5 Ways Retirement Savers are Reacting to 401(k) Declines

Most workers are still saving, but changing their asset allocation

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We call our retirement savings a nest egg because we are emotionally attached to that money. That account is earmarked for comfort and security. And that's why watching retirement account balances decline is particularly heartbreaking.

Here are five ways investors are currently reacting to this emotional rollercoaster.

Assessing losses. Some people are able to put declining retirement accounts out of their mind and focus on the long term. But other retirement savers feel compelled to dwell on their gruesomely declining account balance. The average 401(k) plan balance has dropped 14 percent in 2008 to $68,000, down from $79,000 in 2007, according to an analysis of 2.7 million U.S. employees released yesterday by the human resources consulting firm Hewitt Associates. In the past two months, employees lost an average of approximately 18 percent of their 401(k) plan savings, and some lost more than 30 percent.

Still saving. Despite the significant market declines, workers are still tucking away money for retirement. Savings rates have dropped only marginally from 8 percent in 2007 to 7.8 percent in 2008. Just 4 percent of employees have terminated their 401(k) plan contributions altogether.

Searching for safety. Although they’re still saving, many investors are adjusting their investment mixes and moving money into less risky funds, which also have lower returns. Only 53.8 percent of 401(k) assets are currently held in equities - an all time low - compared to 68.1 percent a year ago and down from a high of 74.2 percent in 2000.

Making your move. Fueled by the daily negative financial news, some investors are nervously shifting their money about. The number of employees making trades has risen only slightly to 19.3 percent, up from 18.7 percent in 2007. But the amount of 401(k) assets being transferred has been significantly higher. So far this year, 5.3 percent of 401(k) account balances savings have been traded, compared to 3.5 percent in 2007. In October alone, 1.25 percent of employees' 401(k) balances were traded, almost three times the historical average. "The concerning behavior we are seeing is some evidence of knee-jerk investment decisions, with a significant increase in the number of investment transfers immediately after the market drops,” says Pamela Hess, director of retirement research at Hewitt Associates. “In the vast majority of cases, employees who impulsively respond to the fluctuations of the market can dramatically reduce their overall retirement savings, as employees are unlikely to readjust their investment portfolio when the market makes a turn for the better.’

Emergency withdrawals. Nest eggs are about safety for many people. But sudden and financially catastrophic events like job loss or health expenses not completely covered by medical insurance can force families to dip into retirement accounts earlier than planned. About 6 percent of employees withdrew money from their 401(k) plans in 2008, up from 5.4 percent last year, due to an upsurge of hardship withdrawals, Hewitt reports. Industries that have been especially hard-hit by the economy have been experiencing hardship withdrawals in excess of 10 percent of their population. 401(k) loan activity, however, has remained consistent, with 22 percent of employees currently having a loan outstanding.

“Because the credit crisis has made borrowing from financial institutions more difficult, we're seeing more employees turn to their 401(k)s to get the money they need to help them get by," says Hess. "It's unfortunate that employees are turning to hardship withdrawals instead of 401(k) plan loans, because hardship withdrawals are subject to penalties and additional income taxes that can dramatically and permanently erode employees' future retirement dollars.”