Wednesday, February 11, 2009

401(k) week, day 3: Why now is a bad time to pull out

If another person asks me if they should get out of their 401(k) because the stock market is down, I'll slap 'em. No,really, I'll do it.

Why? Because it's such a simple thing to understand: would you rather shop for clothes at full price or when they're on sale?

Ok, then. Right now just about the entire stock market is on sale. That scares people because they're watching the value of their 401(k)s drop. What they don't recognize is the opportunity to beef up their accounts by buying more shares at a steep discount.

Say you bought five shares of Company X for $20 each last year. If those shares dropped to $10 each and you sold them, you lost half your investment.

But say you held them, and put in another $100. At that price you get double the number of shares you originally bought. If the price goes back up to $25 your $200 total investment is now worth $375. Remember, every time you put money into your 401(k), you're buying shares of the stocks, bonds or funds you chose when you did your asset allocation.

Get it?? Of course, it doesn't always work that way. Company X could be a dog, and if you bought it as an individual stock, you're at greater risk of losing the whole investment if things go bad. But in a 401(k) your money is spread among many investments (this is called diversification). That plus the long time you have until retirement works in your favor in terms of surviving short term losses and accumulating shares that will grow in value.

The other thing to consider is that if you're not at least 59-1/2 years old and you withdraw or close your 401(k), you immediately pay taxes on the money you take out, plus an early withdrawal penalty. So if you think you're losing money now, imagine if you pull out and then have to pay the government on top of that.

Long story short: unless you've got a really, really, really, REALLY good reason, stay put. You'll be fine.

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