By Tom Breiter
Recent surveys of 401K plan participants have revealed that many are giving up one to three percentage points of return each year because they commit mistakes that are easily avoidable, and that we have covered here in the Sun in recent years.
One to three percent may not sound like much, but it can be a huge difference over time, particularly in tax deferred accounts like IRAs and company sponsored retirement plans. For example, in a plan where the participant and employer contributions total $500 per month, earning 8 percent annualized vs. a 6 percent annual rate over a 30-year career will provide an additional $243,000 of assets in the retirement plan. Couldn’t we all use an extra couple hundred thousand in retirement?
What are the mistakes most commonly made? The first is being too aggressive, but most of the investors committing this foul don’t see it that way. Twenty percent of 401K plan participants had more than half their balance in company stock in plans where owing the sponsoring company’s stock was an option.
Most workers feel good about owning the stock of their employer and don’t see it as a risky bet. The problem is that the facts aren’t on the side of the hard-working plan participant. Owning any individual stock is much higher risk than owning a pooled, diversified investment such as the mutual fund offered in almost every retirement plan today.
By keeping a large proportion of their retirement balance in their employer’s stock, they are taking a huge leap of faith that 1) nothing bad will ever happen, and 2) that the employer’s stock price will defy the long-term odds and provide an above average performance. Experiences of employees of Enron, Worldcom, AT&T, Delta Airlines and others should be a lesson indelibly etched in our memories.
Most success in investing comes from consistently earning average rates of return without absorbing large losses. To avoid that chance, limit ownership of employer’s stock to 10 percent of your total balance.
The second most common error is on the flip side – being too conservative. Many plan participants have just never done much investing and their lack of knowledge and confidence results in the selection of the most conservative options within the plan, even for younger workers who should be investing more for long-term growth.
The really cool thing about 401K plans is that your contributions and the matching contribution of your employer are put to work every pay cycle through all the stock market’s ups and downs. You are buying at regular intervals on a schedule. This is know as dollar cost averaging, and it has been a great technique for building wealth over time.
Dollar cost averaging the majority of your plan contributions into CDs, money market funds or stable value funds that provide about half of the return that stocks have provided historically does not make a lot of sense. Even investors in retirement should put at least a portion of their assets in stocks and stock funds. The right answer here is a blend of stock funds for growth and fixed income funds for stability, based on your personality and time to retirement.
Mistake #3 is buying a little of everything without knowing what the end-result is. While spreading your balance equally across a spectrum of the plan choices may seem harmless and is a better choice than the first two mistakes covered above, I would prefer to see you spend at least a little time understanding what owning each fund does for you and then work toward a proper asset allocation that meets your personal needs
The good news is that there is help for those who wish to help themselves. Most 401K plans have Web sites where you can learn more about the basic characteristics of the different types of investment choices. Many of these even have simple profiling tools that you can use to obtain a recommended allocation after answering some questions about your financial situation.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing.