Should I move my 401(k) stash into cash?

@Money July 28, 2011: 4:50 PM ET

NEW YORK (Money) -- With the debt-ceiling deadline looming, should I move all of my 401(k) investments into cash? I'm not planning on removing anything from my account. I would just reallocate it and then wait to see what happens. I know you normally advise against timing the market, but this seems different considering there is an actual date on which something will happen. -- Ben M., Nashville, Tenn.

Assuming you've already got your retirement savings divvied up in a way that's appropriate for your age and risk tolerance, I don't see any reason for you to move your 401(k) stash into cash.

Given all the debt-ceiling brouhaha, I can understand why you may be wondering whether it pays to move your money around to protect your savings. The fevered press coverage certainly makes the situation seem a lot more threatening than regular old market turmoil.

But the fact that this crisis is Washington-driven rather than market-driven doesn't fundamentally affect whether it makes sense to deal with it via market timing.

For example, you say that it's different this time because there's an actual date on which something will happen. But that date may not be as firm as you think.

You may recall that the U.S. actually hit the debt limit in May. Since then, the Treasury Department has been engaged in various maneuvers to pay its obligations. The August 2 doomsday deadline is the day Treasury supposedly runs out of wiggle room.

But several large financial institutions have estimated that Treasury may actually have enough moolah to meet its obligations for about a week after that date. So there's still some question as to what the "actual date" is.

Yes, "something" will happen if the U.S. fails to meet its obligations, but no one really knows what that something will be. The consensus seems to be that we'll see a major sell off in the markets. And I think it's very likely that could happen.

Debt ceiling and your money: Now it's personal

On the other hand, it's not as if investors haven't had time to think about this event. They have presumably factored their apprehensions into asset prices already, so it's possible the reaction might not be as severe as many think.

Similarly, investors could react more mildly than the Cassandra's predict if they see this more as a political matter than a financial one. After all, it's not as if we're Greece and can't come up with the dough to pay our bills (at least, not yet).

Besides, you're focusing on the possible fallout should the U.S. default. But there are plenty of other ways this could play out.

The boys and girls in D.C. could surprise us and come to some sort of agreement in time to defuse the default threat. And depending on what that agreement is, the market could still drop precipitously if investors perceive it as a lousy deal -- or it could rally if the deal is to their liking.

And, regardless of whether the ceiling is raised in time to disrupt government payments, there's also the question of whether or not the credit-rating agencies will downgrade the U.S.'s bond rating from AAA.

In my opinion, there are just too many possibilities here for investors to put their money on any particular scenario.

You may view moving your investments into cash for the short-term as a risk-free way to protect your savings from potential Armageddon. But it's not. If the setback many people seem certain is coming doesn't occur, or is much more mild than anticipated, you've moved your money unnecessarily, and you could miss out on any gains if the market rebounds while you're still in cash.

If a downturn does materialize, you still have to decide when to get out of cash and back to your normal stocks-bonds mix. Move back before the correction is over, and you still take a hit. Wait too long, and you could be left behind if the markets rally.

Point is, if you decide to flee to cash (or make any dramatic move), you're playing a guessing game instead of following a coherent long-term investing strategy.

So as I see it, investors wondering how to react to the ruckus over the debt ceiling are pretty much in the same position investors are always in: How do you invest when you're not sure what the future holds?

Where to put your money in case of default

If the goal were simply to avoid short-term losses altogether, the answer would be simple: Just keep all your money in FDIC-insured savings accounts. But most of us need some capital growth -- if only to maintain purchasing power -- as well as a measure of downside protection.

To me, the right way to get that combination in the face of uncertainty -- especially when investing for retirement -- is to set a reasonable asset allocation strategy.

If retirement is still many years off, I think this whole debt-ceiling imbroglio is a non-issue when it comes structuring your portfolio. Your investing strategy should mostly be focused on getting sufficient long-term growth, not minimizing short-term setbacks that you'll have plenty of time to recover from.

If you're closing in on retirement, then capital preservation is clearly more of a concern. But that concern should already be reflected in your asset allocation. Your portfolio should be tilted much more toward bonds and cash than in the case of a younger investor. And if you're already retired, not only should your retirement portfolio generally have a more conservative bent, you should also have a good year to two of living expenses in cash as an extra cushion.

(For guidance on which mix of assets makes sense for you, check out the Vanguard and T. Rowe Price target date funds on our MONEY 70 list of recommended funds.)

Bottom line: We may very well be headed for a period of significant upheaval in the markets as the result of this debt limit impasse. But if you have the right mix of investments, you should already be prepared to handle a sizeable downturn. If that's the case, you don't want to undermine what you've done.

But if you don't have a coherent retirement investing strategy -- if you're the type who buys and sells based on the headlines -- then I suggest you use the clash over the debt ceiling as an opportunity to create a long-term investing plan.

Because the risk of loss in the financial markets will always be with us. And guessing when and where to move your retirement savings each time some new crisis erupts is no way to deal with that threat. To top of page

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