Get this: Despite the biggest and broadest decline in financial markets in a generation, the median 401(k) retirement account at Vanguard Group on Sept. 30, 2009, was up 7% from where it was two years earlier, when the market was near its all-time high.

The Reason?…

Continued regular savings matter a lot. If you have continued contributing to your retirement account throughout the stock-market debacle—and even better, if your employer continues to match your contributions—your account probably has more in total dollars than you expected. Younger people, who have smaller balances to begin with, will see a bigger impact from their regular savings.

You can read the full article here.

In a way, continued contributions during a down market masks the losses and helps you feel better about where you are. It’s also a good strategy for making the down market work for you. You can even make it work harder for you by increasing your contributions during the down market. That’s the strategy my wife and I took during this downturn. So far it’s paying off. Our account value is about where it was at the high. Our personal rate of return for 2009 is around 30%.

1. The balance is just a few thousand shy of its previous high-water mark. Yes, that number includes contributions but it’s still shows drastic improvement from the low.

2. Last year’s personal rate of return was somewhere around -40%. This year’s is currently at 29.3%. Remember, the personal rate of return takes into account contributions.

I don’t know where the economy/market is headed but I’m content to stay the course and believe it will pay off in the long run. I have tweaked our 401(k) investment selections a bit but haven’t moved money from asset class to asset class. We are still 100% equities, divided evenly between large-cap, midcap, smallcap, and international. NOTE: I’m NOT recommending this allocation for anyone. I’m just telling you how we are investing our 401(k) account.

Hi,

Your article on 401(k) loans was very informative.

I am trying to decide between 401(k) loan and withdrawal. My 401(k) is not currently active, meaning I do not contribute anything towards it. I have moved to a new employer and my 401(k) was with the old employer.

I am looking to arrange funds for about 10K. I would be grateful to you if you could let me know which option is better?

Thank you,
M.

M.,

First off, you can’t take a 401(k) loan from a 401(k) with a former employer. Had you had an existing loan on your 401(k) when you left your previous company, you would have had to either pay it back or pay taxes and a 10% penalty on the outstanding loan balance.

Now, it might be possible to move your old 401(k) into your new company’s 401(k). Then, it might be possible to take out a loan through your new company. You’ll have to check with your new company’s human resources manager to find out the specifics.

I don’t recommend the withdrawal route because you’ll be taking a 30% haircut on the withdrawal (20% withholding plus a 10% penalty). On a $10,000 loan, you’re looking at losing $3,000. That’s a lot of money.

One last thing I want to address is your reasoning for withdrawing money from your 401(k) in the first place. You don’t mention your reason in the email. I hope it’s for a good reason (perhaps to purchase a house). By withdrawing money now, you are forfeiting future growth on the withrawal, which could be significant. At least with a 401(k) loan, you are paying yourself back in a relatively short time period.

My recommendation is that you try to find the money some other way if you can’t do a loan. If there’s any way possible to avoid withdrawing funds from your 401(k), go that route.

The definition of personal rate of return (I put together a tutorial here) on Fidelity’s website is:

Your Personal Rate of Return is calculated with a time-weighted formula, widely used by financial analysts to calculate investment earnings. The calculated value reflects the result of your investment selections as well as any activity in the plan accounts shown. Other personal rate of return formulas may yield different results. Remember, past performance is no guarantee of future results.

That explains why our personal rate of return looks so good. For one, we increased our contribution amount AFTER the carnage of January and February. Two, the company’s profit-sharing contribution was also deposited in March, missing the bad months of January and February. In other words, our number could look much worse.

My point?

INVEST!

Invest regularly and forget about it! Have your allocation plan set up and STICK TO IT! Don’t worry about the news. If your 401(k) balance is going to bug you, DON’T LOOK AT IT! The worst thing you can do is allow your emotions to take control. Decisions made on emotion almost never work out.

Okay, that’s it. Carry on…

This finding from Scott’s piece reminds me of what I pointed out about the 2009 Fortune 500:

In the 12 months ending Feb. 28, only 12 companies in the Standard & Poor’s 500 provided a positive return. Over 200 companies lost at least half their value.

Finally, this last part regarding how fees can really eat into retirement plans, is telling:

All other things being equal— gross return and career contributions — a federal government worker with a virtually cost-free plan who starts saving 6 percent of income at age 30 will accumulate about 10.5 years of final income by age 67.

A private-sector worker with a typical plan will accumulate only 8.5 years of final income by the same age, if the plan has costs of 1 percent a year.

A worker with a plan that costs 2 percent a year will accumulate only 7 years of final income by age 67.

Those are big differences. Put another way, 2 to 3.5 years of income are siphoned off by the costs of typical plans.

I have a feeling that changes are coming… Let’s hope they are for the better and not some kind of socialist program.

I still think education and SELF-DISCIPLINE are the keys. Employees need to understand just what they are giving up when they elect not to sign up for their 401(k). They need to be updated once a year with something that says, “This is what you could have in your account had you signed up.” Of course, this may do nothing more than lull people into doing nothing since they already feel like they missed out.

I’ll try to highlight the other five articles in the series as they become available.

The stock-market rout has ignited a crisis of confidence for millions of Americans who manage their own retirement savings through 401(k) plans.

After watching her account drop 44% last year, Kristine Gardner, a 35-year-old information-technology project manager in Longview, Wash., feels no sense of security. “There’s just no guarantee that when you’re ready to retire you’re going to have the money,” she says. “You either put it in a money market which pays 1%, which isn’t enough to retire, or you expose yourself to huge market risk and you can lose half your retirement in one year.”

First off: SHE’S 35-YEARS OLD! Why is a 35-year old worried about retirement? People need to understand that the market goes up and DOWN! Simple concept but it is very hard for people to comprehend.

Unfortunately, this woman’s example is leading our idiots in Washington to propose changes (emphasis mine):

Congress has begun looking at ways to overhaul the 401(k) system. At hearings in October, the House Education and Labor Committee heard from a variety of witnesses. Some proposed setting up “universal” retirement accounts, which would cover all workers. One such plan called for establishing accounts that would receive annual contributions from the federal government, and would offer a guaranteed, but relatively low, rate of return. Another proposed automatically investing contributions in an index fund that holds stocks and bonds, with the mix getting more conservative as workers approach retirement. Other witnesses proposed less drastic changes, such as providing better education.

I don’t know about you but I really do not like the first two ideas. The word “universal” scares the living daylights out of me and I can’t imagine the government doing a better job at managing people’s money.

As far as that “guarantee” goes…guarantees come with a price. Let’s look at the math.

Let’s look at two hypothetical examples. The first one is a traditional 401(k) plan in which the participant contributes $10,000 per year for 30 years and gets the LONG-TERM average rate of return of 10%. The other is a guaranteed plan, also with annual contributions of $10,000 for 30 years and with a 5% “guaranteed” rate of return.

Now, say the market crashes and the Traditional 401(k) account’s value drops 40%, while the “guaranteed” account remains unchanged (this would be highly unlikely). Even with a 40% loss, the Traditional 401(k)’s balance after the crash is still $322,000 HIGHER than the guaranteed account. And, that’s assuming that the guaranteed account didn’t drop in value.

Not only that, but people who are at retirement age STILL HAVE A LONG-TERM HORIZON! If you’re planning on being retired for 30+ years, you are a long-term investor. Therefore, you should be investing as such. So what if your account value is down. Just live on a smaller income while your account value builds back up. It most likely isn’t the end of the world.

So, I’m going to say that it’s people’s lack of self-discipline, saving money, and poor choices that are the real cause of their problems and NOT the market’s performance. For example:

Peg Kelley, a 58-year-old small-business consultant in Watertown, Mass., didn’t contribute anything to her 401(k) last year. Instead, she’s been focused on paying down credit-card debt and building up an emergency fund in case the bad economic times turn worse. She’s also still paying off an $8,000 loan she took from her 401(k) plan four years ago to buy a new car.

Afraid of reliving the dot-com market meltdown, which knocked $100,000 off her retirement savings, she moved her entire 401(k) from diversified stock and bond holdings into cash-like investments early last year.

“I’m not going to get rich on my 401(k),” she says, “but also don’t want to get poor because of it.” She had hoped to retire early, but now she figures she won’t quit work before age 65.

She borrowed $8,000 from her 401(k) to BUY A NEW CAR!!!!!!!!

I’m stunned…

Her plan would end the tax breaks for 401(k)s; she proposes instead to give all workers an annual $600 inflation-adjusted tax credit for retirement and force them to invest 5% of their pay into a government-run retirement account managed by the Social Security Administration. She called the 401(k) “a failed experiment.” A McDermott spokesman called her proposals “intriguing” and “part of the discussion.” Mr. Miller hasn’t so far endorsed the plan.

Source: Targeting Your 401(k) ($), WSJ

Do we really want the government to manage our retirements?

There’s also been talk about the government confiscating 401(k) plans. I think that’s a little far-fetched. I don’t think that would happen. Afterall, it is OUR money and the government has no right to it.

Instead of drumming up stupid ideas, why don’t our politicians focus on what’s really the problem: LACK OF EDUCATION! Why don’t they:

1. Concentrate on fixing Social Security.

2. Educating the general public on the purpose and management of their 401(k).

We don’t want the government “looking out for us.” Trust me on this one.

Hi JLP,

I’ve read your blog about the 401k loan. However, it’s still unclear what to do in my case. I took out a 401k loan of $20,000 by June, 2008. The loan is payable within 5 years. However, I will be laid off by my current employer by the end of this month—November. The paperwork shows that I have to pay back the remaining loan within 90 days from the laid-off date. My question is do I have to pay back all the remaining loan by the end of this year (income tax year?) or by the end of the 90 days period (Feburary, 2009)

Also, do I have to add the 401k loan on top of my income this year?

Thanks in advance,
Kevin

First off, let me say I’m sorry to hear that you are being laid off. Hopefully, you’ll be working another job soon.

You have 90 days to pay back the loan, regardless of where it falls in the year.

If you do not pay it back, you will have to report it on your 2009 Federal Income Tax and will also be assessed a 10% penalty if you are under 59½ years of age. Your tax penalty could turn out to be some serious money if you don’t pay back the loan in time.

Whatever you decide, be sure and check with your human resources department and ask them for a copy of the rules. Also ask them if there’s anything they can do to help. The IRS allows plan providers certain leeway for decision making so it never hurts to ask. For additional help, check out these frequently-asked questions on the IRS website.

Best of luck to you, Kevin. Please keep us up-to-date on your transition.

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.

The investments contained in a pension plan are designed to produce income, and are managed by trustees who are experienced in constructing safe, conservative, diversified programs that are just as boring as they can possibly be. Most pension plan benefits are calculated as a percentage of the amount earned while employed. The Social Security retirement/welfare plan is a tontinesque Ponzi scheme based on the government’s ability to continually abuse taxpayers. There are no investments at all, and no trustees… just IOUs.

I simply refuse to believe that people can’t manage their 401(k) plans themselves. It’s not that difficult. Employers should concentrate on bringing in unbiased educational services to help their employees learn about asset allocation and investment selection.

Defined benefit pension programs are rapidly becoming extinct— corporate America can no longer afford them, along with 50% of total Social Security contributions, employee health care, and CEOs who collect $50 million per year from their unwary shareholders. But those that have survived (notably, labor union plans, retirement annuity contracts, and the Congressional Pension System) produce monthly income checks without any problems whatsoever. And here we thought our congressional leaders were incompetent— not when it comes to their own benefit package + COLAs.

Here he hits the nail on the head: pension plans are too expensive! When companies provided pension plans for their employees, the norm was for an employee to retire at 65 and die within 5 to 10 years. Now days, that’s not the case and employers simply can’t afford to pay for a retiree’s 25 – 30 year retirement.

Still, the 401(k) plan deserves to be every bit as popular as it has become. It, and the vast array of complicated IRAs, could help save Social Security, improve the economy, and create jobs— all those good things that neither of the presidential candidates have a chance of achieving. Just two simple strokes of an Oval Office ballpoint get it done: 1) Eliminate all taxes of any kind, at any jurisdictional level, on any form of investment and/or retirement income. 2) Replace the failing Social Security system with a private pension system, funded by taxpayers only and managed by the existing insurance industry infrastructure.

I like both of his suggestions although I’m not exactly sure how they would work. For one, how does the government make up the shortfall in tax revenues if retirees no longer have to pay taxes? That’s a scary thought if the government’s not willing to make the necessary spending cuts.

I bet the insurance industry is salivating at the prospects of his second suggestion. I could go for a private pension or private fund as long as I get to choose where my money goes. I don’t see this one happening any time soon. Politicians are too scared to touch Social Security and AARP would scare the crap out of retirees.

How do we make the 401(k) plan provide more retirement security? That’s not so difficult either. Simply dictate that all plans require participants to invest at least 60% of their assets in individual (plain vanilla) income securities that can be withdrawn “in kind” at retirement.

NO, NO, NO! I HATE this idea! Instead, show people how different asset classes work and show them how to gravitate from one class to the other as they approach retirement. My wife and I have NOTHING invested in income securities at this time in our lives (we’re both under age 40) and requiring us to put 60% of our retirement assets in income securities would be ridiculous.

Finally, I’m tired of all this talk about how bad 401(k) plans are. Yes, there are bad aspects to them. They can be expensive and loaded with horrible funds, but all of this can be overcome with education. If managed properly, a 401(k) can be better than a pension plan with lots more flexibility.