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Why your 401(k) plan can deliver in good times and bad

03/18/2010:

The market drop and rebound since the 4th Quarter of 2008 has been nothing short of a big rollercoaster ride. The drop created fear and the revival for saving for the unexpected. This made people think about how they save in their retirement plans.

For the roughly 50% of Americans that have access to a 401(k) plan, we enjoy an investing tactic that is automatic for the vast majority – it’s called dollar cost averaging. Each pay period most of us contribute a part of our paycheck into our 401(k) account. When the markets are down, your 401(k) contribution buys a greater number of shares. When the markets are up, your money purchases fewer shares. Because you receive more shares when markets are down, you tend to be better off as markets recover.

Take a look at this example of how this can work for you:

Period Amount Contributed Fund Share Price Share Purchased
1 (Market High) $500 $100 5
2 (Market Low) $500 $50 10
3 (Recovering Market) $500 $75 6.67
Totals $1,500 $75 average price 21.67
Value $1,625.25 21.67 shares at $75  
Unrealized Gain $125.25 or 8.35%    

In this dollar cost averaging scenario, you've earned 8.35% even though the market has not come close to exceeding the previous market high. If you checked your 401(k) balance last year and then again now, you’ve probably seen a very nice boost.

To be certain, dollar cost averaging won’t assure a profit or protect against loss as your experience will vary with stock selection and changing market conditions. But, it is a best practice as “timing the market” has proved about impossible even for the best professional money managers. To learn more about developing an investing strategy for your 401(k) account, give this guide a read.

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