buy more bonds, for instance. Your research should not be on individual stocks unless you have an area of expertise that allows you to understand how a certain field trends. I have a relative who specializes in railroad stocks. As a lifelong railroad fan, he has accumulated a vast amount of knowledge about the assets of individual railroads and he knows when a certain stock is undervalued. But he also knows when to take his profit and sell, thus avoiding the disposition effect. If you don’t know that—and I certainly have proof I that don’t—then individual stocks are not the investment for you.

Instead, research funds and fund managers. You want a fund, or a mixture of funds, that gives you a fighting chance to cash in on every stock that is underpriced in today’s market (and there are plenty). But you don’t want or need the heartache of knowing their individual ups and downs. That way lies madness. Your fund should include rebalancing on a regular basis, whether the stock market is in crisis or not. What is a comfortable risk profile when you are 30 is not the same as when you are 60.

And stop checking your 401(k).

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