When it comes to retirement investing, the simplest strategies can be the most effective. But there is a single bullet that works for 401(k)s that can boost your balance by a factor of four.
It doesn't involve market timing and it certainly doesn't involve fancy alternative investments. According to a recent study by the Employee Benefit Research Institute (EBRI) and Investment Company Institute (ICI), the best approach is actually counter-intuitive: Leave your money in your account and keep contributing no matter what the market does.
The study examined six years of 401(k) account activities from 2007 to 2013. As you'll recall, that period included the biggest stock-market crash in recent history and a robust rebound.
The results from 401(k) participants across the study is fairly consistent. By continuing your contribution, your account value goes up over time and compounds. Even when there's a jaw-dropping market sell-off -- the average 401(k) account lost some 26% in 2008 -- you can still make money.
Here's what the ICI/EBRI study found:
-- "Overall, the average account balance increased at a compound annual average growth rate of 10.9 percent from 2007 to 2013, to $148,399 at year-end 2013.
-- At year-end 2013, the average account balance among consistent participants was more than twice the average account balance among all participants in the EBRI/ICI 401(k) database. The consistent group’s median balance was more than four times the median balance across all participants at year-end 2013.
-- Younger 401(k) participants or those with smaller initial balances experienced higher percentage growth in account balances compared with older participants or those with larger initial balances.
-- On average at year-end 2013, about two-thirds of 401(k) participants’ assets were invested in stocks, either through stock funds, target-date funds, non-target-date balanced funds, or company stock. Younger 401(k) participants tend to have higher concentrations in stocks than older 401(k) participants.
-- More consistent 401(k) plan participants held target-date funds at year-end 2013 than at year-end 2007, on net; many of those with target-date funds held all of their 401(k) account in target-date funds."
Why this strategy works is simple. When you stay invested in stocks you won't miss the rallies and won't guess wrong on when to get in and out.
Will you lose money some of the time with this approach? Of course, but you have no way of knowing when that will occur, so why guess wrong and lose even more money?
The best vehicles for employing this single-bullet? Either target-date funds or stock index funds. In either case, they should be buy-and-hold investments that you make no attempt to trade.
Of course, for this strategy to work, you also have to leave your money in your 401(k) until you need it for retirement. That means no loans and no withdrawals for things like college funding. Leave it alone.
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