by Amanda Vaught, firstname.lastname@example.org
The coronavirus crisis has changed the economy and the way you invest in it. Does that make your 401(k) or 403(b) investments out of date? Here are three tips with action items to help you update your account today.
Tip #1: Indexes Don’t Work Like They Used To
From 2010 to 2019, it seemed like everything was going up, so you could go along for the ride. Now there’s a market crisis, and the ride isn’t as smooth as it once was. What happened?
In March 2020, the S&P 500 Index set new records for losses. Then April brought record gains. The market has diverged with a few winners. There are a lot more companies lagging in the S&P 500 Index than before the coronavirus crisis began in February. The companies that were adversely affected by the COVID shutdowns, or that weren’t doing well in the first place, are causing drag in the overall index of companies. To avoid buying these poor-performers, you need to be narrower in your investment selections.
* Remember that the S&P 500 Index is simply a group of the largest companies in the United States. “Large” does not necessarily mean “will survive in a crisis.”
|Action Item: Review your most recent 401(k) statement. What do you own? What are other investment options offered by your plan sponsor?|
"This is the largest gap between the top and bottom S&P 500 valuation quintiles since the dot-com bubble." Source
Tip #2: Limited Investment Choice Means Limited Return
Most 401(k) plans only offer limited investment choices beyond index funds. Some plans allow a self-directed brokerage option, which means you can hire an investment advisor to manage your 401(k) outside of your limited plan options. If your employer does offer it, consider converting your 401(k) to a self-directed brokerage account (also known as a 401(k) brokerage window). By doing so, you gain access to the full suite of investments available through Fidelity (or other plan sponsor), not just those limited choices provided by your employer.
Action Item: Ask your employer if they offer a self-directed brokerage for your 401(k). If they do not, urge them to offer the program. (Fidelity plans can be managed by Propel Financial Advisors, LLC.)
With a limited choice, you cannot use an investment advisor to determine better, more flexible opportunities. For example, many investors are now taking advantage of actively-managed ETFs. Smart beta funds are also popular vehicles. Most 401(k) plans do not offer these types of investment opportunities. They simply offer capitalization-weighted indexes like the S&P 500 Index.
Tip #3: Recalibrate Your Contributions between 401(k), Roth, and Taxable Savings
1. If you’ve lost your job or have an old 401(k) from prior employment
You are eligible to rollover your 401(k) into an IRA (or Roth IRA depending on your plan). An IRA gives you investment flexibility that you don’t have in a traditional 401(k). See our Guide on How-To Rollover your 401(k). If you, or your spouse, lost a job, your tax situation changed. Re-evaluate the benefit of a tax deduction of contributing to a 401(k) versus Roth IRA or taxable savings.
2. If you still have your job
The market downturn could put your accumulation of assets behind schedule. For example, if the value of your 401(k) is down 10-15%, then it could take you at least three years to make up that loss, assuming a 5% rate of return. If you’ve been contributing $10,000 per year into your retirement, then you might need to add $30,000 more just to catch up. This is especially true of people planning to retire soon.
Action Item: Assess your personal budget and lifestyle choices. Determine where you can save money.
In addition to using a traditional 401(k), we urge you to supplement your retirement savings with a Roth IRA. You can do both at the same time. The Roth has long-term advantages that include:
1) never having to pay tax on investment growth;
2) no impact on the taxation of social security income;
3) no impact on earnings, thus no increase in your AGI at tax time, and
4) more flexibility on withdrawals than a 401(k).
Lastly, using a taxable savings account is also a good strategy to increase your savings. It allows you to maximize your flexibility and liquidity while also earning something on your savings.
Action Item: Schedule an appointment with Propel Financial Advisors to power up your financial strategy.