Put your 401k to work

Put your 401k to work

With pensions on the decline, it is common for a 401(k) account to be a person’s largest retirement investment.  For many plan participants, the investment elections in the 401(k) account are largely ignored.  Often times, we see the same investment allocations that were made when the participant enrolled in the plan only now it’s 5, 10 or even 20 years later.  401(k) accounts are very important and the stakes are higher when they are the main source of retirement income.  More times than not, the investment decision-making responsibility falls on the shoulders of the participant…perhaps that’s you.

Participants have a range of portfolio management approaches – some use the “buy and hold” strategy while others opt to hire an advisor to actively manage the account.  “Buy and hold” involves someone selecting an asset allocation and holding it regardless of how the market performs.  This is a passive strategy that relies on time in the market rather than any tactical movements in the portfolio.  There is no inherent risk management being applied other than the philosophy of not having all your eggs in one basket.

The issue with any static allocation is of course choosing the right allocation.  This issue is compounded by the fact that the right mix for a particular investor may not be the same today as is it will be in a week, a year or even 5 years for a variety of factors. It’s like shooting at a moving target. Several years ago, many plans began offering a new type of investment called Target Date Funds. These funds allow investors to choose a single fund with an internal asset allocation that automatically adjusts over time based on the projected retirement date.  This alternative is for investors that do not want or feel they are unable to come up with an allocation of suitable investments and rebalance as needed.

Investopedia defines Target Date Funds as:

“A target-date fund is a mutual fund in the hybrid category that automatically resets the asset mix of stocks, bonds and cash equivalents in its portfolio according to a selected time frame that is appropriate for a particular investor. A target-date fund is similar to a life-cycle fund except that a target-date fund is structured to address some date in the future, such as retirement. Its returns are not guaranteed, but depend on how the market performs.”

Even though target date funds are not actively managed for risk, one may consider them to be a significant improvement over the passive “buy and hold” strategy.  Not only is the original allocation chosen for the participant, the allocation automatically rebalances so the percentages become more conservative as the investor approaches retirement.

Participants also have the option to employ the help of an advisor that can manage the account for them. Financial Engines & Aon Hewitt conducted a study which showed that participants who utilized help did significantly better than those that chose to go it on their own. The study, Help in Defined Contribution Plans: 2006 through 2012 examined the 401(k) investing behavior of 723,000 workers at 14 large U.S. employers. It found that on average, employees using help had median annual returns that were 3.32 percent higher, net of fees, than participants managing their own portfolios.

Aside from participants simply not knowing that they can hire a professional to manage their 401(k) account, there are a few common hurdles that keep people from using an advisor:

1. Some people mistake education for advice but there is a not-so-subtle difference between the two. Many 401(k) plans have advisors that provide some level of education for the plan participants.  However, when asked for specific advice by a participant, the advisor may not be willing or able to render advice to the individual participant because he or she is working for the plan sponsor – or the employer.
2. The participant may not have the ability to have the cost of advisory services deducted directly from the account.
3. Many participants have relationships with investment professionals that assists them with personal investments other than the 401(k) account.  Depending on the structure of the investment firm, they may be precluded from advising on accounts that are held away from the firm.  A 401(k) plan would be considered to be “held away”.

At the end of the day, the most important thing a 401(k) participant should do is pay attention to the account.  If you’re not going to do it yourself, perhaps you should find a professional that can do it for you.  Either way, it is up to you to make sure that you put your 401(k) to work for you.