Your employer sends the money that you choose to contribute, plus employer match if any, to the administrator of the 401k plan who invests the money as you have
directed, choosing between the alternatives offered by the administrator.
Typically, the alternatives are several different mutual funds with different
investment styles, e.g. a S&P 500 index fund, a bond fund, a money-market
fund, etc. Now, a statement
such as "I see my 401k is up 10%" is meaningless unless you
tell us how you are making the comparison. For example,
if you have just started employment and
$200 goes into your 401k each month and is invested in
a money-market fund (these are paying close to 0% interest
these days), then your 11th contribution increases your
401k from $2000 to $2200 and your 401k is "up 10%".
More generally, suppose for simplicity that all the
401k investment is in just one (stock) mutual fund and that
you own 100 shares of the fund as of right now. Suppose
also that your next contribution will not occur for three
weeks when you get your next paycheck, at which time
additional shares of the mutual fund will be purchased
Now, the value of the mutual fund shares (often referred to as net asset
value or NAV) fluctuates as stock prices rise and fall,
and so the
401k balance = number of shares times NAV
changes in accordance with these fluctuations. So,
if the NAV increases by 10% in the next two
weeks, your 401k balance will have increased by
10%. But you still own only 100 shares
of the mutual fund. You cannot use the 10% increase
in value to buy more shares in the mutual fund
because there is no money to pay for the additional shares
you wish to purchase. Notice that there is no point selling
some of the shares (at the 10% higher NAV) to get cash
because you will be purchasing shares at the higher NAV too.
You could, of course, sell shares of the stock mutual
fund at the higher NAV and buy shares of some other
fund available to you in the 401k plan. One advantage
of doing this inside the 401k plan is that you don't
have to pay taxes (now) on the 10% gain that you have made
on the sale. Outside tax-deferred plans such as 401k
and IRA plans, such gains would be taxable in the year
of the sale. But note that selling the shares of
the stock fund and buying something else indicates that
you believe that the NAV of your stock mutual fund
is unlikely to increase any further in the near future.
A third possibility for your 401k being up by 10%
is that the mutual fund paid a dividend or made
a capital gains distribution in the two week period
that we are discussing. The NAV falls when such
events occur, but if you have chosen to reinvest
the dividends and capital gains, then the number of
shares that you own goes up. With the same example
as before, the NAV goes up 10% in two weeks at
which time a
capital gains distribution occurs, and so the NAV
falls back to where it was before. So,
before the capital gains distribution,
you owned 100 shares at $10 NAV which went
up to $11 NAV (10% increase in NAV) for a net
increase in 401k balance from $1000 to $1100.
The mutual fund distributes capital gains in the
amount of $1 per share sending the NAV back
to $10, but you take the $100 distribution
and plow it back into the mutual fund, purchasing
10 shares at the new $10 NAV. So now you own
110 shares at $10 NAV (no net change in price
in two weeks) but your 401k balance is $1100,
same as it was before the capital gains distribution
and you are up 10%. Or, you could have chosen
to invest the distributions into, say, a bond
fund available in your 401k plan and still
be up 10%, with no change in your stock fund
holding, but a new investment of $100 in a
bond fund.
So, being up 10% can mean different things
and does not necessarily mean that the "return"
can be used to buy more shares.
