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YOUR INVESTMENTS: MIDYEAR OUTLOOK AND FUND REVIEW

401(k) Let You Down? Check the Allocation

Some factors affecting performance are beyond your control, but an annual 're-balancing' can go a long way toward maximizing your account.

July 06, 1999|PAUL J. LIM | TIMES STAFF WRITER

Now that the final figures are in, we know exactly how well mutual funds and stock market indexes did in the second quarter.

Many did extremely well. But the question, of course, is how are you doing?

Since many Americans have the majority of their financial investments in an employer-sponsored 401(k) retirement plan, they will know how they did in the coming weeks as quarter-end statements arrive in the mail.

Don't be surprised if your account saw only single-digit gains over the last three months, despite the double-digit increases for many of the world stock market indexes, financial planners say.

"You may be disappointed," says Ridgewood, N.J., financial planner Paul Westbrook. "But don't worry about that." The important thing is to understand why your 401(k) investments performed the way they did, and whether the performance is consistent with your long-term investing plan.

For some investors, poor quarterly results may be the result of picking one or two bad funds. Or loading up on company stock that didn't do so well.

But by and large, it's your overall asset allocation decisions that determine your returns--in other words, how much you have decided to invest in stocks versus bonds versus cash--and which categories of stock funds and bond funds you choose to invest in.

Hewitt Associates, a Lincolnshire, Ill.-based employee benefits consulting firm, tracks the activities of 401(k) investors through its Hewitt 401(k) index.

In the second quarter, it found that the nation's 401(k) investors continued to put more money into large-cap stock funds, which were already the most popular type of mutual funds within 401(k)s.

Meanwhile, overall investments in small-company stock funds and international funds remained tiny.

In fact, at the end of May, 401(k) plan participants overall had only 3.4% of their account balances in international stock funds, Hewitt figures show. And even less--1.2%--was invested in small-company stock funds.

Yet, to have made significant gains during the second quarter, investors probably needed to have a decent stake in either small-stock or foreign funds.

Popular large-growth-stock funds, while they made money, advanced a modest 4% for the quarter. By comparison, the average small-value-stock fund advanced 17.9%, and the average emerging-markets stock fund surged 25.7%.

Now, before you get mad at yourself, or begin to doubt the wisdom of your asset allocation, realize that the situation may not be your fault. For instance:

* Some 401(k) plans don't offer small-cap stock funds as investment options. In fact, nearly half of all plans fail to offer even a single small-cap fund, according to a recent survey of employers by the New York-based employee benefits consulting firm Buck Consultants.

So even if you wanted to invest in one through your company-sponsored plan, you might have been unable to.

* Some plans don't offer international funds as investment options. Three out of 10 plans still don't, according to the Buck survey. And of those that do, only a minority offer an emerging-markets fund. Instead, most plans offer a plain vanilla diversified foreign stock fund, which tends to invest largely in Europe.

And Europe-oriented funds would not have done you much good in the second quarter, given the region's economic slowdown and currency woes. In fact, Europe funds ranked as the second-worst category of stock funds during the quarter, with gains of just 1.6%.

* Your time horizon and tolerance for volatility may limit your risk-taking ability. Emerging-markets funds (and, to a lesser extent, small-cap funds) may be an inappropriate investment for you, given your situation and their relative degree of risk.

In fact, some financial planners, like Ron Roge of Bohemia, N.Y., generally advise clients to avoid emerging-markets funds altogether.

Now, if you're still concerned about your asset allocation in wake of the second quarter's returns, there are some things you could have done differently to perhaps have boosted your results. Among them:

* You could have routinely re-balanced your portfolio. Many financial experts recommended that investors do this at the start of the year. Did you?

Chances are you didn't, because most individual investors don't even know what re-balancing is.

Re-balancing is a simple process in which you determine what your long-term asset allocation ought to be. Then, once a year or so, as your actual investments stray from that allocation due to market forces, you readjust your investments to reflect the original plan.

For instance, in 1998, large-growth stock funds were the market leaders by far. They advanced 36.5%, on average, during the year. Small-value-funds, on the other hand, lost 6.9%.

So, assuming you started the year with a 70%-30% allocation to large-growth stocks and small-value stocks, respectively, that allocation would have drifted to 77%-23% by year's end.

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