Morningstar Investment Management studied how more than half a million 401(k) accounts performed in 2020 to see how participants reacted to the ferocious bear market that hit early in the pandemic.
The great news is that most retirement savers did nothing. They just kept their heads down and stuck with their long-term allocation plan. But those who made changes to their mix of stocks and bonds seem to have paid a big price. The most common action, Morningstar said, was to sell stocks in the first quarter of 2020, when the bear market hit.
That left these investors with a lower allocation to stocks just as the markets went on a ferocious tear. From the low of March 23 through the end of 2020, the S&P 500 returned 70%. Morningstar estimates that people who fiddled with their 401(k) asset allocation underperformed the do-nothing crowd by 7.5 percentage points.
Sure, the 2020 crash and rebound happened at warp speed. The S&P 500 stock index typically needs around two years to rebound from a bear market.
But even with a longer recovery period, the key is to not miss the best days in the market. We're not talking about weeks, or months. It's a few key days that matter most. Morgan Stanley took a look at the performance of the S&P 500 index for the 20 years through the end of 2020. Over the entire stretch, the index returned an average annual gain of 7.5%.
Care to take a guess what the return was if someone missed the 10 best days during that 20 years? The return was 3.35%. Those 10 days shaved performance by more than half.
Morgan Stanley notes that in the past 20 years, six of the seven best days for the index occurred within two weeks of the worst day. Sometimes much faster. The second worst trading day of 2020 was March 12, when the S&P 500 fell more than 9%. The next day turned out to be the second best day of 2020, with the index rising more than 9%.
The hard work of retirement investing is front-loaded. Committing to saving is the first big hurdle, especially how much to save. Set up an automated system for transferring money into your retirement account, regardless of what's going on in the world and the markets. Decide the right mix of stocks and bonds.
If you have a workplace retirement plan such as 401(k) or 403(b), a lot of that is made easy. Most employers "auto enroll" new employees, and may make some key upfront choices for them. That said, you should review the choices. The most important: Set a 401(k) contribution rate that gets you to at least 10% of your pretax salary ASAP.
If you don't have a workplace plan, an hour (or less) of online work to set up an individual retirement account (IRA) is all that's required. You can arrange for automatic periodic transfers from your checking account into your IRA account at a discount brokerage (it will be free on both ends).
This year anyone under the age of 50 can contribute $6,000 to an IRA; if you are at least 50, the annual limit is $7,000.
Not sure of the right asset mix? Look for a target date fund (TDF) that handles all the allocation decisions for you.
Then relax. The bulk of the hard work is done. You are dollar cost averaging (smart), and you have a diversified portfolio of stocks and bonds.
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