February 06, 2009
It is easy to get caught up in all of the headlines lately regarding the economy and the stock market. But it is important to remember that during market volatility, you may need to remain steadfast in your investment strategy. Don't make 401(k) decisions based on short-term trends or emotions. Don't abandon your investment strategy. If you try to play catch-up later, it can result in even greater risk. The best approach is to maintain a long-term disciplined investment approach. Here are some principles to investing in your 401(k) in a volatile market.
Have a firm investment strategy. If you have an investment strategy, you have already clarified your time horizon, your goals and your tolerance for risk. Living with market volatility is a lot easier when you have this investment strategy is in place. If you don't have an investment strategy, consider these questions. How many years do you have left until you plan to retire? What is your retirement goal? How much do you need to accumulate in your 401(k) to create the income you need in retirement? Do you have retirement investments outside of your 401(k)? What is your tolerance for risk? Look at the whole picture to determine whether your strategy should be aggressive, conservative or somewhere in between.
Match your investments to your comfort level. Even if your time horizon is long enough to warrant an aggressive growth portfolio, you need to make sure you are comfortable with the short-term ups and downs. If watching your plan balance fluctuate will affect your health and well-being, think about a portfolio that feels right and set realistic expectations. If you want less pressure on yourself and prefer a more hands-off approach, consider a life cycle fund if your 401(k) plan offers this type of fund. These funds offer management assistance by providing investments that represent various asset classes and investment styles in a single fund based on a single retirement date. Choose the one fund with a date closest to the year you plan to retire. The investments are rebalanced on an ongoing basis to become more conservative as the fund approaches its target retirement date and beyond, and you can leave all of the rebalancing to the fund.
Diversify, diversify, diversify. Protect yourself from market downturns by owning various types of investments. Spread your investments across the three asset classes - stocks, bonds and short-term investments. Then to help offset risk even more, diversify within each asset class (e.g., large cap, mid cap, small cap, value, growth, domestic, international). Keep in mind that diversification doesn't ensure a profit or guarantee against loss. For help with diversification, use www.morningstar.com.
Invest for the long term. Market declines are a normal part of the investment process. Expect them. View the market downturn as a buying opportunity. Don't make long-term decisions based on short-term market events. Focus on long-term trends and your long-term goals. Through dollar cost averaging, you continue to put a set amount into your 401(k) regardless of how the market is doing. Over the years, your money buys more units of each investment option when prices are low and fewer when the prices are high. You end up with an averaged return that could be higher than if you invested your money all at once. You also avoid the temptation of the next principle - timing the market.
Don't try to time the market. Avoid predictions. No one, including the media and the experts, knows exactly where the market will go from here. "What if" and "perhaps" should never be the basis for investment decisions. Don't try to guess what may happen. Trying to buy or sell investments at precisely the right time can really cost you. Most of the market's gains occur in just a few strong, but unpredictable, trading days here and there. To benefit from the market's long-term performance, you need to be in the market on those days. You need to invest for the long run and stick with it throughout the ups and downs. The key long-term investment strategy is not to time the market; it is TIME in the market.
Stay calm and stay invested. Review your investment objectives. If your portfolio is off balance from your original plan, make the necessary adjustments. You should do this once a year. Maintain realistic expectations. By investing regularly in your 401(k) over months, years and decades, you can actually benefit from a volatile market.
It is important to understand how the actions you take today will affect your account on a long-term basis. For more information on personal finances and wellness, check out www.debtandmoneyinfo.com.
Disclosure: Stocks are subject to market loss including the potential loss of principal invested. Diversification does not assure a profit and does not protect against loss in declining markets. Past performance does not assure future results.
About the Author
Lillian Dikovitsky has had a passion for personal finance for many years. She has worked in quality management in the food industry for 25 years, and her formal education was in nutrition, dietetics and wellness. Outside of work she has studied personal finance issues, debt management, investing, retirement planning, etc. View her website and blog at www.debtandmoneyinfo.com.