by: Mary Beth Franklin
from: Kiplinger's Personal Finance Magazine
May, 1999
(The following is an excerpt, please contact us if you would like a copy of the complete article.)
Choose where to put your money
How do you choose among the various investment options inside your plan?
The top two methods, according to a study by M&I Trust, an investment-advisory
firm in Milwaukee: random guessing or simply dividing your assets evenly among all
your fund choices. Ouch.
On the bright side, participants have gotten the message about the importance of investing in stocks for long-term growth. A recent study by the Employee Benefit Research Institute (EBRI) and Investment Company Institute (ICI) found that in 1996 nearly two-thirds of 401(k) plan balances were invested in the stock market, including 44% ins stock mutual funds and 19% in company stock. Ultra-conservative guaranteed investment contracts (or GICs, which offer a set return over a specific period) held just 15% of 401(k) assets.
But as 401(k)s are offering participants more investment options, there is growing concern over whether employees are properly equipped to make those choices. In other words, for millions of harried Americans now faced with financial decisions once left to professional portfolio managers, is more necessarily better?
Roxanne Fleszar, an investment adviser in Peabody, Mass., doesn't think so. Noting that General Motors recently added 15 fund choices to its 401(k) menu for a grand total of 71 options, Fleszar says most participants won't know what to do with that many choices.
"I would rather have them offer fewer fund choices but be clear about why those funds were chosen and how they have performed against appropriate benchmarks." She adds that "lifecycle funds" - which offer a professionally managed portfolio based on an investor's time frame - and fund of funds - which invest in a collection of mutual funds geared toward an investor's risk tolerance - may be the better alternatives for many novice 401(k) investors.
It's no surprise that Robert Markman, manager of Minneapolis-based Markman MultiFunds (a series of funds of funds) agrees. He cites a survey of 877 participants in six different 401(k) plans that offered a good range of reputable mutual funds and, in two plans, a self-directed brokerage option, too. In 1997, a year in which the S&P 500 rose more than 30%, the median return of surveyed plan members was 15.4%.
"The long-term consequences of requiring an unqualified and unwilling person to act as their own chief investment officer should be obvious," Markman argues. "Simply making investor education available - or even mandatory - will no more create legions of Peter Lynches than our state education system will produce thousands of Einsteins."
But you don't have to become a Peter Lynch to succeed, nor is a fund of funds the right choice for everyone. For example, in 1997 - the year of that 30%-plus rise in the S&P 500 - none of Markman's funds broke the 20% barrier. So, what should you do?
Regardless of what's offered inside your plan, your objective is to earn a reasonable return over a long period while limiting risk. Market cycles tend to favor one type of investment - most recently large-company growth stocks - at the expense of other investments, such as small-company stocks. But cycles change, and because no one knows when that will happen, it's wise to spread your investments over several categories. "Last year's highflier may turn out to be the crash stock of 1999," warns Jim Sager, director of Pension Investment Services for the Principal Financial Group, in Des Moines.
If your 401(k) plan is your only major retirement investment, distribute your money among several funds, advises Michael Conn, chief executive officer of Investment Management Associates Inc, in Denver. But if you have investments outside the company plan, make sure your overall retirement stash reflects a good asset mix, even if it means your 401(k) plan is heavily concentrated in one or two areas.
Two-income couples should adopt a similar strategy. "You should look at the two 401(k)s as part of a whole," Conn adds, allocating your contributions to the best funds each of your plans has to offer.
Of course, you have to work within the investment options available to you. Typical plans offer about eight investments, including stock and bond mutual funds; balanced funds, which invest in both; "lifestyle" or asset allocation funds, which include a mix of investments based on your age and how much risk you are willing to take; and fixed-interest investments, such as GICs, or money-market accounts. An increasing number of plans now allow participants to "self-direct" their account by buying individual stocks and bonds.