Home / Lifestyle / The upside to a down stock market: It can boost your 401(k)

The upside to a down stock market: It can boost your 401(k)

DAILY NEWS CONTRIBUTOR

Friday, March 4, 2016, 9:00 PM

NRjmiks/Getty Images/iStockphoto

The stock market may have had an upbeat week, but as far as I can tell no one is very happy about market returns so far in 2016.

Oh, sure, there are those who bailed on the market in 2008, never to return, and now seven-plus years later can finally beat their chest saying, “I told you so.”

But I think even those people can’t be too happy about this, since rubbing it into the faces of friends and family probably doesn’t make one very popular at the local watering hole or Sunday dinner.

EXPERT SAYS KEY TO FINANCIAL PLANNING IS THINKING LONG-TERM

There are those who should be happy about the market decline, but probably are not. What these people don’t realize is that the current decline is creating more future wealth for them than if the market had continued to climb higher and never dropped.

The beautiful thing is that chances are good that you’re a member of this group.

To quote Jerry Seinfeld, “Who are these people?” Well, it’s anyone contributing on a regular basis to a retirement plan such as a 401(k) or 403(b) plan at work.

Why should these people be happy? The answer is simple, one that can be summed up in three words — Dollar Cost Averaging.

Dollar cost averaging is where you invest the same dollar amount each period regardless of the price of the investment you’re buying. When the price of the investment is higher, you buy less shares; but when the price of the investment is lower, you buy more shares.

Since investments tend to go up and down, dollar cost averaging can result in more shares being owned than if all the shares were purchased at once. This simple example should help explain:

Investor A invests $ 1,000 in an investment with a current price of $ 10 per share. Simple division results in Investor A buying 100 shares.

Investor B invests $ 500 in the same investment, currently resulting in a purchase of 50 shares. Then next month, she invests the remaining $ 500 in the same investment, but the price has now dropped to $ 9.50.

At $ 9.50, she was able to purchase 52.63 shares, giving her a total of 102.63 shares, or 2.63 more shares than Investor A.

If the price of the investment had gone up, Investor B would have purchased less shares in total than Investor A.

However, given the fact that markets don’t go straight up or straight down, but do trend higher over time, dollar cost averaging has a very good chance of resulting in you owning more shares than if you purchased the shares in a lump sum.

Nowhere is the power of dollar cost averaging more strongly felt than in your 401(k) account. Each pay period the same amount is taken from your paycheck and invested in investments you have selected. You cheer when those investments are doing well, although at the same time you are buying less shares.

Then when the market takes a dip, you bemoan the “paper” loss in your 401(k) plan, yet you are now buying more shares in those investments.

Truth is what you should really be hoping for is low prices in your 401(k) plan while you are contributing to the plan, since you wind up buying more shares that way. The only time you would prefer the investments to be higher is when you need to take a withdrawal from your 401(k) plan.

In that case, dollar cost averaging works for you in reverse. Selling an investment when it is higher results in fewer shares of that investment needed to be sold. This keeps more of the shares invested in your 401(k) continuing to grow tax deferred.

So now, the next time you hear the market has dropped, look on the bright side. Rather than be upset about how much money you lost, think instead about the additional shares you have purchased inside your 401(k) plan and how you only wish the market would continue to go down so you can buy even more shares.

Better to cheer softly, at least in front of others who don’t yet realize how powerful dollar cost averaging can be. Otherwise, you may wind up sitting next to the “I told you so” friend wondering where all your friends have gone.

Howard Hook is a certified financial planner and CPA with the wealth management firm EKS Associates in Princeton, N.J.

[The content provided through this article and www.nydailynews.com should be used for informational purposes only and is not intended to be a substitute for professional advice. Always seek the advice of a relevant professional with any questions about any financial decision you are seeking to make.]

For more DAILY VIEWS, The News’ new contributor network, click here.

Tags:
daily views ,
wall street


Lifestyle – NY Daily News

Leave a Reply

Your email address will not be published. Required fields are marked *

*