Who’s Watching Over Your 401(k)?
Michael P. Carroll, CLU, ChFC, CFP®, ANB Bank, Colorado Springs LIVING WELL Magazine (formerly SENIOR Magazine)
It is popularly accepted that 401(k) plans are and will continue to be the most important savings vehicle for most Americans. However, they may be the most neglected and/or misunderstood investment that people hold. Recently two studies have been conducted, one by Fidelity Investments and the other by Vanguard. Both of these companies are major players in the 401(k) investment management arena.
The information from these two studies provides some real insight into how people manage or don’t manage their 401(k) accounts.
First of all, some interesting statistics. The Fidelity study pointed out that the average 401(k) plan for participants who had been in their plan for six or more years and are in their 50s was $130,932 for year-end 2009. This was an increase of over $33,000 from 2008. There is no data to show how much of this increase is from market value, participant deferrals or employer contributions and/or matches. The Vanguard study showed virtually the same percentage increase in the plans they oversee. Both studies provide validation that people who are enrolled in 401(k) plans see them as a significant vehicle for retirement savings and revealed virtually identical participation levels of 75%.
In the Fidelity study, 44 percent of those surveyed indicated that they had “no idea” how much money they were going to need to accumulate to fund their retirement. In addition, 28% of those participants age 55 or older either had no money in stocks or 100% in equities as part of their allocation, 15% and 13% respectively. In addition, fewer than 16% of those surveyed traded (made changes) in their account during the last year.
If Defined Contribution Plans are the primary savings tool going forward for the average worker, then they should warrant closer management by the participant. Education, or the lack thereof, is a major problem with work related savings plans. Employers seldom feel that they have the experience and expertise to provide adequate education and plan sponsors and/or administrators fall short in this area as well.
Establishing an End Game
Participants really need to be more informed about some of the critical issues regarding their retirement accounts. First of all, employee participants need to have some idea of what amount of money they are going to need at retirement. Remember, “if you don’t have a destination, any road will get you there.” A good fee-based planner can help you define a financial roadmap. This will then give you an objective for establishing a savings program. Secondly, familiarize yourself with the provisions of your retirement plan. How much can you defer from your salary? How much will your employer match? Is there a profit sharing component to your plan? What investments are available to you and what kind of asset allocation do you need to have to get you to your destination. Do not focus on performance! You cannot control performance, but you can control your asset allocation and choice of investments. You cannot create an effective asset allocation until you have an investment policy statement. Ask your advisor to help you create one.
Investments
How much do you know about your investment choices? What do you know about bond funds and how they react to movements in interest rates? What kind of fixed income investments do they hold: tax free, treasuries, corporate, investment grade, high yield, etc.? What is the maturity or duration of the fund? Longer duration funds have higher volatility, some would call this risk. Higher yielding funds have more volatility as well. As interest rates rise, market values of bonds funds tend to suffer over the short term.
What are your feelings about equities? Equities typically carry more risk (volatility) but provide greater returns over the long run. Most portfolios, even in retirement, will require some equity exposure in order to support a four to five percent withdrawal rate without significant principal degradation. What kind of ratings do your funds have and what has been their track record.
Do you own target-date funds? They are becoming increasingly popular because they appear to be a low maintenance way of investing. These are typically funds of funds that have asset allocations based upon years to retirement. However, target-date funds vary dramatically in their allocations. They also vary significantly in the types of investments they hold. What type of bonds funds, duration and quality make up the fixed income portion? Is there diversification amongst small cap, mid cap and international investments within the equity portion? Or are there concentrations in sectors and/or securities.
These are all fundamental questions for participants. The correct answers will dramatically effect your ability to maximize the potential of your qualified plan.
