Strategies for saving in 401(k) plans (Keith Negley, For The Times )
Every paycheck, tens of millions of Americans diligently save a chunk of their income via 401(k) retirement investment plans.
Yet for many people, much about their 401(k) is a giant mystery. How can you judge whether your plan is a good one — or a dud? And how do you know whether you're investing correctly?
With a record $4.8 trillion now in 401(k)s and similar plans, such as 403(b) plans for public employees, the stakes have never been higher. Recognizing this, new federal rules took effect July 1 that will force employers to reveal more about the often-hidden fees of the programs. Those expenses can eat up a sizable chunk of your savings over time.
The fee disclosures will provide a great opportunity for investors to take a broader look at their 401(k) plans. Particularly if you haven't paid much attention to changes in your plan in recent years, you may find more features that can raise the odds of success — or at least lower the odds of something cataclysmic happening to your nest egg.
Here's a road map for evaluating your 401(k) or 403(b) plan, how to make the most of what you're offered, and what to expect as more companies add new features to their plans:
Do you know your investment options?
Many investors have been frozen in place since the stock market crash of 2008 and the subsequent partial recovery. If it has been years since you last looked at what your 401(k) plan offers, you might be surprised at your choices. Your employer might have added new investments and substituted others, hopefully with the aim of providing a better opportunity to build a diversified portfolio.
Conventional mutual funds remain the main type of investment in 401(k)-type plans, along with money market (cash) accounts and, in the case of publicly traded firms, company stock. The average plan offered 19 separate investment choices in 2011, according to a Vanguard Group survey. That was up from 16 in 2002.
Yet most people use only a few options — 3.2, on average, according to Vanguard. That isn't necessarily a bad thing. For younger workers in particular, a few may be all they need for basic diversification starting out: say, a blue-chip U.S. stock fund, a small-company U.S. stock fund, a foreign-stock fund, and a bond or other income-oriented fund.
"Once you have three or four options in major asset classes, you've pretty much got it covered," said Michael Yoshikami, head of financial-planning firm Destination Wealth Management in Walnut Creek, Calif.
But older employees who have amassed substantial savings are more likely to want additional diversification options. That can lead to frustration, because popular niche investments still are relatively rare in 401(k) plans.
For example, it baffles some financial advisors that commercial real estate funds aren't offered by more plans. The latest survey of 401(k) plans by the Plan Sponsor Council of America found that in 2010 28% offered real estate funds, which typically invest in shares of real estate investment trusts.
Gold and other such "sector" mutual funds are even scarcer. Fewer than 20% of plans offer them. And only a very small sliver of plans include exchange-traded funds on their menus.
Perhaps surprisingly, 401(k) plan options often are more extensive at smaller companies than at big firms, said Michael Alfred, co-founder of BrightScope Inc., a San Diego company that rates about 50,000 401(k) plans.
"But a lot of that has nothing to do with what's best for investors," Alfred said. More likely is that smaller firms' investment rosters reflect the success fund companies have had in marketing many mediocre options to small-company executives. Some small-company plans have as many as 50 investment options, Alfred said. "I think that's definitely overkill."
Should you go the simplified route of a "target-date" fund?
Target funds can eliminate for many investors their most vexing challenge: deciding how to diversify assets and how to change that mix over time.
Target-date funds (sometimes called life-cycle funds) invest based on a specific retirement date. Say you expect to retire in 2040. A fund with that date most likely would hold the majority of current assets in stocks, aiming for long-term growth. But each year, the percentage in stocks would decline while the percentage in typically more conservative, less volatile investments such as bonds would rise.
Target-date funds have exploded in popularity with 401(k) plans over the last few years. Eighty-two percent of plans now offer the funds, up from 58% in 2007, according to Vanguard. And 47% of plan investors use a target-date fund, up from just 18% in 2007.
The jump in participants' use of the funds in part reflects that many companies make a target-date fund the so-called default option for investors: If you don't want to choose specific investments, your savings are channeled into the target-date fund closest to your assumed retirement year.