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6 smart 401(k) moves for rough times
Novices usually do a few dumb things when the market tanks, but you don't have to if you know the alternatives.
Whenever the stock market tumbles, novice investors begin to squeal. They forget the scuffed knees they got when they learned to ride a bike; they think every spill in this arena is a fatal crash.
The pain would be bad enough if investing didn't determine your personal bottom line. But, in today's pensionless world, it does. You're going to ride your 401(k) throughout your retirement. You've got to learn how.
Former President Franklin D. Roosevelt offered excellent advice to a nation gripped by far worse problems in 1933: "The only thing we have to fear is fear itself." Even bear markets of historic proportions end, and when they do, markets quickly come back. Those timid souls who gave up on the market in 2002 have given up profits of nearly 50% since -- and that's even after our current malaise.
What you're afraid of is the unknown. But bad markets are very well known. Generations of investors have endured them and learned from them. The dumbest investing mistakes are also the most common, and smart solutions to them are instantly available. Here are six of those mistakes and their antidotes.
Keeping saving
DUMB: Stop contributing to your 401(k) plan because you're "losing money." In fact, notes Jill B. Boynton of Cornerstone Financial Planning in Newington, N.H., "you are adding to your investments at lower and lower prices, thus lowering your average cost basis."
Everything goes on sale. Stock sales are called corrections or bear markets, but what they are is sales. Markets always come back -- always. The price can be 20%, 30% or even 40% off, but it's still good merchandise.
SMART: Buy the ugliest stuff on the shelf. When any asset is getting beaten up, it will decline relative to others. Keep your portfolio in balance by shifting new money to categories that have fallen below the percentage gain called for in your long-term portfolio plan.
"The market changes all the time. Your long-term asset allocation and goals should not," says Frank C. Boucher, an investment adviser in Reston, Va.
Adam J. Leavitt, with Disciplined Investments in Tulsa, Okla., notes that many 401(k) Web sites have a "rebalance" button that will automate this process of restoring balance between expensive funds and cheap ones. Buying the seemingly worst possible choices "forces you to buy low," he says.
Think long term
DUMB: Dumping your "disappointing" funds for those with better recent results. "This is the classic investor mistake of chasing returns," says Lori L. Embrey of Fairfield Investments and Wealth Management in Columbus, Ohio.
Lately the small-cap value style of investing has gotten walloped, even though over long periods it is among the best-performing styles. For months, commodities like petroleum and gold defied the bad market for stocks, but nothing lasts forever; recently, gold fell 10% in just a few days. Never sell anything simply because it declines in price.
Tim Middleton thinks we're in a recession-induced bear market, but it could be time to buy.
SMART: Even great mutual funds can be expected to underperform in as many as three years of every 10. Assuming the same management team is running the fund in the same way it was when you became attracted to the fund in the first place, stick with it. What Wall Street calls "reversion to the mean" predicts that hot asset classes will cool and cool ones will heat up again.
Look for new opportunities
DUMB: Rejecting investing because today's returns are less than they were in the 1990s. Instead of the double-digit gains back then, the stock market has been delivering annualized returns of about 3.5% in this decade.
Brian Pon, an adviser with San Francisco-based Financial Connections Group, turns that argument on its head. "If you're expecting lower rates of return going forward, you should be increasing your savings," he advises.
And you should be looking in new places for future returns.
SMART: Look ahead for investment opportunities, not behind. For example, U.S. bonds are unsteady, but others overseas are not. "Look for a nice global bond fund," suggests David E. Zumbusch of Sportsmen Dream Financial in Buffalo, Minn. Until very recently, foreign bonds were hard for U.S. investors to own, but now there's even an exchange-traded fund, SPDR Lehman International Treasury Bond (BWX, news, msgs). And while stocks are down in double digits this year, that ETF is up 5.4% as of March 24.
Escape a 401(k) the right way
DUMB: Shunning the 401(k) plan because you're afraid of Wall Street "tricks." If you have an employer match, you're being paid to learn how to avoid them. "If your bank was offering you a dollar for every dollar you contributed, would you think that was a good deal? Of course you would. Yet some people think the 401(k) match is different," says Peter A. North, a planner in Orange Park, Fla.
If you're a novice, look for a fund option that owns both stocks and bonds, like a balanced or target-retirement fund. Own it while you're learning the ropes.
SMART: Getting out of a 401(k) when you leave the company. You can roll it into a self-directed IRA with unlimited investment options at a discount broker. And even good 401(k) plans can have bad rules.
Carolyn T. Walder, president of Lifetime Wealth Planning and Management of Alexandria, Va., says her clients have included beneficiaries of plans that automatically cash out plans upon death and withhold 20% of the proceeds for federal tax (the federal Thrift Savings Plan, notably).
"Get out when you can," she warns. "The beneficiary has no say in how or when they get to take the money out, and this can have a tremendous impact on their tax planning." Self-directed rollover IRAs can be inherited without a huge, immediate tax bill.
Don't owe money -- even to yourself
DUMB: Borrowing from your 401(k) because "you're paying interest to yourself." Don Martin, president of Mayflower Capital in Los Altos, Calif., notes that you'll pay taxes on that interest, "yet no deduction is allowed for interest expense." Also, if you change jobs or get laid off, the whole loan could come due on the spot.
SMART: Pay back any loan as fast as you can, because you'll earn far more on the stocks you can buy cheaply now than on those "interest" payments.
Sell company stock the right way
DUMB: Selling highly appreciated company stock if you're near retirement. "The tax break on net unrealized appreciation will be lost forever," warns Jeremy E. Portnoff, a financial adviser in Westfield, N.J.
This little-known tax dodge works like this: The IRS will allow you to withdraw company stock in-kind (that is, you don't have to sell it first) from a 401(k) or other deferred-compensation plan at retirement and deposit it directly into a brokerage account. The tax "basis" in the stock becomes the value when it is transferred, not when it was originally purchased, when it was presumably worth much less.
Proceeds from retirement accounts are taxed like ordinary income, at rates approaching 40%. With this move, you pay the capital gains rate of 15% or less.
SMART: Selling excess company stock, such as the sort used for the annual match, as soon as you can. Since your income is already tied up in your job, tying your nest egg to the company as well exposes you to extra risk, says Lauren G. Lindsay of Personal Financial Advisors in Covington, La.
"Make sure it's not a substantial chunk of your overall portfolio," she says. "Most advisors like to keep it below 20%, or even 10%."
You don't need a perfect investment portfolio to retire well. But you do need a portfolio. Today's 401(k) plans are loaded with incentives. Take advantage of them. Don't look back from the future in sorrow.
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Economic Stimulus Payments Starting in May, the U.S. Treasury will begin sending economic stimulus payments to more than 130 million households. To receive a payment, taxpayers must have a valid Social Security number, $3,000 of income and file a 2007 federal tax return. IRS will take care of the rest. Eligible taxpayers will receive between $300 to $600 if single or $600 to $1,200 if married filing jointly. Millions of retires, disabled veterans and low-wage earners who usually are exempt from filing a tax return must do so this year in order to receive a stimulus payment.
For more information go to www.irs.gov |
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