I am going to take a contrary view of retirement savings and say that in current market conditions you should think about reducing your 401K contributions to only invest the amount that is needed to get your company match. I am normally a strong proponent of company sponsored 401K and traditional (IRA) retirement plans because of the tax advantages and long term compounding benefits. However in already depressed markets, that are set for further falls in the year ahead, minimizing your 401K contributions may be a smarter investment move overall. Don’t believe me? Here’s an example using two employees earning $100,000 with different 401K contribution levels, and a look at their returns after one year if the market and the value of their investments fall 30% followed by a rise in the subsequent year. To simplify things assume that they have no other investments or deductions. (click on graphic to enlarge)
From the above calculations, you can see that Employee/Investor B is almost $1000 better off when the market falls and when the market rises. Now $1000 may not be a lot of money if you are earning $100,000 but it is cash in hand, which can be especially helpful in today’s market environment. More than the bailout plan or any other government intervention, 401K and retirements funds are the only game in town buying shares today and keeping the market stable. These retirement funds have to buy stocks to stay in adherence with their plan and asset allocation guidelines. So basically by contributing to your 401K you are providing sellers the ability to get rid of their stocks and taking the losses as the market continues to fall. Without 401K plans, the Dow Jones market average would probably be around 6000 today. That’s why investors and Wall street firms should be thanking employees (and not the government) for continuing to contribute to their 401K and IRA plans, despite seeing them dropping precipitously in value.
I am not suggesting that you stop 401K contributions permanently. Once the stock market shows signs of life and the markets stabilize, you must ratchet those 401K investments back up to the maximum and enjoy the benefits of dollar cost averaging and compounding as the prices recover from their lows.
The example above is only a basic guide to illustrate that 401K plans aren’t bullet proof and the key, like all your investments, is to take a much more active role in managing your 401K in these strange economic times. I know I am.
Editor’s note : Can you spot the assumption I am making in the table above, that would reduce the overall savings to Employee B, but still put him ahead when the market falls?