Never before have so many of us (30 million) held so much money ($1.5 trillion) in our 401(k) retirement plans.
And never before has so much of that money been invested in the stock market (76%, or $1.14 trillion). So it stands to reason that in times of market uncertainty such as this, some of us may be thinking--rightly or wrongly--of preserving some of the gains we've enjoyed in recent years.
Yet for as long as Americans have been putting money into 401(k)s (nearly 20 years), we've been advised not to use our company-sponsored plans for short-term trading, timing or preservation strategies.
You shouldn't be trying to "time" the market in the first place, since few can, the argument goes.
Plus, even if you feel like preserving a small portion of your gains, 401(k) money is supposed to be your "long-term" money, notes Elda DiRe, a partner in Ernst & Young's personal financial planning unit in New York City. "You don't want a short-term reaction in a long-term account," she says.
In other words, since long-term money doesn't need to be tapped immediately, it doesn't need to be preserved immediately. In fact, since many of you have a good deal of time to grow your 401(k) accounts--in some cases 30 years or more--you should be investing it more aggressively. After all, the longer your time horizon, the more time inflation has to eat into the buying power of conservative investments.
Still, is it so wrong to use your 401(k)--and not your taxable accounts--to re-balance your overall portfolio or to protect some gains?
Remember, some of us have no assets but our 401(k)s, so that's the only place we have to re-balance our mix of stock, bond and cash holdings--whether it's for long-term strategic reasons or for short-term timing.
According to the Investment Company Institute, the mutual fund industry's chief trade group, 70% of American households that invest primarily through 401(k)s or other employer-sponsored retirement plans don't own any mutual funds outside of those plans in taxable accounts.
For others of us, 401(k) money isn't long-term money. Maybe you're a couple of years away from retiring and needing that money to pay for living expenses. In that case, you might not have the time to wait out a market downturn or make up for mistakes--so maybe some of it ought to be preserved through bonds or bond funds or even a money market mutual fund.
Plus, if you're just re-balancing your portfolio--and not trying to do something dramatic, like shifting half or all of your stock holdings into cash--then "you absolutely should do it in your 401(k)," says New York City financial advisor Gary Schatsky.
"The 401(k) is the perfect place to re-balance when the market has risen," he argues. "Anyone who would say otherwise is not focusing on the tax implications."
Remember, money in a 401(k) grows tax-deferred. So if you're thinking of selling stocks at a profit, by doing so in a 401(k), you wouldn't trigger capital gains taxes as you would by selling in an outside, taxable account.
"That's why we would recommend doing it in tax-deferred accounts," says Edward Giltenan, assistant vice president at T. Rowe Price in Baltimore.
Also, re-balancing stock holdings in a 401(k) allows you to maintain an aggressive stance in your outside, taxable accounts. And there's an advantage to keeping your taxable accounts more aggressive, some analysts argue.
If some of your more aggressive bets in stocks don't work out, you can always sell those at a loss in a taxable account, and apply those losses against gains to reduce your overall tax liability. "You cannot use those losses in a 401(k)," notes Dee Lee, co-author of "The Complete Idiot's Guide to 401(k) Plans."
And if your stocks rise in a tax-deferred account, your gains upon withdrawal at retirement will be subject to ordinary income taxes, not capital gains taxes, which are currently capped at 20%, Schatsky notes.
The concern, of course, is that investors who do use 401(k)s to re-balance or to time the market may go overboard (for instance, going entirely to cash).
Or you may simply forget to reevaluate your 401(k) after you tweak it. For instance, as circumstances change, will you remember to shift back into stocks when appropriate? Or will you simply put yourself on an ever-more conservative course with your long-term money, thereby jeopardizing your chances of retiring with enough money to pay the bills?
"Shifting in a 401(k) is certainly easier," notes Ernst & Young's DiRe. "The risk, though, is, you make a decision based on a short-term move. For instance, let's say you take 10% out of your small-company stock fund and move that to cash or fixed-income. But then the tendency is to not look at your account for a long time--maybe when you get your quarterly or annual statement."