Overconfidence and bias are among the biggest mistakes for investors who want to protect their 401k savings.
Everybody’s heard of sticker shock. But what about account balance trauma?
That’s a form of distress 401(k) savers with all their money invested in stocks will likely experience when they peek at their fourth-quarter account statements.
If you’ve been watching the stock market slump in the final quarter of 2018, you know it’s been a dreary stretch. And that means you can’t dodge the financial pain – and the losses.
By one estimate, the average 401(k) owner with 100 percent invested in U.S. stocks is currently sitting on a paper loss of $8,733 since the end of September. That rough approximation takes into account the 8.2 percent drop this quarter through 11:45 a.m. Wednesday suffered by the Standard & Poor’s 500, an index of large U.S. stocks, and the record 401(k) average account balance of $106,500 at the end of the third quarter, according to Fidelity Investments’ analysis of its more than 15 million 401(k) accounts.
“Most holders of 401(k)s will be shell shocked,” says Sung Won Sohn, an economist and president of SS Economics.
Thankfully, only about eight percent of all 401(k) investors have all of their plan assets invested in stocks, says Meghan Murphy, vice president and retirement expert at Fidelity, the Boston-based mutual fund giant.
The typical retirement saver, Murphy says, has a more balanced mix of assets that includes stocks, bonds and cash, which reduces risks and helps cap losses. In fact, one half of all 401(k) investors with accounts at her company now have 100 percent of their money invested in so-called “target-date funds,” she says.
These funds, which are designed to make sure investors have the proper asset allocation, put money in a specific percentage of stocks, bonds and other assets based on age and number of years left before retirement. These funds get more conservative as investors approach retirement.
And while these more balanced, age-based funds help smooth out some of the market’s bumpy ride, most still hold a sizable chunk of stocks and don’t completely shield investors from short-term losses.
For example, a hypothetical 62-year old investor who wants to retire in five or six years, will be best served by a fund targeting the year 2025. Fidelity’s Freedom 2025 Fund, for example, has a 60 percent weighting in stocks, with the bulk of that invested in U.S. shares, with 36 percent in bonds and the rest in cash.
If an investor in a fund with that asset mix started the fourth quarter with the average balance of $106,500, he or she would still be sitting on a loss of roughly $5,240 for the equity portion of their retirement account. Similarly, someone invested in a fund targeting retirement in the year 2035, with an 87 percent exposure to stocks, would have a loss of $7,598 so far this quarter.
Still, Wall Street pros stress that investing for retirement is a long-term endeavor. They say it’s important to remember that since you’re saving for retirement 10, 20, 30, even 40 years down the road, it makes little sense to panic and get out of the stock market because of one bad stretch. Despite falling nearly 10 percent this quarter, the broad S&P 500 is down just 1.4 percent for the year.
“Depending on what they own and when they last looked at their balance, investors may not be as shocked as you think,” says Kate Warne, investment strategist at Edward Jones. “For the year, many portfolios may be close to flat.”
To be sure, 401(k) investors just looking at the current quarter may see bigger declines, she adds. “But they should put them in context by reviewing the longer-term performance, realizing that returns aren’t going to be positive every quarter,” Warne says.
Fidelity’s data show that investors who rode out the market storm back in 2008, when the average 401(k) account balance was just $56,900 at the end of that year’s third quarter, would have been rewarded with an 87 percent gain in their accounts 10 years later.
“The market goes up and goes down, you can’t control that,” says Fidelity’s Murphy. “As long as you are invested appropriately for your age and time horizon, you should be able to ride out the ups and downs.”
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