Q: I am 45 and I am currently saving 8% in my 401k (Vanguard) and the company I work for matches another 3%. For the last couple of years, I’ve been increasing 1% each year and want to get to the point that I max out my yearly contributions. However, I’m concerned about vulnerability to big market swings as it seems the market is due for a correction soon given the current political climate. I wonder if you have any resources for learning to actively manage a 401K. I hate to see most of what I’ve earned in the last couple of years disappear when the market corrects. I’ve been fortunate that my return for the last year was 25.1%, which is unusually high. I know a 401k should be thought of as a long term investment subject to some wild swings from time to time, but I am concerned about the short and long term implications of our nation’s debt.
A: You’re doing a diligent job saving as you annually increase your way to maximizing your 401k contribution, Great Job!
There is actually a good book you can read that was written by the founder of Vanguard, John Bogle, called, The Little Book of Common Sense Investing. Believe it or not, it reads pretty quickly and as someone who wants to actively manage their 401k, I think it would be a great resource for you.
In reading your email I understand that you did very well last year (up 25.1%) and that you would hate to see your unrealized gains disappear due to a significant market correction.
While there is, “nowhere to hide” in the market, you can significantly decrease your exposure to market volatility and risk. Just remember the old risk and reward adage, the more risk, the more reward and vice versa. The same is true in investing. Based on your 25.1% increase in 2013, I would guess that your portfolio is predominately allocated with securities that are highly correlated with the market, ie growth stocks (large cap, mid cap and small cap stocks). Highly correlated assets all tend to rise and fall together, so when the market is up 25% so is your portfolio. The problem is, they also fall together, so if the market drops 40%, so does your portfolio.
The key to minimizing major swings in your portfolio is to diversify your mix of assets with securities that don’t necessarily rise and fall together. You could accomplish this by holding a mix of vanguard stock funds and bond funds.
As the administrator of your 401k, Vanguard can provide guidance in this endeavor.
Please feel free to call me if you have any additional questions.