The Economy is in a complete recession...What do I do with my 401k?

Don't waste life in doubts and fears; spend yourself on the work before you, well assured that the right performance of this hour's duties will be the best preparation for the hours and ages that will follow it. - Ralph Waldo Emerson

At the time of this writing, the stock market has closed approximately 400 points down today. This is very disheartening information for many Americans today who are constantly saving money for retirement in the stock market. Although many of the analysts and financial gurus are saying that "this is the time to invest", it is hard to contribute 6% of my bi-monthly income to a retirement account only to see it decline 4-5 percent immediately thereafter. Even I find myself becoming a bit more doubtful in the future of our stock market because it just seems like every day we take one step forward, the next day we take two steps back.

This time period has given me the opportunity to begin researching other investment options outside of the stock market to learn the all important rule in smart investing...diversification.

Diversification: A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio. (Cited from Investopedia)

A silver lining in a gray cloud

Some of the online analysts and experts recommend to have a 100% diversified stock allocation if you are saving 20+ years for retirement. I agreed with this particular recommendation until I came across this latest financial crisis. Now I believe that true diversification is having a mix of bond and stock securities at all times no matter the length of years to wait before retirement.

Back in July, during the time the Dow Jones index was around 11,000, I shifted about 30% of my total allocation from stocks to two specific bond securities. Although most of the positions in my 401k portfolio are down at the current moment, however the investments in the bond markets have provided a positive return.

Although a lot of focus is not placed on bonds, I wanted to highlight the two that I am currently invested in. I believe these bonds have the potential to give a decent return in the current market conditions:

1. Inflation Protected Bond Fund (TIPS)
   
• What it invests in
  The return earned on an inflation-protected bond comes from two components that respond to movements in inflation and real interest rates. The first component of return adjusts the yield by the change in consumer prices. In contrast, the second component of return operates inversely with the movement of real rates; if real rates rise, the price of the fund will fall, and vice versa. (Taken from the Prospectus on Fidelity's 401K Site)
  
2. Stable Value Fund
• What it invests in
  The fund invests in fixed-income securities and book value wrap contracts issued by banks and insurance companies, which provide for the payment of a specified rate of interest and for participant withdrawals at book value (i.e. principal plus interest). (Taken from the Prospectus on Fidelity's 401K Site)

Although they do not have great returns, something positive is better than something negative.

Timing is Everything

Although I am looking at approximately 35 - 40 years before I am able to touch the savings in my 401k and Roth IRA, I have already planned how I hope to allocate my funds as it gets closer to retirement. The strategy I plan on following is to place most of my allocated money in an aggressive (higher risk/higher return) allocations and continue to have some money allocated in more conservative (less risk/less return) investments while I have more than 10 years to touch my money.

The thought behind this is that although the stock market may continue to be volatile, I will end up positive in the long run. The goal of this type of allocation is to gain a higher interest rate than that of investing in a high yield savings accounts or in bonds.

As I approach closer to the time where I am able to access that money without penalty (within approximately five years), I will make the shift to a more conservative portfolio that will allow me to reduce my risk in the stock market and continue to keep the majority of my money on fixed rates. Although I will not potentially make as much in interest on my money, I can rest assured that I will not lose the majority of my money in volatile stocks. An example of a conservative portfolio is 75% bonds and 25% stocks.

Eyes on the Prize

The key to succeeding in long term investing is to develop a plan and stick to it. Although I have seen the value of my funds decrease over the past few months, I have seen the overall number of the amount of shares that I own increase. I have continued to contribute to my stocks to continue increasing the shares that I own. It is my hope that the economy will rebound soon to help continue to increase the overall value of my retirement plan.

How are you holding out with your 401K plan? Do you still contribute? Share your thoughts below.