401k

  • 401k

    WHAT SHOULD I DO WITH MY 401K RIGHT NOW?

    The swift drop in the stock market from all-time highs into a bear market has left investor’s heads spinning. Almost before anyone had time to fully process the fall, the market started to rebound. Down 30%+ from the peak, the stock market started to recover and as of the beginning of May was only around 15% below the all-time high in February.

    Good and bad headlines continue to alternate in the news. Historic unemployment numbers, better than expected results due to people socially isolating, infection hot spots popping up due to delayed action, and general unease and uncertainty about how long it will take for things to return to normal.

    So, what should investors expect for the future and more importantly what should they do about it? With regards to both the coronavirus and its impact on the economy and the stock market: Is the worst behind us or are we in store for more bad news before we start to turn the corner? I can’t answer these questions, but I can provide some advice for how to prepare your finances for the future.

    Take stock of your personal finances

    First things first, do what you can to make sure your day to day and month to month expenses are covered. If you are lucky enough to have a stable income coming in at this time, now is the time to review your emergency savings and make sure it is adequate. Most financial advisors recommend between 3-6 months of expenses, but the ultimate number is whatever allows you to sleep soundly at night. If your employment situation is shaky or uncertain no one is going to razz you for having 9 months’ worth of cash in a savings account right now.

    If you are in an industry that has been hit hard by the effects of the coronavirus shutdown and you have or are in danger of losing your income, now is the time to prepare. The stimulus and increased unemployment benefits from the recently passed CARES act can help build a savings buffer, and federal student loan deferred payments may help some as well. If you are worried about missing payments for rent, your mortgage, or other essential services, reach out to your landlord, bank, or creditor before you’ve missed a payment to understand what options you may have for credits or deferral.

    If you feel secure about managing your cash flow then you can move onto the next level and consider what to do about your retirement investments.

    Continue your 401k contributions

    If your personal finances are locked down, you are able to continue working, and have an income coming in, then the right answer for almost everyone is to continue making your contributions as normal. No one can predict with any certainty if March was the low point for the stock market this year or if the worst is yet to come. During these times of market stress, our fight or flight instincts start to kick in and it can feel like you have to do something. But reacting based on your gut is rarely the right move and you should instead listen to Richard Bogle: “Don’t do something. Just stand there!”

    If you are in the early or middle stage of your career and still have a while to go before retirement then this is likely not the last time you will experience a market drop of 30% or more. This is just another example of the volatility you will need to live with to enjoy the returns that come with owning stocks, as well as an opportunity to buy them at a lower price than you could just two months ago. It’s better to focus on your time in the market rather than timing the market.

    If your company has cut matching 401k contributions because of worries about the economy you might want to review the available investments in your 401k and if they are high fee or otherwise don’t meet your needs you could shift your contributions to an IRA or Roth IRA. Just set a reminder to turn your 401k contributions back on when your company begins offering a match again.

    If you are able to increase your contribution, now is probably a good time to do it. Market crashes hurt while they are happening, but they do increase the forecast for future stock returns.

    Create a Financial Plan

    If you have a financial plan in place, now is the time to review it and reassess some of your original assumptions. Were you optimistic or pessimistic regarding your emergency fund, too conservative or aggressive in your asset allocation and risk tolerance, were you focusing on the right goals?

    The steady upward market climb during the past decade had the effect of lulling investors into a false sense of security, where every time the market dropped a few points investors started to scream “BTD!” (that’s “buy the dip!” for those of you who aren’t a part of fintwit). We haven’t seen it for a while, but the market can remain lower and decide not to hit new all time highs for a lot longer than we’ve experienced recently.

    If you don’t have a financial plan now is the time to put one together. As the saying goes, the best time to plant a tree was 30 years ago, the second-best time is today. The same sentiment applies to financial plans. The best time to put together a plan was in the middle of the 10-year bull market we just experienced, the second-best time is today.

    Consider your risk tolerance and asset allocation. If you were invested 100% in stocks or in an 80/20 stock/bond portfolio, how do you feel? If you were comfortable with the volatility and the drop in your portfolio’s value then that’s probably the right allocation for you. If, however you had some sleepless nights, it might be a good time to reconsider the level of volatility you can live with. The stock market will probably not be as rosy as the period from 2009-2019, so you need to make sure you can handle volatility when it comes. Some of the worst financial decisions happen when investors’ emotions get the better of them.

    Another option is to get some help from a financial advisor as you put together your financial plan. One of the biggest benefits from working with an advisor is having an experienced person to talk to and help guide you toward what the right decision is for your specific situation and then help you stick with it.

    With social distancing and stay-at-home orders in effect, many advisors are adding the ability to meet virtually with clients, while some have been working virtually with clients for years 😉

    Have questions about your specific situation?

  • 401k, Investing

    MILLENNIALS HAVE HOW MUCH IN THEIR 401(K)?!

    A recent article in Investor’s Business Daily got a lot of attention online. The subject of the article was how much the average 401(k) balance has increased over the past 10 years split out by generations. Millennials had an average balance of $137k in 2019 up from $10,500 in 2009. While Boomers had an average of $366k up from $98k 10 years ago.

    It seemed that most people responding to the article on social media had a similar reaction along the lines of, “that’s crazy, there’s no way that’s true”. And turns out they were mostly right. The data was taken from a fidelity survey of their 401k plan participants, but what wasn’t stated in the article was that these numbers only considered those individuals that had their same 401k account open for the past 10 years. Once you hear this detail the numbers start to make a bit more sense.

    The majority of millennials are still in the early stage of their careers which is typically a time where people take the opportunity to jump around between jobs, companies, and different places to live and see what fits them best. This is especially true for this generation as we have pushed marriage and home buying later either because of preferences, opportunities or both. It makes sense that those that have had a stable job with the same 401k for the past 10 years would have a much higher balance than the overall average. It’s probably a pretty limited set of the millennial cohort included in this data set, but I think there are a few points we can take away from this info, even if the article seems to have been constructed in a way to get people worked up and share it purely from a “would you look at this *#$&?!” angle.

    Just stick with it

    The accounts included in this group have been open for at least 10 years, which illustrates the amazing effect you can have by continuing to do the little things right month after month and compound them over time. Continuing to contribute to your 401k plan, paycheck after paycheck, is a great first step towards building up your retirement savings. Especially given the benefits that a 401k typically provides vs an IRA: employer matching, higher contribution limits, additional after-tax contributions if available.  

    It can be tempting when moving from one job to another to cash out your 401k rather than roll it over into a new 401k or IRA. There are a few times where cashing it out makes sense from a financial planning perspective, such as in the case of extreme hardships, but it’s typically a much better option to roll it into another plan and continue making your contributions and grow your funds for the future.

    The benefits of having a 401k 

    If your employer didn’t offer a 401k and you only had access to investing within an IRA (with contribution limits below $7k/year for the past decade) you would be hard pressed to grow your account in the same way without maxing out your IRA contribution every year over the past 10. However, with a 401k you could contribute up to $16,500 yourself and $49k total between you and your employer in 2009, and those numbers increased over the decade to $19,000 and $56k respectively. It’s obvious with a 401k that you could contribute much more, especially as your income grows, than with only an IRA, not to mention the benefits of receiving employer match contributions.

    If you don’t have access to a 401k consider asking your employer to offer one. Many small businesses do not offer a 401k because of concerns about cost and matching contributions, but in recent years 401k plan administration costs for small businesses have decreased and companies do not need to offer a full or even any match if they don’t want to. 401k plans have been shown to be great for retention of employees and I’m sure the individuals in the fidelity study are glad that they had the opportunity to invest in theirs over the past decade.

    What else can you do

    So, what can you do if you don’t have a 401k and it doesn’t look like you will get access to one anytime soon?

    • If you are a 1099 employee consider setting up a SEP-IRA. With a SEP you can contribute up to 25% of your earnings or $57k, whichever is lower, for 2020. This can be a way to goose your contribution above the traditional IRA limit of $6k. If you are not a 1099 employee but are considering it make sure to consult with a tax professional whether or not it makes sense to switch from a W-2 to self-employed because there are additional tax consequences to consider.
    • If you can, contribute to an HSA. Stack that on top of your IRA adds an additional $3,550 ($7,100 if you are married) that you can contribute to tax advantaged accounts. HSAs are also one of my favorite stealth retirement accounts because they are triple tax efficient if used correctly. You can contribute tax-free, the funds grow tax-free inside the account, and the funds can be withdrawn tax-free if used for qualifying medical expenses.

    So, there are steps you can take if your 401k or other retirement savings accounts aren’t at the level of those in the article, or otherwise where you’d like them to be. And if you’d like someone to help you put together a plan to boost your 401k or IRA contributions consider reaching out to a fee-only financial planner today.

  • 401k, Investing

    WHY WOULD VANGUARD REMOVE THEIR OWN S&P 500 FUND FROM THEIR 401(K)?

    If you follow the news in the personal finance space you may have recently read a headline that seemed a little odd.

    “Vanguard employees won’t have an S&P 500 index fund in their 401(k) plan”

    And if all you read was the headline, then you might have been left scratching your head. After all the Vanguard S&P 500 index fund is one of the most popular index funds available from any company. As a company Vanguard has led the effort to increase the availability of low-cost passive index funds. So, why would they deny their employees the opportunity to own it in their 401(k) plans?

    The answer has to do with one simple word: simplicity.

    Too Many Choices = Bad Outcomes

    If you took an intro to psychology course in college you may recognize the phrase “the tyranny of choice”. This refers to when someone is confronted with so many options that rather than making a decision, the person opts to do nothing. This can happen when staring at the dozens of different types of cereal in the grocery store, choosing something from the crowded menu at a new restaurant, or even when picking a fund or account to invest in for retirement.

    An often-cited study on this phenomenon was done by Professor Sheena, where her and her students set up a stand at a local market to sell a variety of jams. They would periodically switch between offering 24 varieties or just 6 varieties every two hours. What they found was very interesting. While 60% of people at the market stopped by to see the large assortment, only 40% stopped to see the smaller display. But only 3% of those that stopped to see the 24 varieties purchased jam, while for the smaller display 30%(!) made a purchase. The conclusion she arrived at was that people prefer having more choices in theory, but in actuality when confronted with more options it is much harder to actually make a decision.

    Simplicity is the Key

    So, back to Vanguard and their employee 401(k) plan. It’s not as if the S&P 500 fund was a bad option for Vanguard’s employees for their 401(k)s. After all it is a low-cost fund, it’s still available in many other types of accounts, and it does a great job of tracking the S&P 500. Unfortunately for the fund, but fortunately for Vanguard’s employees, it was removed as part of the process to simplify the offerings for the entire 401(k) plan. As part of the process where Vanguard removed the S&P 500 fund, they also removed 11 others. This brought the number available to 15 plus their target date retirement funds. During the simplification process, Vanguard had to make a choice between the S&P 500 fund and the Total Stock Market Index Fund, which they chose to keep instead. Vanguard recommended the Total Stock Market Index Fund to their employees as a replacement and as a better proxy for the US market, since it reflects the entire US Stock Market (big, medium, and small companies) rather than just the 500 largest public companies contained in the S&P fund.

    Vanguard made a conscious decision to reduce the number of offerings within their plan, leading to a simpler choice for their employees, which they hope will lead to more investment within their 401(k)s, and to better outcomes.If you feel like you have too many decisions to make regarding your financial life and would like someone to help you, start by contacting me today, or you can learn more about Steady Climb Financial Planning here.