Monday, October 13, 2008

Q&A: Investing your 401(k) in tough times

Jessica writes:

Hi Amanda!
I have a question for you:
I currently send 6% of my salary to my 401k and my company matches 4%. During these horrible economic times would it be better to just take my portion back down to 4% and take that 2% and just put it in my ING savings account? I don't want to hurt the economy by panicking but I also want to do what is smart. You're smart, so what do you think?
Oh Jessica!

I'm so so glad you asked me this because I think you're reaction is a normal one and it gives me the chance to talk about one of my other favorite investing principles: DOLLAR COST AVERAGING.

When you invest in a 401(k) through your employer, what you're doing is buying your investments in monthly or twice-weekly installments. When you purchase investments in installments, it's actually somewhat good for you when the market goes down because that means you get to buy MORE of your investment for the same dollar price. It's like getting a discount. And when the market goes up? Well that's cake.

My advice to you, if anything, is to INCREASE the percentage of money you send to your 401(k) right now. Cash (like the ING account) is the last thing you want to BUYING with your 401(k) dollars when basically the entire stock market is at a historically low price. It's like the world's biggest sale is going on right now and everything is 40% OFF. It's a GREAT TIME to invest if you can handle the short term risk.

Of course I'm making some assumptions about your situation. I'm assuming that you're my age(ish) (I'm 32) and that you plan to work a good long time before you retire, like 20 years or more and that your money has time to weather the current storm.

However, if you tend to be more risk-averse and couldn't sleep at night knowing you were investing in the stock market, it might be time for you to increase your allocation bonds (which I'm assuming you already have in your 401(k)).

Good luck!


jessica fantastica said...

Your assumptions are right. I'm 29 so I definitely have some wiggle room. Thank you so much for answering! I would've never thought of it that way.

LizP said...

I found your blog from CitiMama's link today. :-)

I loved your answer to Jessica! I think it's so important that we don't panic (much) with our financial decisions right now. Suze Ormond was on Oprah a couple of weeks ago and she advised everyone to not take their eyes off their long-term goals.

I'm also a Sili-Valley transplant and we're nearly neighbors ... I'm in Eugene, OR.

Mandajuice said...

Welcome, Liz! Isn't it great to live here instead! We need to keep working on Stefania to get her back up here!

LizP said...

My favourite thing about living up here is a 15 minute commute as compared to the 90 minute commute I had living in the bay area. Oh, and milk is $5 for 2 gallons, rather than $7!

Kady said...

Hi, I found you via Citymama as well. I just wrote a post on this yesterday at my blog. I'm going the other direction, reducing my contributions, because I want to make sure I get my emergency fund fully funded w/in the next six months. Both my husband and I are facing situations where we may not have jobs w/in the next year, so for us, to lock so much money away just wouldn't work. We are still putting in 3% (for me) and 5% (for him) though.

Poppy said...

I've always heard that if your employer matches your contribution, you should only go up to what they match (say 6% for example). Then take the rest of the money you would've been contributing to your 401k and put it into a Roth IRA. You have to use after tax dollars, but the money isn't taxed when you take it out at retirement.