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By Robert Barker You needn't have a bunch of money tied up in company stock -- as did so many unhappy Enron (ENRNQ
) employees -- to have too much risk in your retirement plan. Even if you don't own a single individual stock, your nest egg could be threatened by broad, unforeseeable risks, such as interest rates ratcheting up or a sharp drop in the prevailing multiple paid by investors for future corporate earnings.
The good news is you now have a new tool on the Web, 401k CheckUp, to help you get a handle on how much risk you've taken on. It's free, and checking it out is worth your time. RiskMetrics, a J.P. Morgan spin-off, built it as one tool in a kit it hopes to sell to financial advisers and retirement-plan administrators. You can find it at www.401k.riskmetrics.com.
LET'S PRETEND. At 401k CheckUp's home page, a click on the top link, labeled "Access," fetches the tool. It begins with a few basic questions, such as your age and the age at which you would like to retire. It then asks about your 401(k) portfolio. For kicks, I pretended I own 1,000 shares of stock in BusinessWeek Online's parent, The McGraw-Hill Companies ((MHP)
), 2,000 shares of Fidelity Magellan Fund ((FMAGX)
), 3,000 shares of Templeton Foreign Fund ((TEMFX)
), and 4,000 of Pimco Total Return ((PTTAX)
), which is a leading bond fund. (If you hold stocks or funds in a retirement account other than a 401(k), such as an IRA, you can include those in the calculations as well.)
When I was done, RiskMetrics' tool calculated my total (hypothetical) 401(k) account to be worth $331,300. Next, it offered a measure of the account's riskiness: 67, about midway on the scale from 0 to 125, or "Speculative." Based on five years of historical data, the worst three-month return would have meant a loss of 16%, or $55,922, according to RiskMetrics.
But what if some catastrophe struck? As we appreciate much more deeply since September 11, disaster can strike without warning. This portfolio, RiskMetrics reckons, would have lost 14.8% in the "Black Monday" crash of 1987. The tool also told me that the portfolio's big chunk of stock in McGraw-Hill presents a different risk: If that stock were to drop by half, nearly a third of the portfolio's value would go poof!
DIVVYING SCENARIOS. The standard financial-planning answer to that problem -- too much money in one stock -- is the trusted D-word: diversification. The tool scores your portfolio for how diversified it is (mine was 58% diversified), and then turns to the trick of demonstrating how the portfolio might be better divvied up among assets.
You might imagine, as did I, that the best move would be simply to exit company stock. Not so. The tool allows you to play around with different scenarios by clicking on and moving on-screen "sliders." For example, when I used the sliders to cut the portfolio's exposure to McGraw-Hill to zero and reallocate the proceeds among the three mutual funds, I found overall diversification in the portfolio stayed the same.
The most effective diversification move, it turns out, is to buy more bonds and reduce some of the holdings in the stock funds as well as in McGraw-Hill stock, but not eliminating it entirely.
VALUABLE TIME. I was able to play around with the tool and draw these conclusions in less than 30 minutes, including the time it took to read the instructions carefully. A novice but curious investor might spend far more time at the site, however. Back at the home page, RiskMetrics also has provided a link labeled "Educate Yourself: Exploring Risk." Click there and you can start a lengthy tutorial. It has a very detailed introduction, and is broken up into sections on identifying risk, measuring it, and managing it.
The whole tutorial is well done, intelligent, and clear, with an excellent glossary. But for what it's worth, my advice is not to attempt to plow through it all at one sitting. Each of the three modules takes up to 45 minutes to absorb. So go through one a day or perhaps one every other day. Toward safeguarding what is for many people their largest financial asset, it would be time well spent. Barker covers personal finance in his Barker Portfolio column for BusinessWeek. His barker.online column appears every Friday, only on BusinessWeek Online