When should I change my 401K investment strategy from active to passive?

September 24, 2008 1:21 PM

Given today's equity market conditions, when should I change my 401K investment strategy from active to passive?

In my 401K, I'm planning to switch investment styles, moving out of diversified actively managed equity funds to diversified passively managed Vanguard equity, REIT, bond, and TIPS index funds.

The question is, when should I do this, today or when my current fund mix has climbed above the performance of the S&P 500 index? Or, should I wait until the market recovers its YTD losses. I'm using the S&P 500 as a crude performance benchmark. According to Morningstar, my mix of funds is currently underperforming the S&P 500 by 4% YTD and underperforming the funds' respective category benchmarks by 0.25%.

Currently, YTD, the S&P 500 is down 20%.

I can't quite figure out when to make my move. My fear is that if I move money into REIT, bond, and TIPS funds now, I'll lose out if the equity market makes a healthy recovery later.

Any suggestions?

posted by shinybeast to work & money (6 comments total)

The reason for using passive index funds--as I'm sure you know--is because you believe that even the experts (managing active funds) can't predict the ups and downs of the market and different asset classes any better than chance. If you believe this, then why would you--presumably someone who hasn't spent a career studying the markets--think you can time the switch better than chance? Just do it now.
posted by Durin's Bane at 1:33 PM on September 24, 2008

No suggestions, frankly... the thing I keep reading over and over is how there is no safe place right now and how non-institutional investors should just sit tight with what they've got.

The bond markets are the first safe place that money usually runs to when the boat rocks... but they're based on treasury bonds, which have been wobbling as the Fed gets authorization to dump more and more capital into the markets and questions get raised about it being able to meet it's obligations. From there, money would normally fly into the most stable places like stable currencies or commodities like gold, but I've heard that isn't a good idea right now because they keep wobbling too.

For 401k, you're a long term investor... just leave your money in, and shove any new investments towards a fund that's targeted on the year you plan to retire.
posted by SpecialK at 1:38 PM on September 24, 2008

Interesting. Thanks. Two very different recommendations. Yes, I do believe that most fund managers might as well throw darts and, yes, I'm in it for the long haul.

My mix of funds is down 24% for the year so I'm trying to do the math. That's what I need help with.

If I wait for the market to recover the loss, it needs to gain 32%. If I move part of my money into REIT, bond, and TIPS index funds, I don't see a 32% gain in my near future. I think it's much more likely that equities will gain 32% faster than a mix of equities and those other indices.

Does that make sense? I don't want to lock in my current loss by moving into historically lesser performing asset classes today. So, I guess I'm leaning towards waiting until most or all of my losses are recouped before switching to the new portfolio. That could take a year or two or three...

OK. Modified plan... As each of the funds in my current portfolio recoups (or almost recoups) its loss, I immediately take that fund and allocation average it into the new portfolio. I suppose I could eat the loss on any severe stragglers.

How does that sound?
posted by shinybeast at 2:47 PM on September 24, 2008

Ok, I sort of gave the standard 'active' vs. 'passive' argument and ignored the change in asset allocation. Finding the appropriate asset allocation is a whole, huge subject unto itself. For a good start, I'd suggest reading some of the stickied posts (starting here) at the Bogleheads forum and also their wiki, which is run by a bunch of really knowledgeable fans of Vanguard.

You may have to change the way you think about investing some. Many people just consider the historical return for particular asset classes and conclude that they should be 100% equities because they've performed the best on average. But you also have to consider the risk of each asset class. Stocks have high risk so you don't want to be invested mostly in stocks if you need the money in a short time frame. Your current funds could further lose 32% instead of gaining. If you don't want that risk, you have to add less risky asset classes and accept the lower returns that come along with that.

But maybe you're young and don't mind the extra risk of 100% equities, then I'd still suggest immediately switching away from active funds to low-cost index funds in 100% equity.
posted by Durin's Bane at 3:47 PM on September 24, 2008 [1 favorite]

Every day that you do not sell your present holdings is equivalent to a decision to buy them. If you were in cash, would you buy your current holdings? If the answer is no, then you should sell immediately and buy what you really want to hold.
posted by JackFlash at 3:48 PM on September 24, 2008

Every day that you do not sell your present holdings is equivalent to a decision to buy them. If you were in cash, would you buy your current holdings? If the answer is no, then you should sell immediately and buy what you really want to hold.

Um, no.

If you were in high risk areas sell your holdings while the market is way down, you will realize your losses and might climb into an instrument that will go up less quickly and regain value less quickly once the market comes back up.

Example: I buy a share three years ago in a financial firm for $300. The market shits it's pants this year and I decide to sell it at $120 and buy bonds with it because they're nice and safe. Five years from now, when the market recovers and the financial firm is trading at $400, the values of my bonds are only $220 and it will take me another 3 years of holding those bonds for me to even catch up with the financial firm's stock price.
posted by SpecialK at 5:49 PM on September 26, 2008