401K Lessons (Learning it the Hard Way)

Last year was my first full year at work. I managed to max out my 401K contribution with one paycheck left to go. So for the last paycheck I set the contribution rate to 0%. This week I had to go in to reset it back to the original rate. Boy, was I in for a painfully rude shock - my 401K returns were negative. When I was younger I used to wonder why people who have money still worry about money. But in that one moment when I was staring at the numbers in red indicating negative returns on my hard earned money (that I had scrimped and scrounged to save, I must add) it was suddenly very obvious. The knot at the pit of my stomach did not feel good.

To cut a long story short, things have gone further south since then, and as of today, I am down 5% for the year. And my all-time returns have shrunk so badly that the returns on my 401K statement are beginning to resemble that of my bank statement. I have had 401K on my mind for the past few days, and here are some lessons I am learning.

Do not track the returns of the 401K on a daily basis
This is advice I need to learn to live by, since I value my sleep too much. Until this week, I hardly paid attention to how my 401K was doing, except for an occasional look out of curiosity, and I was doing fine. But now that I know it is not doing well, I have an obsessive urge to check it the first thing every morning. And with the losses going higher each day, it is turning out to be a heck of a lousy way to start the day.

Pay attention to asset allocation
When I started my contributions, since it was still very early in my career, I presumed I should be able to take a lot of risk. So I did. I put 100% in stocks - 20% large cap, 40% in mid cap and 40% in International. And now it is clear to me that this risk level is way too high for me to handle. It is very important to look realistically at what risk you can stomach, and balance it against how much returns you hope to make. So, I finally took some time out to go through all the funds, their volatility levels, their performance history, the expense ratios etc. and reallocated my future contributions. My asset allocation choices are - 50% domestic stock, 32% international stock and 18% bonds. And the funds I have selected offer performance close (though not quite there) to what my earlier allocation did but have much lower volatility. I still have a few questions about some of the funds, and have mailed the fund managers for details. Once I get the information, I hope to finalise my selection and freeze the allocation and only visit it once every 5 years or so to see if the risk tolerance is still OK.

Don't lose perspective
I have at least 30 more years to go before I can retire (assuming I do not retire early). The amount I have in my account is a small drop in the pond when compared to the final balance that my 401K account will have. The 5% loss on that small figure is but a ripple in the pond. In the long run, this experience is just a small blip that might not even register on the radar. It is important to have this long-term perspective to avoid losing sleep and to control the temptation to mess with the allocation every now and then.

Nobody else can determine what is best for you
Our company's 401K plan provides us access to some financial software and I went through it to obtain some advice on what my model allocation should be. I also had several discussions with the better half and some older colleagues. I used all this advice, but in the end, what I chose was uniquely suited for my particular situation. It is easier to let someone else handle the decisions (e.g., financial advisers, spouse, parents etc.) but to really be peaceful, it helped for me to go through the details of the funds and determine what was best for me.

In a way, I am glad that I chanced upon looking at my 401K when it was doing particularly bad. I had not paid much attention before and had randomly picked funds with seemingly good performance in an effort to maximize my returns without really paying much attention to the associated risk level. Now I have put in a lot more reading of the funds offered and have picked the ones that I believe are more suitable for me for the long run. I don't know if this is the allocation I will stick with forever, but for now at least, I feel a lot at peace with my choice.

*Image credit: Photograph by jay d [via Flickr Creative Commons]

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SJean said...

I'm glad to see you posting again. I've found myself handling the market dip surprisingly well.

Oh, and I'm totally jealous you maxed out your 401k for the year! Nice work!

thebaglady said...

it's also good to check the fees of the funds you're investing in in your 401k. My hubby had one account that was getting negative returns and I checked it out and the funds were charging 2 to 3%! So I switched his money to a lower cost fund and now the returns are better. Unfortunately some bad 401k plans make finding out this fee amount very difficult.

xshanex said...

yep, I went through the same thing recently. Lost a bit of money when I had some extra cash and made a much larger contriubtion to my Roth a while back. Horrible timing and went against my monthly contribution policy. My high interest savings account luckily just about offset the losses which is sad. The market has just been back and forth a lot the last several months and I'm sure we're not the only ones that had the same thing happen. With the outlook for the next year I'm guessing a lot more people will be losing money if they're not well diversified and conservative. I complained to another person about it who had no sympathy as he was looking at selling his house for at least a $25k loss!

Using a blending of low cost index funds and the long term trend is always up.

Congrats on the 401k max out!

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I am Spanish and my blog covers the analysis of many equity markets.
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Writer's Coin said...

I know how you feel. I did the same thing and reallocated accordingly but we need to remember why we allocated that way in the first place: we have time to ride these bumps out. I too have around 30 years until retirement so I'm sticking to my original allocation and buying in at these low points.

shellyinseattle said...

Good choice in maxing out the 401(k), even though it went negative. By putting money in each paycheck, you at least were able to smooth over some of the rougher spots.

I'd recommend looking at your choices every year rather than every 5, because things like fund managers, fee structures, and just general world economic forces change.

Tanya said...

Mine dipped too. Frustrating! Ironically, it was my most conservative investments that dropped most

Money Blue Book said...

With 401k's...like that cheesy oven commercial says - you set it and forget it.

Not tracking your daily balance is the best solution for those investing for the very long haul.

Coupon Fetcher said...

Interesting post! I check my SEP IRA way to often, almost daily. I am going to try the tactic of just checking once a week, then perhaps only the quarterly statements. I am mid-30's and it is just silly since a have YEARS before I will draw any money from it.

Moneymonk said...

try a target retirement fund

Creative Investor said...

I've actually just went through the 401(k) allocation process myself, made some daring choices, so we will see by the end of this year whether my risk tolerance is as high as I think it is. Although, I've reviewed all the mutual funds beforehand, so hopefully that extra step will help me handle the dips better. Great article!

Alex Liu said...

Thanks for the post. I found it very good and useful especially the one "don't check the returns daily".

Doing that really make me feel very stress and tend to do something like change my plan to some way that make more money but involve higher risk.

Alex Liu
How To Become A Millionaire