Perils of the 401k

Long before the bear market from October 2007 to March 2009, employer retirement plans such as the  401k and 403b, left a lot of investors unfulfilled and disillusioned. The Pension Protection Act of 2006 was meant to improve these plans and make them better vehicles to help people build financial security. Some helpful steps became requirements.

Unfortunately, the majority of participants in these plans don’t get the most out of them. This happens for three key reasons:

1)      There’s no goal.

Most people don’t know approximately how much they want to have in their retirement accounts when they retire.

 2)      It’s difficult to map a path to a goal.

People often have no idea how much they should save each paycheck or each year and what investment returns they will need in order to achieve their goals. 

What percentage of your retirement income will you need to generate from your employer plan to supplement Social Security and any other sources? What account balance do you need to create an acceptable income stream? In other, words, what’s your number? Is it $500,000, $1,000,000, $2,000,000? Remember that you can only spend dollars in an after-tax world so you should consider what impact taxes have on the value of your retirement plan. If you have $500,000 and you expect to be in the 25% tax bracket in retirement, the after-tax value of a 401k account is only $375,000.

3)      One-on-one advice is typically not offered.

Research by retirement plan administrator Hewitt Associates shows that just 29% of plan participants are provided access to advisors who can recommend how to best utilize employer plans in conjunction with other accounts.  This makes it difficult to implement a well-intended investment strategy. Without understanding how all your financial resources fit together it is also difficult to correct your course when markets and life cause detours along the way.

These issues are compounded by the experience of the average worker who changes employers along the way to retirement. Now, they have to figure out how to best allocate their holdings in their taxable accounts, old retirement plans and new employer plan to best meet their short- and long-term needs.

Legislative activity and revised regulations from the Department of Labor have danced around the topic of advice without reaching clarity about how to best make it available. With luck, more information is expected later this year.

We believe that advice from an independent advisor, acting in the best interest of each individual plan participant, could improve both the experience and likelihood of achieving investment success. This would go beyond quarterly educational presentations from a client service rep.

Education initiatives have been one of the clear failures of employer retirement plans. Most people have insufficient financial literacy. The fact is, it’s tough to absorb investment education when it’s not building on an existing foundation of knowledge. Therefore, participants often make poor decisions.

1. They lack understanding of the differences among investment options
2. They are uncertain how much to invest in each asset class so they have a coherent investment strategy
3. They misuse investments in combination with other taxable or IRA investments, increasing risk
4. They chase the best recent returns, try to time moves from one fund to another or succumb to inertia and make no decisions at all

To get the most out of any employer-sponsored retirement plan, we think that participants should:

1. Identify a goal. Understand what you need to save to create an adequate stream of income in retirement. 
2. Understand the objectives and costs of each individual investment choice (both inside and outside your employer’s retirement plan) and how they fit together.
3. Build a diversified strategy with an expected return in line with your goal and your tolerance for market fluctuation.
4. Correct course as often as is necessary when markets change, your job changes or your goals change.

If you need help to be confident in these tasks, encourage your employer to make one-on-one advice available or be proactive and hire an investment advisor directly.