What does no bailout mean for my 401k?

So, the US House of representatives rejected the bailout plan, what does that mean for your 401k you ask? Well, right now the markets are adjusting themselves down on the premise that their will be no bailout, in other words, people are acting scared and are pulling their money out faster than people can buy it – hence the reason the value of the market is going down so rapidly. In a nutshell, you will see paper losses in your 401k for the next few days, weeks, months, or even years (unless you too want to realize them now by withdrawing your money), however, the amount of shares you have still remains the same. Sooner or later your portfolio will rebound above and beyond current losses, and keeping to your long terms goals will allow you to buy up additional stocks (or mutual funds) at bargain basement prices through dollar cost averaging (See below for further explanation). Please, please don’t jump ship now or you will regret it as you will be forced into taking the loss when you don’t have to. Stick to your plan, markets are cyclical and for every up there is a down and vice-versa, however over the life of the entire stock market – the trend has been up, up and away.

Dollar cost averaging — also known as a constant dollar plan or in the United Kingdom as pound-cost averaging — is an investing technique intended to reduce exposure to risk associated with making a single large purchase. The idea is simple: spend a fixed dollar amount at regular intervals (e.g., monthly) on a particular investment or portfolio/part of a portfolio, regardless of the share price. In this way, more shares are purchased when prices are low and fewer shares are bought when prices are high. The premise of dollar cost averaging is that the investor wants to guard against the market losing value shortly after making his investment. Therefore, he chooses to spread his investment over a number of periods.

Since the market has a positive mean rate of return, dollar cost averaging usually requires the investor to give up some expected return for the benefit of reduced variance in his eventual outcome. In fact, research has shown that investing a lump sum according to these principles generally results in worse performance as compared to investing the entire sum at separate times (Constantinides, 1979). However, the investor can expect a reduction in the variance of his performance by implementing dollar cost averaging. While dollar cost averaging can help to limit the downside of a worst-case scenario of an immediate drop in asset value after the lump sum is invested, most market research has shown that such drop-offs are relatively rare compared to the strong emphasis the strategy puts on avoiding them.

Tagged as:

Leave a Response

You must be logged in to post a comment.