We all envision retirement to be this magical time when we don’t have to work anymore and we can spend our time doing whatever we want—enjoying friends and family, travelling or taking up new hobbies. We work hard and save for decades so we can enjoy this time in our lives.
Whatever your vision of retirement is, there are some hurdles you may have to cross to get there. Many investors are frustrated with current market conditions, and others may have put saving on hold due to a temporary lapse in employment. These roadblocks can be difficult, but with the right strategy you can get back on track and achieve your goals.
The markets have once again taken us on a rollercoaster ride this summer…a May and June sell-off, a big rally early in July, and then another sell-off at summer’s end. Each day there is some new piece of data released: on the economy, the goings-on in Washington or events overseas. Each day seems to be filled with anxiety, sometimes rally mode and sometimes panic mode. We’ve seen this happen quite a bit the last couple of years. The news will move the markets up, down and sometimes sideways. What is a 401(k) investor to do with all of these rapid market movements?
Emotionally, when things are going up, we just sit back and enjoy the ride. When things are going down, we tend to panic. 401(k) investors should try to ignore negative news. Assuming you have built a good, solid, long-term strategy for contributing regularly to your plan, and you have built a long-term investment allocation, I would continue to stick with it. Review it periodically to make sure it still fits your goals, time horizon and "long-term" risk level.
Your 401(k) plan is there to help you save for your retirement future, which for many of you may be a long way off. It is not a plan set up for you to buy into a portfolio on a Monday and sell on a Friday. Markets will continue to be choppy, especially as economic and political uncertainty in the U.S. and overseas is here to stay. If you have a long-term, disciplined strategy in place for your 401(k), don’t let market volatility cause you to sell low and buy high. By having a disciplined investment approach and sticking with it, you are able to average into a volatile market with each pay period. When markets go down, you buy at lower prices which will benefit you over the long run if you stick with it. The worst thing to do is sell when things are going down, only to try to time your way back in, typically when things are going up.
Also, another dangerous move is selling out of your long-term strategy and moving to cash, because of the headlines you read. By doing so, you not only lock in your losses and give up future gain/rebound potential, you also typically move it to a cash account that is earning a paltry 0.25 percent or so nowadays. Most interest and dividend rates on the funds within your plan alone are earning you more in income than what you would get by going to cash.
On the other hand, individuals who stop their 401(k) contributions for a period of time may not realize the impact this can have on their savings in the long run. However, increasing your savings rate when you start back up will do the trick. The younger you are when you take a time out, the easier it is to get back on track, but the bigger the damage if you do nothing. That's the miracle of compounding, working in reverse. The opposite is true for older savers—a lapse in saving will do less damage to their nest egg, but to catch up, they need to boost their savings rate more than a younger person would.
For example, the average person socks away eight or nine percent of their paycheck into their 401(k). If they were to stop saving for a year, then they would need to jump up to about 14 percent to get back on track. Age becomes a factor after a three-year time-out. Younger people should step up savings to about 15 percent, over 45 should increase to 16 percent, and those at 55 should start saving 18 percent. Luckily, the IRS allows those over the age of 50 a catch-up provision. In 2011, if you are over age 50, you are allowed to contribute an additional $5,500 above the 2011 limit of $16,500.
While this may seem like daunting news—especially when there may be other pressing expenses—if you can resist the temptation to return to your previous lifestyle, then you will be better able to undo the financial damage of a time-out.
For those individuals who have not yet started to save for retirement, now is the time to start, and a 401(k) is a great investment tool. iBi
Daryl Dagit is a financial advisor with Savant Capital Management.
Savant is located at 7535 North Knoxville Avenue in Peoria. For more
information visit savantcapital.com.
