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What to do with My 401k in the Current Market or How I gave my 401k Some TLC!

Posted on | March 11, 2009 |

It’s not surprising that there are many people who are wondering: What should I do with my 401k in this market? One day the DOW (DJIA) is up 200 points, the nest it may be down 300. More often than not, a good day is a mixed market - maybe the DOW is off by less than 100, the NASDAQ is up a couple points and the S&P 500 is relatively flat.

In fact, a reader of this blog, Danny, recently left a comment along these lines. In writing my response to his comment, I realized that I had more to say than would fit in the comment box. I wanted to go into some detail of what I did just the other night to give my poor 401k some TLC.

In my initial response, I broke my action up into 2 basic actions:

1). Evaluate your options (and their performance).

2). Up your contribution rate through work.

I should point out that both Danny and I are many years from retirement, and as such this post is really geared toward the individual who still has a decade or more of employment ahead before their target retirement date.

Evaluate your options.

It may seem comforting to just ignore your portfolio and hope you haven’t lost much, but that won’t change the fact that your portfolio has lost value - and you won’t be able to retire on hope alone. Here’s what I did.

Gather the data.

You’ll need a list of the investment options available in your plan. Often times this is available on the quarterly statement you get in the mail, or on the 401k plan website. Make sure it has the following information: performance, expense ratio (cost), style and category.

Compare performance.

I went category by category and compared all of the options by return over a 1 year period and return compared to the bench mark index.

I had done the same thing when I initially selected the funds in my portfolio, and not surprisingly every fund I had initially chosen had held up better than their peers over the last year. In fact, some even out performed the index. Don’t get me wrong, my portfolio is not more valuable than it was a year ago, but most investments have lost value over the past year. The point is to minimize those losses and make the best use of what’s available to you.

It’s important to make sure you compare similar categories and styles. For instance, my small cap fund was down roughly 40% over that past year, while my bond fund was up 1%. You may be tempted to cash out the small cap and let it all ride on the bond fund, after all a 1% gain beats a 40% loss, right? Well, yes, but this is a very narrow slice of time. Over the long term (i.e.: your working life) the chances are much higher that the small cap stock fund will vastly outperform the bond fund. It’s similar with large cap value vs. large cap growth. Both funds will have companies of similar size, but different styles and so perform better at different times.

Performance of the options available in my 401k plan differed wildly in some cases. Some small cap funds were down more than 50%. That over a 10% difference between the best performing and worst performing for my plan!

Compare expense ratios.

Expense ratios are the cost of the fund, and usually fall between .25% and 4%. In my opinion, anything over 2% is too expensive. Most of my funds are in the .75 - 1.5% range. Again, it is important to compare similar categories since small cap stock funds tend to be more costly than large cap value funds for instance.

All other things being equal, you want the fund with the lower expense ratio. But what about when things aren’t equal? Well, there are a few funds in my plan that are have expense ratios quite a bit lower than the ones I chose. One example is a small cap fund that has half the expense ratio of the one I currently hold in my portfolio. The problem is that the lower expense fund also lost 5% more than my fund. Since the difference in expense ratio is less than 1%, this 5% trade off is clearly not worth it.

Increase your contribution rate.

Stocks right now are cheaper than they have been in a very long time. The recent plunge in stock prices is disastrous for recent or soon to be retirees who held too much of their retirement savings in stocks, but for those with many years of work ahead of them it is a once in a lifetime buying opportunity.

As I said to Danny, if you can spare the cash, bump up your contributions. I personally think the stock market is not likely to experience significant, long term growth for quite a while but eventually the stock market as a whole will rebound and grow. It make take 4 months or 4 years but the more you buy when prices are cheap, the faster your portfolio will rise when the market rises.

In the meantime, taking action on the things you can control will give you a greater peace of mind.

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