It Takes a Strong Stomach to Get the Most Out of Your 401(k) Plan

A lot of you are cheating yourselves out of a decent retirement.

If your company has a salary set-aside plan for pensions, popularly called a 401(k), you are probably picking investments that won’t do a good job in building financial security.

The best bet for the long haul is the stock market, where mutual funds beat bonds, Treasury bills and bank certificates of deposit. But most of you don’t have the stomach for the ups and downs of the market, the soaring and crashing of the Dow Jones.

Washington policy-makers are trying to figure out ways to encourage American workers to overcome these fears and take a more aggressive approach to picking among 401(k) investment options.

Last year, the Labor Department directed employers to offer at least three choices in these retirement plans and to give participants the chance to switch among them at least four times a year.

Only now, though, are government officials recognizing that workers are adrift in a sea of confusion and hesitancy. People are so fearful of losing money--of suffering a temporary loss as the market fluctuates--that they won’t take risks that can pay off big and secure their retirement in the long run.

“We need to do everything we can to help inform and educate people about investing,” said Olena Berg, director of the Labor Department’s Pension and Welfare Benefits Administration. She is talking about pamphlets, videos and public service announcements to get out the message.

Education means telling workers that they can end up with paltry retirement assets if they pick nothing more aggressive than Treasury bills or guaranteed investment contracts, financial instruments sold by insurance companies to pension plans. GICs today offer a relatively paltry 4.5% or 5% in exchange for tying your money up for three years. Treasury bills are returning slightly more than 3%.

The stock market may be a lot more volatile, but corporate shares can be expected to produce an annual return of 10% over the long haul. And that makes stock mutual funds the best bet for most people’s retirement planning.

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The difference of a few percentage points may not look like a big deal. But as Sylvester Schieber of the Wyatt Co. benefits consulting firm points out, a dollar invested over 20 years at a 4% annual return produces $2.19, while the same dollar invested at 7% gives you $3.87.

Help from Washington to alert workers to the risks and rewards of their investments is long overdue. Do-it-yourself pensions such as 401(k) plans have virtually exploded to $1 trillion in assets last year, up from $343 billion a decade ago.

Traditional pension plans--so-called defined benefit plans--had $1.2 trillion in assets last year, up from $700 billion 10 years earlier.

These plans reward longevity. The company promises a fixed monthly pension based on years of service. It contributes the cash and hires professional managers to direct the flow of funds into stocks, bonds, real estate and other assets. If the investments don’t work out, the company comes up with extra money to pay the promised benefits.

Pensions such as 401(k)s--called defined contribution plans--shift the risk and the worry to the worker. Workers contribute a percentage of their paycheck, with the company typically matching only a portion.

Nothing is guaranteed about these pension plans. The size of the monthly retirement check depends on the success of the investments selected by each worker. And sadly, most workers aren’t carrying that burden very well.

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With workers letting their money wallow in low-risk investments, defined contribution plans commonly have rates of return two or three percentage points behind the old-style defined benefit plans.

“Most people never want to gamble with their own money,” said Robert Guarnera, president of Pension Actuaries Inc. of Armonk, N.Y.

“They tend to take too conservative an option,” he said. “And there is no employer incentive to educate the worker.”

Too many companies abdicate, giving workers an explanation of investment choices with all the clarity and readability of an advanced calculus textbook.

“We’ve created a monster with this do-it-yourself retirement,” said Karen Ferguson, director of the Pension Rights Center in Washington. She wants business, workers and Congress to take a hard look at retirement policies that shift so much risk to workers.

But the national debate could take years. Meanwhile, workers who have a 401(k) and want a decent retirement had better spend more time learning about their choices and thinking hard about the stock market--even if it sometimes resembles a roller coaster.