It's Time to Retune Your 401(k)


By Amey Stone Your quarterly 401(k) statement will be arriving in the mail shortly. Sit down in a comfortable chair, get out your letter opener, and relax -- because you'll probably be relieved when you look at the third-quarter results. With the average stock fund up 19% this year through the end of September, and the average taxable bond fund up 7%, chances are that your 401(k) has recouped at least some of the losses suffered during the three-year bear market (see BW Online, 10/15/03, "The Great 401(k) Hoax, Continued").

This is in contrast to 2002, when the average balance of 401(k) plans fell 8%, according to a review recently published by the Investment Company Institute (ICI) and the Employee Benefit Research Institute (EBRI). The study looked at more than 5 million plans held for at least three years. The drop was harsh, but far less than the 22% plunge in the stock market because most participants continued making contributions.

AGE MATTERS. So, finally, good news. What do you do next? It's time to make sure you're on track to save enough money to be able to retire in comfort. The Internet has hundreds of free calculators, including BusinessWeek Online's own, that can help you determine how much cash you should contribute to your retirement plan each month and the appropriate mix of investments given your age and appetite for risk.

As a rough guideline, if you have 30 years to work before retirement, you should have about 80% of assets invested in stocks and 20% in bonds. Then, you should gradually shift more of those assets to fixed income as you approach retirement age, says Catherine Collinson, senior vice-president for strategic planning at Transamerica Retirement Services.

Warning: You may be doing serious damage to your chances for a comfortable retirement by failing to adjust your mix of investments at least once a year (a concept known as "rebalancing"), say retirement experts. Unfortunately, only a small fraction of people with retirement plans do this annual adjustment. According to human-resources consulting firm Hewitt Associates (HEW), just one in six participants made any kind of trade in their account in 2002. And that's down from one in five in 2001.

TOO CONSERVATIVE? The relatively small average drop in retirement savings in 2002 masks worse damage to the retirement savings of older employees who were aggressively invested in stocks. Workers in their 50s, whose contributions generally were a smaller percentage of their total retirement savings, lost an average of 10% in 2002, even though presumably many of them were conservatively invested, according to the ICI/EBRI study (see BW, 07/28/03, "Managing Risk: Take a Page from the Pros").

"If someone age 55 in 1999 who was planning to retire at age 62 didn't reallocate their assets to prepare for their upcoming retirement date, they're probably not going to retire as soon as they thought," says Gregory Miller, an asset-allocation specialist at mutual-fund firm Waddell & Reed.

Now that the stock market is going up, an even bigger concern of plan administrators is that too many young workers are risk-averse and too conservatively invested in their 401(k)s. In a September survey of records it keeps for nearly 500 large companies, Hewitt estimates that 25% of plan assets are in the low-risk, low-return guaranteed or "stable value" options. With such choices, "you're just treading water," says Lori Lucas, Hewitt's manager of participant research.

LIFESTYLE FUNDS. In retirement planning, striking the right balance is key. And one of the best ways to do that is to be properly diversified in a mix of growth-stock funds and more stable, fixed-income assets. Putting the bulk of your retirement money in company stock is probably the biggest mistake employees make. Some plans don't give participants an option, but legislation is likely to pass next year that will prevent companies from requiring you to keep company stock given to you as part of a matching program for a specific length of time.

"You may work for a company you love, but for reasons that the company may have no control over, it could be destroyed," says Danny Streiff, educational director at ICC Plan Solutions in Charlotte, N.C., which provides education programs to 401(k) holders. "By putting your retirement savings in one stock, you are gambling." He recommends sticking to funds that represent broad asset classes -- like large-cap growth stocks or long-term bonds.

An easy way for procrastinators to stay on track for a comfortable retirement is to choose a so-called lifestyle fund. These are one-stop-shopping vehicles that are diversified and rebalanced automatically each year to accommodate different risk profiles. They're now available at 55% of companies surveyed by Hewitt, up from 35% in 2001. But Hewitt has found that most people don't use them correctly, choosing the lifestyle fund as just one of a mix of different funds. To work as intended, a lifestyle fund should be the only fund selected.

Despite the three-year bear market, Hewitt's research has found that people who are participating in 401(k) plans are on track to be able to retire with at least 85% of their preretirement income (that's including additional income sources, such as Social Security and a traditional pension plan).

But only 68% of employees are participating in their company plan -- down 2.8 points in 2002, with the decline most evident among younger and low-tenure employees, according to Lucas. She also notes that many young people are contributing less to their retirement plans, despite changes in 401(k) rules in 2001 that allow workrs to contribute more each year.

VICTIMS OF APATHY. Even if 401(k) plans can still theoretically provide most employees with comfortable retirements, "there are many pitfalls that could derail people along the way," says Lucas, including being poorly diversified, failing to rollover the assets when you change companies, or borrowing from the plan and not paying it back. Only 17% of plan administrators at companies Hewitt surveyed said they were confident that most employees would be able to meet their retirement goals, says Lucas.

Retirement experts hope the improving economy and accelerating stock market will motivate more people to do a routine tune-up of their 401(k) plan. "There was a tremendous amount of employee apathy in the past few years," says Streiff. "That apathy still exists. But because of the rising stock market, we're starting to see a little of that apathy dissolve."

The first step is opening your 401(k) statement. Go ahead, you can do it. Stone is a senior writer at BusinessWeek Online and covers the markets as a Street Wise columnist and mutual funds in her Mutual Funds Maven column


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