401(k) Guidelines

Around a month ago, several friends and relatives called to ask me if the time had come to significantly increase their exposure to equities.

Based on my past experience, these bullish phone calls are usually a very bad sign for the stock market.

I introduced this growing collective sentiment to my walking friend, Joanne, who is known around the neighborhood as “Boss of the Walk.” I told her my friends are an important leading market indicator, and since they want to increase exposure to stocks, I should sell out of stocks.

“That’s ridiculous,” she replied, assuming I was on one of my bizarre rants.  I was surprised.  I actually thought she ignored me during our daily walks, much like the other women in my life do (but that’s another blog topic).

Anyway, did I sell out of the market? No.

Did the market drop for three consecutive weeks after the bullish phone calls? Yes.

Should I have at least taken some profits? Absolutely.

I find that investors are always trying to time the market, and the results are simply uncanny. Here are my non-empirical observations: when people want to sell, you should buy, and when people want to buy, get the hell out! From an arithmetic perspective, market timing has the accuracy of a coin toss, but I have found over the years that there is an inverse correlation between market performance and decisions made by the average investor.  Unfortunately, they tend to buy high and sell at the conclusion of a selloff.

Not exactly a winning strategy.

The reason behind this phenomenon is that most average investors make emotional, rather than objective, decisions. Unlike financial professionals, the general public tends to increase exposure to risk when the market is overpriced.  Perhaps bull-market euphoria just motivates people to jump in at the wrong time. Whatever the reason, it doesn’t work. Successful market timing requires a disciplined strategy.

So here’s the best recommendation I can give: do not attempt to time the market – especially in retirement accounts with time horizons of five years or more.

So, since most of us have our retirement savings in 401k programs or IRA’s, here are additional guidelines to consider.

  • Do not attempt to time the market.  However, if you choose to ignore my advice, please let me knew when you think the time is right to buy or sell equities.
  • Evaluate the potential benefits of a Roth 401k.  Paying taxes today may be preferable to future taxes and Medicare surcharges.
  • Do not place more than 5% of your assets in the company stock.
  • Diversify, but do not over diversify. 10 to 20 holdings are not required to diversify your portfolio. The following simple approach works.
  • A large-cap blend stock fund, such as an S&P index fund or a growth and income fund
  • Mid-cap blend or mid-cap growth fund
  • Small-cap blend or small-cap growth fund
  • International large-cap stock fund
  • Aggregate bond fund
  • Invest in good performing funds with the lowest expense ratios.  Attempt to keep your portfolio’s expense ratio at around 1%. Long term, it can make a significant impact on results, especially when it comes to bond funds.
  • If you work with an advisor, make him/her aware of your 401k holdings so that portfolios complement each other.
  • Be aware of the contribution level required to meet your retirement income goal.
  • What will your current savings and projected future contributions generate in monthly retirement income?
  • Check out your number at the following Department of Labor site: http://www.dol.gov/ebsa/regs/lifetimeincomecalculator.html. Who knows, based on your expected standard of living, you may decide to increase 401k contributions, delay retirement by a few years, or both.
  • Add future Social Security and pension income to your number.
  • Avoid borrowing against your retirement account.
  • Be aware that you are required to begin withdrawals from tax-deferred accounts at age 70 years, 6 months.
  • Withdrawals will be taxed as income.
  • Do not ignore your 401k. Do your homework on a regular basis.

Most importantly, know what your current investment program is expected to generate in future income. Only then can you design a plan that will help you achieve your retirement income goals. Contribute to your savings programs on a schedule, and for goodness sake, do not attempt to time the market.

I know. By this time, you’ve probably tuned me out just like the women in my life do, but I truly hope that you at least consider my 401k savings guidelines.  A lifetime of market experience has taught me a few lessons, and if I’ve learned anything, I’ve learned to diversify, manage expenses and keep an eye on results.