Savers with individual plans, like Keoghs (for the self-employed) and Individual Retirement Accounts (especially for employees without pensions), face the same confounding question. So do teachers and government workers, who have similar retirement plans of their own. Your future depends on achieving good investment returns. But few people are taught the principles they need to succeed.
The result is exactly what you’d expect. Many plans are managed badly. You’re probably relying too much on bonds or fixed-payment “guaranteed investment contracts” (GICs) and shying away from the stock funds that can deliver better long-term growth. Bonds did well in recent years. But historically stocks have returned an average of 7 percent over inflation, reports Ibbotson Associates in Chicago, while long-term bonds returned only 1.6 percent. When will stocks really shine again? Maybe tomorrow, maybe in 1995. That’s what makes investing so perplexing to many nonprofessionals. You cannot know. You play the odds.
Most employers who offer 401(k)s believe that your investment problems aren’t their lookout. You’re a grown-up, they say; how you handle your pension is up to you.
But that’s a cop-out. The United States has traditionally grounded part of its social-welfare plan in the private sector-and retirement funds belong in the safety net. If companies don’t do their job (as they haven’t with health insurance), then government and society fail, too. Around 100,000 401(k) plans now require participants to make their own investment decisions-up 64 percent since 1988. Having handed you this formidable task, employers have a duty to help you manage the money well.
It’s not enough just to give you a sheet on how each of the funds in the plan invests. Take Ciba, a chemical and pharmaceutical firm. Recently it asked its employees why they kept four fifths of their 401(k) money in GICs. Turns out they didn’t know nearly enough about their alternatives says Bill McHugh, the company’s director of trust funds. Now that Ciba is giving investment seminars, more employees have switched some money into stocks.
At the Bechtel Group, an engineering and construction firm, employees get explanatory bulletins, videotapes and discussions of investment strategy. Bechtel’s employees keep 85 percent of their assets in a fund that principally buys U.S. and foreign stocks and bonds.
The more people learn about their money, the more likely they are to start retirement plans. Contributions reduce your income tax, while earnings on your savings grow tax-deferred. Buying into a 401(k) should be a no-brainer. Most companies add 25 or 50 cents to every dollar you invest-an instant profit just for showing up. Here’s how to improve your retirement plan’s potential for growth:
Tip toward stocks, not bonds or GICs. Younger employees should be 75 to 100 percent invested in well-diversified stock-owning funds, with most of the rest of the money in bonds, says Chris McNickle, a principal in the Connecticut consulting firm Greenwich Associates. In middle age you might drop to 50 or 60 percent stocks. For those past age 60, Brian Ternoey, a principal in the consulting firm Foster Higgins, makes this suggestion: estimate how much money you’ll need to help finance three full years of retirement, and keep that amount in your 401(k)’s bond and money-market funds (the latter is like a savings account). Leave the rest in stocks. More conservative investors might keep five years’ worth of income in money funds and bonds.
If you’re a Keogh or IRA investor, you can get stock and bond funds through a mutual-fund family like the Vanguard Group in Valley Forge, Pa., Scudder Funds in Boston or Twentieth Century Investors in Kansas City, Mo.
Don’t try to “time” the market by switching your money in and out of stocks. Long run, your errors will cancel out your lucky guesses. Instead, allocate a certain percentage of your money to stock funds and stick with it.
For example, say you’re comfortable with 80 percent stocks and 20 percent bonds, a combination that yielded a compounded 11.9 percent from 1947 through 1991. Say, further, that the stock market sinks until the money in your stock fund equals only 70 percent of your 401(k) plan’s total value. At year-end you would “rebalance” your plan by switching money out of bonds and into stocks, until stocks once again account for 80 percent of your investment. Conversely, if the market rises, you’d sell some shares in your stock fund at year-end and put that money into bonds to restore the 80/20 split. With this approach, you are always buying stocks low and selling high (investment Nirvana) as well as holding your market risk to a constant level.
Keep no more than 10 percent of your 401(k) in the stock of the company you work for, McNickle says. It’s risky not to diversify. If your employer puts stock into your plan, invest your own contribution somewhere else.
Who’s responsible if you lose money in a 401(k)? You, if you simply invested badly. For example, you might have left too much money in company stock only to see it drop in the months just before you retired. But your company may also be liable if, among other things, it chooses an unqualified investment adviser, fails to monitor a poor performer or uses the fund for its own advantage, says attorney Richard McHugh of Dow, Lohnes & Albertson in Washington, D.C.
Under new federal rules, employers will be encouraged to offer you more investment choices in 401(k)s. But what most participants really need is guidance in using the funds they have. Some financial planners and stockbrokers are just beginning to get into this game–offering advice for a fee. Employers who want to exercise quality control should set up investment courses themselves.
