Education >> Retirement Planning
New 401(k) Investment Choice Causes Common Mistake by Workers
Your 401(k) plan is your best retirement savings vehicle. You get to grow money tax-deferred for many decades. That’s why so many people accumulate more money in their company retirement plan than in any other form of savings.
But you already know this. You know you need to contribute the maximum amount you can, and that you should never touch the money for any reason other than retirement. But, there’s one more requirement to achieving success: You must pick the right investment choices.
Your plan likely offers you 10, 20, or even 60 investment choices. So, which fund(s) do you choose?
My advice has always been the same: Place 100% of current contributions into diversified stock funds. I don’t care if they’re large company stocks or small company stocks, and I don’t care if they’re U.S. or foreign. I also don’t care if you use just one stock fund, or if you split your assets among many stock funds; it doesn’t matter, as long as all your money goes into stocks.
I say this because your money will be invested for decades (if that’s not true, this advice doesn’t apply to you), and history tells us that the best-performing asset class is stocks. You don’t have to worry about “putting all your eggs into one basket” because you’re not investing all your money at once. Instead, you’re investing a small amount with each paycheck, and you’re doing that over decades. This notion, called dollar cost averaging, allows you to invest your 401(k) fully in stocks, instead of spreading your money around to other asset classes.
But some people may not agree with my advice. They argue that you should diversify among other asset classes for the sake of safety. Others simply fear the idea of putting all their retirement assets into stocks. Still others don’t have decades until they retire. For all these people, the question remains: What should your investment mix be?
Should you invest 80% in stocks and 20% in bonds, or the other way around? Perhaps something in between?
To help answer that question, many 401(k) providers are introducing a new investment choice called a lifestyle mutual fund.
A lifestyle fund invests a certain portion of its assets in stocks, based on the age of the person for whom the fund is intended. A lifestyle fund targeted for a 25-year-old would have most of its assets in stocks, while a lifestyle fund targeted for a 55-year-old would have far fewer assets in stocks. These investment choices reflect an effort by your employer to simplify your investment decision dilemma. Just put your money in one of these funds and go back to work.
It seems to make sense for those who insist on ignoring my advice (which gives you an idea of what I think of these funds). However, even those who use lifestyle funds -- as simple as they’re designed to be -- are doing it wrong, according to a new study by Hewitt Associates.
The study examined big corporations that offer lifestyle funds in their 401(k) plans. They discovered that 88% of workers are using lifestyle funds in combination with other investment choices. In fact, according to the study, a surprising one in six workers uses more than one lifestyle fund!
Hello! The whole point of a lifestyle fund is that it creates a complete investment portfolio for you, so you don’t have to use any other fund. But only 12% of workers in the plans surveyed are doing it correctly.
Say you want 80% of your money to be invested in stocks. That means you should pick one stock fund and one bond fund, and tell your employer to place 80% of your money into the stock fund, and put the rest into the bond fund. Or you could pick a lifestyle fund that invests in this 80/20 mix. But if you pick an 80/20 lifestyle fund and a stock fund, you’ll have significantly less than 20% of your assets in bonds, depending on your allocation of the stock fund and lifestyle fund. And, thus, you’ll be ruining your plan.
That’s what’s happening. Many workers are picking lifestyle funds indiscriminately, and using them in conjunction with other choices. As a result, the worker’s overall allocation model becomes warped -- and not at all what the worker intended.
It’s good that employers are realizing that their workers need help in allocating their retirement savings. Offering new types of funds is a good first step, but employers are still falling short because they aren’t educating workers how best to use those choices.
Take a look at your retirement plan. If you’re using a lifestyle fund, take a closer look and make sure you’re using it properly.
Rescue Your Money, written by award-winning financial advisor Ric Edelman, is your personal investment recovery plan.
