none of the downside, they usually end up buying high and selling low–not a very savvy investment strategy. Markets are unpredictable, and even the smartest market watchers can’t predict sudden rallies and declines.
The dangers of market timing are especially true when your 401(k) assets are in mutual funds, as they should be. For example, if you switch your 401(k) assets out of a small-cap mutual fund and into a large-cap fund because of an attractive rally in large-caps that day, you may already have missed the action. That’s because mutual fund shareholders get a price, called net asset value, or the value of one share in the fund, that is calculated at the end of the trading day. Instead of getting in on a rally, you may be buying after it, at the peak. Similarly, you may have sold the small-cap shares just as they were about to head up.
Ibbotson Associates calculates the effects of market timing this way: If you had invested $1 in an S&P index fund in 1980, that $1 would have been worth $18.41 at the end of 2000. But if you had missed just fifteen of the best days in those twenty years, you would have had only $4.73. It’s impossible to predict which fifteen days out of 5,200 will be the best. Jumping in and out of the market is likely to cause you to be out of the market precisely when you need to be in it.
So how should I be investing my 401(k) money?
Only you can answer this question. But forget about trying to make a killing in the market because of a well-timed purchase of a hot stock or a well-placed tip. You may as well expect to win the lottery. And just owning a bunch of investments is not the same as having a retirement strategy. Only a well-planned strategy will see you through economic good and bad times and help you build a nest egg that will suppor
t you to the end of your life.
To get started, you must decide two basic things: in how many years will you retire, and what is the minimum income you can get by on in your retirement years? For many, the answers will be educated guesses, but that’s better than nothing. A good goal to aim for is having a nest egg that provides you with 70% to 80% of the salary you were receiving at the time of retirement.
Here’s an example: Bob is now 35. His annual salary is $45,000. He has $20,000 in an Individual Retirement Account and he expects to receive about $14,500 a year from Social Security after retirement. His hope is that he can retire at age 65 with about $40,000 a year in retirement income. What will he need in his nest egg at retirement? The answer: $378,000. To get there, Bob will need to save about $7,500 a year. You can do a similar calculation by going to the American Savings Education Council Website,