I think we’ve all been guilty of driving over the speed limit at some time in our lives haven’t we? I know I have. Maybe you were late for an important meeting and thought that driving just a little faster might make things better. After all, this strategy works most of the time doesn’t it?
The reason I bring this up is that someone recently asked me a similar question about their 401(k) plan. This person had recently turned 50 and was feeling a bit behind in his retirement savings. In order to make up for lost time, he wondered if he shouldn’t put the pedal to the metal and get a little more aggressive with his investments. After all, the market was doing well. Wouldn’t it actually be dumb not to take advantage of this opportunity, he wondered? (For more, see: The Best Strategies to Maximize Your 401(k).)
On the surface, this might seem like a good idea. But in fact, it’s a trap I’ve seen many investors fall into.
Three Problems to Approach
From my perspective, there are three problems with this approach. The first is that markets are notoriously unpredictable. In fact, they almost always do what we least expect. A good example is the recent Trump election and surprising stock market rally. Who expected that?
While it is true that the markets have been doing well, we cannot be sure how long this trend will continue. But what we do know with absolute certainty is that:
- If you increase the risk in your portfolio, you will experience more volatility.
- You will also experience greater declines when the next downturn comes. And it will come.
But investors who are inclined to take more risk when times are good often believe they can avoid market declines. They believe they can ratchet the risk back down before things get too bad.
Although this is a compelling idea, it is far more difficult to accomplish than you might expect. Most investors who travel this path wind up doing more damage than good.
The second problem we encounter is that markets are far more volatile than most people realize. In fact, on average the S&P 500 is down 14% at some point every year. I know it sounds impossible but it is true. If the market is down that much at some point every year, it’s not reasonable to expect that you can increase your risk while the markets are doing well and get more conservative before things go down. Don’t get me wrong, some people will attempt this and they will succeed on occasion. But in my experience, this is no better than gambling and will inevitably yield the same unpleasant results. (For more, see: Top 10 Mistakes to Avoid on Your 401(k).)
The third problem in tying your investment allocation to market conditions is that market conditions are always changing. If your philosophy is to be more aggressive when the market is doing well, what do you do when you are surprised by a significant market decline? Do you hold? Even if the market continues to decline? If so, for how long? As you can see, trying to play catch up with your investment portfolio is likely to do you more harm than good.
The Right Approach
If you find yourself approaching retirement and feeling like you are not where you need to be, there are some steps you can take to improve your situation. The first is to make sure you are contributing at least as much to your 401(k) plan as your employer matches. After all, this would be a guaranteed 100% return on your investment. Where else can you get that kind of return?
Second, if you are not contributing the maximum allowed, $18,000 if you are under 50 and $24,000 if you are 50 or older, increase your contributions. If you can't afford to do the maximum now, take a small step. Increase your contributions by 1% or 2% and commit to doing this every year until you are at the maximum.
If you decide to make this change, you probably won’t even miss the money. The reason is that this is a relatively small amount and you won't be paying tax on it anymore because you are putting it into your tax-deductible 401(k). In fact, by taking this action you will be increasing your tax deductions and who doesn’t like that?
Another thing you will want to do is look at your investment allocation and see if it is appropriate for your goals. I can't tell you how many times I’ve reviewed someone's 401(k) plan only to find that half the money is in a guaranteed or low interest account.
If you find yourself in this position, shake things up. Increase your risk to an appropriate level by getting your allocation in line with your goals. This is something you have plenty of control over and is easily corrected.
Enjoy the Ride
If you feel like you’ve fallen behind in your retirement saving, there are some steps you can take to get back on track. Let’s choose the ones that are most likely to give you the results you’re looking for. (For more from this author, see: How Landscaping Can Make You a Better Investor.)
The views expressed in the cited and linked articles are not necessarily the opinion of First Allied Securities, Inc., and should not be construed as a substitute for professional guidance in tax, estate planning or legal matters. This also does not constitute an offer to purchase a particular investment. Individual authors cited here are not affiliated with First Allied Securities, Inc. Web links provided here are for informational purposes only and as a courtesy. When you link to any of the web sites provided here, we make no representation as to the completeness or accuracy of information provided at these web sites. Past performance is no guarantee of future results.