Wednesday, July 22, 2009

Retirement Planning: Estimated Recovery of Your 401(k)

We all suffered losses in our retirement plans. We all saw the account balances in our 401(k) drop significantly from their lofty heights in January 2008. The biggest problem with the stock market crisis was not who lost the most - according to the Employee Benefits Research Institute it was those with the highest account balances - but why.

Had you been in your employers plan for less than five years, your account balance did drop, by almost 50% in some instances. But because this group generally made much more in contributions than they received in actual returns, their balances did not fail below zero. Even older workers who began to use these plans at age 55, still have positive balances in their accounts.

Folks who had the largest account balances, generally those in the study group aged 55-64 years old were seriously impacted by the downturn, losing on average 17%. According to EBRI, this median number and losses associated with it were due in large part to an overexposure to equities.

Despite all of the cries to diversify, to protect assets from just this kind of market correction, and the attraction to those gains offered by staying in equities far beyond when it would be considered wise, older retirement plan investors felt the pain to a much greater degree than younger investors/co-workers.

So what should you do if you are aged 55 or older? What should you do if you are younger, aged 20-34 or if you fall in-between those ages?

The older investor, had they stayed put in their original investments, continued to contribute and withdrew no monies from the plan either with loans or withdrawals of cash, will see their portfolios - and this is an estimate - recover in two to five years based on a modest market recovery of 5%. If you made moves to diversify after the fact, such as moving assets into safer investments such as lifestyle/target-dated type funds or simply moved into investments with less equity exposure, the recovery time could be twice what it would have been had you done nothing.

According to the EBRI: "Estimates from the EBRI/ICI 401(k) database show that many participants near retirement had exceptionally high exposure to equities: Nearly 1 in 4 between ages 56–65 had more than 90 percent of their account balances in equities at year-end 2007, and more than 2 in 5 had more than 70 per-cent."

There is a tendency for investors is to concentrate on the short-term rather than long-term performance. This is especially true of younger investors who realized outsized gains in their portfolios during the last four years. They were better suited to risk and were more likely to see those gains as justification to continue to channel money into their plans. Older investors, who may have been good contributors as well, felt larger losses in their portfolios because they had amassed larger balances.

In this type of market downturn, buy and hold may have been the best method of retaining long-term growth - but only for younger investors. Older investors had to learn the lesson of diversification the hard way. But either group, if they have the time and a modest market recovery, should see their balances return in less than a decade.

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