Money Saving Advice
There's more than one way to get most for your money. For more than 20 years, Gary Foreman has worked to manage money effectively. He's been a Certified Financial Planner and Purchasing Manager. He currently edits The Dollar Stretcher Web site and several newsletters. His mission is to help people "Live Better for Less."
The Dollar Stretcher: My Shrinking 401k
Question: This is my second year contributing to a 401k plan. For the last six
months my statements show that I have lost a lot of money. I invest 50%
into a growth fund. I am young and I want to take some risk, but now I'm
concerned. I don't know if it is smart to keep investing in those
excessive growth funds while the stock market is not doing so well. Some
people advise that I should still contribute every paycheck. They say that
I get to invest at a time where stock prices are low.
Good question! And one that a lot of people are asking now. After a decade
of rising stock prices many people have discovered that stocks can also
decrease in value. So what's the best strategy now? Is it wise to keep
putting money into a 401k plan?
Let's begin by considering 401k plans. No matter what happens to the market
in the short term, a 401k plan is a great way to save for retirement. The
reasons are simple: tax advantages and dollar cost averaging.
The money that you put into a 401k plan is not included in your taxable
wages. So you pay less taxes on your income this year. Plus, no taxes are
due on any interest or growth within the 401k until you take the money out
of the account. That means that the money will grow much faster than it
would in a taxable environment. Assuming that he's 30 now, that could mean
a retirement account that's between two and four times larger than one that
was taxed each year. So continuing to contribute to the 401k plan is a good
But what about the stock market? Denny's losing money now. Is there any
guarantee that will change? Well, there's no absolute guarantee. But 200
years of history show that if he stays in the stock market for a 10 year
period he'll earn about 10% per year. Some years will be better and some
worse. But the average has been remarkably stable.
Which leads us to the second reason why a 401k plan is great for
retirement. Denny's friends have already pointed it out. A 401k forces
Denny to take advantage of "dollar cost averaging". That's where you invest
the same dollar amount regularly. In Denny's case he's investing about the
same amount every pay period. When stock prices drop his 401k contribution
purchases more shares.
Whenever the market does turn around he'll own a larger number of shares.
That means a bigger increase in his account. We don't have space to
describe the math, but if you regularly invest the same dollar amount in a
specific stock or fund, you actually do better if the price doesn't
continually increase. It's better if it dips occasionally.
Should Denny jump out of the market now and get back in when it's ready to
go up? No! It's almost impossible to predict the stock market. He'll make
more money by just using a 'buy and hold' strategy. If he tries to time the
market it's pretty sure that he'll make mistakes that will cost him dearly.
Next let's look at where the money is invested. Denny mentioned that he was
in a 'growth fund'. He needs to recognize that growth funds are more
volatile than other funds. They depend on the companies continuing to grow
at an above average rate. And if that doesn't happen stock prices can drop
quickly. So he might be better selecting a more balanced fund.
Some experts would advise Denny not to try to pick a fund that will do
better than the market. John Boggle, founder of the Vanguard mutual funds,
suggests that most investors would benefit if they just selected an index
fund. Those are the funds that track a specific market or index. Managers
don't try to pick winning stocks. They just mirror a market or index. The
advantage is that these funds have lower expense ratios which helps boost
Denny may not have the option of selecting an index fund. In that case
he'll need to compare the fund goals, performance and management of the
available choices. One thing that Denny needs to recognize is that time is
on his side. He doesn't need a big return every year to build a nice
retirement nest egg. Suppose he gets the 10% historical return on stocks.
If he's 30 now, every dollar that he puts into the 401k will be worth $32
when he's 65. No wizardry is required to save a sizeable amount.
Right now Denny should check to make sure that he's selected the right
mutual funds. Once he's made that selection he shouldn't worry about the
market. He needs to remember that a 401k plan is a long range investment.
Just as you wouldn't judge a marathon runner over the first 100 yards, it's
not wise to judge your 401k plan on one or two quarters. In this case, the
race goes to the steady saver who continues to invest in both good and bad
How can a 20-year-old establish credit
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Gary Foreman is a former purchasing manager who currently edits The Dollar Stretcher Web site www.stretcher.com. Contact Gary at email@example.com. You'll find hundreds of free articles to save you time and money. Visit today!