Roadmap to Riches   
how to invest your 401(k)
Automatic Pilots of 401(k) investing
Impact of Investment Style
Stock Market Cycles
Professional Selections and Monitoring of Funds
Dollar-Cost Averaging
What are the Differences Between Different Funds and Why do These Differences Matter?
Beyond the influence of the stock market itself, the SECOND MOST IMPORTANT determinate for investment success is the investment style of the money manager or mutual fund. Mutual fund managers each adopt different styles of investing.
VALUE investors specialize in large companies that have recognizable value in the form of, say, cash or factories and brand recognition.
GROWTH investors invest in growing companies that may have no cash or valuable assets but that have tremendous potential in the form of new, inventive products.
The different investment styles can be defined by nine possible combinations depicted by the following box:
What this box illustrates is that a money manager (or mutual fund) can be a value or a growth investor -- or a blend of the two disciplines. Then, one of these three qualities can be applied to large companies, medium-sized companies, or small companies. When this nine-frame box is used to describe a manager’s style, one of the boxes will be filled in to indicate where, on the style grid, the manager fits.
Why Is Style Important?
We are always moving through economic cycles. They never stop. At any point during an economic cycle, one style combination will be a winner over all others. Six months later, during a different period in the cycle, another style combination will triumph. We pick up the paper and read that small companies and technology stocks are “hot.” A year later, that style may have fallen out of favor. Instead, large “Blue Chip” companies paying generous dividends will be rising in price faster than anything else. Since economists themselves can never agree on where we are in an economic cycle at any time, it is impossible to know beforehand what new portion of a cycle we will be moving into next or what style will be the most promising.
What Are Stock Market “Cycles” and How Do We Benefit From Them?
The stock market historically has had a 10% “correction” about once every four years and a 20% correction at least once every seven years. “Correction” is just Wall Street’s euphemism or gentle description of a market tumble or crash. In 1987, the market lost 25% of its value in just a few days. In 1974, the so-called “nifty-fifty” stocks included Xerox, IBM, Polaroid, etc. These fifty companies, the Apples and Microsofts of their day, all lost about 40% of their value in just a few months.
The market remained in the doldrums throughout the rest of the 1970’s, and then began to recover in the early 1980’s. A $1,000 investment in 1974 is worth almost $20,000 today. The combination of one of these “corrections” along with a dramatic increase in values a few months or years later constitutes a full stock market cycle.
Therefore, those of us who wish to experience the greater returns historically generated by the stock market, need to be using the market for longer-term financial goals. We need enough time to assure ourselves that we will be invested through two or three market cycles. Five years is not enough time for this guarantee.
If 401(k) contributions are made for the purpose of borrowing the money within five years for a house down payment, then a money market fund is probably the best investment for this short time frame. If the money is contributed for the purpose of retirement itself or college in ten or twenty years, then the stock market is a better statistical bet.
Dollar-Cost Averaging
Appreciate the power of “dollar cost averaging.” When markets go down in value, this is good for 401(k) investors. New inbound money is buying mutual fund shares at lower prices. As “goofy” as this may sound, in the early years of a 401(k) experience, we want to pray that the stock market crashes from time to time. Each crash allows us to buy shares at bargain basement prices which we will be able to sell at higher prices years later to fund our retirement.
Rebalancing
Rebalancing is a variation of dollar cost averaging. If we choose an investment mix today of, say 40% bonds and 60% stocks, we should rebalance and go back to those proportions once a year if gains on one side have caused the percentage mix to depart from our initial balance. This forces us to sell the asset class that has gained in value and we buy the cheaper asset. We are methodically selling high and buying low. Rebalancing once a year is considered to be adequate.
The Bottom Line
On Wall Street, the saying goes “More money is made in falling markets than in rising markets.”
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