This is the first in an irregular series of article that will deal specifically with managing your 401(k) plan. In this article, and most of the series for that matter, I am going to assume that you are saving in your 401(k) for long-term or retirement savings. Given that assumption, we want to select consistent performers that can add value over time.
I am fairly lucky. I actually selected the investment options in our 401(k) plan, so, of course, I think we have a pretty good set of investment options to choose from. Not everyone is so lucky. A lot of HR departments see it as their lot in life to dumb down 401(k) plan investment selections to save us from ourselves, which I might find a little less presumptuous if I actually thought they knew what they were doing. But that’s a story for another day.
I think we have to look at how we handle our 401(k)s slightly differently than other investments because they are one of the few investments we make where we truly dollar cost average. By which I mean we buy consistently when stocks are cheap — so we buy more — and when they’re pricey — we buy less. This, to a degree, evens out the ups and downs of the market over time. In a future post we’ll look at how we might maximize our returns by best selecting where to put our contributions.
Generally, though, I am going to hold to a maxim that if you hang around this blog long enough you will hear me repeat ad nauseam. That is, that we can maximize our ultimate wealth as much by avoiding the significant downturns in the markets as we can by catching the uptrends. Clearly, this leads many of the buy-and-hold crowd to start wagging their fingers at me, but I think I have something here.
As you know if you’ve followed this blog, I use Marketclub’s trade triangles to help me manage my personal portfolios. The same is true of my own 401(k), where I use the long-term trend spotting monthly trade triangles. The monthly trade triangles work especially well in a 401(k) because:
- They follow long-term trends
- They minimize transactions — we don’t want to be making transfers in our 401(k) frequently, maybe two to three a year MAX.
- They let us capture the major up and down trends that affect our individual investments
- They cover mutual funds too. This is huge as a lot of stock services don’t, and at least in my observation, most 401(k)s use mutual funds.
A quick word on Marketclub is in order. As you can clearly tell from this blog, I really like Marketclub and I use it a lot in managing my own portfolios. I do want to let you know that I pay for my subscription to Marketclub like everyone else and converted to membership after a free trial (see opportunity in right margin). I like it because it’s simple and effective, and most so-called “ordinary” investors can use it with little to no learning curve.
Having said that I think the monthly trade triangles work well with mutual funds in a 401(k), I decided to do a back-test to see how right my theory is. I picked Fidelity Dividend Growth fund, ticker FDGFX. This is a conservative, large cap mutual fund that’s pretty typical of the sort of fund you might find in a 401(k) plan. It’s in mine and it’s in my portfolio currently. I started the test in February 2003, which is far back as Marketclub’s data goes for FDGFX. I made the following assumptions:
I would invest $1,000 a month in two$500 semi-monthly investments.
- Funds were purchased the next trading day after the 15th or end of the month.
- When a green monthly trade triangle was in force I invested in FDGFX. When a red monthly trade triangle was in force I invested in cash. For simplicity’s sake I ignored interest or distributions.
- When a red trade triangle appeared I liquidated all holdings to cash the next trading day. When a green monthly trade triangle appeared, I invested all accumulated cash the next trading day. So, I was either long FDGFX, or in cash (in reality you would be in a money market fund).
I compared that strategy to what most folk do, which is just invest steadily twice a month without interruption. Continue reading