Do you have a 401(k) or IRA account? Chances are if you do then you like so many others see their balances at all-time highs. The stock markets in the United States continue to set and then hover around all-time highs, and that means your portfolios are also most likely near all-time highs as well. But this prolonged bull market may have placed you in a position where your portfolio is extremely out of balance from your targets and financial plan. Remember that no matter how you are investing you need to have a well-developed financial plan that you are following.
While the average balance in these two accounts fell slightly in the second quarter of 2015, the overall balances are just above $91,000 for the United States. For those who have been saving in both an IRA and 401(k) for at least ten years their accounts are closer to $250,000. Which does go back to what I have always said, and that is always to invest early and often to maximize your returns over the long haul, say 35 or 40 years. When you do that the compounding of interest over such a period will dramatically increase the size of your savings. Again, if you do not believe me go to Excel and use the Future Value function to play with the numbers and see for yourself what an extended period will do to your balances. The key is to use a reasonable rate of savings and a return rate that is also reasonable. And with your return rate do not forget to consider the rate of inflation as that posed a real threat to your returns.
The increase in the markets has helped 401(k) and IRA savers without a doubt. Since the recession, the market has more than doubled in value creating some tremendous opportunities for all investors. And it was not only the market increases that helped savers. For the first time, people contributed on average more than $10,000 on an annual basis when a company match is taken into account. Also, as I have always stated you need to take full advantage of any company matching you may receive as that is an instant return and is considered free money. Otherwise, you are just leaving free money on the table as the saying goes.
With these increase savings and balances, there is a negative that is also happening in the 401(k) world. That negative is people are taking loans out against their balances for a variety of things. While this may seem like a good idea, it can have some serious consequences if you change jobs while you have an outstanding loan. If you have a loan and change jobs and do not repay the loan within a certain time period that outstanding balance becomes a withdrawal and may be subject to an early withdrawal penalty as well as any taxes owed on the balance. My advice here is to try and avoid loans from your 401(k) unless you are certain you will be able to repay the loan, and you will not lose your job. As you can see, this can create an undue burden at a time when it may not be ideal if you were laid off from the job in which the loan was originated.
Another factor of the increased pricing and values in the equities markets are unless you use target date funds, which I do not recommend, is balancing of your portfolio. With equities more than doubling in the last six to seven years it is more likely than not that your positions in equities and bonds are out of balance with your targets or financial plan. As a general rule, the value of equities will go up, and the value of bonds will go down creating a situation in which you will have a larger balance in your equity accounts. This means you will need to rebalance in some fashion. This can be done by selling off some of your position in the equities you own in the account, or you can reduce future contributions to that asset class and increase the ones that are below your targets. Either way you need to get your portfolio back in balance with your stated goals and targets. As an example during the recession of 2007 and 2008 about 27% of those aged 56 to 65 had at least 90% of their portfolios in equities. When the markets fell by about 50%, this translates into some serious losses for those individuals. That also means retirement may not happen as you had originally planned due to the massive decrease in the value of the portfolio.
Now many people think the last recession was a once in a lifetime event, and I hope that is the case but as you all know nothing about the markets is certain or can even remotely be predicted. And with almost 20% of people aged 50 to 54 with these accounts also have an equity position that is at least 10% higher than what is recommended. And it gets worse as those aged 55 to 59 exceed recommendation at 27% of those surveyed. The most shocking stat is that almost 10% in both groups are 100% invested in equities. While I am a firm believer that people need higher percentages of equities later in life no one that age should be 100% invested in equities.
Remember financial plans are more than 401(k) and IRA holdings but all of you assets that are held as investments. That means you can hold more equities in these accounts provided you hold safer assets outside of them such as bonds or cash in brokerage accounts and financial institutions. These need to be taken into account when you form a plan for your 401(k) account and IRA so when you form a financial plan make it comprehensive in nature.
For more information or if you have any questions feel free to contact me directly.
