Jack Bogle, the legendary investor and founder of Vanguard, has given the same advice repeatedly for years: Diversify the holdings in your 401(k), buy low-cost index funds, and don't look at your monthly statements until the end of the year. But it's hard to heed this advice in good times, and even harder when the waters get choppy.
In case you missed it, inflation fears have investors a bit jittery over the past several weeks. The markets haven't crashed. But the winds of correction are blowing all around us. We haven't felt those concerns in a while, and younger investors may be feeling them for the first time. But if you're thinking about selling stocks and ETFs in your 401(k) accounts, trying to bail out before things get bad, think again.
Any reasonable financial advisor or planner will tell you this is a cardinal sin. Recent history—the last 60 years—will prove it. Market downturns happen, but you have to be able to stomach them if you want to win the long game. Data from Alight Solutions, which tracks 401(k) activity, shows that 401(k) investors were particularly busy traders in 2020. Net transfers for the year as a percent of balance was 3.5% for the year, the highest level since 2008.
"Unfortunately, we saw many investors repeat the unfortunate trend of selling low and buying high that has been shown repeatedly throughout the more than 20-year history of the Alight Solutions 401(k) Index," said Rob Austin, head of research at Alight Solutions. "The busiest days for trading were when the stocks were tumbling, and the trades overwhelmingly went from equities to fixed income (...) It wasn’t until the end of the year—when the market was setting new record highs—that investors traded back into equities.”
- Market downturns happen, but you have to be able to stomach them if you want to win the long game.
- It's OK to re-balance your 401(k) occasionally, but if you try to use it to time the market, you may be digging yourself a financial hole that you will never be able to climb out of.
- The best approach is to diversify the holdings in your 401(k), buy low-cost index funds, and don't look at your monthly statements until the end of the year.
What to Consider for Your 401(k)
Of course, the easiest way to avoid trading too frequently is by being well-diversified in the first place. As we alluded to earlier, mutual funds and ETFs offer a simple way to do that.
Moreover, the specific funds you choose should match your own risk tolerance as closely as possible. It's a lot easier to remain patient in volatile markets when your investments are right in line with both your risk and return objectives.
Here are some of the main categories of funds to choose from:
Conservative funds. A conservative fund typically seeks investments with low volatility, like high-quality bonds, large blue-chip stocks, and other low-risk investments. Your wealth generally grows slowly and predictably in conservative funds, but it grows safely.
Value funds. A value fund typically displays low-to-moderate risk and invests primarily in stable companies that happen to be undervalued. Value funds also tend to look for companies that dole out healthy dividends on a consistent basis.
Balanced funds. A balanced fund generally invests across asset classes, which includes a mix of low and medium-risk stocks and bonds. Balanced funds seek both income and capital appreciation.
Aggressive growth funds. An aggressive growth fund seeks to maximize upside and prioritize capital appreciation above all else. Because of that, aggressive growth funds typically display higher volatility and risk. In fact, over time, the fund may swing wildly between big gains and big losses.
Time in the Market, Not Market Timing
We are not smart or silly enough to predict what the markets will do over the short term.
No one is, and don't believe anyone who promises otherwise. But remember that your 401(k) is not a video game or "fun money." It's your retirement vehicle and your light at the end of the tunnel.
Set up your 401(k) with an asset allocation that is right for you based on your risk appetite and your long-term goals. It's OK to re-balance it occasionally, but if you try to use it to time the market, you may be digging yourself a financial hole that you will never be able to climb out of.