The last time I felt compelled to put down some words 3 or 4 weeks ago, the market was experiencing extreme volatility with huge swings from up to down and vice versa, sending even those with the strongest of stomachs to the antacid section of their pharmacy. Looking at where the market was then and where it is now, you'd think not much had had happened during those few weeks. However, the way the graph of the S & P 500 Index plots during that time period would make a great blueprint for the next newest and most spectacular rollercoaster - although it would be far too dangerous for even the most aggressive theme parks (and their insurance companies would never go for it.)
Has anything changed since then? Not really - debt issues in the Euro-zone are still most often cited as a reason for concern along with the potential for a “contagion effect” on the economy in the U.S., increasing probability of a double-dip recession, and the fact the government may be running out of bullets etc.The economy might have to ultimately work itself out.There's not much you or I can do about most of these issues but as committed long-term investors, we can control how we react, or better still - don't react, as I alluded to in my last piece.
Since for many of us, our 401(k)'s are our largest investment and represent our largest exposure to the equity markets, what can we do to improve our chances for long term investment success while all this mayhem is going on around us? Here are 6 steps you can take - in good times or bad that should improve your long term outlook.
- Re-evaluate and confirm your allocation strategy
Since I've already used the rollercoaster reference, do you remember those cars you used to drive at the big theme parks? No matter how badly you steered, there was that big steel rail in the middle of road that kept you centered and wouldn't allow you to drive off the road. A good allocation strategy (the way you have your account allocated to various asset classes) is like that. Sometimes various factors will have an impact and on a short term basis you end up with more or less than you want in particular asset classes. However, if you have determined what your target percentages are for those asset classes, those targets represent the “big steel rail” in the middle of the road. Do this every few years or even every year as you approach your target retirement age.Your strategy may change based on many factors, most notably getting closer to your target retirement age. Don't get caught carrying too much risk right before you're about to need the money for income during retirement.
- Rebalance your 401(k) periodically
Once a year, maybe twice, review your account and determine if it has deviated greatly from your targets. If it has, make some transfers and get things “back to center”. This is an extremely disciplined way to “buy low and sell high” without trying to time the market (big mistake). It keeps your 401(k) portfolio the way you intended it to be so it is not overexposed to risk during volatile times, nor underexposed to growth when times are better.
- Evaluate how much of your income you are deferring to your 401(k)
When was the last time you evaluated how much you were contributing? I am amazed at how many times I meet with plan participants and they don't actually know how much they are putting in their account. We often find they are deferring at the same rate they were 10 years ago. I challenge people to increase their contribution by at least 1% each year. Increase by a bigger chunk if you can, but I've not found anyone yet who actually did this who said they suddenly couldn't afford it, rather they say they never missed it. I know it's a complicated investment concept, but saving more makes your account bigger. At the end of a 25 year time period how much you actually saved each month is more than likely going to have the biggest influence on how much you've accumulated.
- Make sure you are saving a percentage of your income, not a dollar amount
The next worst thing to not increasing your contribution percentage through the years is having started with a dollar amount and never increased it—the net effect being that you've been saving less and less of your income on a percentage basis. Even if you never increase the percentage, at least your dollar savings increase with any pay increases you get.
- Re-evaluate the investment options available periodically
Take a look at what you're actually invested in. Many plans have changed through the years and offer “lifestyle” options or “target” investment options. These are designed to give you access to a portfolio type approach and may be a better solution for people who are not comfortable putting together their own portfolio. Going back to Step #1, your plan and strategy will drive your asset allocation, and your asset allocation strategy should determine which investments you choose and in what combinations... (NOT which fund did the best last year...)
- Keep Saving!
Not really a “step”, but worth mentioning because another thing that I hear frequently during difficult or volatile times in the market is “I think I'll reduce how much I am contributing until things get better”. Do you look for the most expensive gas to buy, or the most expensive food or clothing? Don't we try to buy everything else we buy when it's on sale? When the equity markets are down, the units or shares of the investments you buy are “on sale”. Yes, maybe their value can go down some more after you buy them, but that doesn't mean it wasn't a good buy. For a long term investor, it usually ends up having been a good time to purchase. So stick with it!
Doing these 6 things on regular basis represents exercising discipline. Without discipline, you're prone to make mistakes at the worst possible time. If your strategy is well thought out, you'll remain confident in it and exercise the necessary discipline that will give you the greatest opportunity for success.
E-mail Kimber with any thoughts you may have regarding this post.