For Those in a 401(k) Quandary, Simple Plan May Be Best

By LIZ PULLIAM WESTON

Sept. 10, 2000 12 AM PT

TIMES STAFF WRITER

If you’re baffled by your 401(k) plan, take heart. You don’t have to be an investment expert to save for your own retirement.

You can create a serviceable plan with just one or two funds. Once a year, you can review your choices, fiddle with your contributions (or not) and be done with it.

If that sounds too easy, you could be picking up the wrong messages from your 401(k) plan’s educational literature about the importance of asset allocation. Many workers are so confused about this topic that they spread their contributions equally among all the available funds (usually not good), choose to put all their money in one stock, bond or money market fund (usually not good) or fail to invest altogether (never good).

Asset allocation, simply put, is how your money is divided up among various classes of investments, such as large-company stocks, small-company stocks, international stocks, bonds and cash. Many investors have the notion (fueled by some of that company literature) that asset allocation accounts for more than 90% of an investor’s returns.

That number comes from a 1986 study done of big pension plans, not individual investors, and many financial planners today believe the 90% figure is greatly overstated. Yet you’ll continue to see it on mutual fund company Web sites.

That doesn’t mean asset allocation isn’t important. Sophisticated investors tend to want to reduce their risk by doling their money into many different investment pots. Workers with big 401(k) balances--more than about $100,000 or so--likely will benefit from branching out into more investment choices. Several Web sites, including those operated by Quicken, Morningstar and Financial Engines, offer tailored 401(k) investment advice for free or a small fee.

But if you’re just starting out, the most important thing is to get your money working for you. Simplifying your 401(k) choices may give you the confidence you need to do so.

The first thing you should know is that you’ll probably need to have most of your 401(k) money in stocks or stock mutual funds. Stocks historically have offered the kind of inflation-beating returns needed for most workers to meet their retirement goals.

Some of your money, however, probably needs to be in bonds or cash--regardless of your age. These investments will give you some respite from the stock market’s occasional swoons. Although some financial advisors insist that people in their 20s and 30s can have all their money in stocks--presuming that these workers have years to recover from a prolonged market downturn--there is still a grave risk that these all-stock investors could panic and bolt from the market should stocks crash. That can be a disaster. Because it’s hard to predict the moves of the stock market, it’s likely that those who get out of the market won’t get back in in time to enjoy the gains when stocks rebound.

Likewise, the vast majority of workers should not have all their money in bonds, cash or “guaranteed” options. Taking too little risk is as bad as taking too much, because inflation eats away at the value of these conservative investments.

Your money needs to stay in the stock market to get those long-term inflation-beating returns. Having at least some of your funds in bonds and cash--which tend to earn steadier, if smaller, returns--can cushion the shock of falling stocks, many financial planners say.

What you don’t want to do is randomly plop money into your fund’s various stock fund choices. The funds may hold many of the same stocks, which means that instead of diversifying your risk, you’re concentrating it.

What to do? Here’s the plan:

* Choose the balanced fund.

Most plans include this middle-of-the-road option, which typically has the word “balanced” in its name. Balanced funds usually invest 60% of their money in stocks and 40% in bonds. Other variations of balanced funds include “lifestyle” funds that link their stock/bond allocations to the investor’s age or years from retirement.

The key advantage of a balanced or lifestyle fund is that the asset allocation and rebalancing is done for you. You don’t have to rejigger your contributions or sell some of your winners to buy more of your losers--which is what the painful process of rebalancing typically requires--because the fund does it for you.

If you’re not sure whether your plan has a balanced fund, ask your human resources department or plan provider.

* Create your own balanced fund.

Your plan may not offer a balanced fund, or the balanced fund choice may be a poor one. (The typical balanced fund had a return of slightly better than 8% last year and about 12% the year before; if your plan’s fund trailed that by much, read further.) You also may want to take a bit more risk to get a slightly better return. Creating your own balanced fund could be the way to go.

For the stock portion of your investment, look to see if your plan offers a broad-based stock index fund--the broader, the better. Many plans offer stock index funds that mimic the Standard & Poor’s 500, an index of large-company stocks. Even better would be a stock index fund that mimics the Wilshire 5000, which includes most of the stocks traded in the market.

When you invest in index funds, you’re assured that your returns will at least “match the market”--in other words, you won’t trail too much behind the benchmark the index was created to mimic. Index funds also tend to have much lower ongoing costs than other mutual funds.

Not all plans offer index funds, however. In that case, look for the broadest-based stock fund available. You’re looking for a fund that invests mostly in large-company stocks and that includes dozens of holdings--not just a concentrated few. If you’re not sure, ask your human resources department or the plan provider. Avoid stock funds that include the word “aggressive” in their names or that seem to invest in a narrow section of the market, such as technology. Ideally, your stock fund will have come close to the returns offered by the S&P; 500, which were about 21% last year and about 29% the year before.

For the fixed-income portion of your investment, you can choose bonds or cash. Most plans have only one or two bond options; compare their returns with the category average, which was a 0.4% loss last year (a bad year for bonds) and an 8% gain the year before. Again, you want the fund that offers the broadest range of investments and preferably a fund that mimics a broad-based bond index.

Alternately, you can choose to put your money into cash or a short-term bond fund, which behaves much like cash. Cash returns in the long run tend to be lower than those of bonds, but you also don’t risk losing money.

Creating your own balanced fund requires more work than simply choosing the plan’s version, because you first have to decide how much to put in each category, and then you need to rebalance the proportions at least once a year. If you’re conservative, close to retirement or want the simplest solution, simply choose a 50-50 split of stocks and bonds (or cash). If you’re more aggressive, you might want your stock proportion to be more like 70% to 80%. If you’re in between, just choose the classic 60-40 mix.

You won’t get market-beating returns with these choices, but that’s not the point. Investors who beat the market one year may trail the market the next--sometimes badly. Your goal should be to get the best returns with the least risk possible--and the least work.

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Complex 401(k)s

401(k) plans are becoming more complex as companies offer workers more choices. A growing number of plans offer a so-called brokerage window, which typically allows investors to choose any stock or mutual fund offered by a regular brokerage.

Average number of investment options:

1993: 4.5

1999: 11

Percent offering brokerage option:

1995: Less than 1%

1999: 7%

Percent offering daily trading:

1993: 22%

1999: 86%

Percent of plans offering these options, 1999

Large-company stock funds: 78%

Equity index funds: 71%