What constitutes smart retirement planning at a time like this, when the market sinks like quicksand? Should you cash out of the stock funds in your 401(k) account? Or stay the course?
After all, the market plunge has wiped out roughly $6 trillion of U.S. retirement savings this year — on paper. Or should you hang tough and stay the course? Stick with the stock funds in your 401(k)?
Fewer retirement savers seem to be hitting the panic button. Fewer are going to cash. Should you follow their example?
If you resist going to cash, you can save yourself more than $90,000 in one easy-to-fall-into trap.
Meanwhile, here's what's happening now. Despite the whopping 16% stock market tumble this year going into Thursday, retirement savers are less jittery. That's according to new data from retirement savings giant Fidelity Investments. And if true, retirement savers' increasingly cool and calm behavior is exactly the right reaction, investment experts say.
In fact, experts wish even more retirement savers had ice water in their veins. "It's Investing 101," said Leanna Devinney, branch leader of Fidelity Investments' investor center in Framingham, Mass., near Boston. "When the markets are down, we believe in sticking to your disciplined investing plan."
401(k) Retirement Planning
That means sticking to whatever mix of stock funds and bond funds you've had in your 401(k) account to get you to your target date for retirement. It's based on your stomach for risk. And on your spending goals once you get there.
And that's exactly what more retirement savers have done during the current market meltdown.
During this year's first quarter, when the S&P 500 lost 4.6%, owners of just 6.8% of Fidelity's self-directed 401(k) accounts shifted money out of stock mutual funds into cash, cash-like stable value funds and other conservative investments that typically do not change in value much during market turmoil.
That was roughly just one-third as many retirement savers who fled stock funds for the assumed safety of cash and bond funds in previous, recent market messes.
Take the start of the Great Recession in the first quarter of 2008. Then, 19.6% of Fidelity's self-directed 401(k) accounts moved money from stock funds into cash and other conservative investments.
Likewise, 20% went to cash and other conservative assets in the fourth quarter of 2018, amid a market downturn.
And 20.8% sought safe havens like cash and bond funds during the start of the coronavirus pandemic market tumble in first quarter of 2020.
So are retirement savers finally starting to avoid the temptation to go to cash and bonds during market declines? "People have seen firsthand the importance of looking at the big picture and not overreacting," Devinney said.
Is Carnac's 401(k) Outperforming Yours?
Some retirement investors are dismayed when they're told not to liquidate their stock mutual funds and shift the proceeds to cash. "They say, 'Staying the course couldn't be right.' But it is," Devinney said.
One advantage of staying the course is that, with the market down, your regular periodic contributions to your 401(k) and additional retirement accounts buy extra shares. "That's the benefit of dollar-cost averaging," said Brian Stivers, founder of Stivers Financial Services.
In contrast, why is darting in and out of the market with mutual funds futile? Because it's impossible to know in advance the right time to get out. And only fortunetellers like Johnny Carson's Carnac the Magnificent know in advance the right time to get back in.
Individual mutual fund retirement savers lacking a crystal ball? They rarely, if ever, get out of the market near its top amid market volatility. And they rarely, if ever, get back into the market at its bottom.
In the 20 years ended Dec. 31, 2019, the broad stock market in the form of the S&P 500 rose 6.06% on average each year. But by flitting into and out of the market in reaction to market ups and downs, the typical stock fund shareholder gained just 4.25% each year on average, according to research firm Dalbar.
If You Cash Out
That inability to read the mind of the market can cost you big bucks.
Look what happens if you have a $100,000 balance in your 401(k) account and the market falls 16%, the way it has so far this year.
Suppose you shift your $100,000 from its S&P 500 index fund into cash. Further suppose you leave it in cash for 18 months. And let's say that nine months from now the market begins to rally.
But because you're scared, you don't shift back into your stock fund right away. You want the market to prove itself before you make such a move. So you wait. And wait.
When you finally return to the stock fund in your 401(k), let's imagine that you've missed a market rally of 8%. At that moment, your balance is worth $92,000 — your original $100,000 minus 8%.
Let's make another assumption. Let's say that the market averages a 7% annual return. That's reasonable. It's actually well below the 10.35% annual average by large-cap stocks such as the S&P 500 from 1926 through Feb. 28 of this year, according to Morningstar Direct.
So, what happens? After just 10 years, your missing $8,000 would have grown into $16,109, according to the investment calculator at calculator.net, compounded daily.
Here's how your $8,000 would have grown over time:
- After 15 years, your $8,000 would have grown into nearly $23,000.
- 20 years: $32,437.
- 25 years: $46,029.
- 30 years: $65,316.
If you continued to work and invest for another 35 years, that $8,000 alone would have ballooned into $92,685 in your 401(k), IRA or other retirement account.
What About Short-Term Savings?
That's the potential cost of cashing out and sacrificing $8,000 from your 401(k) and other retirement savings.
Remember, this applies to the long-term portion of your retirement portfolio. You no doubt have another portion of savings whose purpose is to pay for shorter-term goals, like a wedding or education of your kids or grandkids.
For that segment of savings, it is OK to go to cash in a market nightmare. "That's generally anything you want to pay for within the next three years, for example," said advisor Stivers.
Follow Paul Katzeff on Twitter at @IBD_PKatzeff for tips about retirement planning and actively run portfolios that consistently outperform and rank among the best mutual funds.
