The Right Way to Invest in a 401(k)

By Michael S. Brown on March 17, 2014

One of the biggest dangers that investors face are themselves.

When the markets crater, many investors panic and pull out of stocks and/or they simply stop adding new money to their accounts.

Even though this behavior is understandable, making drastic changes to a portfolio in times of market trauma can be a terrible move for long-term investors. Stocks are volatile, but patient investors who hang on, and even better, continue to pump more cash into their accounts through dollar-cost averaging, will often be rewarded.

2013 studyopens PDF file  by the Employee Benefit Research Institute and theInvestment Company Institute, illustrates why investors should continue to invest during rocky markets.

The study looked at what happened to the account balances of millions of 401(k) investors during a four-year period beginning with the recession of 2008. The researchers, who took advantage of EBRI/ICI’s database of millions of 401(k) accounts, were particularly interested in the account balances of participants who continued to invest in their retirement accounts compared with all the 401(k) participants.

To give you a sense of how bad it was during the recession, the average 401(k) balance plunged 34.8% in 2008 before stocks started recovering. Over the four-year time period, however, the average account balance increased by 5.4 percent annually.

The study showed that workers who never paused their contributions fared much better than the overall pool of 401(k) investors.  By the end of 2011, the average account balance among consistent 401(k) contributors ($94,482) was 60 percent higher than the overall 401(k) participant pool that had an average account balance of $58,991.

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