As 401(k)s Come Off Their First Losing Year, It's a Good Time for a Checkup


If your 401(k) account balance has shrunk along with the stock market, you're not alone.

Assets in 401(k)s fell last year for the first time since the creation of the popular retirement plan 20 years ago, with the average account declining $4,821 to $41,919, according to a recent survey by consulting firm Cerulli Associates in Boston.

Cerulli blames the drop largely on last year's stock market plunge. Still, the decline may be a good reminder to employees to review accounts to see whether their investment decisions or level of contribution also could be hurting returns or putting them off track for retirement.

"Mistakes are inevitable," said Mike Rose, director of retirement planning for Lord, Abbett & Co., a Jersey City, N.J., money manager. "What you are doing in many cases is taking people who have never made an investment decision and you're setting up an investment account for them to begin saving and investing for their retirement with really very little guidance."

Among the missteps to watch for:

* Too conservative. Young workers, in particular, choose investments that are too conservative, such as money market funds, given that the account won't be tapped for 35 or 40 years, said Larry Beltramo, a financial planner and owner of Regency Securities in Irvine.

The more years until retirement, the more money workers should put in stocks, which over decades provide the best return, experts said.

* Too aggressive. This often happens with older workers who are near retirement but still have the aggressive portfolio of a 25-year-old.

"They are just about to retire, and they still have it all in the market when the market is dropping," Beltramo said.

As retirement looms, experts suggest shifting some money into conservative investments, although older investors still will need stocks to keep their portfolio growing for a retirement that may last 30 or more years.

* Lack of diversification. The typical 401(k) has 10 to 12 investment options, but workers generally invest in only two to four of them, experts say.

Diversifying a 401(k) portfolio by spreading money among, say, six to eight investment options will lessen the chance that the entire account will be dragged down by one laggard, experts said.

Diversifying, too, is more than just choosing between stocks and bonds. A diversified stock portfolio, for instance, would contain domestic and international, value and growth, and large-, small- and midcap stocks, experts said.

* Too much company stock. This is an easy trap to fall into. "Many times the company is matching with company stock, and the employee is buying company stock as well," said Michael Scarborough, president of Scarborough Group in Annapolis, Md.

The result: A large chunk of workers' 401(k) assets is tied to one company, which already is the source of their paycheck, health insurance and pension, he said.

Some say company stock should not make up more than 5% of a worker's 401(k) portfolio; others go as high as 15%.

Scarborough advises against owning employer stock. The risk, of course, is not getting in on the ground floor of the next Microsoft, whose stock made millionaires of its workers.

"Then they have a situation like Lucent, where the stock falls 90%," Scarborough said. "And people wonder why their portfolios are not doing well." In the last year, Lucent Technologies' stock traded as high as $61.44 per share and as low as $5.04.

* Not seeing the big picture. When selecting investments, workers need to consider the 401(k)'s role in light of their outside investments and potential sources of retirement income, experts said.

For example, workers may be able to invest more heavily in stocks in their 401(k) because they will receive Social Security and a pension that will help fill the role of bonds or other fixed-income investments, said Michael Falk, an investment expert with ProManage Inc. in Chicago, which manages 401(k) accounts for workers.

* Failure to rebalance. After workers decide how to allocate their contributions among the 401(k) investments, they often don't make changes for years, experts say. But an initial asset allocation of, say, 80% stocks and 20% bonds could quickly turn to 95% stocks in a bull market, giving the worker too great an exposure to stocks.

Experts advise that workers annually rebalance portfolios, basically moving money among the investments until they are back to the desired asset allocation.

"It forces people to buy low and sell high. You buy what underperforms and sell what's outperformed," said Wayne Gates, general director of the Investment Pension Group for John Hancock Life Insurance Co. in Boston.

* Great expectations. According to a John Hancock survey this year, 60% of workers say they know what returns to expect from investments. Many were too optimistic. "The people most optimistic considered themselves the most knowledgeable," Gates said.

These workers expected the average annual return over the next 20 years to be 19.3% for stocks, 12.9% for bonds and 12% for money market funds. Reality: The historic annual returns are 11% for stocks, 5.7% for bonds and 3.8% for money market funds.

The danger, Gates warned, is that inflated expectations of returns may cause workers not to contribute enough to retirement plans.

* Not contributing enough. On average, a 401(k) participant puts 7% of pay into the plan and the employer provides a 3% match, said David Wray, president of the Profit Sharing/401(k) Council of America in Chicago.

"The problem is for people who start saving in their 40s, which a lot of baby boomers have done; 10% is probably not going to be enough," he said.

Worse yet, the weak market is affecting contributions.

"I'm starting to see people who are starting to cut back on contributions to their plan because they lost money last year," Scarborough said. Workers who have been putting, say, 10% of pay in the account have scaled back to 6%, just enough to get the full employer match, he said.

* Loans. Most 401(k) plans allow workers to borrow from their accounts, but experts recommend against loans because that means the money is no longer invested for retirement.

Plus, if workers lose their jobs, they may have to repay the loan immediately. If they don't have the money, the loan would be considered a distribution, and workers would have to pay a penalty and income taxes on the withdrawal.

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