Your 401(k) Guide for 2009

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This is a bear market. The S&P 500 if off 42% from the October 2007 highs, and almost 30% just since September. The nation is undergoing the worst financial crisis in decades and many think things will get worse before they get better. All this has raised a pressing question among millions of Americans. What should I do with my 401(k)?

Americans are understandably shaken by the turn of events. Many are afraid to look at their statements until they learn from osmosis that things have gotten better. Or, they’re tempted to put everything in cash and ride out the storm. While it can be traumatic to see your 401(k) plummet, this isn’t the time to hide your head in the sand. This is the time to actively position your 401(k) for the future.

In fact, if you have 10, 15 or 20 years left before retirement, this bear market could end up serving you well. If you have some time, you can ride out the current cycle and likely get back what you’ve lost. In addition, while the market has averaged about 10% per year since 1926, investing at the valuations found in the depths of a bear market has yielded even higher returns over time. In the longer view, this market has provided a golden opportunity to add new money to your 401(k) at bargain prices and dramatically increase the propensity to grow your 401(k) going forward.

But, in order to properly position your account, you need to continue adding to your 401(k) and maintain your allocation.

Keep Adding
New money is the great opportunity presented by this market. You should always add money to your retirement account in any event. But now, with stock prices at valuations not seen in years (and in some cases decades), it is crucial that you continue to add as much as you can. A dollar added buys more shares because they are cheaper. Having more shares increases the degree to which your account appreciates when the market comes back.

Maintain Your Allocation
Emotions tend to propel investors toward the wrong course of action. That is, when the market is booming, we tend to want to add more money and get more aggressive so that we can earn even more of those great returns. When the market is crashing, we tend to want to flee to safety and pull our money out of a bad situation. In other words, we’re compelled to buy high and sell low. Obviously, we should do the opposite.

Many 401(k)s offer plans with different mutual fund allocations (percentage investments in stocks, bonds and cash) that vary in accordance with the contributors risk tolerance. For example, a younger person who has more time to invest and can accept more risk would likely invest a greater percentage of the plan in stocks, while older contributors would invest less in stocks and more in bonds and cash.

Assuming that you chose an allocation that was proper for your age and risk tolerance, you should maintain it. Some 401(k)s offer automatic rebalancing, but some don’t. If your account doesn’t automatically rebalance you need to take care.

For example, let’s say you allocated 60% in stocks, 35% in bonds and 5% in cash at the beginning of the year. After stock and bond prices have fallen this year, your allocation has likely changed. Your allocation in stocks has likely fallen considerably and you need to rebalance to the allocations that existed at the beginning of the year. This involves buying more stocks at today’s lower prices.

Think Long Term
Nobody knows how long it will take the market to come back. In the short-term, the market is a risky bet. But, longer-term, investing becomes less of a bet on market fluctuations and more of a bet on this country. Historically, this country has been something you can take to the bank.

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