401(k) plans were never designed to function as a primary savings vehicle to fully fund an individual's retirement. Nevertheless, this is what many individuals use as a primary retirement savings tool. Originally, retirement plans were private, company funded, pension plans. These plans could be heavily funded endowment policies, high cash value whole life insurance plans, or annuity contracts.
Over time, pensions became increasingly expensive to fund, and while there was Social Security to supplement pension plans, the Government turned to a "3rd leg"-401(k) plans. Combined, it was thought that this approach would provide a stable income for individuals when they turned 65 and wanted to retire.
But, many companies slowly started to phase out their pension plans and pushed more of the responsibility onto the employee. Unfortunately, that responsibility didn't come with a lot of education. Individuals naturally lacked the investment and business savvy that skilled wall street traders have. And, they've paid the price over the years. Every business cycle comes with a corresponding reduction in 401(k) account balances.
This graph from the Employee Benefit Research Institute tells an interesting story:
2008 arguably represents the worst downturn in the market since 401(k) plans were introduced. It wasn't a good year for a lot of folks. But, what I want to focus on is the data on the far right side of the graph. Individuals who have contributed to their plan and "stuck it out" for 30 years or more still lost a significant amount of money. The industry recommendation to "buy and hold" basically wiped them out.
We're often told not to worry about any market corrections, because eventually, the market will bounce back. That may be true, however, when you're aged 55-64, you don't have time to wait for the market to recover. You have to keep working or retire on much, much, less than what you expected.
I guess an important lesson to learn, as an investor, is that there is nothing inherently wrong with "buy and hold" as long as you aren't planning to cash out your investments and spend the money. If you want to spend your savings at some point, you had better come up with a real financial plan for the later years of your life, because "buy and hold" isn't an exit strategy.
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_________________________This entry was posted on July 4th, 2010 by David. Edits may have been made to keep this entry current. · No Comments · Investing, Retirement Planning