A Conversation With a Friend About His 401(k)

This morning I got a call from my friend. Our conversation went something like this (I’m pulling a 15 minute conversation from memory so bear with me):

Friend: I was looking at my 401(k) statement last night. One month ago I had $23,000. This month it’s down to $17,000. I lost $6,000. What should I do?

Me: Forget about it.

Friend: But if it keeps this up, I won’t have anything left.

Me: What do you mean?

Friend: If I keep losing $6,000 a month I’ll be out of money in three months.

Me: No. You have to look at it as percentages. You had $23,000, now you have $17,000 so you lost about 40% [I was estimating]. If you were to lose another 40%, you would be losing it off a smaller amount of money.

Friend: Oh, I see what you’re saying. How much farther down do you think it’s going to go?

Me: I don’t know but it’s possible your account could go down to $12,000 or so. I really don’t know. All I know is that we are closer to a bottom than we were before.

Friend: So what do you recommend I do?

Me: Keep doing what your doing and forget about your balance for now. It’s not going to do you any good to worry about it. I will say that cashing out now would be a mistake.

Friend: Okay, thanks.

I want to zero-in on something he said at the beginning of the conversation about losing $6,000 each month. That’s not how it works. The dollar-amount of the loss is based on the amount you have invested. If you have $100,000 in your 401(k) and it goes down 20%, you have lost $20,000. If you have $20,000 in your account and the market drops 20%, you have lost $4,000. See, the dollar amount isn’t a constant but the percentage is.

In other words, it’s highly unlikely your account would go to $0.00 as a result of a down market (unless you are using lots of leverage or you close out your account). I know it’s not exactly comforting but it’s better than nothing.

21 thoughts on “A Conversation With a Friend About His 401(k)”

  1. I agree with your answers intellectually (although don’t you run into Zeno’s Paradox rather quickly with your particular answer?) but I sure do understand how it feels to be your friend. I spend all my time closing my eyes and hanging tight. (It’s a good plan, but makes it hard to type comments!)

  2. Friend: If I keep losing $6,000 a month I’ll be out of money in three months.

    If your friend keeps losing $6,000 a month, he WILL be out of money in three months.

  3. Not sure how this guy’s 401K is invested, but if it’s in index funds, they won’t go to zero unless a mega-disaster happens. And if one does, we’ll all have far more immediate concerns than our retirement portfolios.

    Also, the friend should be happy in a way: if he’s still fairly young, he has a long time to go before retirement. He’ll get to benefit from DCA-ing into a cheap market for awhile, which is a Good Thing.

  4. My mom is terrified by the market volatility that has really lowered her retirement portfolio. She will retire in 5 years, but will have a pension so she will not need her portfolio money to provide all of her income in retirement. She is wondering if she should go ahead now and shift some of her stock mutual funds into a money market account or bond fund?? She now realizes she had too much exposure to stocks, but obviously this doesn’t help now. Any opinions? Should she wait it out and reallocate on the days the market is up by shifting a little money out of her mutual funds at a time or take the plunge all at once? I feel so sorry for her, she is sick over her losses. She felt like she had things lined up pretty well, but has lost a bundle this year, especially the past month. Thanks for any advice or help you can give us.

  5. To Bert: your mom shouldn’t be in a hurry to reallocate money, esp if she doesn’t need it in the next 5 years. I’d sit tight for a year or so and see if the market recovers a bit. She can start putting any extra savings in cash to give her some peace of mind/cushion.

    If the market still shows no sign of recovering, she could dollar cost average, as advised by Foobarista above, by moving a small amount periodically (monthly, quarterly, etc depending on the transaction charges) so that she’s not immediately selling at low points. If she were purchasing stock it wouldn’t hurt so much as she’d be both selling AND buying low, but if she’s going to move into cash then there’s no immediate upside except peace of mind (and perhaps a deductible loss if she’s selling below her basis in a taxable account.)

    Look ahead, not backwards. That’s what I’m trying to do (while being violently ill over our “losses”)–esp. the 529s for college 🙁

  6. “Friend: If I keep losing $6,000 a month I’ll be out of money in three months.”

    If that happens, that would mean a total collapse of the US’s financial system. If that occurs, his 401(k) will be the least of his worries.

  7. To Stacey:
    Thanks Stacey for your advice. I am trying to reassure her, but it is hard to see her lose so much in so little a time. I sincerely appreciate you taking the time to help.

  8. Hi,

    Your logic is interesting and idiotic at the same time. Telling your friend that because he’s losing gradually a lesser percentage of bugger-all and should therefore ignore it is like telling the passengers leaning over the rail of the sinking Titanic that, percentage wise, there’s less of the ship to sink now then there was 20 minutes ago.
    Given the current state of the market, you friend probably won’t have to worry about his shrinking 401K for much longer, whatever percentage he’s losing. Tell him that once the balance is zero, he’ll be fully stabilized against further losses.

  9. couple of things to keep in mind…

    1. Yea the markets have just had a hissy fit. I have a friend at work that is all worried about his 401K.. i finally convinced him not to dump everything… I told him to compare the market to this upcoming winter. We “know” at some point the market is going to recover and a boom will happen again.. when? .. I have no clue.. I told him.. If you had to bet that we would get snow between Now and Next April would he bet on that? He said well duh… I said the market is the same way.. You know at some point in the next 6 months we’re gonna get snow.. But what day(s) it will snow.. you have no idea for sure. so its best to have your bucket ready to catch snow before it starts snowing instead of having it snow for 4 hours before you realize it and try to run outside with a bucket in the middle of a blizzard hoping to get the most snow possible.

    2. Even if retired, you aint going to cash out the whole thing at one time, your just going to bleed some income off those investments. My suggestion is to make sure you have enough cash in safe places to cover your living expenses for at least 6 months to a year at any given time… (like a money market or savings account)and any extra money over that.. leave in the market so it can continue to grow once the market turns around.

    I dont even pay attention to what the market value of my investments are right now.. I focus more on how many shares of each fund I own and do anything and everything I can (once all my bills for the month are paid) to add more shares to those funds. I’ve Invested about $8000 this year since march.. but i have no clue what the true market value of them are… and I dont really care what it is.. Other than make sure my funds stay in balance with each other.. 25% in each of the following.. Growth.. Growth & Income.. Aggressive Growth and International..

  10. Hey, Wilson, why don’t you share your secrets w/the rest of us so we can all double our money? We could use it about now…

  11. I posted on this forum about using free trend signals including $CPCE 10/21day EMA, odd short sales ratio, etc.

    Now I give you another tip, that is, delta neutral trading.

    Everyone likes to pick the bottom. You may like to buy 1,000 shares of Citi-Group at $15.09, with delta=10.0. To neutralized the delta, you may consider buying December $12.5 put options, each with a delta of -0.26. Simply buy 38 CXZ at $1.09, costing $4142. This makes your initial investment $19,232 pus $38.5 commission, assuming you trade at Interactive brokers.

    Now, if in one day C moves drops to $12.5, CXZ would be worth $1.99 each contract. The value of your initial investment becomes $12500 + 38*1.99*100=$20,062. If you close all your positions, you could make a profit of $753 (=20062-19232-38.5*2).
    On the contrary, if C moves up to $17.5, CXZ would be worth $0.60 each contract. The value of your initial investment becomes $17500 + 38*0.60*100=$19,780. If you close all your positions, you could pocket a profit of $471 (=19780-19232-38.5*2).

    C could easily move 5 dollars in two days. In that case, if you don’t adjust your delta during the course of the movement, you could make $3,573 (=3.39*100*38+10000-19232-38.5*2) on the way down or $1,907 (=0.32*100*38+20000-38.5*2).

    For more enlightenment, please read the following page at http://www.thepitmaster.com/options/deltatrading.htm.
    It’s easy to make money ….

  12. Thanks Wilson. Do you do all the initial selections/subsequent adjustments yourself or do you have a computer program that aids in determining the mix?

  13. I don’t have program yet.
    I prefer dynamically adjusting the delta by myself in real time using Fibonacci fractals.

  14. My question to you is this: how do you know that the market will go back up within a reasonable time frame?

    A professional investor or amature speculator (which most of us little ‘uns are) cannot afford to wait 10, 20, 25 years for the market to recover to what it *was*. We’re not talking about a new gain on top of that.

    It is far better to cut your losses at 10% max. That’s your stop loss limit. Your friend has already lost 40%. Why in the hell are you advising him to accept more losses?

    “Oh, it’ll come back, don’t worry.”

    How do you know? When? How much? To what level? To what it was, or beyond what it was, so he can catch up on what he would have earned if the market hadn’t crashed in the first place?

    Limiting losses is a critical part of any wealth growth strategy.

  15. JLP,
    I like your reasoning…what I want to know is why doesn’t it work the same way with taxes? That is, if you make $100,000 and pay 20% that is $20,000, but if you make only $20,000 and pay 20% you’d only pay $4,000; and if you make $1million, you’d pay $200,000! Flat tax makes so much sense to me. Though actually I prefer a national sales tax, taxing what you spend rather than what you earn.

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