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Step 1
First, avoid the impulse to stop contributing to the 401K or even worse cashing out entirely. Remember that a 700 point drop in the Dow can be scary but the loses are only on paper until you sell. Assuming that the manager of the 401K is sane and the companies he invested in do not go bankrupt chances are your investments will go back up. Stock is cyclic.
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Step 2
Now study history. Think about the last 20 years and how the Dow in 1987 fell 23% in about a month or 47% in the 2000-2002 market. Now think about how much people made in the Dotcom era. Are you feeling better, good the point of thinking about this is to make you feel better and think analytically (which can be hard when you see a 50% or more drop in your investment values), now you are ready to act.
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Step 3
Now study your 401K and look at what they are investing in. Look to see if you have different plan options, if so you may want to switch to a plan that is investing in high value stable stocks such as PG&E that you know won't likely go the way of Circuit City. If you are older you may consider a plan that has more bonds and money market funds which typically give a lower rate of return but are much less risky.
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Step 4
Look at your tax bracket. Take your tax bracket percentage and subtract the tax bracket percentage you expect to be in when you retire. This gives you a rough number of what type of rate of return or loss you can absorb from your 401K and still be ahead. For a more precise extimate take into consideration the impact of contributing on your current tax bracket, are you dropping down a bracket. If so add this into the mix as savings from contributing to a 401K. You may find that you could loose 10% of your 401K and due to the tax benefit still come out better than if you canceled the 401K.
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Step 5
Last but not least get help from employers and financial advisors. A recent survey by Charles Schwad showed that investors who invested in 401K plans through work earned approximately 3% more than do-it-yourselfers. If your work doesn't offer one check with your local credit union for guidance or a financial planner. Not all 401K's are created equal so you likely need to talk to people who have been tracking them for years.
Comments
sneedc said
on 12/22/2008 Yeah. It's all a crap shoot. Gotta stay in it for the long haul to produce a favorable outcome. Don't think short term. Great tips!