3 Tips for Maximizing Your 401k-IRA Returns in a Volatile Market

The employer-sponsored 401k Trust and its job transition heir-apparent, the IRA, have become by far Americans’ most popular vehicles for accumulating retirement assets during our working years. According to Investment Company Institute’s March 31, 2008 report, some $17.1 trillion or 40% of American households’ net worth are retirement assets.

Of that $17.1 trillion, IRAs own $4.5 trillion and 401k’s (and equivalents) own $4.3 trillion respectively. The product of choice for half of these IRA and 401k assets is the mutual fund.

It’s a well known fact in the financial industry that when share prices rise (and account balances swell), investors experience emotional exuberance and pour money into more shares. Conversely, when share prices decline (and account balances shrink), investors experience emotional distress and liquidate their shares.

Although this is the very opposite behavior that a mutual fund investor should employ, it is a well documented and well-rutted ritual that is not likely to change.  The following three (3) ideas will enable you to take maximum advantage of an investment’s price volatility, or as I like to call it, The EKG Effect:

• Bet the House’s Money: If seeing your account balance decline or as you refer to it losing money makes you nervous, then put the house’s money at risk instead of your own. Not “rent money,” but house money. You’ve been to Vegas or a casino somewhere so you know what it means to play with the house’s money. In a 401k Plan, house money comes from several sources. One source of house money is Fedtax.  Fedtax is that line item dollar-amount shown on your paystub that was witheld from your pay.  However, if you contribute to your 401k Plan, house money is that amount that you [would have] given to Uncle Sugar if you hadn’t paid it to yourself instead via your 401k Plan.  Just take a look at your paystub if you’re the visual type.  Additionally, house money comes from the matching dollars and the Profit-sharing dollars that your Employer may add to your account because you participate in the Plan.  This house money could easily be as high as $16,000 or more annually at max participation and funding levels.

Here’s a hypothetical example to illustrate this concept. Let’s say you’re married and earn between $65,100 and $131,450. According to the IRS Tax Schedule below, you would reduce your tax liability by $0.25 cents for every $1.00 dollar you contribute to your 401k Plan. That means $0.25 is technically house money and rightfully it should have gone to Uncle Sugar. If you contribute the max $15,500, then roughly $4,000 is house money.

Now, let’s say that your employer matches Plan contributions dollar-for- dollar up to 4.00% of your $50,000 annual compensation. That’s another $2,000 in house money. And, if you Plan has a Profit-sharing provision, that’s even more house money. Makes sense so far?

In this example, if you’re a nervous Nellie and you can’t stomach the decline in your account value and the roller-coaster volatility is making you nervous, here’s a suggestion. Rather than liquidating your accounts at the absolute worst time to do so, segregate your own money from your house money. Commit your own money to the more conservative bond or fixed income fund options in your 401k Plan and leave it that way. Alternatively, commit the house money to the more aggressive stock or growth fund options in your 401k Plan and leave it that way. Deploy your new deferrals and matching contributions in the same manner.

• Hedge Your [401k] Bets: Hedge is a just a fancy word for insurance. Funny…we seem to understand insurance when it comes to material assets, but we don’t quite get the concept when it comes to money. But, don’t you agree that it’s just as important to insure [protect] your money as it is your car? Well, here’s how you can do that.

You’ll remember that in the above-referenced ICI report, about half of that $17.1 trillion in retirement assets was split equally between employer- sponsored retirement plans and IRA accounts. To me, that suggests that most folks who have 401k Plans also have an IRA. If that’s you, then you have the necessary tools to hedge your 401k. To do this, simply invest your IRA assets in investments that have no correlation, low correlation, or negative correlation to the funds inside your 401k Plan. This will require a little research and due diligence, but it’s really not that difficult. By hedging this way, you will feel less anxious about volatility since the bulk or your investments will no longer be closely related to each other; and therefore, they will probably not reflect the same volatility characteristics at the same time. This means that you will not feel the emotional duress that motivates investors to liquidate at precisely the wrong time.

• Save the Maximum Possible [both] Inside and Outside your 401k Plan: Currently, the maximum available contribution level to a 401k Plan is $20,500 annually if you’re age 50. According to separate studies by Hewitt and Fidelity, the average employee defers 6.00% – 7.00% of their compensation. That amount is well short of the 15.00% cap, which means that there is a lot more opportunity for saving.

Because of its tax-advantages and expense structure, there is no better primer to accumulate retirement assets that the 401k or employer- sponsored retirement plan. Every American should maximize his or her contributions. After all, a huge part of those contributions are HOUSE MONEY.

We have spent countless hours in strategy with clients in order to determine the best course of action for each client.  We would be glad to put our intellectual capital to work for you so you gain greater clarity about the financial future that awaits you.

by Larry DeRamus, President
DeRamus Wealth Management, LLC