The 401(k) Lutz: Set It And Forget It Approach Sara Grillo, CFA, President at Grillo Investment Management
“I have no idea how much I have in my 401k, I’ll have to dig up the statement.” How can you not know how much money you have? It’s like not knowing your blood type. It’s vital. At any moment, you could be hit with an immediate need.Growing rich is exactly that: growing. The word “growing” is a verb. It is a process, an action, something that requires effort. Lack of money, job, or savings is not as big a problem as is the lack of caring or attention for the wealth process. Talk to any person who grew wealthy over time and you’ll see that she didn’t become rich by accident, and many times she didn’t get rich quickly.
If you don’t want to act to protect and guard your wealth, inevitably it will go away from you. And that happens a lot more easily than you think. There’s nothing cool or fun about being broke, by the way. It’s not like how they glorify it in the Jay-Z rap videos.
401(k): Approach to passively accumulate savings
For Generation X and Y, much savings is held in employer sponsored savings vehicles (401k, 403b). An approach of “set it and forget it”, or allowing savings to accumulate passively without paying close attention, has more serious implications than most people realize. Here’s why.
We wrote about Ben Graham's activism at northern pipe line, but there are other interesting stories involving the father of value investing Value investing and activism go hand-in-hand. Benjamin Graham, the godfather of value investing, discovered how important it is to incorporate activism into a value strategy relatively early in his career, a strategy that Read More
You may be Auto-Enrolled. Many employees are not aware that employers will automatically deduct a certain amount of your pay and invest it. You should be notified in writing of this, and given the option to either opt out or choose your own elections. Many times the default option is a Lifestyle fund chosen based on your age. You can opt out if you don’t want to be enrolled, or make changes to the investment elections or the contribution percentage.
Old plans are likely still charging you fees. Even if you don’t work there anymore, the company is likely deducting small fees for recordkeeping, legal expenses, etc. Small charges can add up over time. If you’ve got a 403(b) or 401(k) plan at a past employer, it might make sense to consider rolling it over into a qualified account such as an IRA. You may wish to consult a tax advisor for help with this process.
Junk Food Menu. Here’s a false assumption that most people make. Company plans are not necessarily provided to you for free, out of the goodness of your company’s heart. In other words, don’t assume that the fund options on the platform are the best possible investments for you. I’ve seen some real junk food out there.
Companies do not provide 401k or 403b plans because they care about you; they do it because they care about themselves. They can not afford not to offer a 401k plan because it would reduce their ability to attract the highest quality employees to work at their company. It’s a marketing tool that the company uses to be on par with their competitors.
The menu may not work for you. Those funds are not necessarily the best available in the world; they are the most popular with the HR department or CFO. Sometimes the fund is chosen on the basis of being on the “preferred list” of a consultant who recommended it to the company. Sometimes they are chosen due to solid past performance rather than future potential. It’s not as bulletproof a process as you would think. You can always take that money and invest it on your own, or with the help of a financial advisor.
Watch out for Lifestyle Funds. In recent years, “Lifestyle Funds” have become popular. These funds compose an asset allocation (combination of stocks, bonds, and cash) that is suitable for individuals who plan to retire in a certain year. The mix changes as you approach retirement. Let’s use a hypothetical example. Pretend that the Brokerage XYZ 2042 Retirement Fund is an asset allocation fund for people who plan to retire in 30 years. It should contain mostly equities and possibly some bonds. In contrast, Brokerage XYZ 2015 Retirement Fund would be for people on the verge of retiring, so it would be more conservative, investing heavily in bonds and cash.
Such funds have become the default option in many employer plans. In a sense, they allow people to invest passively. You don’t have to make decisions; the fund adjusts as time passes. It seems easy but there’s a lot more going on here than meets the eye. Firstly, many such funds contain a high amount of cash. You’re paying fees to hold cash; you could do that on your own for free. Secondly, many of these funds invest in other mutual funds. That means that there’s an additional layer of management fees that is charged by the second tier of funds. Thirdly, it’s a flawed premise to assume that your willingness to take risk is determined by your age.
Investment Options tend to be Repetitive. Be sure to conduct through research on all options; don’t just invest the same percentage in each one without drilling down to the holdings level. Many of the fund options are managed in a similar way, and even hold the same stocks.
Actively Managed Investment Options Tend to Have Higher Fees. The majority of investment options in an employer plan tend to be actively managed mutual funds. Mutual funds commonly carry higher management fees than index funds because they are actively, as opposed to passively, managed.
Look Out for Overlap. A common mistake that people make is neglecting to view their plan balances in relation to other investments. For example, if you own a house, it might double up on risk to invest your whole 401(k) in certain real estate funds. Or, if you work in biotechnology and your portfolio contains mostly biotech stocks. At least once a year, conduct a thorough financial analysis that combines all IRA or individual brokerage accounts with your employer plans. Examine your holdings for overlap and sector/industry concentrations. You may wish to consult a financial advisor, as this process can be quite involved.
Employer sponsored plans are powerful vehicles that can substantially impact your wealthy. A small amount of your paycheck compounded over time can grow quite large – but don’t fall asleep at the wheel or you’ll end up a 401(k)lutz..